The Retail Misconception
A White Paper by Peace Software

"Retail" has become a dirty word in the North American energy industry. The industry is rife with stories about the rise and fall of energy retailers in gas and electricity markets that have opened to retail competition.

We have heard the stories of startup affiliate retailers and new players entering competitive retail markets, taking on the regulated utilities with false hopes and promises and, soon after, admitting defeat. Few of the 1997-1999 Era of new entrants in North America are surviving let alone prospering. Most have collapsed in debt or non-profitability, been sold off, or exited the market, sometimes defeated by the failure or closure of the market itself, as was the case in California.

By contrast, retailing is a respectable business and necessary tier of the distribution chain in other industries. And in other energy markets around the world, retail is similarly considered essential. So why has energy retailing developed a bad reputation in North America? The answer lies in the interpretation of the term "retail".

What Retail Really Means
According to the Energy Information Administration (EIA), a statistical agency of the U.S. Department of Energy, retail means "sales covering energy supplied for residential, commercial, and industrial end-use purposes." Retail, as the end-use sales part of the utility industry supply chain, is distinct from generation, transmission and distribution.

Retail is the customer touch point—the downstream part of the energy industry that sells the energy commodity directly to the end consumer. Unlike the corner stores, strip malls and Wal-Marts, which commonly characterize what we might think of as the "retail industry", the energy retailer does not need a store front to attract walk-by traffic. Instead, sales can be completed over the phone, online and by sending out a regular bill, all of which directly "touch" the end-consumer.

Defined in this way, as sales to end-use customers, retail clearly applies to traditional regulated energy markets as well as deregulated energy markets. It follows that the properly defined term "energy retailer" applies to all energy market structures—regulated, transitioning and competitive. Granted there are different retail rules for different markets, but all energy markets contain the retail function.

Regulated Utilities are Energy Retailers
As we look at U.S. energy markets and the progress of deregulation, we can identify two distinct forms of energy retailing—regulated retail and competitive retail. In a traditional regulated market the vertically integrated utility performs generation, transmission and distribution as well as retail functions. In its regulated retail role, the integrated utility signs up, services and bills energy consumers according to Regulated rules and tariffs. The misconception that regulated utilities are not energy retailers is exactly that—a misconception.

In transitional retail markets, such as the Pennsylvania, New York and Ontario electricity markets, not only are new market entrant "retailers" operating competitive retail businesses, but the regulated utilities maintain their regulated retail operations for the customers who haven’t switched to a competitive retail supplier. In these transitional market structures, regulated retail operates in parallel with competitive retail.

In contrast, in a fully competitive market such as the Texas electricity market, the historically vertically integrated utility is disaggregated (separated) into separate business units corresponding to the main components of the energy industry—generation, transmission, distribution and retail. The generation company produces the energy commodity; the transmission company transports the energy in bulk; the distribution company manages the wires, switches, and transformers that serve neighborhoods and businesses; the utility retailer is left to sell the commodity direct to the end consumer in a free market environment. The utility retailer plays by the same free market rules as new entrant retailers.

We refer to these previously regulated, now competitive utility retailers as "incumbent retailers". In the competitive Texas electricity retail market, for example, market share is dominated by three major incumbent retailers—TXU Energy, Reliant Energy Retail Services and AEP (through its subsidiaries AEP Central Power & Light and AEPWest Texas Utilities). The big three compete with one another alongside other smaller incumbents and new entrant retailers such as Green Mountain Energy and Republic Power.

In a fully competitive market, all retail participants, including both incumbents and new market entrants, are classified as competitive retailers. However, in some competitive retail energy markets, including the Texas electricity market, a regulated retail role does continue in the form of POLR (Provider of Last Resort). We see competitive retail businesses providing the supplementary POLR role to support social policy objectives for otherwise unwanted consumers as dictated by the market regulator.

So it would appear that "retail" is not such a dirty word after all. Energy retailing has existed since Thomas Edison established his utility business in the financial district of New York City in 1882, and exists today for 188 million U.S. electricity and gas consumers. It is just that much of the retail in the U.S. Today is regulated as opposed to competitive, and this has caused confusion in terminology.

Regulated Markets are Retail Markets
A related misconception in the North American energy industry is that all retail markets are competitive markets—one and the same. So often we hear people referring to"retailers" and "retail markets" when in actuality they mean "competitive retailers" and "competitive retail markets" which are subsets of the overall retail function.

The EIA defines a retail market as "a market in which electricity and other energy services are sold directly to the end-use customer." By this definition, every U.S. energy market includes retail, whether it is regulated, transitioning or competitive. This is not to be confused with the 26 retail gas markets and 23 retail electricity markets that have transitioned to some level of retail competition. The other 24 gas and 27 electricity markets in the U.S. are regulated retail markets.

Almost all other energy markets around the world use the broader definition of the term "retail energy market" to refer to the end tier of the energy distribution chain. In Australia, where New South Wales and Victoria have evolved toward competition and Queensland, Northern Territory, South Australia, Tasmania and Western Australia remain regulated, there is no talk of regulated utilities versus competitive retailers. All Australian energy companies billing the end-consumer consider themselves energy retailers in the retail energy business.

Leading Australian energy retailer Country Energy, which supplies gas and electricity to750,000 consumers in five Australian states, has always led with its retail mindset. John Adams, Group General Manager Retail, explains, "If you’re in the business of billing energy consumers then you’re in the business of energy retailing, it’s as simple as that. Energy retailing is about pushing the boundaries of excellent customer service and operational efficiencies, whatever market you’re in."

Xcel Energy in the United States shares this retail mindset regardless of the fact that 99 percent of its consumers are in regulated markets. Headquartered in Minneapolis, Minnesota, Xcel Energy is the nation’s fourth largest utility company serving both electricity and natural gas customers. The company has regulated retail operations in 11 western and mid-western states and competitive retail operations in Texas.

Patricia Vincent, president of Retail Services at Xcel Energy, is responsible for customer service, marketing and sales across the company’s regulated and competitive territories. Her title and role reflect Xcel Energy’s forward-thinking view on the retail business function.

She comments, "My focus is on retail services for 3.2 million electricity customers and 1.7 million natural gas customers in a wide range of markets. Our retail customers don’t think of themselves as being regulated or competitive, and we don’t pigeonhole them either. They want high quality service from their energy retailer and we are here to Provide that consistent level of service across all customers in all markets."

Common System Core
Business drivers will differ in regulated and competitive retail markets but the basic cash flow/revenue cycle is critical to both retail disciplines. A regulated retailer will be driven by regulatory service obligations within a defined supply territory, whereas a competitive retailer will focus on customer acquisition to Increase market share or customer retention to defend market share across many distribution areas. However, the billing/payment cycle is the cash flow lifeblood of any retail energy business, whether regulated or competitive.

The diagram below demonstrates that there is significant functional overlap between regulated and competitive retail businesses. The center overlap area of the diagram contains the critical business functions common to both types of retailers. This includes premise management, bill presentment and calculation, accounts receivable, account maintenance, Internet self-service and customer care.

These common business functions account for the majority of retail energy transactions, as well as manage the cash flow lifeblood of the business. Usage, interval usage, billing, accounts receivable and collections transactions occur ten to50 times more frequently than other periphery transactions such as customer signup or field service. This means that system scalability, robustness, usability and efficiency are at least ten times more important in these critical overlap areas.

Independent Energy learned this lesson the hard way. The high profile start-up retailer entered the competitive United Kingdom electricity market with strong public and government support, and it signed more than a hundred thousand customers in a relatively short period of time. However, when it came tactually billing their large volume of customers, Independent Energy experienced significant difficulty, resulting in poor cash flow and eventual bankruptcy in 2000.

Retailers are wise to concentrate on the core functional areas first and foremost when evaluating and selecting a new Customer Information System (CIS) for improved service performance and efficiencies. Further, attempting to bolt on pieces of functionality in these core areas is simply not feasible because of the high transaction volumes and associated risk. Togo the distance requires an advanced, reconciled system core.

Converging Functional Requirements
The functional overlap between regulated and competitive energy retailing is becoming more pronounced in today’s dynamic energy industry. These days the expectations of regulators, customers, and shareholders are changing and a new, forward looking regulated industry is swiftly emerging with intense emphasis on improved customer service, operational efficiencies and cost-savings—in other words, "competitive" best practices.

An emerging driver for adopting competitive best practices is performance-based regulatory (PBR) schemes, whereby regulated utilities can earn extra profits above the allowed rate of return, conditional on improvements in performance. At the same time, forward-thinking utilities are looking to replace their legacy systems to Reduce their risk or to prepare themselves for competition. As a result, the system needs of regulated retailers are becoming more aligned with their competitive counterparts.

On the other side of the equation, competitive retailers are becoming more intent on core functionality in an effort to realize further efficiencies in the areas that count most. This is because the early days of U.S. energy competition were dominated by small start-up retailers focused primarily on acquisition and enrolment to Increase market share. Today, there exist large-scale competitive retailers in North America, such as American Electric Power (AEP) and Direct Energy, which have more mature functional needs centered on robust and scaleable billing, customer care and accounts receivable and collections. In this respect, they have much in common with the traditional large-scale utility.

There are many signs of the convergence of regulated and competitive retail needs. Due to changed market conditions and client feedback, for example, META Group’s Energy Information Strategies for Unregulated Markets and Energy Information Strategies for Regulated Markets services were earlier this year consolidated to form a single Energy Information Strategies practice, which covers both regulated and competitive retail markets.

One System for All Markets
It is not uncommon in North America for energy industry executives to think in terms of a regulated CIS versus a competitive CIS. This stems from the misconception that regulated utilities are not retailers and therefore require a vastly different system to their competitive counterparts. In reality, an advanced competitive CIS with support for regulated functions can span all market types.

An example of this is Country Energy Central in New South Wales, Australia. New South Wales introduced a staggered timetable for electricity deregulation as early as 1995, starting with very large commercial and industrial customers and extending to all customers over a five-year period. During this time, Country Energy Central maintained a single competitive CIS for its 120,000 regulated and competitive customers. As each customer segment became competitive, Country Energy Central would simply switch between regulated tariffs and competitive rate plans within the same system.

While a competitive CIS can support regulated retailing, a legacy system built for traditional regulation cannot deal with the complexity of competitive retailing, no matter how many competitive functions are bolted-on. This is because the central focus of a regulated system—the assumption that the regulated energy retailer also controls the premises and meters in a defined franchise area—does not hold true for a competitive market. The customer is the asset and primary focus in a competitive market, requiring a customer-centric CIS that tracks customer details across multiple distribution areas and markets. The fact that an advanced competitive CIS can support regulated as well as competitive businesses is proof that new market entrants, incumbent retailers and traditional utilities have much in common.

They are all energy retailers selling the energy commodity directly to the end consumer. It makes sense that they will have similar system requirements in performing the retail function. We need to stop ourselves from thinking in polarized terms of regulated versus competitive markets, participants and systems, and start adopting a broader retail mindset focused on the business function at heart—energy retail.

The Peace Advantage
Peace Software is the world’s largest energy CIS software developer. The company’s browser-based Energy suite has been selected by regulated and competitive retail energy companies to drive efficient operations and provide excellent customer care for 13 million residential, commercial, and industrial customers in 40 markets around the world. The innovative Energy suite can be phased into existing CIS environments and new version upgrades are available every 12-18 months. Founded in 1984, Peace Software has offices in Australia, Canada, New Zealand, the United Kingdom, and the United States.

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