by

John Jones
jones_john@bah.com

Bruce Pasternack
pasternack_bruce@bah.com

Harry Quarls
quarls_harry@bah.com

Andy Steinhubl
steinhubl_andrew@bah.com

Electric Utilities
A New Operating Model
 1

Electric Utilities
A New Operating Model

The progressive liberalization of the electric utility
industry has inspired energy companies to seek
new strategic positions on the value chain of power.
Traditionally an industry of vertically integrated
companies, the boundaries of which were defined by
geography and historical accident, the utility sector
has undergone a fundamental and comprehensive
restructuring in recent years. Regulatory mandate
and market discipline have driven the development
of intermediate, wholesale markets and new pure
play business models in transmission, generation
(gas, nuclear), trading, and retail services. The market,
recognizing that each of these niches offers distinc-
tive growth and risk characteristics, has generally
applauded this trend. Indeed, as recently as a year
ago, it appeared that the single most important
capital, intangible assets, and energy pure plays.
In fact, investors appear reluctant to bet on any partic-
ular strategic posture these days. As a result, average
valuations assigned to different plays on the utility
value chain have converged, while, at the same time,
valuations within particular strategic niches have
spread (see Exhibit 1). The question, What strategic
position should we occupy in the energy value chain?
is less important today than the question, How do
we create value from the position we do occupy?
Exhibit 1
Competitive Differentiation Is Increasingly a Matter of Execution,
Not Strategy
December 2000 December 2001
Generation
33
Companies
9

driver of an energy companys market valuation was

the strategic position it elected to occupy on the
Wires 12
industrys value chain. But that was a year ago. Companies
14

Since then, the ground has shifted, and many of the Integrated
13 11
Companies
assumptions underlying energy companies strong valu-
ations have been shaken. The industry lost $90 billion
in market value in 2001, and continues to hemorrhage P/E Ratio
0 40 0 40

in 2002. Falling energy prices, looming overcapacity, P/E spread between strategies P/E spread within any strategy
Mean P/E
and a crisis of confidence have cast a pall over mer- is greater than the spread
within any strategy.
is greater than the spread
between strategies
chant energy companies and generators. The California
One standard
energy crunch and the Enron debacle have stymied the deviation
progress of deregulation. And investors have stepped
back from their lofty endorsements of intellectual Source: Booz Allen Hamilton
2

Exhibit 2
Translating Strategy Into Effective Organization

Strategic Imperatives Behavioral Imperatives Organizational Imperatives

STRATEGY What must the firm do well How must individuals behave, What kind of environment ORGANIZATION
to be advantaged relative act, or make tradeoffs to must the organization provide
to our competitors? succeed at our strategic to promote those behaviors?
imperatives?

and creates a customized

The process begins translates that strategy into
organization based on the
with the strategy what the design must accomplish
particular company and situation.

Source: Booz Allen Hamilton

As the spotlight moves from a companys broad strate- In moving through this three-step process, most utili-
gic positioning to its specific performance potential, ties have directly addressed the question of strategy.
issues of organizational design and management They have unbundled and rebundled, consolidated and
rise to the fore. To be effective, strategy must be globalized. All too often, however, companies have
translated into behavior and ultimately institutionalized failed to move beyond that strategy, to the questions of
and operationalized through the organization (see how they will execute it, and how their internal organi-
Exhibit 2). zation will enable that execution (see Exhibit 3).

Exhibit 3
Utilities Have Failed to Harness Value From Strategic Positioning

Vertical Pure Play Type Horizontal Repositioning Has Value Creation from M&A Has
Repositionings Have Not Resulted in Yielded Unimpressive Results Proved to be Elusive for Many
Superior and Sustainable Valuations
P/E Ratios of Different Share of Non-Regulated Revenues Mergers Announced
Utility Business Models Versus Total Shareholder Return (TSR) 19971999

Distribution Companies
Integrated Utilities
Utilities Average Share Performance

40%
Since Announcement to 5/31/01

Energy Merchants
35 300%
Power Generators
20%
Total Shareholder Revenue 19982000

30 250%
0%
R2 = 0.01
25 200%
-20%
20 150%
-40%
15 100%

10 50%
WE G CM r
CW P
PG EP C R
NiS AR B SC CPL VV
ou ost ANA FPC
SC om C
Ce Dom olum d
Exe an ior a
Un G LI G
m O
Ave CO
e
SE e

rag
ysn in bi
OC mE
A ICO

NIP Ed C PSN

lon BU CN
ico LC
NY Pow

PE
ast da

N
y E eva

5 0%
erg N
En acific

02/01 08/01 02/02 20% 40% 60% 80% 100%

ce
P
rra

-50%
NS
Sie

% Non-Regulated Revenues
(19982000)

Source: Booz Allen Hamilton


During the course of our work with clients in the energy
sector, we repeatedly hear the same execution complaints:
Performance Anxiety: The organization just isnt
performing, and we are not getting results.
Get With the New Plan: Our strategy has changed
and, as a result, we need to overhaul how we structure
and manage the business.
Merger Migraines: The success of our merger(s)
is hampered by our inability to integrate organizations
and deliver on expectations.
Crippling Costs: My cost centers are bloated and
adding questionable value.
To a greater or lesser extent, all of these concerns apply
to utilitiesas they do to the automotive, aerospace, or
pharmaceutical industries. The question every executive
wants to answer is how do you overcome these hurdles
and develop a new operating model for success?
The purpose of this article is to introduce the elements
of a New Operating Model for electric utilities, one
that not only enables strategy but also unleashes long-
lived competitive advantage. By operating model,
we refer to the full gamut of organizational levers from
structure, to measures, to incentives, to processes,
and responsibilities.
Is a company able to respond quickly and effectively
to market signals? Does it have mechanisms that con-
tinually promote internal efficiency? Is it capturing all
potential economies of scale and scope? Does it fully
capitalize on outsourcing opportunities, while develop-
ing strong internal capabilities of strategic value? Are
the companys institutional functions and accountabili-
ties aligned in a manner consistent with its external
value propositions? These are the questions the New
Operating Model is designed to address. While organi-
zational configurations will continue to differ across
utilities, the basic elements of the New Operating
Model are consistent and enduring.
3
The New Operating Model
This new operating model can best be understood as
the application of five key operating principles to five
different organizational building blocks (see Exhibit 4,
on following page):
1. Profit Centers
2. Shared Services
3. Corporate Center
4. Alliances
5. Connective Rules & Tools
The five key operating principles that shape and guide
the conduct of these five organizational building blocks
collectively constitute a philosophy that is focused on
value creation throughout the organization.
Align organization with strategy: An ancient prescrip-
tion, but always challenging. To align your organization
with your strategy, you first need a clear understand-
ing of what that strategy actually is. What are the
key value propositions and the critical markets? What
capabilities and positioning are needed to provide
competitive advantage with respect to these value
propositions? Then you must carefully assess how
well the organizations design supports this strategy.
Do the right people day-by-day have the right informa-
tion, the right motivation, and the right authority to
make critical decisions on a timely basis?
Use market-like mechanisms to allocate scarce
resources: The organizations primary function is
to marshal and deploy resources in order to create
value. It makes sense that the organization would
seek out or simulate the efficiency of market
mechanisms in fulfilling that function. Even his-
torically stodgy utilities are now reforming their
procedures of resource allocation and internal service
delivery, and moving toward market-based shared
services organizations and outsourcing. Subjected
to internal market discipline, support services are
becoming more efficient, more competitive, and
more responsive to user needs.
Co-locate decision rights and information: Decision-
makers whether in the corporate center or on the
plant floor need ready access to the enterprises
best information. Sometimes this means delegating
decision authority to those in the organization who are
4

Exhibit 4:
New Operating Model Building Blocks

Small executive leadership team to determine vision,

strategy, goals, and broad resource allocation,
plus lean corporate staff for governance, compliance,
and selective expertise

Example functions: Strategic Planning, Risk Management,
Investor Relations, Acquisitions

Corporate Center

Connective rules
Profit Centers Alliances
and tools

Primary profit capture points,
responsible for strategy,
value creation, and
customer relationships
Examples: Generation, T&D,
Trading, Retail Services
Mechanisms to coordinate activity and resolve conflict across organization Outside suppliers, service
Examples: Peformance Measures, Management Processes, Incentives providers, and venture partners
Examples: IT outsourcers,
contract call centers, B2B
procurement exchanges
Shared Services

Administrative service organizations

that support profit centers,
cost centers, and the corporate center
Examples: HR, Finance, Information
Systems, General Services

Source: Booz Allen Hamilton

closest to the information, and sometimes it means
moving information closer to those with the decision
rights and authority. Regardless, the scope of organi-
zational design choices available to an enterprise will
depend critically on the flexibility and scope of its
information systems (see sidebar).
Address the whole rather than tinkering with the
parts: Organizations are complex and dynamic entities
with multiple interactions, handoffs, and feedback
loops between and among business units, corporate
headquarters, support services and external
partners. Like any ecological system, an existing
organization reflects myriad accommodations and
adaptations. Changes made to any single element
of that ecology will have far-reaching and often
unintended consequences. For this reason, discrete
projects designed to fix seemingly isolated issues
often create more problems than they solve. Truly
effective and lasting organizational improvement
invariably requires a system-wide perspective.
Strive for transparent decision-making: Enterprises that
aim for market efficiency, that rely on explicit sharing of
 5

Information Technology

Technology is critical to the effectiveness of the new operating model for utilities. It is the primary source of
business process automation and cost management in an industry where the value potential of substituting
technology for labor is far from exhausted. It is the desired transaction medium of high margin customer
segments and the foundation for emerging customer-focused, non-asset-based businesses such as retail
and wholesale marketing.

Energy companies typically spend 30 to 40 percent of their administrative budget on I/T and rely heavily on
these services. Over the past several years (including Y2K), utilities have invested large sums in systems
renewal and consolidation to ensure scaleable, reliable, secure, and cost effective service. The benefits of
standardization and streamlining have been largely achieved and costs have come down.

Now, utilities need to tailor their I/T to the different requirements and capabilities of their increasingly broad
and diverse array of services. Commodity businesses such as gas delivery require simple, low cost service.
Trading functions need highly reliable, secure, high-end technologies. Remote sites in distant geographies are
much more difficult to service than corporate campus environments. Exhibit 5, below, highlights the dramatic
differences in I/T cost-to-serve among various profit centers.

Exhibit 5:
I/T Cost-to-Serve Differs Widely Among Energy Profit Centers

ILLUSTRATIVE Desktop TCO Cost-To-Serve By Segment

(Per Seat) Company Average is greater
$8,000 than the Industry Average...
... however the company has a large
population of remote and Mobile users
$7,000 $6,865 Cost difference between company
$364
and industry is explained by difference
$488 in employee mix
$6,000
$5,308
$142
$5,000 $488 $5,000
$4,168 $4,340
$142
$2,511
$142 $3,933
$4,000 $488 $4,000 $168
$488 $1,578
$3,289 $3,292 $3,292 $3,289 $488
$142 $142 $142 $144
$3,000 $3,000
$488 $488 $488 $488
$2,074 $2,074 $1,844
$2,000 $2,000
$1,578 $1,578 $3,502 $1,578 $3,100 $1,500

$1,000 $1,000
$1,081 $1,464 $1,638 $1,081 $1,081 $1,100 $1,433
$0 $0
General Power Users Traders Execs Remote Plants Mobile Industry Company
Average Average
Labor Hardware & Maintenance Software Other

Source: Booz Allen Hamilton research on segment cost drivers in utilities

Clients tell us that their information technology function is too removed from these unique business unit
requirements. Standardized or a-few-sizes-fit-all systems cannot meet the collective needs of utilities new
operating models. Yet, companies cannot afford expensive, dedicated resources and services. In our experi-
ence, shared services management and pricing disciplines need to evolve quickly to deal with this dilemma
both in the infrastructure and business application arena. Moreover, I/T needs to augment its current
account management functions with real customer relationship capabilities such as customer segmentation
and service delivery optimization.
6

information, and that strive to balance autonomy and
coordination can ill afford opaque and insular decision
and information flows. The only way to deliver signifi-
cant and sustainable economic value is to render
decision-making, indeed the organization itself, as trans-
parent as possible. Transparency expedites the flow of
information and allows an organization to assess the
full economic impact of decisions made throughout the
company both the revenue and cost implications,
including consequent costs borne by other parts of the
organization. It imposes a healthy discipline on decision-
makers: the discipline of having an informed audience.
Meanwhile, many power companies are distilling their
corporate focus, drawing sharper distinctions around
what markets they will and will not pursue. Many play-
ers are streamlining their corporate center, stripping
out inefficient overhead and refocusing headquarters
staff on overall governance and strategy. Newly lean
corporate centers ensure the optimal transfer of
capital, talent, and ideas across the profit center units.
Meanwhile, the profit centers themselves are increasingly
focused on prosecuting discrete market opportunities
across borders, rather than being defined and limited
by geography.

With these operating principles in mind, lets consider
the issues that each building block presents to the
overall challenge of building an effective organization.
Building the New Operating ModelBlock by Block
In the utility sector, each of the building blocks of the
New Operating Model is changing shape as the market
forces transforming the industry penetrate the organi-
zations operating within it. As concepts like service
contestability and market-based pricing take root,
the primary means of allocating resources and talent
within gas and power companies is shifting from com-
mand and control to contract and cajole. The
growing reliance on shared services (e.g., basic admin-
istrative and technical support functions) bears
witness to this trend, as does the adoption of asset
management models for operating and servicing key
assets such as the transmission and distribution
network or generation units. Some companies are even
looking outside traditional organizational boundaries
to business process outsourcers for complex types of
administrative and technical services, beyond back
office functions.
Starting with these building blocks and a set of strate-
gic objectives, a utility can begin to design and/or
optimize its operating model. Lets evaluate each build-
ing block in turn from a utility perspective.
Profit Centers
The profit center is the front line of a companys busi-
ness strategy, the place where the companys output
meets the market and succeeds or fails in creating
economic value. Traditionally the only profit center in
an energy utility has been the utility itself. Every function
from generation through transmission and distribution
(T&D) to customer care has been integrated and
housed within a single organizational unit. P&L respon-
sibility has never extended below the level of the CEO
or COO; other executives merely managed costs.
In response to the new perceived market opportunities
ushered in by deregulation, however, profit centers
have taken root at levels below the C-suite. This
devolution of industry decision-making authority and
the concomitant evolution of focused profit centers
has been the most salient outcome of recent industry
restructuring. Even energy companies that continue to
regard themselves as integrated nonetheless oper-
ate today through multiple, market-facing profit centers.

Where and how the boundaries are drawn between

profit centers will depend on how a utility chooses to
match its capabilities with various market opportuni-
ties. In the first round of industry restructuring, many
utilities formed profit centers around strategic posi-
tions on the energy value chain for the reasons
depicted in Exhibit 6. In the months to come, a new
view of market dynamics may well take hold, prompting
a redrawing of utility profit center boundaries.
 7

Whatever strategic market insight energy companies Do profit centers have access to the most cost-effective
ultimately organize around, the principles of the resource options? Not every resource required to deliver
New Operating Model still challenge the profit center value needs to be housed within the profit center.
to respond to that insight effectively, by posing However, the profit center should have substantial
several questions: discretion to decide what resources it will draw on,
and from where. If it surrenders administrative
Are each profit centers boundaries aligned with corpo-
resources to a common corporate pool of shared
rate strategy? The challenge is both to include within
services, for example, it should be assured, in return,
those boundaries what is needed and to exclude what
an economic benefit in the form of more efficient or
is not. The resources the profit centers command, the
superior support services. When resources are avail-
capabilities they offer, and the markets they address
able both within and outside the organization, profit
need to cohere around a set of enterprise-level value
centers should have substantial leeway in choosing the
propositions. At the same time, profit centers need
source that will optimize their operating performance.
to be distinct and differentiable; their P&Ls should fur-
nish a reasonably accurate picture of their economic Do profit centers have the information and the
contribution and specific competitive advantages. decision authority needed to make optimizing choices?
Are both the delivery and the retail business units
Whether generation and trading, for instance, properly
aware of the total value of a particular customer
constitute one natural profit center or two depends on
or customer segment? When the retail unit offers dis-
the companys strategic positioning in the wholesale
tributed generation to industrial customers, does it
market. A generation portfolio whose competitive advan-
appreciate the impact on the distribution or genera-
tage resides in efficient baseload production might
tion profit centers? Does the generation profit center
exist in a separate profit center from trading. A portfo-
have ready access to insights gleaned on the trading
lio whose competitive advantage resides in flexible
floor, and vice versa? With regard to shared services,
peak production at critical market choke points, on the
do profit centers know what the true cost impact will
other hand, might coordinate so closely with the trading
be of the choices they make? Are they empowered to
floor that together they constitute an integrated eco-
act on that information? Regulation may limit informa-
nomic activity and, hence, a single profit center.
tion sharing among profit centers, but within those

Exhibit 6
Utilities Have Built Profit Centers Around Value Chain Positions

Value Chain Wires

Centric Generation Trading (Transmission & Retail
Business Units Distribution)

Sources Location Sufficient scale Strong asset management Brand

of Rent Innovative fuel contracts Broad scope Business process optimization Scale
Operational excellence Superior operational excellence Operating efficiency Product leadership

Operating flexibility that permits Advantaged information Optimized reliability Broad portfolio of

capture of peak prices or analysis service offerings

Timing of major investments, Proprietary operating models

plant retirements, and

asset sale decisions

Value Availability Price realization O&M and CapEx efficiency Margin per customer
Levers Thermal efficiency Volatility Procurement leverage Churn and acquisition costs
Fuel cost efficiency Deal flow Optimized reliability CRM efficiency

O&M and CapEx efficiency Processing costs Receivables management

Procurement leverage

Source: Booz Allen Hamilton

8

constraints, do the corporations information systems Shared Services provide energy companies with signifi-
and processes ensure that the best available informa- cant opportunities to reduce cost and hone business
tion is accessible to those who need it? unit focus. However, these benefits have eluded many
utilities that have implemented shared services models
Do the profit centers interact with each other and
recently. Energy companies have spent too much
with other organizational units in a mutually reinforc-
energy on the legal and regulatory issues that attend
ing way? Many of the points noted above emphasize
setting up a separate support services operation and
the autonomy of profit centers, but they are also
not enough on capturing the economic benefits. In
interdependent parts of a whole. A corporation is a
fact, many utilities misuse the term shared services
complex system, and decisions in one area often
to refer to centralized and fully insulated staff support
have effects in others. Incentive bonuses paid to
functions rather than independent, market-focused,
traders, for example, may demoralize employees work-
accountable service providers. Shared Services is
ing elsewhere in the company. A decision by T&D
not just a new name for cost center. Anything but.
to use a different telephone carrier may result in
increased costs for all other business units. The When a company chooses to organize around shared
organization needs be configured in such a way that services, it consolidates support services from head-
these tradeoffs and externalities are explicit and quarters and business units into a single organization.
transparent; only then can a suitably comprehensive Rather than functioning as an arm of the central hierar-
perspective be applied to decision-making. chy with costs allocated to the rest of the organization,
this new shared services organization sits down and
Do other units within the company understand why
collaboratively plans requirements and pricing with its
profit centers make the particular decisions they do?
internal business unit customers. The fundamental
The profit centers are the lifeblood of the corporation.
principles of shared services noted in Exhibit 7 impose
All other units exist to help them prosper. To perform
market-like discipline (and incentives) on the provision
that role effectively, those other units need to under-
of internal support services, inspiring quality improve-
stand what the profit centers need and how they
ment in the services provided, while limiting the services
succeed. Transparent mechanisms for understanding
provided to those that the user is willing and able to
support requirements, for reviewing regulatory needs,
pay for. The service providers become not only vendors
for assessing investment requirements, and for shar-
to the internal customers, but also expert advisers
ing performance results are critical to making the new
on what services may be available inside or outside
energy corporation with its multiple profit centers,
the company, what services may best suit the business
as effective and efficient as it can be.
needs of the customer, and whether they should be
sourced internally or externally.
Shared Services
As competition increases, shared services organiza-
tions (SSO) are playing a greater role in helping utilities
wrestle with the changes in their markets. At a mini-
mum, gas and power companies are complying with
state commission regulations as well as SEC rules
that require utilities to organize a separate legal entity
for overhead support services and to follow specific
guidelines regarding pricing services and invoicing cus-
tomers. In response to these mandates, many utilities
have established shared services as an independent
legal entity charged with providing support services to
their newly separated regulated and non-regulated
business units.
 9

Exhibit 7
Shared Services Principles Rest on Market-Like Mechanisms

Shared Services Principles

Price Transparency Each service has its price. The business unit determines how much, if any, it wants at that price.

Business Management The service is managed as a business, not a fixed overhead. It exists to serve internal customers.

Market Responsiveness Service levels are determined by what the users want, not by what support staff thinks they need.

Best Practices Proliferation Internal and external best practices are continually identified and, if appropriate, incorporated.

User Governance Users have the dominant voice in setting standards and processes for commercial interaction.

Service Culture Support services exist to serve the business needs of the users, proactively as well as reactively.

Source: Booz Allen Hamilton

Again, the key principles of the New Operating Model What is the effect of market-like mechanisms on
challenge utility organizations with a series of questions: shared services? As energy utilities well know, there is
a world of difference between serving a captive client
Is the shared services organization aligned with
and serving a client with real choice. Those shared
corporate strategy? There are two primary factors
services organizations that have submitted to the rig-
to consider in this assessment.
ors of competing for internal customers with outside
Appropriate skills: An energy companys unique
suppliers have almost invariably become more effi-
strategic objectives will dictate what support skills
cient and more focused. Savings of 20 to 30 percent
are required and in what quantities. A company that
in services are typically attainable (see Exhibit 8).
aims to provide low-cost gas delivery will prioritize
Equally important, the commercial give-and-take of
its shared services requirements differently than
service provider and consumer, combined with the
one focused on providing tailored energy solutions,
external benchmarking and internal cost transparency
or aggressively trading its portfolio. Shared services
that characterize shared services planning, provide
organizations need to either furnish the skills
a solid, organic foundation for outsourcing and supply
appropriate to the particular strategy or be adept
chain management initiatives. While commercial
in accessing them externally.
discipline keeps shared service providers in line, it
Appropriate alignment: To properly align shared serv-
also tempers the extravagant demands of internal
ices with corporate strategy, utilities must establish
customers. No longer a free good, shared services
a trade-off between two legitimate sets of claims.
now offer products with costs and benefits.
On the one hand are the claims of general expertise
Corporate and profit center customers make trade-
and scale efficiency that argue for consolidation.
offs accordingly, with an explicit appreciation for the
On the other hand are the claims of highly specialized
true economic impact of their choices.
expertise and of functional intimacy that argue for
distributed services. The answer is rarely clear cut.
Even with a particular profit center trading, for
example an organization may need shared support
for its desktop computers, while it requires special-
ized, dedicated support for the maintenance of
its trading algorithms. The question is whether, at
a particular time for a particular strategic purpose,
the shared services organization has struck an
appropriate balance.
10

Exhibit 8
Shared Services Drive Hard and Soft Savings for Utilities

Shared Services Drives Significant One-Time Reductions in A&G Expense Shared Services Ensures Savings Sustainability

Factor Costs Benchmarking

Market Competitiveness
0% 8% 30% Market pricing

or higher levels of BU coordination

Requires more strategic decisions

(Off-Shore Centers)
Demand
Key Levers of Support Services Cost Reduction

Management
0% 3% 25%

Automation
5% 12% 18%
Major Service Service contracts
Standardization Delivery Improvements Innovation in
and Scale service offerings
3% 8% 12%
Broader array of
service offerings
Work Practices Customer aligned
Total Range of Opportunity

3% 4% 5% incentives

Typically captured in earlier

phases of Shared Services
Booz Allen Experience
Delayering & Skill of What's Typically Achieved
Mix Reallocation
2% 3% 5%
New Value-Added Scaleable
Capabilities
infrastructure
Total Impact Increased ability
15% 20% 50%
to plug and play
0% 5% 10% 15% 20% 25% 30% 50%
Best Practice
capture
Impact On Overhead Cost Reduction

Source: Booz Allen Hamilton

Does the shared services organization provide its shared services are healthy up to a point. They
internal customers full information on costs, benefits, need to be tempered, however, by three considerations.
and alternatives? If internal customers are asked to 1.Stewardship. Some support functions are non-
choose on economic grounds what and how much of negotiable. They are vital to effective corporate
a service they want, they need to know the true costs stewardship and cannot be fully appreciated at the
and consequences of those decisions. Allocated over- level of an individual business unit. Of particular rele-
head costs that simply pop up elsewhere when unit vance to energy companies, for example, are regulatory
consumption declines distort the price signals that affairs and risk management. Clearly such functions
business unit customers need. Inadequate knowledge need to be responsive to the needs of the profit
of the internal or external alternatives to a particular centers, but the judgment of the profit centers cannot
service offering yields inefficient choices. While no be taken as the full measure of their value.
mechanism is perfect, the key to a shared services 2.Incubation. Some support capabilities may need to
organizations value proposition is its role in fostering be nurtured as a matter of corporate strategy, even
though they may not yet be cost-competitive with
dialogues and information exchanges that support
outside offerings. Proprietary information technology
informed choice.
is an example.
Do the rules of engagement between shared services 3.Smooth Transition. Abruptly introducing strict market
and internal customers take proper account of enter- mechanisms into a corporate culture built around
prise as well as business unit interests? For all the command and control systems and structures can
reasons above, the market-like mechanisms utilized by be disruptive and counterproductive. If utilities intro-

duce market rigor too quickly, the result may well be
inaccurate pricing comparisons, imperfect informa-
tion, short-sighted decisions, and needless acrimony.
Instead, they should develop a thoughtful transition
plan that reflects a balanced view of the corporations
needs and its readiness for new approaches.
Is it clear what drives shared services costs and
service levels? Sending accurate internal price signals
is challenging. It requires a more refined understanding
of cost drivers than most internal service providers
possess; in particular it calls for a reasonably clear
picture of the fixed, semi-fixed, and variable components
of ones cost structure, and how those categories
shift under different circumstances. It also requires
an ability to distill that complex picture into its simplest
elements to permit an effective dialogue between
shared service providers and users. Finally, it requires
some shared understanding of how stranded costs
will be assigned when a user shifts priorities. There
Client Case Study: Transforming AEPs Shared Services
AEP is a multinational energy company with a bal-
anced portfolio of energy assets. AEP is the United
States largest generator of electricity. AEP is also
one of the largest electric utilities in the United
States, with almost 5 million customers linked to
its wires in Arkansas, Indiana, Kentucky, Louisiana,
Michigan, Ohio, Oklahoma, Tennessee, Texas,
Virginia, and West Virginia. With 22,000 employ-
ees, AEP generated revenues of $61 billion and a
net income of $1 billion in fiscal year 2001.
In 2000, AEP set up a shared services organization
to furnish its operating companies with general and
administrative services (e.g., I/T, HR, Real Estate,
Procurement, Telecommunications). Responding to
market changes, AEP restructured these operating
companies, creating discrete business units (i.e.,
profit centers.) As a result, the shared services
group came under intense scrutiny. In making the
11
is probably no perfect solution to this dilemma, but to
the extent that providers and users aim toward
mutual price clarity in their ongoing dialogue, the
company will move toward increasingly rational and
focused resource decisions.
Corporate Center, Alliances, and the
Connective Tissue
The foregoing discussion provides insight on how
the New Operating Model themes apply to utility profit
centers and shared services organizations. For the
remaining three building blocks, some particular issues
bear mentioning.
The key question the corporate center needs to
address is an existential one. What value does it add?
As energy companies delegate issues of business
strategy to their profit centers and centralized support
activities to shared services, what remains of the cor-
porate center is typically a significantly stripped-down
set of functions that revolve around strategic leader-
transition to the new structure, the shared services
organization took up the challenge by the business
units to compare its service offerings with the
marketplace in terms of quality, price, and respon-
siveness. If this challenge could not be met, the
alternative was for the business units to potentially
outsource or self-perform these same services.
To resolve these issues systematically and consis-
tently, the shared services leadership team assembled
seven transformation teams. The mandate: Put
yourself in your customers shoes and define a
higher level of performance. The teams quickly
concluded that critical customer alignment mecha-
nisms were needed at all levels in the organization.
In response, AEP shared services, together with
its business unit customers, embarked on a four-
pronged alignment strategy (see Exhibit 9).
(Case Study continues on following page)
12

Client Case Study: Transforming AEPs Shared Services (continued)

Exhibit 9
Alignment Strategy
SHARED SERVICES (SS) STRATEGIC IMPERATIVES CLIENTS (BUs)

1 Implement Workable Rules and Processes to Achieve Stronger

Policy

Office Of The Chair

SS Strategic Alignment with Customers BU
EVP EVPs
Policies and rules Feedback
2 Overhaul Service Offering and Pricing Frameworks to
SS Improve Customers Ability to Run Their Businesses
Strategy

BU Line
Functional SVPs / VPs
Managers (Key Buyers)
Client / Account Managers Create Necessary Customer Management
3 BU Financial Managers
and SS Strategy
Capabilities to Be Customer Driven
Service offerings and metrics Feedback
Operations

SS Delivery 4 Upgrade Performance to Build

Managers, Supervisors and Employees BU Users and Employees
Customer Confidence

Source: Booz Allen Hamilton

Establish Strategic Alignment Framework: The AEP executive team developed formal rules and processes
to resolve critical issues such as outsourcing, mandated (stewardship) services, fixed cost allocations,
shared services operations, and management (O&M) and capital commitments so that the corporation as
a whole derived the greatest benefit. A cross-functional Buyers Council was established to address tactical
decisions and set priorities.
Overhaul Service Offering and Pricing Framework: Using I/T and telecommunications as a pilot, shared
services developed a new model to overhaul pricing mechanisms (see Exhibit 10).
Develop Customer Management Capability: Shared Services put in place a solid, realistic CRM framework
that enables far more collaboration with business unit customers and optimizes cost/benefit tradeoffs.
As part of this CRM effort, each customer will have an integrated account plan that captures critical infor-
mation on its needs and shared services performance in meeting those needs.
Improve Shared Services Performance: The transformation teams identified significant customer cost
savings opportunities, most of which will be applied to O&M and capital budgets in 2003. Once fully
implemented, these savings opportunities will help AEP meet cost containment targets it has set.

Exhibit 10
New Model for Pricing Mechanisms

What Will Change

Customers will have a better understanding of what they are buying
Customers will be provided with more choice through a broader menu of services to match their unique
Redefined Products and Services
requirements and affordability levels
Products will be unbundled to facilitate an understanding of cost levers that customers can influence
Services bundles will be defined to facilitate apples to apples benchmarking against alternative providers

Prices will reflect the true cost of delivering the product or service
Fixed and variable components of prices will be made transparent so that BUs can accurately
Redesigned Pricing
gauge the impact on their economics by varying their consumption
Stranded costs will be charged to specific BUs in the event that they reduce their usage of fixed
cost assets significantly, unless SS can eliminate these fixed costs or find alternate users

Source: Booz Allen Hamilton

 13

ship and risk management. Needless to say, corporate Exhibit 11

centers are shrinking accordingly, from 500 to 1,000 Lean Corporate Center
employees, on average, to perhaps 100 to 200
highly skilled individuals, depending on the size of the The Shrinking Size of the Corporate Core...

company (see Exhibit 11).

The diminished role of the corporate center begs the SIZE OF CORPORATE CORE RELATIVE
TO COMPANY SIZE
question: Would the profit centers assembled under
the corporate umbrella fare better on their own? This 1.53

is not an idle question. Investment bankers have been 1.10 Utility Client
= 0.98%
arguing for at least two years that spin-offs and/or
1.00 1.00
break-ups in the energy industry could unleash tremen- 0.98
0.94
0.93
dous locked-in value. 0.85

$70 MM Opportunity
0.80

Median Corporate Core Costs

Our purpose is not to advocate one position or

as a Percentage of Sales
another, but it goes without saying that the corporate
center should be organized to serve some kind of 0.60

value-adding function. If the function is to manage the 0.55

0.45
portfolio, that begs the question, to what strategic
0.40 0.41 0.39
end? Most energy companies have a portfolio of 0.36
0.33
profit centers that are almost all energy related, thus
their fortunes ride on a common set of market forces, 0.20 0.20
Strong Form HQ Model 0.19
though often to different degrees and with divergent Moderate HQ Model
effects. The value a corporate center adds, beyond Minimalist HQ Model

what an intelligent diversified energy investor could 0.00

5,000 10,000 20,000 50,000 >100,000
expect, must reside in some purposeful leveraging
10,000 20,000 50,000 100,000
of information and capital to position the enterprise
Total Number of Employees
optimally through acquisition, divestiture, market
positioning, and shifts in asset deployment for
Source: Booz Allen Hamilton Benchmarks of corporate Core Costs for 43 U.S. Corporations
swings in the energy market. in the Heavy Manufacturing Sector

Many energy companies today are satisfied that they

have remained integrated, but, as observed earlier,
integration today means something entirely different
than it did five years ago. Then, it meant operating as
a single business. Today it means operating multiple
profit centers at different points on the value chain.
Todays integrated energy utility needs to move beyond
passive portfolio monitoring and wield its multiple
strategic positions to beat the marketconsistently.
This being the case, corporate centers need to ensure
that they have the capabilities and information
resources needed to exercise this active portfolio
management role. Without undermining the autonomy
that profit-centers require for top performance, the
corporate center needs to access current information
on shifting market dynamicsand act on it decisively.
When it comes to alliances, the central issue is one
of control. How willing is a utility to delegate important
activities? The central objective of the New Operating
Model is to create a strong, streamlined organization.
By exposing the economics, the capabilities, the alter-
natives, and the strategic relevance of all resources
internal and external available to a company, the
New Operating Model helps the company concentrate
those resources in the most productive ways. Implicit
in that selective intensification of focus is a willingness
to withdraw from those areas and activities deemed
non-core and delegate them to others.
Pushing beyond convenience outsourcing is difficult,
and few North American utilities have yet made the
14

Exhibit 12
The Connective Tissue of an Organization Raises Many Complex Issues

Summary of Issues/Concerns

Mission/Vision Development Goal Setting Strategic Planning

Should provide greater long-term, Too many goals Unclear strategic planning process
top-down direction to organization Focused on activities, not results Strategic plans inconsistently communicated
Vision not readily understood, Inconsistently integrated across company Plans not clearly linked to goals or integrated
not communicated with other management processes
Goals developed for external publishing
Inadequately addresses new business are too vague or unspecific to drive Strategic and tactical planning are intermingled
environment decisions and shape performance Takes too narrow a view of issues
Customers
Goals dont consistently drive strategic plans Fails to proactively identify and evaluate
Competitors
and action plans emerging issues
Regulators
Definition and characteristics of good goals Strategic decisions supported with
Insufficiently robust or inspirational
not clearly understood budget level detail

Action Planning Budgeting Performance Measurement

Insufficient top-down strategic direction
Process requires greater integration
and coordination
Regulatory scrubbing reduces effectiveness
Process unwieldy and time-consuming
Poor balance between detail and timeliness
Business unit plans are inconsistently
integrated with action plans
Not consistently driven by action plans
Too much detail
Multiple iterations are time-consuming
and cumbersome
Process does not support decision-making
Final budgets are inflexible
Multi-year commitments difficult to consider
in annual budgeting cycle
Inconsistently linked to goals, strategies,
or action plans
Too internally focused unrelated to
customer/competitive trends
Driven by budget
Focused on controlling inputs, not
motivating outputs
Measures insufficiently integrated
across company

Source: Booz Allen Hamilton

breakthrough. Most utilities take an expansive view
of their core competencies, and see little advantage
in outsourcing. Concerns about abandonment of sunk
costs, day-to-day manageability, maintenance of service
standards, and cost control contribute to the reluc-
tance. Moreover, some of the functions that can be
outsourced, like asset management separate from
asset ownership, require a different way of thinking
about existing practices. Without strong competitive
pressure, these barriers are difficult to overcome. As
the logic of the New Operating Model takes hold, how-
ever, energy companies will recognize that the ongoing
economic benefits of focus and discipline swamp
the one-time costs of overcoming these hurdles.
Then, outsourcing and alliances will extend from tradi-
tional supplier relationships and housekeeping chores
to more strategic elements of the value proposition.
The connective rules and tools of an organization
consist of the management processes, people policies,
technology, information systems, and institutional
expectations that govern how the other building blocks
behave and how they interact. They are the processes,
measures, and incentives that keep an organization
focused on its strategic objectives. The issues
surrounding this building block are numerous (see
Exhibit 12), but they tend to cluster around two central
themes: consonance and consistency.

Are the rules and tools of engagement actually
consonant with one another and with the other building
blocks, or do they work at cross purposes? Moreover,
are they consistent with the strategy and its execution
requirements so that they truly support the individuals
on the ground who must execute the strategy, by
providing them with the information, motivation, and
decision authority they need, when they need it,
to make the right choices.
Absent from this discussion is any mention of cost
centers. That is a deliberate omission. In the New
Operating Model we are proposing, there is no place
for overhead functions, as traditionally defined.
By overhead or cost center, we refer to consoli-
dated centers of expertise that serve multiple internal
clients. These units have no revenue line or external
face to the market. Instead of being measured or
managed to a profit target, these organizations are
controlled via a budget, and their costs are allocated
to other units within the organization (e.g., profit cen-
ters, corporate center) using a formula loosely based
on the units use of the cost centers services. This
type of approach has some key flaws:
Annual budgets are typically based on the previous
years budget plus or minus some increment, so cost
centers have no incentive to economize. If they save
money in a given year, that only means they will have
a lower base from which to negotiate the following
year. This use it or lose it logic argues for spending
every dime in the budget. As a result, cost centers
tend to provide high-cost services. (Zero-based budg-
eting attempts to avoid this trap, but typically relies
on cost build-ups that are based on past experience
and, therefore, subject to the same inflation problem.)
Because business units are typically charged for cost-
center services via a tax or other ad-hoc rule, rather
than an incremental-fee-for-incremental-service, they
demand ever-increasing quality of service. As a result,
many cost centers respond by providing Cadillac
services, when Chevrolet would be the better
choice for the bottom line. Since the process is not
subject to any market discipline, costs quickly spiral.
It is no surprise then that cost centers typically
become the collecting point in an organization for all
15
sorts of abuses and inefficiencies. The New Operating
Model addresses this problem by striving to eliminate
cost centers altogether, either by outsourcing them, re-
configuring them as profit centers, collapsing them into
shared services organizations, or rolling them into other
business units where their costs will be subject to
the demands of a bottom line. While few organizations
have actually gotten to the point of eliminating cost
centers altogether, the discipline of thinking about
them in such an extreme fashion fosters more creative
and value-enhancing solutions than simply well have
cost centers because weve always had cost centers.
Getting Started
Today the market is not content simply to know that
a utility has chosen to be a wires company or a gen-
eration company. It wants to know how effective the
company will be in that role. Purposefully deploying the
principles and building blocks of the New Operating
Model against strategic objectives is a critical first step
toward realizing the superior performance that share-
holders now expect.
The New Operating Model represents the types of
organization design that energy utilities are gravitating
toward in their pursuit of strategic coherence, resource
focus, and market effectiveness what many utilities
call a culture of excellence. It is not a specific
organizational prescription, but an approach that can
manifest itself in different end-points and in different
stages of evolution.
Exhibit 13 provides a quick diagnostic for assessing
where a particular utility stands on the New Operating
Model scale. It can furnish some insight on where
to begin. It might suggest building on some existing
strengths. It might suggest addressing a particular
deficiency. Or it might suggest redesigning the
entire organization.
The industry has played out its current repertoire of
strategic moves and has not found a clear winner. Our
belief is that strategic positioning alone will not drive
competitive advantage moving forward. Executional
excellence is equally critical, and execution is a matter
of organization. In an era of strategic ambivalence,
market esteem is gravitating toward the fundamentals:
16

Exhibit 13
Worksheet for Companies to Assess Their Conformance With the New Operating Model

Does not apply Applies fully

Shared Services
Corporate Centers Profit Centers Alliances Rules and Tools
and Cost Centers

Foundation Does it add value Are their boundaries Do they provide Do they enable the rest Do they foster the
in strategy to the profit centers it clearly aligned with the support skills the of the organization speed, coordination,
presides over beyond corporate strategy? strategy requires, to focus more fully on flexibility, and controls
what they could create located in the its strategic posture the strategy requires?
on their own? appropriate place? and execution?

Market Does it benchmark Do they have Do they use market-like Are their offerings Do they provide
discipline its ownership skills market access mechanisms to determine continually assessed for maximum feasible
against market to the resources what service is provided against alternative, application of
standards? they need? and at what price? including internal market discipline?
offerings?

Information Does it provide the Do they have the Do they provide their Do they have the Do they provide
access businesses the information and internal customers with information needed to those who hold decision
information needed decision authority full information on play a fully productive rights the best
to make the right needed to optimize costs, benefits, and role in the extended available information
choices for the their performance? alternatives? enterprise? relevant to those
overall enterprise? decisions?

Comprehensive Does it ensure that Do they interact with Do their rules of Are the costs and Do they motivate
perspective all building blocks each other and with engagement with benefits of alliances and enable
are aligned, motivated, other organizational customers take assessed in terms consideration
and enabled to units in a mutually proper account of of total impact on of the total
execute the strategy? reinforcing way? common as well as the company? consequences of
particular interests? particular decisions?

Decision Is it clear why it Do other organizations Is it clear what drives Are the costs and Do they promote
transparency makes the decisions within the company shared services value of alliance logically consistent
it does? understand why they costs and service levels? arrangements clear and understandable
make the decisions to internal users and decisions throughout
they do? partners? the company?

Source: Booz Allen Hamilton


consistent delivery on earnings and performance
targets; clear, credible strategic direction consistently
communicated to the Street; strong operating perform-
ance; and solid and stable return on equity.
Few have the culture and capabilities to deliver consis-
tently on these expectations or the desire to make the
tough organizational decisions to compete effectively.
Those who do have a clear and marked advantage.
In the current back to basics market environment,
demonstrated skill at running an enterprise efficiently
may be more important than ever. Additionally, as
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17
large oil companies, financial investors, multi-utility
innovators, and European giants eye the North American
energy landscape, they will bring their own benchmark
standards of excellence drawn from significantly
different corporate traditions. Whether or not outside
players succeed in reshaping the ownership patterns
of the industry, they will almost surely reshape the
prevailing expectations of the industry with respect
to resource efficiency. Those utilities that recognize
these realities early and adapt their operating models
accordingly are the best positioned to succeed.
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