By William Nicholson and Mike Malloni, Capgemini Smart Energy Services
High costs, rapidly changing technologies, and shifting energy market dynamics continue to impact smart meter programs and challenge the conventional business models used by utilities to implement and manage these programs. Traditional accounting and regulatory rules that govern these programs have limited the commercial and delivery options available to utilities, constraining their ability to fully optimize quality of service, costs and benefits.
The typical capital-centric governance models used to manage smart meter programs see a utility acting as the commercial and delivery principal, managing multiple vendor agents, often resulting in sub-optimal quality of service, inflated costs to ratepayers and lengthened timelines for implementations. These inefficiencies in achieving a program’s goals and the limited capacity for a utility to manage the process effectively under these conditions reflect the classical economic model of the Principal-Agent problem.
Standard Principal-Agent theory states that a principal – such as a utility – will hire one or more agents – a vendor or supplier for example – to achieve an outcome that it either cannot achieve on its own or cannot maximize without support from the agents. The challenge of operating under this model is that the self interests of all parties are never fully aligned and a principal never has full visibility into an agent’s self interests, creating asymmetry in information and objectives. In order to align an agent’s interests to its goals and optimize performance, a principal must develop incentive mechanisms that will influence agent behavior.
Utilities apply classic economic incentive mechanisms to smart meter programs to influence vendor and supplier behavior. These include both positive and negative incentives such as performance bonuses, milestone incentives, rate cards, bonds, and termination conditions. The challenge lies in attempting to align and manage these incentives across a network of vendors and suppliers and remove the issue of asymmetric information. The size and complexity of these programs have forced utilities to shift attention away from their core competency – electricity delivery – to managing legal and commercial frameworks needed to align incentives. Today, it is commonplace for a utility to have a dedicated full time commercial team assigned to a smart meter program.
In response to these inefficiencies, some utilities are starting to adopt a Managed Business Service (MBS) approach to smart metering – an option that improves the principal-agent problem significantly. It shifts the burden of managing inherent asymmetric information across multiple vendors to a single primary service provider. Outcomes are optimized by reducing multi-vendor complexity to a single contract between the utility and primary service provider that is directly based on overall business performance and objectives. Refreshingly, with MBS, managing multiple vendors and suppliers is the responsibility of the service provider, which has expertise and experience with this model.
What is MBS?
So what exactly is MBS? Let’s start by looking at large scale smart meter programs, specifically the fact their subsequent support operations require a complex network of stakeholders to implement and manage their functions. The traditional hierarchical commercial and delivery models employed by utilities to govern these programs carry structural risks that prioritize efforts on cost, stakeholder and schedule management. Although these programs represent fundamental business transformations to a utility, the resulting principal-agent relationships applied to these complex programs do not inherently maximize service and value creation, nor do they align the rational choices of the agents (vendors) to the key principal (utility).
A smart meter MBS transforms a utility’s meter-to-cash lifecycle into a series of services measured against business-based goals. A utility can focus on service and value creation through a shared governance model that shifts and shares risks with a service partner. Costs become predictable through unit-based pricing models over fixed contract periods. The service provider is responsible for sourcing, installing, operating and refreshing the smart meter infrastructure and systems, thereby minimizing upfront investments and technology risks to the utility.
On average, an end-to-end smart meter program can require five to 10 major vendors covering various services and products including meter operations, systems integration, telecommunications, field services, and meter infrastructure. Under this scenario, an experienced service provider has clear advantages over a utility. The service provider will have long term relationships with vendors across multiple smart meter and utility programs in various geographies. This experience, intimacy and ability to re-use common work products and processes across programs results in superior program and operational performance.
Sharing risk is also an important benefit of the single service-provider approach. Utilities that self-manage the implementation and operation of smart meter programs ultimately incur the sole burden of managing and mitigating relevant delivery and commercial risks. Traditional governance models used for smart meter programs are hierarchical, placing final responsibility on a utility, not on the prime contractor. A managed business service provides utilities with an opportunity to share risks with a service provider under a more balanced governance model that shares responsibilities across both parties. The utility and its service provider assume equal responsibilities to manage and mitigate delivery, commercial and strategic risks.
Under a managed business service model, a utility gains a number of delivery, commercial and strategic risk mitigation elements. From a delivery perspective, experienced people and access to expertise, standardized and proven solutions, architecture, support operations and business process, and an established network of technology and equipment, all reduce risk. Commercially, business-based service measures achieve business outcomes through a risk and reward approach, cost certainty is improved through predictable pricing models and the commercial environment is simplified through a single prime contractor. Finally, strategically, alignment to regulatory and legislative changes and relevancy to global industry business methods all mitigate risk further.
Applying traditional delivery and commercial approaches to large scale smart meter programs result in inflated costs and a limited ability to make mid stream changes once a program is underway. Utilities are forced to spend long lead times in planning programs before an actual kick off, and build multiple layers of time, resource and cost contingencies into their programs. Technology choices are made early in the planning cycle, restricting solution adaptability and committing significant investments ahead of fully understanding the conditions and requirements of the program. An MBS approach provides a more flexible structure where ideas and technologies can be tested and replaced with much lower investments of time, resources or money.
In conclusion, smart meter programs are challenging utilities to better link contracts to anticipated business benefits and create relationships that best align to their overall objective. A smart meter service provider is in a better position to create a stronger principal-agent relationship with sub-vendors compared to a utility. As a result globally, MBS approaches to smart meter programs are growing, with many jurisdictions purposely developing market conditions for MBS success because of the proven improvements to program objectives, costs and value to both the utility and its customers.
By recognizing the significant business transformation triggered by smart meter programs, a utility opting for an MBS approach gains the flexibility to more broadly share risk, reduce costs, and accelerate the realization of business values. The MBS model reduces the constraints of the principal-agent problem, allowing utilities to focus on their core business of providing reliable electricity to its customers.