Value-Added Services in Utility Markets -- a Strategy for Success
Richard A. Wight, President

The Rules Are Changing, The Players Are Changing, The Measurements and Key Success Factors Are Changing, The Key Influencers Are Changing, The Playing Field Is Changing,

Your Strategy Should Be Changing!

INTRODUCTION

• A tidal wave of change is building in the utilities industry. Omens of this coming tidal wave include:
• Utilities splitting into four entities: GENCOs (Generation only companies), TRANSCOs (Transmission only companies), DISCOs (Distribution companies) and RETAILCOs (unregulated companies)
• Extreme competition in DISCOs and RETAILCOs because of Retail Wheeling and Customer Choice de-regulation
• Significant loss of customer market share as experienced by electric utilities in the United Kingdom and telecommunications companies in the US after the introduction of competition
• Mergers, downsizing, and unregulated subsidiaries
• New non-regulated competitors, such as ENRON, AT&T, Time/Warner cable systems, and Microsoft

WHAT DOES THE TIDAL WAVE PORTEND FOR DISCOS AND RETAILCOS?

1. Your strategies will no longer be driven by regulators. They will be driven by market conditions and by Wall Street.
2. Customer choice and retail wheeling will produce significant customer switching and loss of customers in existing service territories.
3. New energy suppliers will emerge. Some suppliers will offer a wide variety of services which may include telephone, and cable, along with energy related services because their customers may want fewer suppliers. Many people are calling this new generation of suppliers RETAILCOs or DISCOs (I prefer DISCO+ to differentiate them from a strictly "poles and wire" company).
4. Service bundling for "value-added " services will need to be flexible to meet the varying needs of different customer segments.
5. Customer choice measurement will be the key to managing the business. Value will be the key driver of choice. Knowing the components of VALUE will be critical to success in the competitive marketplace.
6. Customer segmentation methodologies that integrate profit potential, purchase behavior, and customer needs will be developed and utilized by successful utilities.

All six of the above items require utility marketers to think in terms of target marketing and profitable "value-added" services.

WHAT ARE "VALUE-ADDED" SERVICES ANYWAY?

I agree with the author of a recent paper that "Value added" services are [any] products and services that add value from a customer’s (or electric cooperative member’s) viewpoint over and above basic electric or gas service.

The market research I’ve done and my experience show that the competitive marketplace will require utilities and other competing service providers to market ALL SERVICES (other than "basic" services) as though they are "VALUE-ADDED" services. This will include any forms of special billing, and technical, consulting, or customer services not strictly involved in providing basic "pipes" or "poles and wire" service. Examples of these diverse "value-added" services include:

• home and business security systems
• appliance service and warranty programs
• high speed communication networks
• digital telephone and personal communications services
• internet, cable and satellite TV
• home automation and business energy management systems
• remote meter reading
• natural gas and propane service
• equipment leasing and financing
• internal power system installation and maintenance services
• credit cards and life insurance products

THE THREE KEY COMPONENTS OF A WINNING STRATEGY

A WINNING STRATEGY WILL REQUIRE:

I.	A reorientation of how your company thinks about and looks at customers and how it measures success.
II.	Tools to determine the market-based prices of "value-added" services.
III.	Implementation of multi-dimensional customer segmentation schemes that allow you to target customers based on their profit potential, their "drivers" of purchase behavior and choice, and their needs.

Following is a discussion of each of the three components outlined above.

I. REORIENTATION
A utility CEO recently said, "Change will be the only constant in the electric utility for years to come." Certainly everyone who has watched the industry recently would agree that BIG change is coming and there are new players entering the market either through mergers, acquisitions, or directly almost on a weekly basis.

A winning strategy will require a reorientation (change) in how your company views customers and measures success. In a competitive marketplace winning strategies will be based on understanding and acting on these issues:

• All customers are not equally desirable. You lose money serving some customers, and in addition, they all do not have the same potential for purchasing "value - added" services at enhanced profit levels.
• All revenue is not good revenue. Some services were being provided below acceptable margin levels and thus should be stopped. Remember CHOICE is a two-way street.
• Maximizing your share of profitable customers’ expenditures is critical to success. The future marketing goal will be to maximize the share of profitable customers expenditures not to maximize market share. Historically utilities have enjoyed very high shares of the market. Because competition will remove the need for "universal service", utilities should accept the above two bullet points and focus on profitable customers and getting as many of their service dollars as is profitable. This will yield the highest rate of return on marketing investments and that is the name of the new game.

So what is driving this change, or reorientation in how customers are viewed? The answer is (A) changes in the marketplace, and (B) the changing expectations of Wall Street and thus Investors.

A. CHANGES IN THE MARKETPLACE
Changes in the marketplace are the result of two characteristics; (1) the customer’s desire for CHOICE, and (2) their expectation of CHANGE.

1. The Customer’s Desire for Choice
   There are four key components of a customer’s desire for choice: A) There are trade-offs between choice and complexity; B) Customers will exercise their right to choose, C) Customers will voluntarily limit their choices, D) Fickleness and volatility will prevail in some customer segments.

A.	There is a tradeoff between the number of choices a customer has and the potential complexity/confusion that the choice creates. All customers, both consumer and business, want choices but not necessarily unlimited choices As a recent Services Marketing Today article pointed out, marketing’s philosophy has been that more choice is better than less choice. In many industries, such as banking and telecommunications, and soon in utilities, an overabundance of choice is creating a confusing marketplace for customers. The new goal for service marketers is to make choice easy by bundling services, such as local phone service, cable television, and energy, together into one package.or complicated choices.
B.	Customers will exercise their right to choose. Share losses for electric utilities in their existing service territories may approach those experienced in the United Kingdom where DISCO’s lost 20%-55% of their customers in two years, or by AT&T where they lost 40%-55% of their customers (depending on the service and segments) over a 13-year period.
C.	Customers, from residential to corporations like Wal-Mart, want to reduce the cost, risk and complexity involved in the choice decision. They will do so by deciding to limit their choice set to a few service providers and vendors. As Susan Solger, Manager of Utilities for Wal-Mart, said at a recent conference, they expect de-regulation to give them choices including the opportunity to have one national electricity supplier. Ms. Solger indicated that Wal-Mart definitely wants fewer suppliers but not one national supplier. They want "regional" suppliers.
D.	As we have seen in the telecommunications market, some customers will move from vendor to vendor, sometimes with a strong reason and sometimes just because they want to change. When customers can choose, even satisfied ones will exercise their choices and switch service providers when they perceive they can get a better value or if they are less than totally satisfied. This will create a volatile, fickle electric consumer base.

As Frederick Reichheld pointed out in The Loyalty Effect, and Jones and Sasser pointed out in the article "Why Satisfied Customers Defect":

• The linkage between customer satisfaction and customer choice is definitely not linear. When a monopoly’s hold on customers disappears, the relationship between satisfaction and choice can change suddenly.
• Satisfaction is generally considered to be a combination of expectations of what will happen and perceptions of what did happen. Choice on the other hand, is future behavior related.
• Businesses that ignore the power of choice-based management and marketing will experience turnover of up to one-half of their customers in five years. These defections, if ignored, produce low growth, weak profits, and short corporate life expectancy.

2.

The Customer’s Expectation Of Change Our research at Energy Market Solutions, in partnership with Hughes Research, "Measuring and Managing Loyalty Among Electric Utility Customers" indicates that the expectations of large C&I customers (residential and small to medium C&I will follow) for deregulation of the electric energy market fall into three categories. They expect that deregulation will:

A.	Create new supplier and services choices Customers expect that deregulation will create choices of new suppliers and services. These suppliers and new services will better meet their needs and help them manage their costs (i.e. add value to the basic product being provided - electricity). They will also offer additional services to add new value to the relationship. The wide range of services that utilities are thinking of offering range from cable and telephone service to credit cards to energy management and end-use equipment.
B.	Result in lower prices Large C&I customers expect and will demand lower prices. Some experts predict up to a 30% drop in wholesale / bulk power prices. Nobody seems to have a good estimate or feel for the changes in residential or small C&I prices. Some say residential and small C&I prices will rise 30%. I do not agree.
C.	Produce a more responsive and flexible mix of electricity suppliers Customers are waiting for a "new form of electric supplier" that offers flexibility in bundling the services that customers need and a "cultural change" in the way that the supplier responds to the customer. While utilities are felt to generally provide reliable service, they do not offer a variety of "value-added" services and they are not flexible. Customers’ "ideal" supplier is one that:

• Is more flexible than existing utilities
• Offers a variety of services at competitive prices
• Provides reliable service

B. THE CHANGING EXPECTATIONS OF WALL STREET AND INVESTORS
The first question is: Has anything really changed? The answer from the Vice President of Marketing and Financial Services for the Utility Industry at Moody’s Investor Services was Absolutely! As the following table shows, the most important evaluation factor for Wall Street before deregulation was the regulatory environment and after deregulation it drops to least important! In addition, assuming that Moody’s reflects Wall Street’s thinking, all of the other issues important to Wall Street have changed.

• The role of regulators will decrease and be confined primarily to the DISCO part of the business.
• The role and importance of Wall Street (and investors) in the utility industry (and thus for utility affiliates) will increase dramatically.
• Wall Street’s key utility evaluation factors have changed dramatically.
• The importance of Marketing in utilities will increase tremendously. "Value-Added" services (services and products related to customer satisfaction, choice, cash flow and customer base) will have a key role in which utilities prosper and increase their market value.

  IN SUMMARY, THE FIRST KEY COMPONENT OF A WINNING STRATEGY IS REORIENTATION.
  
  
  

II. MARKET-BASED PRICING
Market-based pricing is not currently used by utilities but it is used widely by competitive industries. Market-based pricing is based on a customer’s Perceived VALUE for services received. Market-based pricing is usually described as the amount a customer is willing to pay for a specific set of services (or products) from a specified provider (or Brand).

As a result of the desire by customers for choice on one side and the absolute need to reduce this potential volatility in demand and sales on industry’s side, leading researchers are concentrating on measuring value and predicting choice in order to control/predict/reduce customer defections. My experience and research, as well as the various market research methods I have studied, indicate that behavior (and thus choice) is closely related to the perception of VALUE. The value/choice relationship, and its key drivers or components, is shown in Figure 1. This model, developed by SDR, Inc., has shown remarkable power in its ability to highlight and define the important factors in the value/choice relationship.

The key value/choice drivers are:

• Brand Equity (intangible service provider characteristics like image, reputation, etc.) Even though the characteristics may be intangible, they are measurable and thus "Brand Equity" can be measured and quantified. It is shown as Wequity in the model.
• Service or Product Features (tangible features such as building commissioning, energy management, security lighting, etc.) Virtually any "bundle" (i.e. combination of services or products) that can be described and linked to a benefit, can be "valued". The net "value" of that bundle is shown as Ws in the model.
• Price It can be expressed in absolute ($50 per month) or in relative (5% more, 5% less, etc.) terms and is shown as Wpr in the model.

Unlike traditional utility pricing, which is based on utility costs and load research allocations to customer groups, market-based pricing is based on a customer’s perception of "value". The information about a customer’s perception of value is determined from market research.

To illustrate how the VALUE MODEL works for pricing unbundled services, imagine that a customer, or group of customers, is given a series of choices to rank in order of preference and that each choice contains different "sets" of services for different total costs (i.e. prices). By having a customer, or group of customers, go through this exercise, we are able to determine their ranking of preference "sets" and the incremental value or price they attach to each service component. This is done by using a highly modified version of the general research technique called "trade-off analysis". Note in this example we only varied service attributes and price. If we chose, we could vary brand as well. Had we chosen to vary brand as well, we would then have been able to establish the "value" of various providers or "brands".

As this brief example shows, the versatility of this approach allows a utility to determine:

• The incremental value or market acceptance price customers are willing to pay for a wide variety of services. This capability is extremely valuable in determining how to bundle (or unbundle) combinations of services for different customer segments.
• Which characteristic dominates current or potential customer’s purchase behavior (i.e. "brand" or service provider reputation, service attributes / features, or price). Clearly, by knowing this a utility is able to best position itself to compete in the various customer segments with the best "bundle" of services.

If a utility were using this Value Model, they would be able to determine the best way to:

• "bundle" their services for various customer segments, and
• price their services to maximize profitability. By using this approach to determine what customers are willing to pay and their costs of providing these services, a utility can then determine how best to maximize profitability.

In short, winning strategies require the ability to price products and services profitably. In order to do that you must be able to predict what customers will do at a given price (i.e. will they buy or not?). These market-based prices (i.e. what customers are willing to pay) should then be compared to the costs of providing these services to determine profitability (or the lack of profitability). It should be remembered that revenue in the future will be based on costs and market-based prices, and not strictly on costs as it has been in the past.

IN SUMMARY, THE SECOND KEY COMPONENT OF A WINNING STRATEGY IS MARKET-BASED PRICING

III. MULTIDIMENSIONAL SEGMENTATION
In order to determine the best prospects for "value-added" services DISCOs and RETAILCOs should implement a multi-dimensional customer segmentation scheme, such as the one that is illustrated below (see Figure 2). EMS and SDR, Inc. developed this approach to integrate:

• Customer size and potential for profit\
• Purchase behavior based on value and choice as described above
• Customer needs for services

As shown in Figure 2, the X dimension is a clustering of customers based on their similarities in energy purchases and choice behavior, based on the Value Model in Figure 1. This model, described above, uses the components of Brand Equity (or image), Service (or product features), and Price to determine their Value profile.

The Y dimension is a clustering of customers based on their similarities in: A) Their energy usage or size; B) Their present margin/profit contribution; and C) Their margin/profit potential from "value-added" services.

The Z dimension is a clustering of customers based on similarities in: A) Their internal needs (such as expense control, profit focus, capital conservation, market expansion, etc.); and B) The type of energy needs important to them (such as stand-by generation, power quality, cheapest short-term price, best guaranteed long-term price, etc.)

WHY THIS APPROACH TO SEGMENTATION ?
This segmentation scheme is being adopted by companies in competitive industries because it identifies the best target customers for a wide variety of present and future services and products which improves bottom-line marketing performance. This scheme is also extremely flexible and can be customized for the specific needs of various internal customers/users such as Brand Managers, Market Planners, Field Sales Managers, and Communications Managers. The above approach to segmentation is being adopted because it gives the firm the capability to:

• Determine which customers have what needs.
• Identify how best to influence the various segments behavior to (a) continue their purchase/usage patterns that are meeting their needs and producing reasonable profit for the provider(s), (b) purchase new products or services from providers, or (c) change their purchase/usage patterns or provider so that their needs are better met and/or profit is increased to the new provider.
• By using the information from #1 and #2, a utility can:
  1. Develop market strategies and plans - "provide what to whom"
  2. Design targeted marketing programs - "how to influence whom"
  3. Execute these programs in an effective manner thereby "influencing the bottom-line"
• Develop a sales tracking system whereby the purchase of new products or services is captured and can be related back to each segment and how well the actual results match predicted results.

IN SUMMARY, THE THIRD KEY COMPONENT OF A WINNING STRATEGY IS MULTIDIMENSIONAL SEGMENTATION.

CONCLUSION
There is a tidal wave of change coming in the utilities industry. Your company can ride the wave or be engulfed by the wave. In order to ride the wave your company’s strategy must change. In the future your actions will be driven by market conditions and Wall Street, not your public service commission. New competitors will emerge and they won’t all be other utilities. . Value-added services will be critical to your success. Customers will choose their energy supplier and value will be the key driver of choice. Knowing the components of Value will be essential to keeping and winning new profitable customers. Customer segmentation methodologies that integrate profit potential, purchase behavior, and customer needs must be put in place to understand customer needs as well as their behavior and target market to them profitably.

Successful strategies will encompass three key components. They are: (1) a reorientation or change in how your company thinks about and looks at customers, (2) the development of tools to determine market-based prices for value-added services, (3) the implementation of multi-dimensional customer segmentation schemes that allow your company to target specific customer groups based on their profit potential, their "drivers" of purchase behavior and choice, and their needs.

Acknowledgment
The author wishes to thank Michael Mabey for his help in editing this paper and encouraging me to develop it.