Leveraging business acumen for utility success.

There's a perfect storm brewing. And it's headed our way.

In organizations that are responsible for delivering utility services, the business side of the equation is often overshadowed by the technical and operational components. The reason is simple: customers notice when the lights go out or water stops flowing, but rarely take the time to question the effectiveness of the business behind the utility. That is, until there is a rate increase or some other event that prompts an investigation. For this reason, many utilities can be slow to change and often harbor basic inefficiencies that impede everything from procurement to maintenance to customer service delivery. This is especially true when it comes to ingrained business processes in the organization. As long as the process seems to function and generates some result, the impetus to take on the formidable task of change usually disappears. But today, storm clouds are on the horizon. The need for business acumen, that is, the ability to make smart business judgments, has never been greater than in today's increasingly demanding environment. For example:

* Billions of dollars in stimulus funds appear to be available, but these will require final accountability;

* The industry seems almost frenetic in its drive to create all or some elements of a smart grid;

* Many jurisdictions are mandating initiatives that ultimately will result in dynamic pricing;

* Customers are increasingly vocal in their expectations of their utility to bring robust technologies to their disposal, and

* The broad range of stakeholders are pressuring for rate stability while the utility faces increasing power purchase costs.

It is not surprising that multiple stakeholders are urging utilities of all types and sizes to achieve maximum efficiencies and effectiveness. With huge sums of capital funds being deployed combined with the current focus on transparency in governance, all areas of business decision-making are subject to after-the-fact critique. Electric cooperatives and utility providers across the country are recognizing the need to address the less visible business issues that underlie organizational effectiveness before a critical need for action arises.

Addressing those obscured business issues requires looking for ways to impart business intelligence into the core business attributes. And implementing that intelligence, that sharp-edged business acumen that separates average from exceptional organizations, yields the greatest benefits when it is integrated into processes so as to 1) make a notable difference and improvement, and 2) yield sustainable improvements.

Capital Optimization Meets the Criteria

One particularly applicable opportunity for directing business focus into a process--that is, inculcating business acumen into the organization--is the process for evaluating and deploying capital investment. This is because improvements in capital deployment processes hold great potential to conserve scarce resources at the same time enabling the organization to meet its mission with maximum organizational benefit. Capital resource deployment is crucially important now as utilities cope with competing investment needs for new generation, green-house gas reduction, aging electrical system replacement, smart grid initiatives and new enabling technologies. And some of these investments, like smart grid, reflect strategic decisions that affect future cost efficiency and operational effectiveness for decades to come. Atop all these needs, the American Reinvestment and Recovery Act stimulus package funding will direct $16 billion for energy efficiency and renewable energy projects alone. The pressure to spend funds on both large and small projects together will be unprecedented in the utility industry, and the approach to deploying capital investment against these competing needs requires a strategic focus.

While virtually all utilities employ some structured means for deciding on annual capital investments, few approach this mission-critical process from the perspective of optimizing those capital expenditures. More often, capital deployment is synonymous with capital budgeting, and the focus descends to one of achieving some bottom line number that reflects total capital spending level. Even worse, many utilities then focus on efforts to reduce that bottom line, a process that results into various cost cutting exercises. Instead of viewing capital investment as a strategic decision, utilities reduce it to a budgeting exercise. When utilities apply business acumen to capital budgeting, the process transitions from budgeting and cost cutting to one that focuses on strategies for optimizing capital assets and resources. Business acumen does not focus on budgets--it shifts the focus to finding ways to measure and assess the value of capital resources and then maximizes that value to the enterprise in support of its mission.

Optimization Approach

Altering processes away from traditional budgeting requires deploying capital in such a way that achieves sustainable and tangible value and has a means to measure that value and gauge the relative degree of optimization. The first step is to create a clear definition of optimization that articulates the strategic factors that must converge for clear enterprise success. These might include:

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How Is Capital Optimization Achieved?

Traditional cost cutting approaches lower spending but usually miss optimizing investments. At best, budget-driven cost cutting initiatives usually exemplify sub-optimization. At worst, they squander expenditures. Budget cuts that target reducing--or cutting specific projects may achieve a one-time cost reduction, but meaningful and sustainable savings only result from implementing improvements to the underlying processes and procedures used to develop the capital investment plan. Rather than merely a cost-cutting exercise, capital optimization focuses on identifying and evaluating value-maximization strategies. Imparting business acumen fosters a creative environment in which to design appropriate approaches to optimize value for all the utility stakeholders.

Whether the need for capital expenditures comes from shovel-ready projects related to stimulus legislation, major utility initiatives or the typical capital project necessary to manage day-to-day expansion and replacements, electric utilities in the United States will deploy enormous sums of "capital" monies. One impediment to achieving value stems from the utility mindset that there is a difference in capital and O&M dollars, as if they are different colors. When utilities apply business acumen, the facts emerge that both capital and O&M expenditures require the same green money and all spending strains the enterprise cash flow. Despite the similarity, annual O&M budgeting often is subject to a thorough, structured development and review process requiring scrutiny and justification. Typically, O&M spending requires transparency between the expenditure and the results. In contrast, capital monies are often more complex, involving multi-year projects with myriad impacts and benefits that cross numerous functions. Unfortunately, capital projects often receive a less thorough review. Many organizations are reluctant to challenge assumptions about the sacred cows of customer growth, service quality and safety. Thus, utilities authorize many projects with less hard justification than that required for O&M spending. Nevertheless, this is precisely the area where spending should be scrutinized to validate the necessity, confirm value is realized and assure alignment with the enterprise mission because:

* Investments made today are typically for projects with a 10 to 50 year life span

* Funding often involves debt obligations that will burden the utility for 20 to 30 years

* Growth-related projects usually incur a delay between the projects that serve that growth and the funding revenues for that growth.

In an effort to manage capital spending, utilities have tried many approaches. Utilities have applied various prioritization schemes and asset management techniques. Frequently, utilities rank projects and establish a line of demarcation at the budget level. The problem with these approaches is that they address the project as presented as opposed to investigating aggressively the underlying justification. Projects can still rise above the line that reflect "personal or "pet" initiatives, chasing "sunk" costs, institutional belief systems, faulty assumptions and the easy path.

The complexities of capital spending do not lend themselves to simple cost cutting. Competing needs and interrelated priorities require a more sophisticated approach. Capital optimization involves implementing a broad scope and high-profile initiative across the enterprise targeted at fundamentally revisiting the decision criteria and mission-critical business processes used to identify and authorize capital projects. Instead of looking at individual projects with an eye towards cost cutting, capital optimization investigates the core business processes in the project lifecycle and looks at how projects evolve from initial needs identification through to project closeout. In that review, capital optimization uncovers and examines perceived project "drivers" that propel a project to approval and completion. The review provides a contrast with how a project is viewed when measured on its value. Not surprisingly, even where a structured project lifecycle exists, it is uncommon to find consistently objective and unbiased project assessments. Adding to the problem, many utilities are not organizationally equipped to uncover unsubstantiated requirements that masquerade as mandatory criteria, highlight unrealistic or untested benefits claims and challenge major initiatives that do not reflect broad enterprise endorsement.

Organizations must tailor any capital optimization process to their specific needs. But the goal of any capital optimization program is to instill business acumen across the range of individuals involved in the project lifecycle. With that goal in mind, a typical optimization program might involve the following six steps:

Process/Approach

1 Capital Program Development and Execution

* Internal perspective of processes and results

* External stakeholder review

2 Program Management Assessment

* Capital program delivery process

* Bidding and contracting

* Project delivery methods

Project management

* Scheduling and costing

3 Capital Projects Process Assessment

* Diagnostic review of process steps

* Evaluate timing and sequencing

* Define linkages to strategy and business planning

* Assess approval process

4 Staffing and Organizational Review

* Organizational design assessment

* Staffing limitations and impediments

* HR management

* Resource requirements

5 Opportunities and Recommendations

* Assess performance measurement and metrics

* ID Core finance and project process improvements

* Enhanced performance management system

* Consistent value measurement approach

6 Implementation Roadmap

* Conclusions and Recommendations

* Structured organizational transformation

* Implementation plan

* Program progress monitoring and reporting

Detailed Evaluation

After an initial data gathering, the optimization process evaluates the capital program taken together. The process evaluates longer-term trends such as annual budget versus actual spending, distribution of project sizes and trends in capital projects based on project drivers, needs and categories. This analytical approach identifies programmatic issues affecting how a company manages capital resources:

* Capacity to accomplish the capital scope of work--many organization repeatedly budget more than they can accomplish or manage

* Project budgeting accuracy--estimating and budgeting are essential to understanding true capital requirements and capacity

* Project and program management effectiveness--where breakdowns occur

This is an example of how one organization had planned a dramatic increase in the planned capital program over a five year period. But when the variances were examined, they tracked inversely with the budget size--the more this organization planned to accomplish, the less they did. Some organizations show a direct correlation between the size of the capital plan and the percentage of unfavorable variances. Both results indicate systemic opportunities to improve capital deployment.

With an understanding of how and where capital projects funds are spent, the next step examines the individual steps that make up the project lifecycle. While each organization may have their own process approach to project design, approval and management, the elements of delivering a successful project can be identified and evaluated. Most organizations can identify how needs are identified and/or how projects result. But the next set of steps, evaluating alternatives, justifying the best project that adds greatest value and authorizing the project expenditure are often where inconsistency and process breakdown occur, leading to projects that fail to reflect optimization. These particular steps reflect the "Danger Zone" as well as the best opportunity to be proactive in avoiding poor projects by employing the basic concepts of capital optimization. A review of all project lifecycle steps might include:

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In the "danger zone," poorly defined and easily manipulated criteria exist in identifying project alternatives, justifying a project approach and authorizing one project over another. Under the guise of necessity or misapplied corporate performance metrics (such as safety), utilities spend capital that appears to be warranted but 1) is not necessarily linked to enterprise goals and performance metrics, 2) responds to wants, not needs, 3) does not adequately consider higher value alternatives (including "do nothing"), and 4) is not well peer reviewed and internally vetted.

Instead, utility decision-makers should carefully review and test each step of the project lifecycle. They should realign each step to bring business acumen into the decision-making process. Finally, utilities should redefine success at each step in terms of ensuring measurable and sustainable value for every invested capital dollar. Process participants and owners, acting with business savvy, can now approach routine decision-making in a more aligned fashion. Decision makers need to consider:

* Projects should link to company goals and strategies--overall capital investment gets directed by financial guidance as opposed to simply reflecting a list of projects

* Project/capital planning and annual budgeting process become more synchronized with a longer-term view while still serving individual needs

* Each step in the project lifecycle reflects clear tasks, responsibilities, and authorities to exercise acute business judgment

* Enterprise capital planning and budgeting become transparent to all functions and reflect an endorsement process based on enterprise value

* All projects reflect consistent and mandatory analytical rigor subject to a constructive challenge process

* Project prioritization criteria are clear and defined at the enterprise, service (utility) and division levels

* There is a clear and empowered governance structure at the functional and enterprise level--a capital review or steering committee oversees capital spending on behalf of the enterprise and makes well defined apportioning decisions

* Prudent and structured business risk is incorporated into investment decision-making

* Cultural transformation works to develop a business orientation that provides direction for professional development and advancement

Conclusion

Today, many utilities are challenged, managing upward rate pressures, strategic capital investments and tightening of the credit markets. The pressure to implement capital projects is unyielding, but many organizations have institutionalized capital budgeting processes that may not reflect adequate scrutiny. Even when they have, many of these organizations cannot confirm that all capital projects are warranted to an equal extent. The goal, then, is to create an enterprise-wide program that aligns capital project decision-making around a consistent view of measurable value to the enterprise, insofar as capital investment funds are limited, a capital optimization program focuses on selecting and delivering the best array of projects to meet the diverse needs of a progressive electric utility.

The key to successful capital optimization in any organization is to instill business acumen across the wide scope of decisionmakers involved in selecting and approving capital projects. The organization needs to embrace cultural values that support sound business judgment. The capital optimization program approach works by defining the business process steps in the capital program, redefining the roles and responsibilities at each step and promoting the use of business judgment aligned with the enterprise's mission, strategies and business goals. This bottom up approach is coupled with top down efforts that create an organizational design, process definition and information tools that support the process contributor.

To be sure, instilling business acumen in an organization and implementing a capital optimization program are long-term, continuous efforts requiring leadership commitment and patience. The results, however, are clearly warranted in direct improvement in capital investment value and in preparing the utility for long term strategic success.

Fred Jennings is an executive consultant at R. W. Beck, an SAIC Company. He has 30 years of experience in utility industry program design and implementation, strategic and business planning, and cost and performance management.

             Variance      Variance %

Year 1         $2.6           -2%
Year 2         $6.2           -4%
Year 3        $28.8          -17%
Year 4        $24.4          -14%
Year 5        $42.2           25%

Note: Table made from bar graph.