Silicon Valley Meets Houston: the emergence of collaboration in energy markets
Business utilities, a new breed of company in the energy market, are poised to tackle severe inefficiencies that have plagued the sector for decades. Energy players that recognize the potential of these emerging models can, and will, wield a competitive edge. But are large energy companies standing in their own way? In this article, Rashed Haq highlights how the energy markets can take inspiration from Silicon Valley to establish collaborative business models that unlock unimaginable opportunities.
In today’s energy marketplace, businesses are feeling intense economic and regulatory pressure on many fronts. There is pressure in terms of commodity prices, with lower demand and high production, as well as a regulatory push to stringently limit speculation and manipulation while protecting the environment (see Figure 1).
Customer and employee expectations are also evolving. In May 2015, Millennials became the largest generation in the US workforce. These people grew up with the internet and the latest consumer electronics, such as the iPhone. They expect to be continuously digitally connected, with real-time, visually rich information at their fingertips. For example, they want to watch a soccer game on TV while looking at satellite-tracked trends on an app on their iPhone.
Millennials also want greater power and freedom to influence their lives, work and environment and are very open to new business models, such as Uber and Airbnb. During the last decade, technology innovations have continued to evolve. There has been an exponential increase in computing power, the advent of the cloud, proliferation of sensors and cognitive computing beginning to go mainstream. These advancements are creating great opportunities, but they are also posing competitive threats to traditional business models.
THIS ENVIRONMENT DEMANDS BUSINESS EVOLUTION
Consider the energy market. For every energy producer, there are many consumers—and a very complex network in between. Figure 2 shows an overly simplified view of this network, in which business processes and information exchange is very intricate and time sensitive.
Most companies have put forth significant effort to automate many of their processes. But more often than not, connecting to external parties is done manually. A key factor is the lack of a formal authority or single decision maker to solve the problem. This leads to challenges of governance as well as equitable costs versus benefits across participants.
In some instances, a few companies have decided to establish connections bilaterally with another company (left side of Figure 3). But it is cost prohibitive for firms to build bilateral bridges to every partner in their ecosystem.
Fortunately for the energy industry, business utilities are emerging that are well positioned to address this collaboration issue (right side of Figure 3). They are automating information flows among producers, consumers, traders and asset operators.
One of the features of such a model is a huge network effect: the more participants join, the greater the value for each participant, and vice versa. Simply put, energy companies will benefit most once the model reaches critical mass.
Energy companies participating in this network will benefit in five ways:
- Productivity—It minimizes repetitive data entry and gives employees more time for value-added activities.
- Trusted information—Having high-quality and timely information
with minimal errors improves decision making. Often, the productivity and efficiency gains from business utility models more than offset the incremental cost. But with today’s advances in analytics, the benefits from trusted information are eclipsing the sizeable benefits of efficiency.
- Scalability—Automation from business utilities allows firms to optimize part of their operating expenses (OpEx). Right now, most companies size their resources close to peak business. For example, if a firm does approximately four to five thousand transactions per month, then it would staff for five thousand. When it exceeds that amount, employees work nights and weekends; and when it decreases, firms pay for holding the peak resource capacity. Leveraging business utilities can more seamlessly align OpEx with transaction volumes.
- Capital efficiency—If a firm belongs to a business utility in which it can send an invoice and its counterparty can send a purchase statement, the firm can match these within a specified amount of time. With this, payment terms can move from months to weeks or days. This will free up capital and enable firms to better utilize credit limits. In addition, firms can create new payment terms. For example, if invoices are not paid within the threshold and they go into exception management, firms can charge a pre-agreed amount to offset the cost of exception management. This creates incentives to have fewer exceptions.
- New products and services—A collaborative network can also fuel the development of new products and services—and entirely transformative models of product service ecosystems that drive innovation and create entirely new opportunities.
As innovations and new technologies, such as the Internet of Things, emerge, collaborating within these kinds of networks will become increasingly necessary for all businesses.
PRODUCT AND SERVICE EVOLUTION
Today’s focus is on combinatorial innovation, where companies are connecting things in new ways to create greater value. A large part of combinatorial innovation is connecting points inside the company with points outside the company (B2B and B2C), enabled by advances in a broad set of enterprise technologies. This is dismantling industry boundaries and creating a new business paradigm of greater B2B collaboration, because it is simply not possible for any one company to have dominance across all these technologies. Collaboration is the key to combinatorial innovation. This is why Harvard Business Review says, “collaborating is the new competitive advantage.”
To understand how this new paradigm is affecting business models, it is important to understand the nature of products. Traditionally, firms made a product and included complementary services with it. For example, BMW made a car, then sold maintenance. Eventually, the company embedded maintenance into the car purchase.
In the last 10 years, “services” have become a way to deliver “products.” In this view, products are delivered as services. For example, Microsoft Word and Excel are now sold as Office 360 for a monthly fee.
Another example involves GE Aviation, a world leader in manufacturing aircraft engines. The market for aircraft engines is small and highly competitive, but for GE, selling maintenance, spare parts and financing is where the company makes most of its profits. Services are 25 percent of revenue and 50 percent of profits. Over time, GE started losing services to smaller competitors. When this happened, GE transformed its business model and created a program called “Airplane Uptime by the Hour,” which requires no upfront costs for the customer and better aligns GE and airline incentives. Through the program, GE maintains a group of specialists who fly anywhere in the world within twenty four hours to repair an aircraft. They focus on rapid learning by developing sophisticated algorithms and real-time telemetry for predicting likely sources of future engine failure and the optimal time to service the engine to prevent such failures. This information is then shared with the maintenance organization as well as engine development. Not only has GE’s new program improved service revenues, it has also reduced competition in the aftermarket for its spare parts and repair services.
More recently, services are connecting to integrated systems, forming product service ecosystems. These ecosystems have multiple layers to engage others in building new services, which is accelerating the pace of innovation. They are collectively developing new products and services, where value is being created from outside the firm, but benefiting both the participants and the firm. For example, Apple takes a 30 percent share of all companies selling through the App Store while enabling hundreds of thousands of businesses to participate and get value from their ideas and services. This collaboration has enabled a level of accelerated innovation that resulted in the development of products and services that Apple had never imagined.
THE ROAD AHEAD
While the paradigm shift to more collaborative business models is well underway in other industries, and has historically been led by Silicon Valley, it is now just emerging in the energy segment. A number of business utility platforms are in the early stages of building their ecosystem, with the majority of the benefits in the productivity and information quality stages. While all the ingredients exist for the energy industry to move in this direction, there are a number of hurdles in the way:
- Energy companies are slow to adopt new technologies outside of upstream, as other segments within their organizations are not seen as important or high priority.
- Organization or process change is more difficult for companies that are not organized for agility. There is often a ripple effect of process change into peripheral segments that receive significant pushback.
- Most of the platform companies building business utilities are startups, while the customers that would help build the ecosystem are some of the largest companies in the world.
- Many believe the myth that they are invincible, change will happen over long time periods, and there is no immediate imperative to change.
What will it take for participants in the energy market to embrace the business utility model? Likely, only under direct threat from a Google- or Uber-type company will this change occur. But by then, they will only be able to participate under Google/Uber leadership, rather than take a leadership role themselves.
is Vice President and Lead for Analytics & Optimization for Commodities at Sapient Global Markets. Based in Houston, Rashed specializes in trading, supply logistics and risk management. He advises oil, gas and power companies to address their most complex challenges in business operations through innovative capabilities, processes and solutions.