Ferranti - Regulated utilities: creating strategy amidst confusion
Regulated utilities are often envied by their peers in competitive markets. After all, they enjoy a government-granted monopoly for their activities and face no direct competition. Most of them are either grid operators in unbundled markets or integrated utilities performing both sales and delivery operations.
Their counterparts are deregulated utilities (often retailers) competing in unbundled markets, which have a clear goal: profit maximization. Deregulated utilities are free to pursue this goal by differentiation or cost leadership strategies and have the right to choose their clients.
Compared to this, the situation of regulated utilities is not as enviable as suggested by their seemingly unassailable position. Even without direct competition, regulated utilities often need to compete against substitutes (electricity vs. gas vs. home solar panels...). Moreover, instead of merely having to maximize profits, they are evaluated on many, often contradictory, objectives.
First of all, most regulated utilities are not allowed to run losses, but their profits also cannot exceed a predefined, low-single-digits percentage. Secondly, their prices are tightly regulated, but they face stringent restrictions about which customers they are allowed to refuse. And thirdly, most of them are obliged to pursue several environmental goals.
In the past decade, the burden of these environmental goals has steadily increased. Technological innovation (smart meters and grids) and the fight against climate change and energy dependency have thoroughly raised the bar for utilities around the world. Many regulated utilities are now tasked with handing out subsidies, reporting countless KPI’s about sustainability and running energy-efficiency programmes to reduce demand for their own product.
In such operating environment, devising an optimal strategy becomes enormously complex. Instead of merely maximizing a single factor (profit), regulated utilities must pursue opposing regulatory goals by constantly balancing a multitude of factors.
Imagine this example: a regulated utility is mandated to introduce an expensive energy-efficiency programme. Inadvertently, the programme mostly reduces the demand from profitable customers. The cost of the programme and the foregone revenue eat away the operating margin required to subsidise unprofitable customers. Since prices are dictated by the regulator, a loss becomes unavoidable and the utility is penalized. How can they square the circle?