Corporate Strategy: PowerGen - Essay Example

No PowerGen (Case Study) 07 May Executive Summary Corporate planning and the formulation of a corporate strategy for PowerGen which is involved in the electricity industry of England and Wales was a complex undertaking. Various management models were used to guide this analysis in a logical manner. Electricity industry underwent changes due to changes in operating environments such as government regulations, pollution concerns, privatisation, innovations and industry competition. The analysis is both on the macro-economic level affecting the industry as well as micro-economic considerations unique to the company and to the other industry players. Power generation is a crucial component of a countrys economy as it affects industry and businesses to a very large extent and greatly contributes to its economic progress. In past years, electricity demand showed little growth (only 0.6% a year) during the period 1990 to 1997 in the UK and there was excess generating capacity of 11,000 MW in 1990-1991 (based on projected demand of 50,000 MW vs. 61,000 MW capacity) in the country at the time. However, electricity demand grew by healthy percentages such as the USA (projected at 30% for next 2 decades), big developing countries like India (10%), China (9%) and poorer nations possibly more. On average, global electricity generation will grow at 2.6% annually until 2030 (Economy Watch, 2010:1). Changing conditions due to the technology innovations used in generating electricity brought about industry consolidation and vertical integration of most big players. PowerGen was not so well prepared for the industry shakeup despite its size and lost market share due to its failure to acquire a regional electricity company (REC) which is a crucial component for industry players because it deals with the retailing of electricity. Introduction The electricity industry is very important to a nations growth and progress. This has a profound impact on a country by providing its citizens with the conveniences of modern life. Many nations in the poorer regions of the world such as Africa and Latin America where a big majority (4/5 of the worlds entire population) live (Hofstede, 1993:11), the tendency of most governments is to somehow price their electricity artificially low. This social pricing structure does not reflect actual or true cost. The industry was recently liberalised to allow big players to make the necessary big investments to make electricity cheaper and also improve service to consumers through healthy competition. Many external factors affect industry players like environmental concerns of global warming, climate change and emission of pollutants to the atmosphere (carbon and sulphur dioxide emissions). There have been several options and proposals put forward to set up a carbon-trading mechanism in Europe for producers of carbon emissions with tax incentives as part of a global climate treaty (Harvey, 2010:1). The global electricity industry as a whole is now shaped by three economic forces, namely: liberalisation, privatisation and de-regulation. Technology innovation like the shift away from coal-powered plants to gas plants had significantly lowered barriers to entry for new players (Jennings, 2003:431). It easier now to put up a plant through lower capital costs, shorter construction times, higher efficiencies and lower levels of pollutant emissions (ibid.). New players heightened rivalry due to additional capacity, reduced market shares and pricing pressures. PowerGen did not react fast enough or used its dynamic capabilities to respond adequately to these threats. It was also saddled with mostly older plants which were inefficient resulting to higher prices. In general, the company was left behind by newer players and had to re-assess its position by changing its corporate planning processes many times and also underwent several reorganisations. Global Corporate Strategies - Big industry players had to adopt new strategies to cope with the increased industry rivalry. Before the triple forces of privatisation, de-regulation and globalisation impacted on industry players, global giants in the industry relied on their vertical integration. Their strategies meant controlling the downstream as well as upstream activities such as power generation, transmission, distribution to retail end users and investing in energy sources. The industry structure is three-tiered composed of generators (actually producing it), distributors (they own the transmission lines or network) and suppliers (at end-user level). Todays new environment requires a different paradigm. Industry players now compete also at the final step in electricity distribution by investing in or acquiring regional electricity companies (RECs). These RECs control the metering and billing of electricity consumption. An example of a vertically integrated electricity provider is Electricité de France (EDF) which controls the entire energy chain (from sourcing, trading, generation, transmission and finally, distribution-supply to end users). This approach gives it competitive advantages like financial stability, economies of scale, international expertise, more intimate knowledge of client needs, greater procurement capabilities and access to better R&D resources (www.edfenergy.com). On the other hand, another significant industry player which is E.ON is UKs largest private investor-owned gas and power company. It is slightly smaller than the EDF Group and as such has limited itself only to the generation and distribution of electricity. However, it has engaged in other electricity-related activities such as home energy services to retain loyalty in its client base, boiler installations, heating system maintenance and repairs. Like EDF, it has a significant investment in most renewable and clean energy such as wind and biomass power generation. In fact, it now has 21 wind farms across the UK (www.eonenergy.com). E.ONs strategic approach means it has engaged in concentric diversification which is doing what is technologically similar – producing electricity using renewable and clean energy sources. Discussion PowerGen is a smaller industry player and as such wants to do forward integration by planning to acquire or merge with a regional electricity company (REC). It realized it needs to diversify its revenue sources by investing and creating value in other energy-related areas by using its core competence in power generation (Jennings, 2003:711). In pursuance of the new strategy, the firm invested in other countries like Germany, Hungary, Portugal and Indonesia (ibid.) and reiterated its mission as first and foremost a power generation business. Overseas markets offered higher potential profits but developing them requires longer gestation periods before returns on investments can be attained. Additionally, foreign markets offer a unique set of challenges such as governmental regulations regarding electricity pricing, political risks and foreign exchange fluctuations (most likely currency depreciation). An issue facing PowerGen was how to acquire a REC to help improve its industry position. Strategy – simply put, strategy refers to a course of action that need to be taken over the long term to achieve an organisations objectives or purpose (de Wit & Meyer, 2005:26). It is the series of actions that will bring the firm from where it is now to where it wants to be in the future. In other words, strategy requires logic, analysis, use of creativity and innovation to achieve competitive advantage (Ulwick, 2000:17). The strategy process involves using three steps which are: thinking (how ideas are used in strategy formulation), formation (the actual formulation itself) and lastly, strategic change (how to prepare and change the organisation to achieve the strategic renewal process successfully). Mintzberg offered his 5 Ps of strategy that include plan, pattern, ploy, position and perspective (Kew & Stredwick, 2005:203). He also had criticised corporate planning as mostly a left-brain activity consisting mostly of numbers and linear analysis when in fact the strategic formulation process should be something more of the creative process involving ideas, patterns, intuition and making certain connections. Corporate planning is the execution of corporate strategy which a firm had decided to pursue. This translates to an organisations ability to make effective choices to control its destiny and thereby attain its stated objectives using the resources it has and the capabilities it possesses. Corporate planning contains the nitty-gritty aspects (details) of the strategy which an organisation had chosen to pursue among a variety of options available. It represents the structured and formal approach to evaluate an organisations resources (human and material resources), its expertise and skill sets to match the environment it is operating in and possible changes that can occur to that environment in the future. Scanning is a necessary aspect so the organisation can anticipate events that can impact on it. It involves having several scenarios as a way of predicting the future and take steps to prepare for that future (Thierauf, 1987:117). Strategy formulation and corporate planning are now been combined into modern concept of strategic management because these functions of senior management are closely related to each other and are essentially reiterative processes (Jennings, 2004:713). Critical elements in corporate planning are correctly defining the objective (or problem to be solved), the use of creative thinking to come up with viable alternatives and then brainstorming for new ideas. Critical Evaluation – the privatisation and de-regulation of the electricity markets had brought with it development of the so-called wholesale electricity pool. This concept became a new focus and dominant component of PowerGens corporate strategy requiring commercial orientation because of new competitive pressures that needed increased operational flexibility. The new requirements made the previous centralised planning a very outmoded and obsolete approach because it was cumbersome and time consuming. A critical failure of PowerGens is that it failed to leverage its resources and core competencies in the newly-deregulated market. There was plenty of synergy that could have bailed out PowerGen from its troubles but it had failed to do this such as aligning its position and integrating related activities. The altered industry structure required PowerGen to re-organize itself anew from its previous functional specialisation because of the technical complexities in power generation to a new paradigm based more on the realities of a de-regulated electricity market. The new organisational structure was patterned to address specific concerns so it can react quickly to new market developments. The net effects of moving from a centralised planning approach to the new planning processes based on inputs from regional business units put more power into the hands of business unit managers. In the previous corporate planning system, a top-down approach was used where business targets in key success areas (KSAs) were given to the units for them achieve within the given time frame. In retrospect, PowerGen’s should have made an evaluation first on whether reorganisation was the right approach to meet new challenges. The result of its reorganisation was that it created new problems instead of solving old problems. The new organisational structure based on divisional levels changed the entire process of corporate planning. The planning process which usually takes more than a year had been reduced to nine months only as a form of rapid response to market developments and provide operational flexibility (Jennings, 2004:712). The new organisational structure was supposedly to align its business units to the new industry reality by giving them more power to add inputs to the corporate planning process. This new procedure was designed to make PowerGen into a more responsive business entity to market developments. The new structure was to align the organisation into its new corporate strategy of diversification. The stated objective was to expand into other energy-related areas in order to have new revenue sources other than its core business activities. The new planning process became more complex because it required several levels of inputs from the business unit level to the divisional level to the corporate level and then back again for the necessary changes along the way. This in turn required a considerable degree of negotiations and lobbying. The new planning process had one major defect: it required very few details expressed in a few sheets of paper (Jennings, 2004:713) instead of being more detailed as business units were in the front lines and supposed to know more about actual operating and environmental conditions than the people in the corporate head office. The previous organisational structure was based on functional divisions because the electricity industry prior to liberalisation was a complex business and it requires special expertise to be successful. More importantly, the old structure had fewer layers of management in it (ibid. 709). From this perspective, this was a better arrangement because corporate planning was a more centralised process that contained the main essence of its corporate strategy. In other words, there was a better alignment among the companys organisational structure and its overall strategy through centralised planning. The new planning set up also did not give enough power for the finance department to provide its inputs when financial considerations are very important to overall strategic plans of the company. Corporate plans necessarily have to include financial projections and various estimates under varying assumptions and this resulted in some problems in the years between 1993 and 1994 (ibid.). This was partly due to the reorganisation undertaken the year before in which divisions were no longer defined by function but by its target market and products sold. There was no strong fit between the firms structure and its new strategy which is called the organisational fit framework. An example was the emergence of capping about pricing in the electricity pool that greatly affected projected revenues. However, planning at the divisional levels added an unnecessary bureaucratic level and capping of prices was not included in the earlier plans. Important issues and priorities were often filtered, then altered or even watered down at this level before being tackled. Alarmingly, only one person did strategy formulation and producing the corporate plan, thereby preventing the use of other useful ideas (ibid.). One person alone cannot formulate a good comprehensive strategy for a firm so large. Core Competencies – these are the specific skills which an organisation can have and these are something hard to imitate by competitors. It can take many forms but in very general terms, these are the things which an organisation does best such as distinctive ways of service or production technique (perhaps patented and protected by copyright), strong organisational culture that promotes employee excellence or extreme customer loyalty based on a superior product or service. Core competencies are in effect the accumulated knowledge of a learning organisation and more importantly, something that can be leveraged to other activities such as entering new markets (whether that market is related to the present market or not). The key element is that the organisation with core competencies can do it better than others but it takes time to be developed. An example would be an airfreight logistics firm venturing into a land-based delivery of cargoes using its present core competencies in the logistics industry. At the time of its vesting during the 1991 first tranche of privatisation (60%), the firm was allocated 21 power stations. PowerGens core competencies were in electricity generation using coal or dual-fired (coal & oil) that accounts for some 94% of its output (ibid.:709). The other competencies of PowerGen were in upstream gas-related activities, entering the energy- related foreign markets, expertise in project management and operation of generating plants (ibid. 711). Its plants were less older and less competitive with the end result of PowerGens cost of electricity is usually higher than its competitors and this is shown wherein it was able to set pool prices 35% of the time in 1995-96. PowerGens was late in adopting the latest gas- generation technology (in 1996, slightly only over a third of total production came from gas). What it did was refurbished its old coal units but market share loss continued as its electricity price was high (ibid.:711). PowerGen did not use its core competence to offer lower prices or improve service to consumers to regain lost market share. To get back competitive advantage, PowerGen must offer customers something valuable and unique not available from rivals. Dynamic Capabilities – these refer to an organisations ability to quickly transform or reconfigure itself to respond to new external challenges. This requires the organisation to put internal resources to exploit opportunities brought about by changes in their environments. In a simple way of explaining, dynamic capabilities refer to a firms ability to adapt to changes. By implication, this adaptability therefore signifies a high degree of innovation and creativity (Helfat et al., 2007:1). The concept is more inward-looking in the sense it takes a critical view of how an organisation uses its resources to gain competitive advantage within a changing environment. Management and strategy expert Prof. Michael E. Porter sees it as the fit in an organisations external environment and core competencies. A good example of these dynamic capabilities would be the world leader in cellular phone manufacturing which is Nokia from originally making military boots to making top-of-the-line cellphones. In terms of dynamic capabilities, PowerGen was slow to adopt to its changing markets such that even late into the game it still has not acquired a REC yet. Other industry players by now had completed their forward integration by buying or acquiring RECs such that only one REC had remained independent out of the original 12 (ibid.:717). In addition to operating old expensive plants, PowerGen was also locked out of the lucrative retail markets (those using 100kW and below). PowerGen had been slow to acquire a REC despite its core competence. The REC holds the key to profitability considering the retail price of electricity is higher than those sold in the wholesale pool (PowerGen derives 70% of total revenues from pool sales where price is lower due to government-mandated cap as agreed with the industry regulator). Lack of a REC adversely affected PowerGens profit before tax as a retail market has higher profit margins (retail accounts for half of total demand and 2/3 by value). A good area where PowerGen can use its dynamic capabilities will be in the international electricity markets as it requires adapting to heterogeneity (Teece, 2009:138) of which it is quite good at. EDF and E.ON – both companies have their core competencies in the generation of electricity. In the case of Electricité de France (EDF), it is vertically integrated in the sense it has control of both upstream and downstream activities. It has further expanded its expertise into other areas such as using alternative (clean and renewable) energy sources for producing electricity on long-term sustainability by not relying on coal-fired or crude oil plants. It has likewise leveraged its expertise to corner the market ranging from individual homes to large-scale energy users such as big business establishments. Similar to EDF, the smaller E.ON has also ventured into other energy sources such as solar, wind, tidal, wave and biomass energies when generating its electricity. However, a big difference between the two is that E.ON is not vertically integrated. This is the reason why it want to acquire a REC (Midlands Electricity) because it does not possess distribution capabilities at the retail levels. E.ON does not own its energy supplies but purchases them from outside suppliers through long-term contracts. In terms of dynamic capabilities, it seems EDF has the edge because it was able to up its market share due to its presence in all market segments (from small users to big industrial users). It was able than other electricity producers to quickly take advantage of liberalisation (privatisation and de-regulation) by snapping up various RECs before government industry regulators could raise concerns about over-concentration in the industry and possible effects of a monopolistic or oligopolistic situation. It quickly positioned itself into the new trends in electricity generation which are sourcing supplies from renewable and clean energies like the solar, wind and nuclear options. E.ON had also pursued the same strategy of diversification in regard to its supplies but only a limited basis since it is a smaller company compared to EDF. However, it engaged in ancillary energy services such as home energy services, repairs of the residential central heating systems and in the retail of gas to residential end users. Both firms had utilized their dynamic capabilities in various ways in which they do not compete directly. Liberalisation – this government initiative entailed privatisation and de-regulation of the UK electricity market but did not achieve its aim of lowering electricity prices (only 4%). The government policy failed to achieve its objective of lowering prices because of increased concentration within the electricity industry as shown by the mergers and acquisitions that had occurred between RECs and electricity producers. The privatisation process allowed some big companies with enough financial clout to buy up other companies that the prospects of only a few super-utilities which will survive the industry shakeout is a real possibility. This had the government regulatory agency (Monopolies and Mergers Commission or MMC) worried about monopolistic pricing tendencies arising in the electricity industry. It was demonstrated in the case of PowerGen in which it was able to set electricity prices in the wholesale market pool at least 35% of the time in 1995-1996 (Jennings, 2004:714). The other adverse effect of firms becoming too large is the danger of cross subsidies. This was clearly the case if the merger of PowerGen and Midlands Electricity plc had pushed through. The industry regulators concerns were valid with regards to the possible monopoly that will arise if the two companies will merge. For one, Midlands Electricity is already the local monopoly of supply in its geographical area. PowerGen, on the other hand, presently supplies about 16% to this particular market (and it is incidentally also the largest supplier with that 16% market share in this franchise area). If the deal is approved, a monopoly in the generation (PowerGen) and distribution (Midlands) will occur. This is contrary to the aims of the de-regulation policy which was to encourage private competition among industry players to lower price of electricity and also improve service. This was the essence of privatisation but not to the extent of creating a new monopoly by allowing mergers between its two biggest players in a local geographical area. The government was correct in blocking the merger but it deprived PowerGen a lucrative source of profits in the retail sector where prices are higher. Cultural Constraints – PowerGens venture into newly-liberalising international areas where it can use its expertise in electricity generation could cause possible problems with its centralised approach to corporate planning. This is because its management techniques might not be too applicable in other countries where different cultural practices prevail with regards to management styles. This is the gist of Hofstedes work regarding the limitations of certain management theories when applied in other cultural contexts. In other words, there is not a single set of universally applicable management theories that will work in all situations and different cultures. For example, the British and American management style is centralised on the individual manager (as the cultural hero) who can focus on achievement by motivating all the other people to give their best to the organisation and is more shorter term in his outlook. As PowerGen expands its operations to other countries, it would do well to consider how the various cultures of these countries can be adopted to suit its corporate planning processes. In the case of the old centralised planning approach by the previous CEGB, it would no longer work in a new environment of the firm. This was because of increased geographical diversification in which the company had now ventured into foreign markets where national cultures are at play. The former top-down approach of centralised planning is not suited to the new realities of operating as a global company. PowerGen needs to reconsider this approach. For example, PowerGen ventured into East German market with mining-related acquisitions. In Germany, most workers are considered very highly capable after undergoing several years of apprenticeship. Previous centralised style of corporate planning would meant dictating the companys goals and objectives to its employees in Germany and that would not have worked at all. This is because everyone there is considered an expert and the British style (reclaimed from American style of management) of having a manager is not necessary in a German work setting or subsidiary. There are no cultural heroes in Germanys management structures. Conclusion PowerGen can try to leverage its core competencies into new foreign markets where competition is not very strong and where government regulations can be quite lax. It needs to capitalise on its core strengths of project management, upstream gas-related activities and the ability to operate and manage power generating plants. It can use its knowledge of generation to leapfrog into the newer but overall long-term trend towards renewable energy because the world is fast running out of oil supplies (Deffeyes, 2008:159). It is a real concept known as peak oil where production is falling off (permanently) because oil is non-renewable. From all of the foregoing discussions, the foremost industry trends are the continuing liberalization process in most countries of the world and a move towards clean and renewable energy sources. For the former, this is to encourage more private sector investments because the electricity industry is a capital-intensive industry. It is better left to private enterprise than for governments to make investments in electricity generation, transmission and distribution. The role of government is merely regulatory as far as the industry is concerned and to see to it the industry is functioning as it should in terms of lower prices and better consumer service. It cannot compete with private investors in this industry because it is inefficient and will result to higher electricity prices. By regulating the industry, it will try to prevent monopolistic or any oligopolistic situations where there might be tacit price fixing among a few big players. On the other hand, opening up the industry to foreign competition has led to a growing trend towards consolidation despite the government’s best efforts to promote competition. A healthy competitive environment can exist only if there are many players within an industry. 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