To Our Readers

Welcome to Joules, which features articles written by Oliver Wyman’s partners in the Energy/Utilities practice that are derived from our recent work with clients around the world.

Utilities are facing several earnings challenges. Aging transmission and distribution infrastructure and generation capacity shortages are now forcing many utilities to confront a major new build-out cycle. Global com-petition for natural resources and tight labor markets mean this cycle will occur at a time when input costs are high and climbing. In addition there are questions about the type of build-out necessary, the technology of next-generation transmission and distribution, and the structure of the customer service of the future. The pressure to squeeze earnings and cash flow from existing assets in order to fund this build-out is greater than ever.

By offering a broad selection of topics, including M&A and the management challenges of an aging workforce, Joules aims to provide you with guidance on how to tackle strategic and operational challenges that will help drive increased performance and value. We hope you enjoy this first issue, and we welcome your comments for future issues.

Sincerely,David HoffmanGlobal Energy/Utilities Practice Director

Energy/Utilities

2008

3 Rethinking the Distribution Operating Model: Targeting Resources and Work

9 Releasing the Value of Hidden Assets

17 Making Utility M&A Succeed in 2008

21 Anticipating the Challenges of an Aging Workforce

26 Lean Tools to Raise Productivity Across the Value Chain

30 Top of the Commodity Cycle or Structural Shift for Sourcing?

37 Managing Customer Satisfaction Involves More Than Improving Reliability

44 Contact Oliver Wyman

Joules

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Rethinking the Distribution Operating Model: Targeting Resources and Work

Opportunities exist for utilities to redirect spending, up to 15% of O&M and capital, to needed infrastructure and reliability improvements. To do this, managers will need to creatively rethink the entire distribution oper-ating model—rather than performing incremental process redesign. The key is to make work disappear (rather than just reengineer) and to chal-lenge basic assumptions about the business.

Utility executives are facing greater challenges in managing their distribution operations today:

Demand for increased investment Aging infrastructure that requires increased replacement or repair Heightened sensitivity to reliability, with resulting pressure to “harden the infrastructure” against storms

Continued load growth and, in particular, surges in peak load or demand

Limited capital availability Continued pressure on earnings and cash flow Inflationary pressures from rising input costs (labor, energy, raw materials) Limited gains in efficiency and productivity from “traditional” sources Competing opportunities to invest internally both within and outside the regulated businesses

Addressing infrastructure challenges and improving reliability—while still delivering earnings—will require significant investment. But opportuni-ties exist for utilities to redirect spending, up to 15% of O&M and capital, to needed infrastructure and reliability improvements. Even top-perform-ing distribution companies can remove or redirect 5-10% of costs without adversely affecting service, freeing up funds for aging infrastructure.

To do this, managers will need to creatively rethink the entire distribution operating model—rather than performing incremental process redesign—to identify where work can be eliminated (without harm to reliability or customer satisfaction) and where resources should be refocused to add the greatest value.

The key is to make work disappear (rather than just reengineer) and to challenge basic assumptions about the business.

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Challenging the Status Quo of WorkDistribution managers and staff typically focus on the day-to-day work of serving new customers, replacing and upgrading infrastructure, and “keeping the lights on”—not on examining what is done so as to eliminate the work itself. In fact, few people tend to view the work they perform as unnecessary.

Eliminating significant O&M cost from the organization requires challeng-ing the fundamental operating model. This means rethinking what is done and how much is done, rather than simply how work is performed.

Over time, many distribution organizations, even top-performing, “low cost” companies, can create—without realizing it—unnecessary work or process intensity. To uncover unnecessary work, managers must ask a number of penetrating and challenging questions to test basic assump-tions about the business:

What assets do we really need to own? How intensively do we need to perform certain activities? Who are the best people to perform each task?

The answers to these types of questions can generate significant value.

Exhibit 1 Rethinking the distribution operating model: Opportunities to reduce costs

Change what is done(“Do the right things”)

• Eliminate assets (and associated costs)

• Eliminate work completely

• Ask others, such as custom-ers and developers, to do the work “for free”

• Automate the work

• Control job scope and ”scope creep”

• Design standardization

• Electronic data transfer with developers, towns, etc.

• Facilities to consolidate, exit, or close

• Analysis of data (AMI, GIS) vs. diagnostic inspection vs. maintenance

• Job-site reporting

Change how much is done(“Focus the effort”)

• Reassess service-level targets

• Examine policies and standards

• Question whether “require-ments” are really necessary

• Focus on the 80%, determine if the 20% is economical

• Segment or simplify the work

• Restore vs. repair philosophy

• Customer service levels, e.g., response time commitments

• Project priorities

• Maintenance program scope: e.g., targeted vs. broad application

• Process and work segmenta-tion, e.g., complex vs. simple work, large vs. small developers/customers

Change who does it(“Structure the work”)

• Simplify organization structure

• Reduce company scope; outsource

• Consolidate (or disperse) operations

• Functional vs. regional structures

• Generalist vs. specialist roles

• Porosity of district boundaries for crew assignments

• Workforce and fi eld crew composition

• Management of shift schedules and overtime

• Use of third-party outsourcing

Change how it is done(“Do things right”)

• Streamline processes –Segment work –Digitize work

• Business process improvements

–Effi ciency and productivity –Effectiveness and results

• Employee performance management/incentives

• Customer pricing strategies, e.g., premium for off hours or speedy response

Potential impact of cost-savings opportunities

Illustrative opportunities

Rethinking the operating model

4 Joules/2008

Exploding Long-held MythsSignificant gains can be achieved by exploring and challenging current poli-cies, practices, and structures that are built on long-held corporate myths.

These myths are perspectives, views, and beliefs within a company about what customers need, regulators require, or senior management demands. They often have not been revisited or challenged in many years. Our experience from working with utilities is that many myths can be debunked or refuted when reviewed by current management teams. And often, these myths are a source of major costs.

Exhibit 2 Illustrative myths or practices to challenge and explore

Serving customers’ needs

• “We must provide 24 / 7 non-emergency call center services; we can’t stop at 8 p.m.”

• “Our customers like to talk to us. We could never require customers to use the IVR for certain types of calls.”

• “We have to review bill exceptions, otherwise we would be swamped with customer calls.”

• “Due to local labor and political pressure, we will never be able to close that call center.”

Maintaining the infrastructure

• “Raising fi eld productivity will take a long time, and I’m not sure if we will ever have combined electric-gas URD crews.”

• “We can’t outsource too much—we would risk the contractors going to other utilities.”

• We can’t outsource all locating; it’s too risky. Our maps are not accurate enough.”

• “If we close any more service centers, we will seriously harm our service levels.”

Working the regulatory process

• “Economic development is very profi table for us. We do it well and should not cut back.”

• “Account managers are critical to our public image. Large customers want us to visit them proactively.”

• “We need most senior managers involved in the regulatory process. Their participation provides good ideas and high visibility.”

Providing back offi ce (G&A) support

• “We need to be able to reach our employees at any time, so they must have pagers, cell phones, and radios.”

• “We have already cut (staff, cars, inventory levels, etc.) as far as we should. Any more and service will suffer.”

• “We cannot outsource an entire function. The risk is too great.”

Managing people and the organization

• “People work for a utility because of the stability. We could not have over 50% of directors’ compensation be performance-based.”

• “Our culture will not let us operate like GE and ‘weed out’ the bottom 10% of performers.”

• “We need to have regional organizations so we can maintain local accountability.”

• “Our costs would go down with a functional organization.”

Core processes

Enabling processes

Taking an Outside-In PerspectiveAn outside-in perspective can be used to surface a full set of options and push managers beyond their typical ways of thinking. Benchmarking to understand how other utilities operate is an important first step. But to highlight additional strategies and opportunities, the following provocative questions also must be explored. What would we do (or not do) and how would we do it, if we:

Were starting a brand new company?

Were a contractor (and not a utility)?

Could only do 10 things in-house, with the rest outsourced (Exhibit 3)?

Had to reduce functional costs by 25% (with no operational constraints)?

Owned the company (your company and the profits were yours)?

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6

Exhibit 3 Where would you position each function being considered?

Outsource

• Non-core, but performing well

• Outsource to allow outside experts to take to the next level

Core—retain

• Strategic processes, high performance

• Invest to maintain performance

Purchase/outsource

• Fix to harvest low-hanging fruit

• Then purchase or outsource services

Able to fi x• Keep in-house and fi x

broken processes

or

Can’t fi x—outsource

• Outsource to experts to turn around

High

LowLow

(Non-core)

High

(Core)

Strategic value

Performance

Objectively Assessing Performance and Capabilities A key underpinning of efforts to rethink the distribution operating model is an objective and honest assessment of a company’s perfor-mance and capabilities—both strengths and weaknesses. Developing a data-driven, process perspective to evaluate distribution costs, prac-tices, and performance is a critical component in challenging basic assumptions about the business and taking out unnecessary work.

Exhibit 4 Representative issues and opportunities to be examined

Strategy

Process

Organization

Systems

Culture

• Target scarce resources to appropriately support objectives

–Service requests and outage restoration

–Maintenance and system reinforcement

–New business

• Leverage outsourcing where internal costs or capabilities are not adequately competitive

• Develop the right procurement strategies for contracted services, equipment, and material

• If needed, rebuild core capabilities to achieve best practices and reduce cost

• Determine where to best use employees and contractors to effectively spend the budget

• If needed, tune up core processes to achieve best practices and reduce cost

• In construction, promote consistent hand-offs and controls; develop appropriate processes

for simple vs. complex jobs

• Ensure that interfaces with other groups work smoothly (e.g., customer service, support services)

• Appropriately allocate resources, e.g., among management, fi eld forces (employees and contractors), clerical staff

• Rationalize roles and organization—responsibilities, spans of control (staff supervised, budget

managed), skills mix—to meet current challenges

• Further improve performance and processes by better leveraging existing systems and technology

• Develop an implementation approach and plans that can lead to successfully realizing the desired benefi ts

6 Joules/20086

Reinventing the Fundamental Operating Model The distribution operating model should be “reinvented” by both (1) addressing existing performance issues and (2) “starting with a blank sheet of paper.” A successful improvement effort will likely include changes to holistic or top-down approaches as well as to individual bottom-up operating elements.

Exhibit 5 Reinventing the distribution operating model: Representative changes

Strategy

What scope of services do we offer?

How do we price the services? Where

do we focus resources, e.g., on what

core activities? What to outsource?

Process

How do we execute our core activities?

Organization

Who performs the work? How do

we best organize and align people,

capabilities, and resources?

Systems

What technology, systems, and tools

are required? What information is

made accessible, to whom, how?

Culture

How do we build a culture of success?

• Tailor channels (relationships) to customer or developer segments,

e.g., centralized vs. regional approach, face-to-face vs. remote contact,

residential subdivision vs. C&I vs. small builders

• Reduce scope of services offered, e.g., ask developers to dig trenches;

eliminate low-value work

• Adopt modifi ed scheduling priorities and paradigms

• Change pricing structure, e.g., simplify options and pricing, capture full

(including upstream) costs

• Streamline or segment processes, e.g., triage new business by complexity, send simple

jobs to fi eld, standardize offerings, eliminate account reps as a bottleneck for certain

types of orders

• Split customer design from capacity planning / engineering part of work

• Drive consistency and standardization (modularization) across regions and employees

• Centralize or functionalize activities to leverage scale (e.g., initial developer contact,

subdivision design, CIAC processing), drive consistency/standardization, or balance

fl uctuating workloads

• Change roles, responsibilities, and hand-offs, e.g., generalist vs. specialist

• Realign or reallocate resources across regions, customers, jobs, or skill types

• Change skill level requirements or job descriptions

• Leverage and improve legacy systems or invest in new systems for process

breakthroughs

• Take advantage of Internet and e-commerce; provide employees/developers

with more access

• Manage by measurement, using common data and systems

• Integrate process fl ows with automation tools, e.g., mobile data

• Build a strong platform for change

• Establish horizontal process management and feedback loops, with

clear vertical roles

• Strengthen accountability through targeted performance management,

e.g., x-day guarantee

Planning,

analysis,

and forecasting

Request

initiation/

requirements

development

Engineering,

design, and

estimating

Work

management

and scheduling

Construction/

build/close-out

Elements of an operating model

7Joules/2008

* * *

Many distribution organizations are trying to cope with the increasing cost and complexity brought on by aging infrastructure, revenue streams, and workforces. More progressive companies are taking action to rethink their business and operating models and increase the cash flow needed to rejuve-nate infrastructure and improve reliability.

Forward-thinking distribution executives can meet the twofold challenges to maintain (or more likely improve) reliability while simultaneously delivering on earnings and budget commitments. Successful leaders must be ready to adopt new approaches and the business models needed to succeed.

Opportunities for Managers

Are there opportunities to rethink the way we do things? Opportunities to eliminate work? Or make sure we do it right the first time?

Can we identify activities that drive significant volumes of work out of proportion to the value produced?

Which work has impact on performance, reliability, and the customer experience? Which does not?

What changes may not significantly impact reliability or customer satisfaction?

Can we influence changes in customer behavior to eliminate work?

8 Joules/2008

Releasing the Value of Hidden Assets As energy utilities complete their retreats from unsuccessful deregulated ventures, their financial statements contain less debt and suggest a high-er-quality earnings outlook. Divesting assets identified as “discontinued operations” has shored up earnings across the sector. In fact, the power and gas sectors currently trade at record P/E multiples. However, there is a major earnings challenge on the horizon. Aging Transmission and Distribution (T&D) infrastructure and generation capacity shortages are now forcing many utilities to confront a major new build-out cycle.

Global competition for natural resources means this cycle will occur at a time when construction costs are high and still climbing. The pressure to squeeze earnings and cash flow from existing assets in order to fund this build-out is greater than ever.

To address this challenge, energy utilities should look at large, untapped sources of hidden value: their portfolios of what we call hidden assets. Electric and natural gas utilities can unlock the latent potential within these exploitable asset pools, yielding major earnings contributions.

Uncertain growth prospects During the 2003-07 period, the Dow Jones Utilities Index posted a healthy run-up, as shown in Exhibit 1. However, as the infrastructure build-out cycle takes hold, energy utilities will be hard-pressed to create the next wave of shareholder value, for several reasons:

9

Exhibit 1 Utility investors have been pleased in recent years

Dow Jones Utilities Index500

450

400

350

300

250

200

March 11, 2002

2003 2004 2005 2006 2007Source: Yahoo

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10

Power generators face large and growing capital needs from environ-mental retrofits, costs of new capacity (especially nuclear), and an impending Carbon Regime.

T&D franchises are contending with aging infrastructure, capacity needs to support new generation, and increased expectations for ser-vice reliability.

Rate freeze extensions coupled with utility commissions’ desire to buffer consumers from rate shocks make the rate-setting process more risky.

Population migration to the Sunbelt and continued retrenching of the U.S. manufacturing base is reducing load growth in Northeast and Midwestern states to a trickle.

Utility M&A strategists, seeking growth through consolidation, are adapting to recent setbacks in the Exelon/PSEG and Constellation/FPL transactions.

Within many energy utilities, financial planning teams are growing anxious over the lack of compelling stories for sustained earnings growth in the face of the most expansive and expensive capacity build-out in history.

Utilities thus are approaching an inflection point concerning value creation, which raises several questions. Will utilities be content to accept lower P/E multiples and deliver shareholder value largely through promises of impending rate relief? Do rising interest rates and superior returns elsewhere suggest that investors will move to other sectors? Will energy utilities relinquish their recent run-up in shareholder equity?

A Universe of Hidden T&D Assets Our research and work with utilities suggest that a significant source of earnings growth, contained in hidden assets within existing operations, remains untapped. We’ll focus here on the T&D sector as an example of the potential for capturing millions of dollars annually in new, highly profitable revenues.

Finding and deploying these hidden assets centers on the latent value in non-metered revenues. Every U.S. energy utility has extensive customer interactions not associated with the meter point. By “non-metered rev-enues,” we mean revenues from the array of products, services, or assets not directly tied to the sale of energy, as shown in Exhibit 2.

Although the energy utility equivalent of “call waiting” or “voicemail” has never materialized, there is surprising growth in demand for products,

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11

services, assets, and technologies held by T&D providers. In fact, T&D utilities have expended billions of dollars and thousands of person-years over many decades building their hidden asset portfolios––a natural byproduct of developing an infrastructure and delivering energy to customers. Oliver Wyman’s client work suggests that demand growth (estimated at 6-12% per year) in many of these non-metered areas is three to five times that of the typical T&D franchise. Demand has accelerated for several reasons:

Customer needs are proliferating in areas such as growth-related expansion, options for higher service reliability, and advanced meter sets and related data.

New, complementary technologies are advancing, including BPL, Wi-Fi, and broadband video applications.

Under-used real estate and rights-of-way have increased in value, including cellular towers, billboards, grazing rights, storage facility sites, and pole attachments.

Core offerings are in growing demand, ranging from everyday appli-cations like temporary electric service or joint pole maintenance to more exotic high-voltage construction work.

A new wave of demand side-management products and services is emerging as California and Texas set the stage by allowing these capital dollars to be rate-based.

For many T&D utilities, demand for these services is beginning to

Exhibit 2 The universe of hidden T&D assets

Joint poleand attachments

PCStowers

Jointtrenching

Temporaryfacilities

Publicrelocates

New construction

RevenuesDamageclaims andcollections

Property andright-of-wayleasing

Connect newcustomers

Mandatoryremoval/replacement

New homes,carnivals, etc.

Make readywork

Host cellproviders

Shared poleplant

Real estate management

Uncollectible Net revenues

Potentialroot

causes

+ + + + + + + =

• Estimates nottrued-up

• Bills not rendered

• Collections slippage

• Weak record-keeping

• Missing billingtrigger

• Work done at costnot at market rate

• No billing trigger

• Work done at out-dated cost

• Lack of timelytemporary to per-manent service

• Weak record-keeping

• Lack of under-standing on coststo company

• No billing trigger

• Under-marketrents

• Lack of subscrip-tion on valuableright-of-way

• Limited site mar-keting capabilities

• Unknown attach-ments

• Cost to maintainjointly ownedpole plant

• Bills not rendered

• Risk averse

• Under marketrents

• Lost opportunitiessuch as billboards

• Late or missingrecords

• Aggressive counterparties

• Inaccurate billingdisputes

• Can yield $60 to$80 million in alarge utility

Customer work Infrastructure rents Claims and other

Revenue leakage from non-metered operations

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12 Joules/2008

crowd out more traditional activities tied to operating, maintaining, and refurbishing the network. Yet, many still tend to view these demands as a nuisance that distracts line crews, creates unreasonable customer expectations, saps budgeted resources, and undermines the brand. Our experience suggests that a T&D utility serving 3-5 million customers has the potential to realize between $40 million and $80 million in new rev-enues over a two- to three-year improvement cycle. Moreover, the costs to capture these revenues is negligible (as the labor needed is already employed), with gross margins in the 60-80% range.

The Operational Barriers To date, T&D utilities have not fully realized non-metered revenues or turned these opportunities into a growth business. Most of the reasons for this neglect are operational in nature:

Nobody is in charge. This business-within-a-business cuts across the entire franchise; customers request these services all the time. Yet, the standard daily work––thousands of transactions involving linemen, real estate agents, field technicians, and engineering staff––is performed in the context of maintaining or expanding the network. Non-metered revenues are viewed as a “step-child” of operations with limited focus on the business, its size, customer value, growth potential, or contribution to earnings. No general manager has a P&L statement here and no one has a clear incentive to grow contribution.

Business development resources are in short supply. Simply put, there are no “deal sharpies” in this crowd. Every time a customer asks for access to real estate, an upgrade to service, or the relocation of equipment, the request is handled locally with limited oversight. Discussions about cost versus market value rarely occur. Worse, the service often is viewed as part of “good customer service.” As a result, utilities perform many transactions for no charge or at well below

Exhibit 3 Revenue cycle characteristics

• Many locations across the service territory

• Constant fl ow of high-value customers

• Customers care deeply about the experience

• Served by many employees, so many of moments of truth

• Heavy reliance on fi rst-line supervisors to make it work

• Employees view as a lower priority; nobody owns results

• Complex, paper-intensive billing process

• Training focused on safety and operational procedures

• Limited fi nancial and performance reporting

• Undefi ned performance metrics and benchmarks

• Regulatory strategies disconnected and ad hoc

13Joules/2008

cost. From a revenue realization perspective, this lack of commercial oversight costs millions.

A flawed revenue cycle. The revenue cycle process for these services is complex, for the reasons listed in Exhibit 3.

This complexity, coupled with a lack of dedicated resources, makes for weak process flows. Typically, we find the revenue cycle is undermined by four factors:

– Lack of acknowledgement that a process with well-conceived roles, responsibilities, and communication links should exist

– Inadequate attention to simplifying and efficiently routing nec-essary data to generate an invoice. For instance, billing triggers are often missing, leading to completion of field work with no invoice.

– Lack of automated tools that would make event notification, esti-mating, execution, and invoicing seamless

– Lack of a revenue assurance function, as revenue cycle transac-tions occur without a team devoted to stopping all the process leaks

Back office systems don’t like complex billing. If a utility does rec-ognize the need for an invoice, producing the bill can be difficult. Customer information systems handling millions of meter points are not well-suited for these types of transactions. For the most part, these are complex “bills of one” that are unique to particular circumstances, such as a large public relocation job. Full realization of these revenues would suggest the development of a complex billing unit.

Financial accounting systems are fragmented. Establishing metrics, setting targets, monitoring performance, and benchmarking perfor-mance levels all seem like a well-chanted corporate mantra. Yet, when it comes to non-metered revenues, most utilities get stuck on the first verse. Lack of meaningful financial or managerial accounting data makes it extremely difficult to track performance. Our experience is that these revenues are among the least understood line items on the income statement.

Lack of regulatory strategy devalues the opportunity. Bringing these many opportunities, from billboards to gas leak checks, to the bottom line requires regulatory acumen. While some utilities have adopted strategies tied to recovery (e.g., contributions in aid of construction)

14 Joules/2008

and others rely on a wide variety of tariffs (e.g., temporary service), no utility has positioned these businesses for a clear upside. Instead, many wind up abandoning these lucrative businesses in the face of General Rate Case pressures. When the “earning between the regulatory lags” is over, they fold up shop. However, these are valuable assets, services, and capabilities that lend themselves to a regulatory solution where all parties can benefit––utilities can be rewarded for innovation, and customers can share in the gains.

Utility cultures favor engineering and operations. Not surprisingly, utility staff would rather build or fix anything rather than trifle with even the most lucrative commercial terms or invoice data. Most field forces abhor the type of revenue cycle work-outs advocated here. Hence, the culture does not embrace the opportunity and many continue to give away the store in the name of good customer service.

How to Make It WorkWith all these tough issues, how does one simply get the cash in the door? In our experience, the most effective approach runs along four straightfor-ward steps summarized in Exhibit 4 and elaborated below.

Exhibit 4 Getting to the earnings

1. Identify the leakage and its root causes. First, mine the financial system for transaction values and types. Like a divining rod, most ERP financial sys-tems extend their reach beyond company walls to customers and partners. This data not only identifies transaction volumes and revenue dollars by region and district, it can also offer intra-company benchmarks to reveal, for instance, why it is that Region A bills three times the pole attachment reve-nues as Region B. Coupled with diagnostic interviews of field staff, a number of hypotheses for root causes rapidly appear.

2. Quantify how much can be captured and the ROI. This is an exercise in revenue cycle process work-outs coupled with a sound financial model. After unearthing the details of a revenue cycle process, even when pro-cesses are sketchy or haphazard, you are in a good position to determine

where therevenue leakage is occurringand the root causes

how much can be captured and evaluate the return on investmentfor recovering the revenues

Identify... Quantify... Capture...

the revenue by devising and executing tailored solutions and viableregulatory strategies

Form...

a revenue-responsibleorganization

15Joules/2008

what the value of making investments will be. As one example, Exhibit 5 lays out the type of work needed for pole attachments. Most utilities recover a fraction of their attachment revenues, much less the costs of making available jointly owned poles. We routinely find a host of issues in this type of arcane process.

3. Capture the revenues by devising tailored solutions. This is a multi-dimensional issue and it requires solutions on a variety of fronts, including:

Process work-outs

Stronger communication flows

Paperwork automation and simplification

Establishing billing unit rates and standard prices

Concerted efforts to free up linemen from paperwork and insert administrative resources

Incorporation of stand-alone, complex billing units

Redesign of financial systems and financial reporting for tracking purposes

Assignment of business developers to grow and manage revenues

Establishing proper credit scoring and other risk tools

Upgrading collections functions

Developing standard legal terms and conditions

Exhibit 5 Pole attachment process checks

Region CRegion B

Region APartner 1

Partner 2

Partner 3

Recover lost revenueProtect against over-billingEnsure cost recoveryReconcile attachment discrepancies(between owners and attachers)Ensure an organized process formanaging attachment requestsCoordinate pre-inspection,make-ready, and post-completionStreamline record-keeping, reporting, and billing functionsEstablish evergreen audit policies

•••

•

•

•

•

Real estate assets

$ $$$ $

Cellular towers

Fiberoptics Etc.Advertising

Cellular towers Fiber optics Advertising Etc.

•

•••

•

•

•

•

Sub-objectives (preliminary)

Etc.Tx towers Comm linksPole plant High use sites

Joint use/attachments

Joint use /attachments

Given the level of organizational change required and the amount of potential upside, we advocate pursuing these changes in waves as opposed to trying to attack every revenue cycle simultaneously. This may mean working on three to five revenue cycles at a time (e.g., start with billboards, pole attachments, and damage claims). Look for high-value, simple chang-es that don’t have unwieldy implementation risks.

4. Form a revenue-responsible organization. This does not imply rethink-ing core responsibilities in the field for the execution of core work. Rather, it means focusing on the organization that does not exist, namely, the Front Office––the classic business development functions associated with conceiving and executing market strategy, such as product development, pricing, promotions, and distribution channels. Assemble a function accountable for revenue realization and create a formal business-within-a-business structure. Infuse this business with a profit and loss (P&L) statement and name a general manager. This includes working carefully with legal, credit, risk, and regulatory disciplines to effectively position the business.

Closely proceeding along these four steps will help to avoid the inevitable turf wars and boundary disputes associated with a cross-functional pro-cess that has no owner. The trick is to not allow the systematic realization of quick wins to get bogged down by overly complicated, perfect fixes. It’s critical to break through the culture with rapid execution.

* * *

Any CFO or CEO should be delighted to find an unexpected $50 million in new earnings contribution from a latent source, particularly since the investments needed to realize the revenues are already in place. The energy utility equivalent of “call waiting” is a viable growth strategy. It just needs to be recognized as such and released from the operational limitations that bind it.

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Making Utility M&A Succeed in 2008Despite many hurdles, merger and acquisition deals are getting done, as shown by National Grid/KeySpan, TXU, and WPS/Peoples Energy. However, obtaining the necessary regulatory approvals requires persis-tence and resilience, and creating lasting value from a merger or acquisition remains a tough proposition.

With private equity and financial players now entering the utility arena, such as Macquarie with Duquesne and Puget, and KKR with TXU, com-petition for good deals is intensifying. Private equity players and infra-structure funds bring low-cost financing and an operational discipline to the table. Strategic buyers such as utilities need to creatively and aggressively identify the distinctive value that they can deliver.

Unlocking the Value Most utilities focus M&A value creation on cost reduction and opera-tional improvement. Some also pursue revenue growth opportunities by leveraging underused assets, such as power plants, or by extending their natural gas or unregulated businesses. Leading utilities go a step further, using M&A not just to drive costs out of the target company but also as a catalyst to transform and drive costs out of their own organization.

Oliver Wyman’s recent work with utility transactions has focused on helping companies examine and evaluate the deal up front and successfully deliver value during post-merger integration planning.

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Utility net acquisitionor merger benefits

Regulated businesses cost savings Regulated businesses cost to achieve (one-time)

Informationsystems5 – 15%

A&G-related

10 – 20%

Facilities5 – 10%

Procurementand supply chain

5 – 15%

Increased revenue

• Generation operation and optimization• Gas penetration/market share• Non-regulated business growth

Personnel costs(payroll and benefits)

50 – 65%

Non-labor costs35 – 50%

Transaction-related

Personnel-related

Transition-related

IS -related

Exhibit 1 Potential value-creation opportunities

18 Joules/2008

Beyond SynergiesStrategic buyers in the utility industry cannot make deals succeed financially through synergies alone. They must tap other sources of value as well.

Beyond integrating operations, M&A should serve as a catalyst to transform both companies, not just the target. We typically find many “performance push” opportunities to transplant better practices in areas where pure syn-ergies tend to be small—for example, in transmission and distribution (T&D) field work and generating plant maintenance. Exhibits 2 and 3 illustrate the types of performance push improvements possible in T&D operations.

Leading utilities also use M&A to acquire talented senior managers, migrate to new ERP or operational information systems, standardize processes and practices, and transform an organization’s culture and behavioral norms.

Exhibit 2 Signifi cant value comes from “performance push” opportunities

Good performer Poor performer

Performance push: Improve under-performing functions using merger or acquisition as the catalyst for change:

Good performer: Share best practices

Poor performer: Transplant preferred model

Synergy: Create value from increased scale

Exhibit 3 Representative T&D or energy delivery value-creation opportunities

Synergy

Performance push

Savi

ng

s

Cost

• Headquarters and back offi ce

consolidation

• Adjacent service territory and fi eld

operations integration

• Information systems

• Material and equipment standards

• Procurement

• Training course development

• Field crew work practices and methods

• Process streamlining

• Engineering and construction standards

• Contractor and project management

• Maintenance program design

Asset optimization and utilization

• Facilities

• Corporate offi ce space

and buildings

• Service centers

• Inventory: Safety stock,

emergency spares

• Specialized construction equipment

• Project evaluation and selection

• System planning criteria

• Engineering and construction standards

• Vehicles

Risk mitigation or management

• Material availability (inventory)

• Labor (strike) contingency planning

• Service levels

• Reliability and gas leak response practices

• New business / customer hook-ups

• Engineering and construction standards

• Reliability program management

• Environmental and safety programs

19

19

Joules/2008

Exhibit 4 Utility deal makers and breakers

Deal makers

• Potential to create signifi cant value from M&A combinations

– Synergy savings, primarily from combining

back offi ce (A&G) functions

– “Performance push” value from transplanting capabilities

and practices to take performance to a higher level

• Opportunity to quickly acquire capabilities through M&A,

rather than growing or nurturing internally

– People or expertise (e.g., management talent, trading

capabilities, power plant management skills)

– Information systems

• Desire to build scale quickly

• Cultural fi t between companies supports the

development of strong relationships between

leaders of the two entities

• CEO demographics – one leader ready to retire

in near future

• CEO’s desire to leave a legacy

• Acquisition of a distressed asset is often easier, as regulators

may be happy to see a management change

• Desire to get the deal closed

• Tolerance for uncertainty, willing to deal with

long and uncertain approval period

Deal breakers

• Risk of giving most or all value to other stakeholders

(e.g., customers, special interest groups) to acquire regulatory

approvals, leaving little upside value for shareholders

• Risk that regulators will seek to capture synergy value from the

integration of unregulated businesses in addition to the value

from the regulated entities

• Transaction is opportunistic and not based

on a corporate strategy

• Differences that naturally arise between two

companies’ leaders during the long “engagement” (regulatory

approval) period foster tension and a “we-they” mindset

• CEO demographics – neither leader looking to retire or move on

• Both CEOs have strong need to lead, rather than

also act as a team

• Diffi cult to acquire well-performing company if regulators are

satisfi ed with management status quo

• Jurisdictional protectionism (e.g., parochial staffi ng level

requirements) inhibit ability to achieve synergies

• Desire to put the deal behind them

• Need to put a stake in the ground and not face

uncertain, seemingly endless regulatory

approval process

Economics

Corporate vision and strategy

Relationships and culture

Regulatory approval process

Management priority or focus

Persistence and Resilience Value creation does not guarantee that a utility M&A transaction will close. Merging two companies is fraught with challenges, and senior management and the board of directors must have the stamina and fortitude to see the process through.

For the utilities sector, the fragmented regulatory structure in the United States poses challenges that other industries do not face: typi-cally requiring many regulatory approvals and many local stakeholder demands to appease. Management will have to cope with uncertainty and stay the course throughout a long period between announcing and closing the deal. Executives must ensure that the deal makers outweigh the deal breakers, as shown in Exhibit 4.

20

Successful Post-Merger Integration Success requires careful planning and targeting, as well as aggressive execution. Oliver Wyman employs a variety of best practices to help utilities in their M&A planning and post-merger integration. As shown in Exhibit 5, we organize these practices around three main stages: developing the integration strategy, performing post-merger integration planning, and implementing these plans.

Joules/2008

Exhibit 5 Integration best practices

Strategy development and targeting

Focus on the deal logic

and drivers of value

• Clarify how value will be created:

– Synergies (e.g., in procurement)

– Applying a better operating model

to optimize reliability and costs

• Set integration philosophy (e.g., speed,

risk tolerance) and guidelines for

integration approach

• Screen candidates and involve operating man-

agers in rigorously evaluating potential savings

• Use due diligence to calibrate potential con-

straints on synergy savings and

integration ease

• Make early decisions to create the vision

for the merged entity and guide

integration work

Integration planning

Set clear

integration priorities

• Set aggressive targets

• Use M&A as a catalyst for signifi cant

performance and cost improvement

• Create a formal integration management

structure

• Integrate as completely as feasible to

maximize savings

• Rebut “we’re different” attitudes with

solid analyses

• Identify champions to help push issues

and drive change

• Consider and anticipate implementation chal-

lenges

Execute and implement

Start transition

early and execute rapidly

• Move quickly

• Name new management early enough to

ensure adequate ownership of integration

recommendations

• Place as much emphasis on softer change man-

agement issues as on traditional

operations and strategy questions

• Closely track progress and modify plans

as needed

• Capture quick wins and publicize to employees

21

Anticipating the Challenges of an Aging WorkforceShifts in workforce demographics and business requirements are creating real risks for utilities. To mitigate these risks and lay a founda-tion for an effective future workforce, senior managers must understand the dynamics of their current employee base, the drivers of turnover, the knowledge and skills that must be shared before they are lost, and the best ways to tap into the future talent pool.

Joules/2008

Demographic shifts• Aging population• Increasing diversity• Changing attitudes

toward work• Emerging talent

shortages in select areas

Looming workforce risks

• Loss of key skills and experience through downsizingand retirement

• Misalignment of remaining skills with future businessrequirements

• Employee dissatisfaction with existing career paths and reward systems

• Increased turnover, training, and recruitment costs• Shifting cultural and behavioral norms

Economic pressures

• Need to grow earnings to reduce debt and support equity values

• Need to rationalize staffing after M&A

Operating pressures

• Rising customer and regulator expectations

• Changing job and technology requirements

• Increasing use of off-shoringand outsourcing

Exhibit 1 Current employee base dynamics

22

The Emerging Labor GapAt many firms, especially those in mature industries such as utilities, upstream oil and gas, chemicals, aerospace/defense, and aviation, the work-force is rapidly growing older on average. Most U.S. utilities, for example, will see between 40% and 50% of their workforce become eligible for retirement over the next five to ten years. Consider the trends depicted below:

Joules/2008

Despite this inevitable demographic trend, there is scant evidence of suc-cessful strategies and activities by employers to date. A recent MetLife study noted that more than one-third of all employers, and nearly half of those with 25,000 or more employees, agreed that the aging workforce will have a significant impact on their operations, yet more than three-quarters of them have not taken any steps to accommodate older workers.

Oliver Wyman’s research and client experience suggest that there is no single solution to address the challenges of an aging workforce. Instead, each utility will need to develop an approach that’s tailored to its own busi-ness requirements and operating environment and includes a mix of tactics addressing turnover, recruiting, training, rewards, and knowledge transfer.

As just one example, utilities that run nuclear plants face a shortage of young engineers and other staff who are trained and certified to operate and repair the plants. University programs for such positions have also waned. Aging nuclear workforces thus pose a major challenge for utilities, especially those that may be gearing up for a wave of nuclear plant construction.

Powerful Analytics Needed to Address the Key Risks Historically, most utilities have relied on high-level benchmarks, existing per-formance reports, and anecdotes to identify and evaluate workforce issues. These traditional approaches, however, cannot provide information that is suf-ficiently specific and forward-looking to be useful in answering detailed ques-tions such as:

U.S. population age 65 and overas % of total population

Projected growth in U.S. work-force by age group, 2002-2012

External labor market data forecasts, jobs vs. employees

0

5

10

15

20

25%

1950 2000 2050

10%

-7%

14%

51%43%

13%

-10

0

10

20

30

40

50

60%

20-24 25-34 35-44 45-54 55-64 65+

Employee’s market

Fewer jobs than people

Employer’s market

transition

More jobs than people

140

145

150

155

160

165

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Civilian labor force (employed or looking for work)Employment (jobs available)

2002

Sources: Projections based on the intermediate assumptions of the 2005 Trustees’ Reports, IAEA, NEI, Offi ce of the Chief Actuary, Social Security Administration, Oliver Wyman HR, AARP, Oliver Wyman analysis.

In millions

Exhibit 2

23Joules/2008

Which skills and capabilities are most at risk?

In what functions, levels, and geographies will these be located?

What new skills and capabilities are required by business objectives? Where will these be located?

What is the trajectory––the promotion path, training needs, and tim-ing––for internal candidates to fill key roles?

What external talent pools will be needed? What is the outlook for candidates in these areas?

Which career paths and reward systems must be redesigned to respond to new employee needs?

A more rigorous analytic approach will help managers to define, priori-tize, and mitigate their workforce risks. We have found that an effec-tive first step is a workforce gap analysis that brings together busi-ness strategy requirements with detailed workforce data to highlight any gaps between the current trajectory and the targeted future state. Gap analysis can target the workforce broadly or specific subsets of employees. Identifying the gaps then helps shape an action plan to address the most important risks.

Strength asa platform

forworkforcestrategy

High

Low

• Simulations/forecasting• Causation analysis• Correlation analysis• Benchmarking• Performance reporting• Reactive checks• Anecdotes

Strength asa platform

forworkforcestrategy

development

High

Low

•••••••

Desired state: business requirements

Current state: workforce dynamics and external labor market

Gap analysis, plan design, and implementation

Inputs include:• Market and customer data• Strategic and operating plans• Performance targets• Productivity data

Inputs include:• Labor market data• HRIS and payroll data• Employee perspectives and feedback• Recruiting data (quantitative and qualitative)• Other internal data (training programs, etc.)

Outputs include:• Perspective on:

–Workforce required bybusiness objectives

–Expected evolution of current workforce

• Assessment of priority gaps• Targeted initiatives, timing,

and responsibilities• Milestones and metrics for

tracking progress

Exhibit 4 Workforce gap analysis

Exhibit 3 Major analysis tools

Examples of Oliver Wyman Analysis

Workforce planning

Analysis of workforce future requirements helps:

Identify areas at risk by level, pay bands, job classifi cation, occupational groups, departments, and sites

Establish retirement patterns, and eligibility including pr omotions and lateral movements

–Not just numbers, but also the skills to enable gap analysis

Identify succession management needs, focusing on selected problems instead of generic responses

Talent development

Mapping how employees develop in targeted functions helps:

Identify future gaps between the current trajectory and desired future state

Identify actions to be taken, such as:

– When and where external hiring should be considered

– What types of training programs should be introduced and when

– What other steps might be helpful,e.g., phased retirement

Best practices

Analysis of initiatives against a set of utility and other industry best practices helps:

Determine new initiatives that might have been overlooked

Understand potential success of current initiatives in development

Prioritize initiatives against identifi ed gaps

Goal 1Create a bigger pool of laborthrough education support

Goal 2Increase pool of non-traditional applicants

Goal 3Increase channels of reaching applicants

Goal 4Increase company and indus-try appeal to recruits andraise yield

Goals Initiatives/Focus

NoneCollegecampus

presence

Co-ops/Internships

Company-sponsored

tuitionsuport/

scholarships

Educationalprogram

support (i.e.,equipment,sponsoringprofessors

Pre-collegeefforts

Traditional“feeder”

(Undergrad/grad

students)

Minority/female Military

Experienced,older, pastemployees

Non-traditional

schoolsForeign

Traditional (colleges, printonline websitesand big boards, e.g., Monster)

Professionalrecruiter Referral

Niche associations and onlineniche sites

Workforce investment

board

No additional efforts

Improve compensationand benefits to stay

competitive

Ad hoc efforts toincrease appeal

Highlight companyand industry benefitsthrough PR campaign

√√ √√ √√ √√

√√√√√√

√√

√√ √√

√√ Company X ongoing

√√ Company X partial/planning

Identified best practice

Talent Development Map

Entryengineer

Engineer

Seniorengineer

Supervisor

Consultant

Manager

2 years

6.4 years 2.4 years

10 years

1.4 years

24 Joules/2008

Source: Mercer

Source: Mercer

25

Questions for Managers

Workforce gap analysis

Joules/2008

Desired state: business requirements

Current state: workforce dynamics and external labor market

Gap analysis, plan design, and implementation

� How are your company’s business requirementsgoing to change over the next five years? Ten years?

– New skills?– Replacement skills?– Changing employee preferences and needs?– Other?

� What is your current workforce situation?

– Demographics?– Available skills?– Job mix and career path options?– Systems (reward, recruitment, knowledge transfer, workforce planning)?– Other?

� What is the outlook for the external labor market?

� How well do you understand these issues across your full workforce?

– Management?– Technical staff (engineers, certified staff, etc.)?– Support and shared functions?– Other?

� What key issues and gaps exist?

– Known?– Possible?

� What degree of confidence do you havethat the most important gaps are:

– Identified?– Defined and prioritized?– Targeted by action plans?– Being addressed with appropriate effort and speed?

� Have you sufficiently explored potentialaction areas in:

– Job and career redesign?– Creative hiring practices?– Knowledge management and

transfer practices?– Pay and benefit alignment?– Culture and communication practices?

26 Joules/2008

Lean Tools to Raise Productivity Across the Value ChainUtility companies are trying to find ways to reduce operating expenses without impacting service levels. Best-in-class utilities have reduced operat-ing and maintenance costs by 15-25% in as little as six months and have continued to improve performance out to 18 months. What drives these high levels of operating performance and productivity are “lean” concepts and tools that make organizations more nimble, efficient, and productive.

Leaders and StragglersThere is a large gap between productivity leaders and stragglers in the indus-try. The bottom quartile of electric utilities are performing with ratios of oper-ating and maintenance (O&M) expenses to operating revenue that are 1.7 to 2.0 times that of the 1st-quartile benchmark.

While O&M expenses of electric utilities range from 40% to 80% of operating revenue, the best performers are operating in the 40-54% range. Laggards can increase profitability through an operational lean transformation, and even solid performers can rise to the next level by using lean techniques to fine-tune their operating model.

Exhibit 1 O&M expense as a share of operating revenue

0

10

20

30

40

50

60

70

80

90

100%

E1 E2 E3 E4 E5 E6 E7 E8 E9 E10 E11 E12 E13 E14 E15 E16 E17 E18 E19 E20

Electric holding companies with operating revenue greater than $3 billion

1st quartile54%

2nd quartile65%

3rd quartile69%

27Joules/2008

Lean SolutionsAlthough lean concepts have been around since the 1980s, adoption out-side the automotive industry has been sporadic. Lean tools drive waste and inefficiencies out of the value chain to drive improvements that flow to the bottom line.

Exhibit 2 Common utilities problems and lean solutions

How Lean Works by Reducing Inefficiencies Sample field observations of work crews have revealed non-productive time of as much as 50-60%. This wasted time is often driven by factors outside the worker’s immediate control, such as waiting for material, poor sequencing of work tasks, or delays in arrival to the job site.

By establishing work standards, pre-staging and kitting material, effi-ciently sequencing work activities, and measuring performance against established work standards, companies can dramatically reduce wasted time and cost while they improve productivity.

Measuring and Targeting Inefficiencies The effectiveness of functional groups (engineering, technical services, planning, and scheduling) in supporting the field is an important factor in resource utilization. Completing a mapping analysis of their work streams helps to identify inefficiencies and improvement opportunities, which are shown as starbursts in Exhibit 3. Management can then target these inefficiencies through an action plan to eliminate temporary solutions, excessive hand-offs, and interruptions in the flow of work, information, and material to the field. The goal of the action plan is not only to increase labor productivity in the back office, but also to drive efficiency in the field.

• Operational centers of excellence• Standardized work • Work structuring and sequencing• Equipment, tooling, and material presentation• Synchronized scheduling

• Scheduling visibility• Material pull replenishment• Kitting and material presentation

• QCDS metrics (KPIs)• Standardized work (maintenance)• Rapid response protocols• Problem solving

• Lean management operating system• Lean office station design• Standardized work for support personnel

Key symptom Lean solution

Poor labor productivity

Poor material availability

Poor system reliability

Ineffective operations and maintenance support (engineering, technical records, planning, quality)

28

Case Study Applying lean methodologies and tools to transmission and distribution operations can deliver significant results, as shown with a Oliver Wyman utilities client in Exhibit 4.

Joules/2008

Exhibit 3 Sample value stream mapping analysis

Exhibit 4 Impact of Oliver Wyman lean project

These results were achieved through a series of lean initiatives, with sig-nificant improvement in operating performance in the first six months and continuous improvement out to 18 months and beyond (Exhibit 5).

Beginning of project End of project % change

Annual labor spend

Work order process steps

Work order process cycle time

Project lead time, new construction

$20 million $17 million -15%

31 steps 20 steps -35%

20.7 hours 12.4 hours -40%

52 days 33 days -37%

29Joules/2008

Exhibit 5 Lean impact on O&M expense

Questions for Managers

Is your company lagging in operating performance? Or if a solid per-former, do you want to move to the next level?

Are you bogged down by:

Poor crew utilization and labor productivity?

Construction cost overruns and delays?

Excessive construction lead time (engineering, transmission, and distribution)?

Poor service levels?

Excessive administrative hand-offs?

Complex and cumbersome work management systems?

30 Joules/2008

Top of the Commodity Cycle or Structural Shift for Sourcing?Sourcing strategies have returned as a critical issue for energy utilities. External pressures on the supply base are raising new risks and fewer opportunities, and utilities that lack a truly strategic approach to sourcing will likely be surprised.

A unique set of cyclical price pressures in raw materials and labor markets is causing upward price volatility. If mishandled, these pressures might transform today’s cost savings programs into tomorrow’s cost avoidance programs. A strategic sourcing approach can anticipate these developments while continuing to deliver major improvements to the bottom line.

Cost-saving efforts today have a defensive quality, as rising fuel prices for utilities in all regions of the U.S. have put upward pressure on customer rates. Faced with intense legislative, regulatory, and consumer scrutiny, utili-ties hope that cost-cutting will protect their earnings outlook. Unfortunately, many components of rising costs lie outside utilities’ direct control, notably:

Input fuels and purchased power

Required power plant environmental investments

Transmission capacity investments

Employee health and welfare coverage and pensions

Security and insurance premiums

Raw materials (e.g., copper, steel) impacting purchased goods

Emerging labor shortages impacting supplemental labor costs

Regulatory compliance (e.g., Sarbanes-Oxley)

While the situation varies from one utility to the next, widespread cost escala-tion in raw materials and labor markets (Exhibit 1) means the industry needs to more carefully manage interactions with the supply base.

The Appeal of Sourcing StrategiesAn old cost-savings favorite, sourcing strategies, is back in vogue. Strategic sourcing has been practiced by utilities since the mid-1980s, and many have returned to this work with a vengeance. Cost take-out from the supply base holds appeal on several dimensions:

Represents a significant component of utilities’ cost structure and offers real bottom-line impact

Spares upheavals and the loss of morale associated with eliminating employees (especially given complexities tied to an aging workforce)

Benefits from widespread board support, since many directors have used supply chain initiatives in their own companies

Constitutes significant synergy savings in horizontal mergers between utilities with overlapping supply bases

The traditional expectation for savings from addressable spend is 3-6% for commoditized hard goods (e.g., cable, conductor, meters, and distri-bution transformers) and 5-10% for services (transmission and distribu-tion (T&D) line contractors, information systems contractors, and power plant supplemental labor forces). However, in the face of manufacturing capacity shortages, lower craft productivity, and labor shortages tied to an aging workforce, many observers now project these costs will increase. For utilities spending billions of dollars on goods and services as part of an infrastructure boom, these estimates translate into tens of millions of dollars of potential savings at risk.

Many sourcing efforts start with detailed spend summaries and a short list of spend categories and sourcing strategies for a one- or two-year fore-cast period. Our experience suggests that this traditional approach falls well short of anticipating today’s dynamic supply markets. The lack of a truly strategic approach to sourcing stems from several tendencies:

31Joules/2008

Exhibit 1 Key components driving utility cost increases

–

Supply baseIllustrative components

Representative escalation

CAGR

Input fuels

Raw materials

Direct labor

Indirect labor

• Labor cost index, wages and salaries

• Crude oil

• Natural gas

• Labor cost index, white collar wages and salaries

• Copper• Steel• Industry chemicals

118%

228%

313%

119%

436%167%169%

Employee benefits

Insurance and security

• Labor cost index - total benefits

• Risk premiums• Security costs

122%

N/A

3.3%

14.5%

21%

3.5%

27.8%8.9%9.2%

4.1%

10-15%

cost inputs Period

Source: Bureau of Labor Statistics, Commodity Research Bureau, Yahoo Finance, Oliver Wyman analyses.Note: Price changes for input fuels and raw materials for the period - January 2000 to December 2006; for labor expenses, insurance and security from Q1 2001 to Q4 2006.

32 Joules/2008

Lack of a big-picture view

Prevalence of backward-looking, static tactics

An inward focus that misses developments in core supply markets

An ineffective overlay of sourcing strategies onto asset management programs

Separately, each of these influences will limit results. Together, they dra-matically undermine the potential for cost containment while increasing the risk for cost escalation. Let’s look at each in turn.

Understand the Big PictureStrategic efforts, by design, need to consider a broad landscape in order to put sourcing initiatives in the context of value creation. Oliver Wyman rou-tinely captures this view through intensive benchmarking of performance by individual purchase category and across the entire supply chain.

Findings from these benchmarking efforts have led to several strategic insights. On the quantitative side, examples include:

Significant gaps in spend benchmarks suggest large potential savings when total purchases of goods and services are normalized per customer (for distribution) or per megawatt hour of production (for generation).

These benchmarks point to 20-40% cost reductions per category for under-performing utilities, far better than the 5-10% reductions sug-gested by generally accepted practice.

For many utilities, these figures represent tens of millions of dollars in untapped savings potential.

Findings on the qualitative side reveal emerging trends that underpin the nature of future spend. For example, in the distribution sector:

Self-diagnosing distribution grids are on the drawing board, consistent with widespread deployment of two-way communication technologies.

Line crews will work predominantly in a live-line environment, with repair crews expected to master new skills.

Distribution circuits should perform much closer to design margins than previously.

33Joules/2008

Each of these trends has the potential to change the nature of a utility’s relationships with its suppliers. Informed sourcing strategies will monitor and anticipate shifts to the operating environment.

Take a Forward-Looking ApproachStrategic thinking pays close attention to future positioning and needs. Yet most strategic sourcing work is inherently backward-look-ing. It uses spend trees built with historical data to target savings, while forecasts of future needs and related spend on goods and services tend to be missing or inaccurate. Managers spend little time integrating forward-looking asset management strategies with stra-tegic relationships in the supply base, such as the need for high-volt-age line contractors in transmission build-outs. Moreover, strategic contributions from the supply base are rarely called out as a vital part of a utility’s business design.

The net effect for most strategic sourcing efforts is a one-time con-tribution of cost savings, rather than a continual alignment of supply base relationships with asset investment programs. Supplier rela-tions tend to focus instead on consolidating volumes and reducing prices, which hinders efforts to build longer-term partnerships.

As the industry increasingly needs to rebuild, reinforce, and expand infrastructure across the power sector value chain, a static view becomes especially limited; forward-looking supplier partnerships will become a key lever for sustainable value creation (Exhibit 2).

Exhibit 2 With suppliers, take the long view

Higher level of savings

identification and capture

Quicker time to savings realization

Continuous improvement Enhanced

sustainability of savings

Strategicsourcingevent

Ongoing supplier relationship management

Strategic sourcingimplementation

Time

Potential additional savings with ongoing supplier relationship management

Potential savings from status quo sourcing approach

Potential lost savings without ongoing supplier relationship management

Savings realized over time (illustrative)

34 Joules/2008

Cultivate an External PerspectiveSourcing work, by definition, requires an external focus and attention to emerging supply market developments that does not lend itself to internal discussions of planning criteria and annual budget reviews. Procurement teams often focus on providing superior service to “internal customers” and dwell on internal demand signals for goods and services. They lose sight of the depth and severity of changes occurring in core supply markets and fail to advise operating units of critical develop-ments. The recent run-up in power transformer prices is a classic exam-ple (Exhibit 3).

For years, transformer manufacturers have experienced a wave of con-solidation, removed excess capacity, moved their operations off-shore, and experienced dramatic run-ups in commodity metals prices. Clearly experiencing an upward price cycle over the past several years, shrewd procurement teams were refreshing their sourcing strategies and locking in volumes and price points two to three years ago. Those not anticipating these types of supply market shocks are being relegated to “price takers.”

Another wave of rising prices is now occurring in craft labor markets serving the power sector, where more workers are retiring just as the power sector build-out hits its stride. Conversely, service contracts with application software providers offer significant savings potential as they strive to link services with software to avoid commoditization of their product lines.

Integrate Asset Management and Sourcing StrategiesIn many instances, senior supply chain executives are not intimately involved with the asset management strategy, and asset investment plans are not tied into the evolving dynamics in supply markets. Furthermore,

Exhibit 3 Power transformer prices accelerate

Large power transformers price index

Raw materials price increases change, year-over-year

2004 2005

� Aluminum 21.1% 8.8%

� Copper 67.5% 34.3%

� Steel 34.4% 8.5%

2003 2004 2005 2006 2007

80

90

100

110

120

130

140

150

160

170

180

2006

26.8%

79.8%

9.0%

Source: BLS (PPI - Power and Distribution Transformers, ex. Parts), Oliver Wyman analyses

35Joules/2008

asset strategies tend to be more akin to spending programs than asset investment plans. The lack of clarity around asset investment plans can undermine supply chain management’s ability to make a substantial contribution. Factors such as the timing of large purchases, current sup-ply market conditions, or the availability of supplemental laborers do not inform key trade-offs within asset management strategies.

As a result, sourcing strategies often fall out of step with core market conditions and utilities use procurement models that are aligned with past supply environments, which featured commodity and service excess capacity. Practices that maximized value in this environment, such as spot bidding, will not work well today when capacity shortages are loom-ing. The inability to access certain construction services skills is already starting to affect the timing, duration, and cost of major projects.

Put Strategic Thinking Back into Sourcing WorkAn early emphasis on the strategy of a utility and how asset plans inter-sect with vital supply markets allows managers to achieve significantly greater operating and financial results. Oliver Wyman backs this notion with robust benchmarking databases that clarify the size of the opportu-nity for cost take-out (Exhibit 4).

Exhibit 4 Is the current response suffi cient to meet future challenges?

Short list of improvementopportunities

Establish gaps in needs/expectations

Review assetmanagement

programs

Identify supplierrelationship

management status

Agree on benchmarking and

best-practice framework

Map capabilities vs. framework

Establish gaps in performance

Rank opportunity costs

Do we get results?

Do we follow best practices?

Pre-determined factors

Clarifymarketplace

changes

Do we have a clear view of the market?

New, driving forces

Emerging responses

Major uncertainties

Become familiar with asset

management needs

Overlay onto supply base

Rank gap-closing

options

36 Joules/2008

Seven principles can help guide the effort:

1. Define scope strategically. Choose purchase categories consistent with your asset management strategies (e.g., in support of environmental retrofits or transmission build-outs) and adopt practices that start with internal customer priorities and use benchmarks to size the opportunity.

2. Employ joint teams. Use multi-function teams and involve suppliers to promote innovation and buy-in.

3. Collaborate with suppliers. Share information in a meaningful way and choose partners based on their track record for driving change within utilities.

4. Use targeted, objective goals. Focus on a short list of purchase catego-ries with explicit targets for cost take-out. Avoid long lists of tactical categories, vague sourcing strategies not tied to the market, or broad ranges of estimated savings.

5. Stick with the tried and true. Since many companies source office supplies, wireless telecommunications, legal services, and servers, tap into known best practices by purchase category and extract value from tried and true methods.

6. Bake targets into budgets. Become part of the solution for lines of busi-ness like T&D operations and the nuclear fleet. Offer line units innova-tive ways to contain their escalating budgets and show them the value in supply base initiatives.

7. Create governance models with “teeth.” Establish business-unit led procurement councils that drive sourcing efforts, infuse teams with courage to challenge the status quo, and track progress. Strong councils fuel multi-year success.

These principles, backed by rigorous analysis and solid data, will put the strategic thinking back into strategic sourcing.

37Joules/2008

Managing Customer Satisfaction Involves More Than Improving Reliability

Electric utility executives have long understood that customer satisfac-tion has great value even in a regulated environment. Customer satis-faction informs and shapes corporate and regulatory strategies, serves as a rallying point for employees, and helps prioritize system invest-ments to better meet customer expectations.

What’s not always clear to executives is the role that customer satisfaction can play in generating shareholder value over the long term. Moreover, utilities are facing new challenges to managing customer satisfaction:

Among customers, the traditional emphasis on system reliability aver-ages—as measured by traditional indices such as CAIDI (Customer Average Interruption Duration Index) and SAIFI (System Average Interruption Frequency Index)—is giving way to concerns about reli-ability at the community or feeder level.

Regulators are moving from overseeing the entire utility value chain to a focused review of how customer satisfaction links to rate relief procedures.

Shareholders are emphasizing targeted spending to improve returns instead of maintaining spending in line with previous years.

The reality is that most utilities have a long way to go in mastering the discipline of managing customer satisfaction. A recent analysis by Oliver Wyman shows that the gap in satisfaction between top-perform-ing utilities (as measured by the American Customer Satisfaction Index) and median-performance utilities is close to 10 points and growing (see Exhibit 1).

Addressing these challenges requires a clearly defined process and broad organizational support. Our research into utilities known for best practices suggests that the most effective process has four key elements:

1. Develop an overall understanding of customer satisfaction, its percep-tion drivers, and opportunities to improve performance.

2. Commit to a model that focuses on both satisfaction performance and perception and differentiates among customer segments.

38

3. Develop and rank initiatives through a well-structured process.

4. Mobilize the organization to implement the right initiatives.

1. Develop an overall understanding of customer satisfaction, its percep-tion drivers, and opportunities to improve performance.

The first step for a utility is to establish the drivers of customer satisfaction for its own set of customers. Using customer survey data, the utility must determine what matters most to its customers: Is it reliability, price, informa-tion about how to save energy and reduce costs, or other factors?

Current market research models typically provide useful insights into satis-faction, but they do not link the levels of individual perception drivers with overall customer satisfaction clearly enough to be useful for investment or resource allocation decisions. Instead, one must mine available data to link specific satisfaction attributes to overall satisfaction scores—for example, how changes in perception of reliability drive overall satisfaction scores.

The outcome of the analysis should be a customer satisfaction model that represents the relationship between perception drivers and overall satisfaction (see Exhibit 2). These drivers are based on customers’ perceptions on how the company is interacting with them. Perceptions will be driven from a variety of sources, such as direct interactions with company employees, media reports, and communications from city officials and community organizations.

In the model’s hierarchy, the first-order drivers (those with a direct impact on overall satisfaction) are service, price, and reliability; the second-order perception drivers are customer responsiveness, company reputation, man-agement reputation, and outage frequency and duration.

Joules/2008

Exhibit 1 ACSI customer satisfaction performance index

66

68

70

72

74

76

78

80

82

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Top-performing utilities

Median utilities

Source: American Customer Satisfaction Index, residential scores.

Top-performing utilities have made customer satisfaction improvement a priority.

What are the implications for utilities with lower customer satisfaction?

39Joules/2008

A robust satisfaction model allows managers to understand how much overall satisfaction would increase if, say, they raise their price percep-tion score by five points. The insights lead to concrete actions in invest-ment and customer communications.

Of course, the model needs to evolve to respond to shifts in customers’ perceptions. A utility might find that customer service is the key driver of perceptions following recent operational problems, but once the com-pany regains a certain level of performance and customers recognize that recovery, other factors such as billing or outage communications might emerge as more important.

Once managers understand these drivers, the next step is to assess opportunities for improvement. For instance, one can see how the util-ity compares to first-quartile performance, so as to determine where to direct resources. Drivers with the most influence on perceptions might not be those with the largest gaps to first-quartile performance, and this type of analysis can reveal counterintuitive findings. For example, although reliability may be the largest driver of satisfaction, it might be already at a first-quartile level, with further improvements difficult to achieve. A less important driver such as customer responsiveness might have a larger gap to first-quartile performance, making it more important to improve (see Exhibit 3).

2. Commit to a model that focuses on both satisfaction performance and perception and differentiates among customer segments.

Customer satisfaction involves managing both performance and percep-tion. Utilities generally are better at the first, since they have well-defined processes to manage outage duration, call duration, power quality, and

Exhibit 2 Customer satisfaction model

Exhibit 3 Opportunity based on gaps to fi rst quartile

Company reputation Management reputation Outage management Customer services

Environment Employee attitude System maintenance Vegetation management Call center Billing

Reliability

Perception drivers

Overall customer satisfaction

Service satisfaction Price Reliability satisfaction

Price 1.6

Billing 0.9

Outage duration 2.2

Reliability 2.5

Customer responsiveness 3.0

System maintenance 0.5

Management reputation 0.9

DriverImpact on

satisfaction1

Total 11.6

1 Based on opportunity to impact overall customer satisfaction through a move to fi rst-quartile driver performance. Benchmark information may not be available for all drivers.

Note: Drivers and impacts vary by company. Perception scores are determined based on customer responses to survey questions.

40 Joules/2008

so on. Not many utilities, however, have an equally clear process to manage customers’ perceptions in such areas as: How many outages did the customer think occurred over the past quarter? What perceptions of the company do customers get from news coverage?

Case in point: A utility preparing to file a rate increase decided to survey its customers on their perceptions about rate behavior over the past 15 years. The survey revealed that although rates had not changed over that period, close to 90% of customers believed rates had increased. Based on this knowledge, the utility launched an aggressive advertising program to prepare the customer base for the rate case. Clearly, addressing both perfor-mance and perception involves capabilities outside of traditional customer service operations—for example, media relations and brand management during rate cases and mergers.

Utilities will also benefit here from more subtle customer segmentation that goes beyond the traditional revenue class categories. Industrial and com-mercial customers will have varying tolerances for the acceptable duration and frequency of outages. A wood manufacturing company will tolerate outages of five minutes or less, while a warehousing company could tolerate outages as long as 45 minutes. Analysis should use different segmentation variables, such as duration and frequency of outages, urban versus rural location, payment and usage behavior, and exposure to advertising.

A visual model containing the key components will help managers stay on course as they develop initiatives to close identified gaps (see Exhibit 4).

Exhibit 4 Manage performance and perception

Customer satisfaction

Financial performance

Residential Commercial Industrial Community Etc.

Performance Perception

• Price/costs

• Outages

• Power quality

• Call center response

• Etc.

• News media

• Advertising

• External factors (e.g. rate case, mergers)

• Etc.

• Price/costs

• Outages

• Power quality

• Call center response

• Etc.

• News media

• Advertising

• External factors (e.g., rate case, mergers)

• Etc.

41Joules/2008

3. Develop and rank initiatives through a well-structured process.

Once managers have identified the key satisfaction drivers with the larg-est performance gaps, they should develop specific initiatives that take into account the potential impact on satisfaction and profitability. Here are suggested steps to do so:

Step 1: Ask customers the right questions. To understand what drives per-ceptions about billing, for instance, a utility might ask customers: How accurate are the bills? How easy to understand are they? Are we correct-ing billing errors promptly?

Step 2: Map questions to the business processes. Once those questions have been identified, link them to the processes that influence the outcome of the answers. In billing, the utility would identify that the meter reading process and the billing exception management process are responsible for ensuring that the firm produces accurate bills.

Step 3: Assemble and integrate all relevant customer data. This data includes relationship customer surveys (e.g., JD Power, ACSI), transactional customer surveys (call center, new business), customer satisfaction benchmarking data, complaint tracking reports, customer comments, operational metrics, and focus group reports. A full set of customer data helps managers gain a clear and complete understanding of customers’ perspectives on performance.

Step 4: Determine the state of current performance. Use internal survey and operational data to disaggregate the impact of performance and percep-tion. One can link actual operational data to perceived operational data through time series regressions. For example, compare how customers answer the question, “How long did outages last on average over the past two months?” against the CAIDI operational data. This regression analysis will determine the extent to which changes in the operational metric are driving changes in perception. Then, model changes in customer satisfac-tion given changes in key business conditions—e.g., improving CAIDI by X% increases customer satisfaction by Y% (see Exhibit 5).

Data mining will also uncover pockets of dissatisfaction. One utility conducted an analysis of its feeders, categorizing each feeder into a cus-tomer segment that had a set of expectations (e.g., for segment A, cus-tomers will tolerate no more than one outage per year). The utility then analyzed feeder performance against customer expectations and identi-fied that more than 30% of the feeders had performance below customer expectations. In response, the company developed options to improve performance for these feeders and identified an improvement of 10% to 30% in customer lost hours.

42 Joules/2008

Step 5: Find potential initiatives to close the gaps. The focus should be on high-impact areas that need improvement. One source to help identify these initiatives should be best-practice analysis from relevant firms inside and outside the industry.

Look not only at initiatives that will address current perception gaps, but focus also on those initiatives that will mitigate potential erosion in satisfaction in the future. For example, utilities considering filing for rate increases should develop specific satisfaction initiatives to mitigate nega-tive perception from customers, the media, and opinion makers.

Step 6: Evaluate and rank initiatives. The evaluation should be along several dimensions, including estimated customer satisfaction impact, investment, and ease of implementation. To determine the impact on satisfaction, managers must be able to estimate the number of customers impacted, the frequency of the contact, and the magnitude of the change as seen from the customer’s point of view. Once that impact is estimated, managers can calculate a return on investment (see Exhibit 6).

Step 7: Establish performance metrics to track progress. With the designated initiatives in place, utilities will need to develop a set of performance metrics aligned with the initiatives and the perception drivers. To mea-sure reliability performance, for instance, one utility went beyond the tra-ditional CAIDI and SAIFI measures to develop metrics such as 1% worst-performing circuits, customers interrupted X times or more, and trouble cases caused by equipment failures.

Exhibit 5 Reliability performance (illustrative)

CAIDI (minutes per outage)

High LowLow

High

Customer satisfaction

with reliabilityLarge gains for reliability improvements

Limited additional customer satisfaction impact

Modeling can determine your position on the curve to allow for focused allocation of scarce resources.

43Joules/2008

4. Mobilize the organization to implement the right initiatives.

Success in influencing the many stakeholders and environments involved in managing customer satisfaction will hinge on broad organizational support. How do you get different departments and functions to collaborate across the entire customer experience and numerous customer touch points?

The commitment should start among the most senior executives, where accountability and ownership of customer satisfaction likely is unclear or perceived to reside only within the customer services organization. Best-practice firms usually assign clear ownership (through a high-level steer-ing committee that meets monthly or bi-monthly) to drive accountability across the organization. These firms also tend to incorporate the initia-tives into their business planning process, as well as track performance metrics that are communicated widely within the organization.

Finally, to ensure widespread support for the approach, utilities should establish cross-functional teams to review the data and identify and rank initiatives.

* * *

Achieving higher levels of customer satisfaction is in itself insufficient; the goal is to link satisfaction to shareholder value growth. To do that, manag-ers must connect their insights about performance and perception to the economics of the business. For many companies, this will entail a shift in mindset from a traditional inside-out, operations-centric focus to outside-in thinking that starts with the priorities of customers. The customer repre-sents the most reliable compass to help you chart your course.

Exhibit 6 Initiative evaluation (illustrative)

Initiative description

• Redesign bill for greater

simplicity

• Increase accuracy of estimated

response times

• Increase focus on worst

performing circuits

Customer satisfaction

return on investment

(points/$)

High

Medium

Low

Ease of

implementation Potential ranking

1

2

3

Driver

Billing

Reliability

Etc.

Oliver WymanWith more than 2,900 professionals in over 40 cities around the globe, Oliver Wyman is the leading management consulting firm that combines deep industry knowledge with specialized expertise in strategy, operations, risk management, organizational transformation, and leadership development. The firm helps clients optimize their businesses, improve their operations and risk profile, and accelerate their organizational performance to seize the most attractive opportunities. Oliver Wyman is part of Marsh & McLennan Companies [NYSE: MMC]. For more information, visit www.oliverwyman.com.

Oliver Wyman’s Energy/Utilities PracticeOliver Wyman’s Energy/Utilities Practice has assisted utilities and related companies (e.g., fuel cycle, engineering and construction, infrastructure services, retail energy marketing) across North America in addressing a broad range of strategic, organizational, and operational issues. We have worked with more than 75 utilities and energy companies on a wide array of assignments, as well as hundreds of companies in other industries.

For more information, please contact:

David Hoffman, Practice Director

david.hoffman@oliverwyman.com

Alan Feibelmanalan.feibelman@oliverwyman.com

Andy Pattersonandy.patterson@oliverwyman.com

Camilo Sernacamilo.serna@oliverwyman.com

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