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THE DEMISE OF CONVENTIONAL ENERGY

A report by PwC and ING Bank ŚląskiApril 2015

OR HOW TO SURVIVE AND WIN ON A CHANGING MARKET

The demise of conventional energy, or how to survive and win on a changing market 3

Ladies and Gentlemen,

We are pleased to present you with the fifth edition of our report. The crucial issues discussed in this docu-ment are not linked to the ones which we drew attention to only five years ago. Since then, the energy sector has undergone fundamental changes: from a limited but certain profits activity, it has turned into regular bu-siness. It is now a sector that can bring extraordinary gains, but on the other hand bankruptcy is no longer an unrealistic scenario.

Right before our very eyes the largest energy groups are altering their strategies in order to survive on the market. The external environment has given rise to conditions in which a conventional power utility model does not work any more. The change has become fact.

This transition affects all countries to a greater or lesser extent; and it concerns trends observable in the sec-tors of conventional energy generation, distribution and sales. It is disputable whether Poland, amongst others, should follow the directions of change visible in the world; after all perhaps our energy sector is diffe-rent and reflects domestic factors. It is however doubtless that the changes affecting the European energy sector have already become visible in Poland.

The increased popularity of renewable energy sources means that there is less room for conventional system power plants: either fewer of them are actively used or they work far below their generation capacities. From the generator’s viewpoint, it gives rise to the side effect in the form of plummeting prices of electrical energy. This means that there will be not enough room in the system for all the current conventional generators; only those offering the lowest operational costs will be able to keep their heads above water.

Given its natural monopoly, the Distribution System Operator’s (DSO) role will have to remain neutral, but pro-active at the same time. The distributor must cope with the increased presence of uncontrollable energy so-urces in the grid and the transfer of smart data about the customer. On the other hand, it must ”do more for less”, which means that it needs to deal with the cost pressure imposed by the regulator. Thus, only smart and efficient DSOs can be market winners.

Customer centricity: the time has come for the Customer to perceive electrical energy as a ”product” and to realize that one energy seller can be easily replaced with a new one. This creates new opportunities from the point of view of the seller. Yet, it generates new threats as well. Electrical energy has ceased to be a product per se; it competes with additional products or services, while the customer’s experience or a unique relation between the customer and the company have become new areas to compete for. Moreover, the electricity industry is no longer a market dominated by incumbents: new players and competitors from other sectors experienced in selling products to the mass market customer are now entering the game.

To survive and win in this new reality that revolutionizes the conventional energy sector one must implement strategies allowing for adjustment to the new market conditions in various business areas.

In this report we offer some hypotheses on the strategies of companies operating on the electricity market. Some of them may seem controversial, but we do believe they are viable. It is the extent to which those stra-tegies will be pursued that will decide which players will lead the market, and which will merely fight for survi-val. The examples of activities undertaken by international companies in reaction to trends that are also visible in the Polish energy sector are the best evidence that preserving the status quo will be untenable.

Have a pleasant read!

Piotr Łuba Kazimierz RajczykPartner Advisory, Energy Group Leader Managing DirectorPwC ING Bank Śląski


Content

THE NEW FACE OF THE EUROPEAN AND POLISH POWER INDUSTRY 7

New rules of the game in the conventional generation market 8Limited room for conventional power plants in the system 9Wholesale electricity prices under downward pressure 12

New role of distribution system operators 14Grid flexibility in the face of RES developmen 14Active neutrality: a new role of distributors in shaping the business environment 151.2.3. More for less: cost pressure exerted by the customer and the regulator 16

Electricity as a product 18Electricity price – the main value driver for the Customer 20Additional products and services – building up the margin 21Customer experience – a new area of competition 22

THE FOUNDATIONS OF NEW MARKET STRATEGIES 25

Generation market 26Certain work in the ”base load” 26”Good-bye base load,” or how to survive in the system 26„Must run” 27

Distribution System Operators 28Smart DSOs 28Efficient DSOs 28DSOs as distributors of information, not only energy 29

Supply 30Understanding and managing the customer base 30Smart partnerships 31Developing an „energy” value proposal 32

The new face of the European and Polish power industry

The recent several years have been marked by fundamental changes in all of the European electricity markets, with the only differentiator being the depth and pace of those changes. There have been three shared trends strong enough to make energy groups adjust their traditional business models to the changing reality:

• Trend No. 1 – Stagnation in the conventional generation market – leading to permanent reduction of asset value or deci-sions on the sale of assets. This trend, visible in the Polish market to a much smaller extent, will result in the players altering their strategies on the generation market,

• Trend No. 2 – Assigning new roles to distribution system operators (DSOs) – the development of renewable energy sources (RES) along with new DSO obligations necessitate far-reaching investment in the distribution grid on the part of the players, as well as the creation of a platform for cooperation and information exchange with the consumer,

• Trend No. 3 – Developing a product offer on the electricity market – no longer is electrical energy treated by the end cu-stomers and energy companies as a public good; rather, it has become an individual product on the market. In order to compete, the sellers need to create a value proposal to be able to appeal to diverse customer groups.


New rules of the game in the conventional generation market

The European markets of electricity generation have bro-ught about a change in the rules of the game in the area of driving the profitability of investment in the market of conventional generation. The current rules according to which a relatively cheap energy source could count on a place and work within the system may prove untenable. As a result, conventional generation in Western Europe has ceased to create significant added value for interna-tional energy groups since it is no longer able to compete on a large scale with RES. The latter, having a privileged position in energy systems and subsidies are:

• limiting room for conventional units in the system, pu-shing out conventional energy according to the merit order, hence reducing the volume of energy produced by said sources,

• creating strong pressure on decreasing wholesale elec-tricity prices due to low variable cost of production, in practice close to zero.

Consequently, conventional generators struggle with par-ticularly low or even negative profitability of generation ac-tivity. In addition, conventional sources are facing further increase of production costs; arising from increasingly strict environmental standards in terms of air emissions (BREF LCP) and cutting CO2 levels (Phase 3 and 4 of the EU ETS under which, in principle, free emission allowan-

ces are not and will not be allocated to the power energy industry).

In many cases, large resources of conventional generation will constitute a substantial burden for energy companies. For this reason, they have been seeking solutions and strategies for survival in the changing energy market, ad-opting restructuring and reorganizational initiatives aimed at improving their financial standing.

Energy groups are considering the following steps to survive:• sales of assets,• closing down production in unprofitable units, mostly

gas-fired ones, • comprehensive change of business models.

The following figure presents the list of gas-fired units withdrawn from operation on the grounds of lacking profi-tability.

Although the problems occurring in Western European co-untries also touch the Polish market, the differences in the stage of growth of RES, microgeneration and the market structure, mean that the incumbents in the segment of sys-tem power plants are not being forced to take radical steps.

Mothballed

Other:

Converted intoa peak-load source

Maintaned in the standby mode

Divested

Shut down, decommissioned or the regulator was contacted to prevent shutting down

* Planned

Installed capacity(MW)

842

2.192

4946

774

Other

OtherMothballed

OtherMothballed

OtherMothballed

OtherMothballed

Mothballed

Mothballed

Mothballed

6491.085

1.982

430

1.297

840

417

580

Source: Ben Caldecott, Jeremy McDaniels, ”Stranded generation assets: Implications for European capacity mechanisms, energy markets and climate policy”, Working Paper, January 2014, Smith School of Enterprise and the Environment, University of Oxford; data of the companies; the date in brackets is the extension date.

Decommissioned generation capacities of gas-fired power plants due to lack of profitability of energy generation


LIMITED ROOM FOR CONVENTIONAL POWER PLANTS IN THE SYSTEM

Until the first half of the first decade of the 21st century, electricity generators in Europe had been operating in a stable and predictable market environment. The de-mand for electricity was covered by generation units ente-ring the market based on the marginal production cost of electricity. As a result, the basis of the system was formed by nuclear power plants, or lignite-fired, or occasionally coal-fired ones, depending on the characteristics of indivi-dual energy systems. Peak electricity demand was in turn covered by older coal power plants or gas-fired units.

As a consequence of the above, the power energy system was created in a fashion that allowed for centralized gene-ration of electrical energy and its transmission over large distances.

The centralized model of electricity generation was reflec-ted in the fuel mix structure of installed capacities that, depending on the local availability of fuels and energy po-licies, were predominantly based on nuclear and coal energy sources.

Fuel mix of generation sources in the EU in selected years [%]

Over the period of 2000 to 2010, gas-fired energy sources started to play a role in the conventional generation sys-tem; the reason was their high efficiency (as compared to coal-fired or nuclear ones), low emissivity, liberalization of the European gas market and a short construction time that allowed them to cover the growing demand for elec-tricity in a swift fashion.

Consumption of electrical energy and gas for the production of electrical energy in Span and Germany in the years 2000 – 2013 [in thousands GWh]1

Since the end of the first decade of the 21st century, sub-stantial changes in the fuel mix of the energy sector have been observable, in particular a growing share of renewa-ble energy sources within the mix. The European Union has set ambitious climate goals for the economies of the member states in the area of the development of renewa-

1 Electrical energy supplied to end consumers excluding grid losses and own

consumption by electricity producers

Source: http://www.iea.org/statistics/resources/unitconverter/; http://appsso.eurostat.ec.europa.eu/nui/submitViewTableAction.do

Źródło: Energy Information Agency.

2000

Other fuelsOil

RESGas

CoalNuclear

31,1%

31%

29%

29%

2006 2012

27%

17% 21%19%

15%

6%1%

15%

4%1%

24%

2%1%

27%

2002

540

520

480

500

300

200

250

100

150

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2002

gas consumption electricity consumption

260

SPAIN

240

200

220

250

100

200

150

0

50

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

GERMANY

gas consumption electricity consumption


ble energy industry, curbing greenhouse gases and en-hancing energy efficiency. This has translated into robust support for RES development which can be seen at the levels of:

• prices: financial support systems for RES have been de-veloped by the Member States, for instance in the form of a certification system currently in force in Poland, or guaranteed electricity prices in place in Germany,

• volumes: renewable energy sources have a privileged position in energy systems and are given priority in the merit order. As a result, the development of RES results in less room for conventional energy in the system. This situation applies not only to off-peak hours of the night (the demand for electricity is lower at night), when high volumes of electricity is produced by wind sources, but also to peak hours (that is the time of increased demand for electricity), when photovoltaic cells generate the hi-ghest output.

Promoting RES affects both the strategies adopted by energy utilities but also the behavior of the consumers. Some of the states have been actively promoting prosu-merism, resulting in a dynamic upsurge of installed capa-cities in microgeneration facilities – mainly photovoltaic ones. The above phenomenon is visible, for instance, in Germany and the Czech Republic. There, home installa-tions have been strongly supported (the majority of home prosumer photovoltaic installations is connected to lo-w-voltage distribution grids).

As a result of the development of microgeneration and an increased number of prosumers we can observe that the energy industry that is systemically based on fossil fuels is being pushed out of the system. On the other hand, we can see decreased demand for electricity owing to the fact that prosumers themselves have been able to partly cover their own demand2.

Following the said changes, the current operation model of the power system has been undergoing strong evolution.

Electricity output in photovoltaic sources (PV) and their connection type in Germany and in the Czech Republic

Source: PV GRID European Advisory Paper, September 2014, www.pvgrid.eu

Germany [GWh]

2013

31.009

26.380

19.599

11.729

6.5844.4193.0752.2201.28355731318811660

2.0332.1482.182

No. of PV installations connected to the grid in the Czech Republic in 2012

The Czech Republic [GWh]

Low voltage

Medium voltage

Hight voltage

No. of PV installations connected to the grid in Germany in 2012

Low voltage

Medium voltage

Hight voltage

Extra-hight voltage

1.270.000

28.000

513

1

20.376

1548

4

615

881321000000

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

2013

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000


The base load demand for electrical energy is lower and characterized by far greater volatility, whereby it is covered by noncontrollable sources with irregular output. Genera-tion units that so far covered the base load, are now cut-ting down on the generation volume and work time, taking over regulatory tasks. In practice, this leads to reduction in the revenues of conventional electricity generators.

The trend described above, related to limiting room for conventional units within the power system, translates di-rectly into particular business decisions taken by energy groups, as well as regulatory measures.

Swedish Vattenfall, one of the largest electricity producers in Europe, announced in October 2014 that it would scru-tinize the possibility of changing the ownership structure of its German lignite-based assets. The aim of such activi-ties is to limit the company’s exposure to risks related to CO2 emissions and production volumes.

French GDF Suez in turn recognized an impairment loss with respect to the value of its generation assets at the end of 2013. The amount was decreased by EUR 14.9 billion so as to reflect the impairment of gas-fired units caused by the development of renewable energy sources, hence pushing gas sources out of the system.

The changes in Polish regulations are an example of the steps taken in order to restore control over the generation market and active management of RES development.The

stage of RES development in Poland currently differs from the one in Western Europe. The share of RES in the do-mestic energy mix accounts for a substantially lower per-centage than it does in Germany or the UK. At the same time, the capacity of units classified as microgeneration facilities on the Polish market amounts to merely several dozen MWe3.

The Act on Renewable Energy Sources signed by the Po-lish President on 11 March 2015 is a key factor determi-ning the future picture of RES and microgeneration in Po-land. The fundamental assumptions behind the new support system for the renewable energy industry include:

• introduction of an RES auction system,

• introduction of feed-in tariffs for RES microgeneration.

By implementing an auction system, the Ministry of Eco-nomy is able to control the pace of growth of renewable energy industry and support its development, at the same time balancing 1) obligations imposed by the EU concer-ning the development of RES, 2) the impact exerted by this segment on the electricity generation market, 3) bur-dening the end consumer with the costs of the support system.

Simultaneously, the total capacity of microgeneration units4 covered by the system of feed-in tariffs has been limited by the Act to the level of 500 MWe. However, the Ministry of Economy might pass an ordinance stipulating an increase of this amount. Thus, the Polish government by adopting the RES Act, has opted for a balanced trans-ition to a dispersed model where the generation market will be exposed to the trends visible in Western markets. However, one should assume that thanks to the opportu-nity to exert influence on the pace of growth of RES, Po-land will be able to avoid uncontrollable changes in the generation segment.

Percentage of electricity generated by RES in individual states

Source: Analysis by PwC based on the following data: Germany – Federal Statistical Office and EEX as cited in Fraunhofer Institute for Solar Energy Systems; the UK – data from 3 quarters of 2014 and the last quarter of 2013, Department of Energy & Climate Change; Poland – ARE

18,1%

UK

30,0%

Germany

12,4%

Poland

2See more on this topic in the report by PwC and ING entitled Five Myths of Po-

lish Power Energy Industry, May 2014.

3Analysis by PwC based on the data of the IEO Microgeneration and Produmer

type Decentralised Energy in Poland. The number of installations as at the end of

2012

4Units with capacity within the range of 3 kW to 10 kW.


WHOLESALE ELECTRICITY PRICES UNDER DOWNWARD PRESSURE

In terms of electricity prices, similarly to electricity de-mand, power generators also enjoyed a more or less sta-ble market environment until the end of the last decade. Admittedly, during night off-peak hours, when the de-mand for electricity is lower, energy prices were lower; but the rates were still profitable for baseload generators (nuc-lear power plants and, cheaper, coal-fired power plants). The generators operating at peak times of increased de-mand imposed margins on the sale of electricity at peak hours, when the price was considerably higher than at off-peak hours at night. This is how they compensated the generation of energy in units with higher production costs, even in limited periods of time, from a few hours up to a dozen hours a day.

Dynamic development of RES and their privileged position within the power system has led to permanent changes in the market: RES, receiving subsidies and with variable production costs close to zero, may offer electrical energy at lower prices than the ones offered by conventional units. In addition, given their noncontrollable nature and the lack of a possibility to precisely plan output, they may result in the ”overproduction” of electricity; this applies in particular to the periods of decreased demand, e.g. at ni-ght or during bank holidays. In such situations, entities affected by overproduction, working according to the in-structions of the transmission system operators, will be forced to sell the surplus at home or abroad. The classical interplay of demand and supply may even lead to negative prices of electricity on the market.

Average production profile of wind farms on the Polish market in 2014 and an approximated profile of photovoltaic cells on the German market

Source: EEX Source: EEX

Source: Analysis by PwC based on information in public domain: The wind farm profile - PSE (generation of wind farms) and ARE (installed capacities of wind farms), the photovol-taic cell profile – based on the data of SMA Solar Technology AG, Performance of PV in Germany, average market profile for 2014 based on a sample of randomly selected 36 days5

Wind farm Photovoltic cell

0

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21Hour of the day

22 23 24

5

10

15

20

25

30

35

Comparison of electricity price in Germany Day-Ahead (Phelix) on EPEXSPOT on 23 December 2005 and 2014, as well as on 1 July 2005 and 2014 [EUR/MWh at a given hour]

80

60

40

20

20

-

80

60

40

20

20

-

01.07.2005 01.07.2014 23.12.2005 23.12.2014

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24

5Stratified sampling with replacement was conducted; 3 separate days were drawn for each month of 2014


Two basic types of RES demonstrate different standard production profiles:

• wind sources generate energy mainly during evening and night hours,

• photovoltaic units generate energy during the day.

Different generation profiles of wind and photovoltaic faci-lities have the following implications:

• during night hours, increased performance of wind faci-lities generates downward pressure on the prices of electricity at off-peak times,

• the performance of photovoltaic facilities throughout the day results in lower prices at peak hours.

The above phenomena lead to a drop in the average elec-tricity price. Given the fact that during the day, at peak hours, electricity is generated both by wind, and photovol-taic facilities, the downward pressure on prices exerted by RES is greater than at night off-peak hours. Hence, the difference between peak and off-peak prices is also de-creasing.

The described trend translates into tangible business de-cisions made by energy groups.

In August 2014, German RWE announced it would be for-ced to shut down some of its power plants as a result of insufficient revenues generated by electricity sales; those in turn were the result of persistently low prices. This infor-mation was published about one year after the company announced the decommissioning of 3.1 GW of installed capacities based in Germany and the Netherlands in con-nection with the development of the renewable energy industry.

In March 2014, German E.ON announced the shutting down or sale of approximately 13 GW of capacity in Euro-pe, constituting over 25% of its total assets. At the end of last year, E.ON went on to announce the sale of generation assets in Spain and Portugal (about 4 GW of installed ca-pacities) and in Italy (about 4.5 GW of installed capacities).


New role of distribution system operators

The majority of strategic discussions in the energy indu-stry are centered around two business segments:

• generation, with RES development altering the condi-tions underlying the whole industry,

• end customer, where the activity of consumers allows for the creation of new business models, and electrical energy, from a homogenous product, turns into a (profi-table) element of a service.

Within those discussions, the area of electricity distribu-tion is still perceived as a regulated business, a petrified natural monopoly, with its main challenge being technical grid management. However, a close analysis of the chal-lenges faced by this sector reveals that a more intense debate on the future role of the DSOs within the power system is necessary, along with a description of a busi-ness and regulatory model fostering the implementation of new business roles. In this context, one may differentiate 3 key challenging issues for distribution system operators:

Issue No. 1: Grid flexibility in the face of RES developmentIssue No. 2: Active neutrality: the new role of DSOs in sha-ping the business environmentIssue No. 3: More for less: cost pressure exerted by the customer and the regulator

GRID FLEXIBILITY IN THE FACE OF RES DEVE-LOPMENT

A key factor changing the conditions underlying the ope-ration of companies serving as DSOs is the rapid growth of capacity installed in RES observed in the recent years, and the further growth forecasted for the future. A DSO is in charge of the development of the distribution system, as well as assuring its stable performance even in extreme circumstances. As a result, the companies need to plan system development with a ‘safety margin’. Consequently, maintaining the current method of grid planning and deve-lopment (in English-speaking sources this is frequently referred to as the „fit and forget” approach) would lead to two effects:

• Difficulty in financing the ”peak” energy offtake capabilities of the distribution grid (necessary only in extreme situ-ations such as particularly windy days). Bearing in mind the privileged position of renewable energy within the grid, as well as unstable performance of wind facilities – the dominant RES technology – we are facing a situ-ation where the grid must be ”ready for more” in order to distribute to a lesser extent as part of the RES output is consumed locally,

0

2008 2009 2010 2011

The growth of RES capacities expected by the Ministry of Economy in connection with the introduction of a new support system

2012 2013 2014 2015 2016 2017 2018 2019 2020

2.000

4.000

6.000

8.000

10.000

[MW]

Wind Other

Source: Analysis by PwC – historical data based on ARE data; data for the forecast – Ministry of Economy, Results of Regulations pursuant to the RES Law dated 29.01.2014.The above is not a forecast on the growth of installed capacities of RES by PwC.

RES capacities, historically and as forecast by the Ministry of Economy


• Local limitations in connecting RES to the grid – DSOs are in charge of defining whether (additional) RES may be connected to the grid in individual areas. Adopting a co-nventional (reactive) approach to this issue would create the risk that the operator may at some point conclude that there are no possibilities to connect additional sources to the grid.

To avoid such limitations, ”flexibilities” must be introduced at different stages of grid planning and management, and the DSOs must adopt a proactive, dynamic manner of di-stribution system management. Such a shift may be intro-duced in a number of areas such as:

• At the stage of grid development planning, in particular in the face of RES development, one should consider implementing coordination measures between DSOs and institutions in charge of allocating subsidies for RES, for example. Such cooperation has been taking place in Spain, where applications for connecting RES to the grid are assessed by a joint committee made up of the TSO, DSO and local authorities. Having conducted technical analyses scrutinizing both negative (problems with voltage regulation) and positive impacts of RES on the grid operation, as well as business analyses related to, for instance, the availability of funding, the DSOs fina-lize their grid development plans and the local admini-stration adjusts the process of funding allocation,

• At the stage of grid development planning, one should consider the use of ”flexible” conditions of connection that provide the operator with the possibility of tempora-ry (short-term) reduction of the generation of particular renewable energy sources. This is practiced for example in Germany; there, it is commonplace to connect photo-voltaic panels under contracts pursuant to which the operator of the local distribution grid may curb the gene-ration of a particular source to the level of 70% of its nominal capacity. In fact this right is rarely exercised (dri-ving the volume of energy fed into the grid down to 5%), but it has a substantial influence on the possibility of connecting additional sources to the grid. According to the data of EWE Netz based on a simulation, obtaining a 5% flexibility of the generation of sources in a given balancing area translates into the possibility of connec-ting 220% more capacities to the grid,

• In the process of grid operation, mechanisms should be developed that allow DSOs to purchase ”flexibilities” from commercial entities and recognize the costs of such services as ”reasonable” company costs. So far, such services have been a tool used in the majority of

countries, including Poland, by the TSOs, but in the me-dium-term perspective, they should be made available to the DSOs as well.

ACTIVE NEUTRALITY: A NEW ROLE OF DISTRI-BUTORS IN SHAPING THE BUSINESS ENVI-RONMENT

The new tools described above which in the future should be made available to the distributors and used by them as a way to manage the grid more flexibly imply a major shift as far as the participation of the DSOs in the shaping of the business environment is concerned. Given their com-mercial neutrality resulting from the position of natural mo-nopolists, the DSOs will need to make a more active use of a growing array of tools when conducting their activity.

In this context, the DSOs should develop and be more active in the following two areas:

• Co-creation of regulations and legal provisions in the area of distribution and related areas

The tools defined above that the DSOs may and should use in the future to be able to run their activity in a more active fashion demand not only amendments of regula-tions and the tariff model, but also their active participa-tion in the process of creating implementing provisions, in particular with respect to RES development. The creation of rules on the recognition of costs related to purchasing ”flexibilities” as reliable costs and establishing mechani-sms of assessment of various alternative options are key challenges; the latter issue concerns, for instance, whe-ther it is more conducive to reinforce the grid in a ”traditio-nal” manner or to build an energy storage facility. At the level of operations, this implies that the DSOs must essen-tially strengthen their capacities in the area of regulatory analytics, as well as continually monitor legal and regula-tory solutions. The scope of said monitoring should not be limited to the ”distribution” area only. A good example may be the issue of the operational monitoring of limits impo-sed on prosumer facilities eligible for subsidies under the Act on RES. Even though the DSOs are not responsible for the monitoring in question, one should expect that they will bear the brunt of customer contacts in this area. This is just one of many examples indicating that system ope-rators should actively shape the new law and regulations on the one hand, and that their participation in finding tho-


se solutions should be a permanent element of the legisla-tive process on the other.

• Developing tools and methods of customer communication

According to the model in place in most of the EU states, where the DSO owns the meter installed at the end custo-mer’s house (UK being an exception in this regard), it is the distribution company that triggers customer reaction: that is, their consumption data. With the advent of mass implementation of smart metering – which regardless of the pace of progress, means that one should expect that within 7-10 years from now most customers will be equip-ped with smart meters – the scope and level of detail of those data will essentially increase. This will pave the way for the pursuit of social goals related to boosting energy efficiency, as well as commercial ones concerning the ap-plication of customer reaction for the purpose of flexible grid management. Both purposes mentioned above are however achievable only once efficient communication with the customer has been secured. For this end, a large-scale awareness campaign should be initiated as a first step, informing the customers on the possibilities related to the use of ”smart” solutions. In Poland, such measures have been already undertaken by the Polish Power Trans-mission and Distribution Association, and as a result of such campaigns, the awareness among consumers has considerably increased. These are positive signs, but a shift from ad hoc measures to reshaping the process of communication with the consumer into a permanent pro-cess delivered by the DSO is needed.

More intense communication with customers is also of key importance to manage the third challenge faced by the DSOs, i.e. to ”justify” high investment expenditure and to create a positive image of the distributor, being a com-pany undertaking continuous steps to achieve ”more for less”.

MORE FOR LESS: COST PRESSURE EXERTED BY THE CUSTOMER AND THE REGULATOR

Given the substantial outlays required to assure high qu-ality and uninterrupted supplies of electrical energy as well as new connections to the grid, companies serving as DSOs in the most economically developed European sta-tes have been investing over 40% more annually than a simple restoration of assets would require.

At the same time, one can easily observe the trend of surplus of investment over depreciation dropping. This phenomenon is also reflected in the messages sent by the largest Europe-an companies serving as DSOs. The key element of those messages is the statement that regulatory uncertainty and unsatisfactory rates of return from investment lead to limited investment activities6. At the same time, the 40/27/27 EU tar-gets (to be achieved until 2030, include the reduction of CO2 emissions by 40%, increasing the share of RES in the gene-ration mix to 27% and improvement of energy efficiency by 27%) assume the scenario of further development of RES; this entails necessary integration of those sources into the grid, and hence additional investment expenditure. As a re-sult, striking the right balance between the DSOs, RES and the customers is getting tougher.

Investment activity of the European DSOs (investment expendi-ture to depreciation), 2008-2012

Source : Eurelectric, Electricity Distribution Investments: What regulatory framework do we need

0

0,2

0,4

0,6

0,8

1

1,2

1,4

1,61,66

1,51 1,511,46 1,46

2008 2009 2010 2011 2012

1,8

Investment/depreciation

6 Eurelectric, Electricity Distribution Investments: What regulatory framework do

we need.


At the same time, the trend in the area of investment in distri-bution was far more visible in Poland than in the majority of other European states. Investment plans agreed by compa-nies with the President of the Energy Regulatory Office (URE) as well as the investment activity of the companies themse-lves have marked the beginning of the ”time for investing”.

There is no doubt that one should take note of another starting point for Polish and foreign DSOs, as well as take into account a different asset structure. Still, irrespective of the differences between Poland and other countries, observable in several previous years in this regard, the challenges to be taken up in the upcoming 4-5 years will be shared; they will be centered around striking the right balance between the need to connect more RES capaci-ties to the grid and the requirements of the consumers with regard to high-quality supplies, along with reducing the increase in distribution fees.

Investment activity of the Polish DSOs (investment expenditure to depreciation), 2011-2013

Source: Analysis by PwC based on the companies’ data (the data concerning Polish DSOs are not fully comparable with the data from foreign markets owing to the process of reevaluation of regulatory assets ongoing in the presented years)latach proces przeszacowania WRA)

2,4

2,0 Average rate

1,6

1,2

0,8

0,4

2011 2012 2013

0

PGE Dystrybucja Tauron Dystrybucja Energa Operator Enea Operator


Electricity as a product

The liberalization of the European electricity markets (granting freedom to switch energy suppliers - TPA) has been the impetus for significant changes at both the sup-ply and the demand side. Its two key consequences are:

• Changes in demand - increase in customer awareness:

Value proposals offered to customers in mature mass in-dustries (banking, telecommunications, etc.) have taught them that they can request a better offer from the service / product supplier. Moreover, the possibility of switching energy suppliers has become a tool that allows customers to „fight” for their rights in their relationship with the energy supplier. Survey results show that the vast majority of cu-stomers are aware that they have this right. In Poland, this percentage is about 60%-70%, while in more mature mar-kets, e.g. in the UK, it is respectively larger and amounts to about 80%7. Customers know their needs connected with electricity – they are primarily looking for savings. Ho-

wever, they are also afraid of change: they fear that they may experience power outages.

• Changes in supply – entrance of new players on the market:

Encouraged by the market opportunity, new players star-ted to enter the electricity market. Based on business mo-dels from other industries, energy companies began to create new models of operation. The most visible is the cheap brand model, which is the response of market competitors to the needs of the market segments that are most price sensitive. In the UK, 6 incumbent players expe-rienced the entry of new dynamic entities actively seeking customers, while on the German market, cheap brands were created by the incumbent players themselves.

Wide

High

Narrow The scope of the offer (gas, additional services, etc.)

Low

Price

Incumbent players

Competitive price as the main value lever of the new players at the initial stage of market development

The development of the product offer as a new competition area

SSEE.onBritish GasScotish PowerEDF Energynpower

E.onRWEEnBWVatenfall

PGETauronEneaEnergaRWE

OvoEnergyEcotricityGoodEnergy

rst:utility...

eprimo (RWE’s discount brand)

YelloStrom (discount brand of EnBW)

...

Energia dla mDuonFITen...

New players

Competition area

The necessity of finding a distinguishing element, while keeping a competitive price

The necessity of finding a distinguishing element, while keeping the lowest price

Source: PwC analysis based on publicly available information

Players on the energy market in selected European states

7Source: PwC analysis based on publicly available information


In Poland, after the liberalization of the market, 5 incum-bent players experienced competition in the form of new entrants, which are mostly „small” players actively looking for customers and quickly adjusting their offers to the changes in the market. The competitive war started in the business segments (A,B,C), where the right to switch sup-

pliers was supported by the liberalization of prices. The competition in the household segment (G) was delayed owing to this market’s relatively lower attractiveness (lower volumes) and non-liberalized margins. However, it is now becoming more intense.

In the initial phase after market liberalization, customers are relatively loyal to their traditional suppliers, as they perceive energy to be a product that requires specialization. Even the segments of customers who look for savings are more inclined to sign a new contract with their current supplier than switch. In countries with the most developed markets (UK, Germany), the ongoing customer education process entered into the second phase of development: an open-ness to switching suppliers, including even to new ones.

The two changes mentioned above - increased customer awareness and a greater number of market players – have led to an increase in the number of customers who decide to switch their electricity suppliers. In Poland in recent years, the number of customers switching their electricity suppliers has increased, reaching the ratio of about 15 thousand per month (approx. 0.1% of the base) in 2014. On the most developed markets, e.g. in the UK, this figu-re is approx. 270 thousand per month, which equals abo-ut 1% of the base8.

Source: PwC analysis

Source: PwC analysis

Competition development path on the Polish market

The evolution of the customer’s inclination to purchase electricity from specific types of market players

8 Source: PwC analysis based on data from URE and Ofgem.

Incubent player+ a number ofnew ones2

2004 2007

Tariff groups

2010 2015

Incubent player+ from 11 to 19new ones2)

Incubent player+ a few dozennew ones3)

Aktive marketplayer

Concentration of the competitive war

A B GC2 C1

A B GC2 C1

A B GC2 C1

A B GC2 C1

A B GC2 C1

1) eg. Polenergia, GDF Suez, Axpo; 2) eg. Energia dla rm, FITen, EDF; 3) eg. Energetyczne Centrum, ePower, Orange, Plus

Extending the competitive war to new segments and increase in the number of players

Savings + Security

Phase 1 Phase 2

Savings + Specific needsCustomers’ needs defining their approach and inclination to selecting their electricity supplier

Incumbent players – energy companies Incumbent players – energy companies

New players – energy companies

Incumbent players – energy companies

New players – energy companies

New players – banking, telecommunications, etc.The evolution of the customer’s inclination to purchase electricity

Phase 3


Fiercer competition and increasing consumer awareness have led to the necessity of looking at electricity from a different perspective. Competitors are trying to respond to the specific needs of individual segments by expan-ding the market offer.

They do it by developing energy products and adding to them new non-energy ones. In this way energy products are becoming similar to the products offered in other indu-stries and may be described by the following product lay-er model:

• Electricity,• Additional products and services,• Customer experience.

ELECTRICITY PRICE – THE MAIN VALUE DRI-VER FOR THE CUSTOMER

Customers perceive the price of electricity as too expensive. Therefore, the most important factor enco-uraging them to switch suppliers is price reduction. Consumer surveys in Poland show that the average

The first layer is formed of the conditions of electricity sup-ply. They constitute the answer to consumers’ preferen-ces with regard to price, exposure to the risk of its chan-ge, consumption in time zones, etc. The next layer is formed of additional products and services which answer consumers’ preferences in terms of the purchase of pro-ducts under an offer combined with other products and services, the use of new solutions, etc. The last layer con-sists of customer experience. It addresses consumers’ preferences with regard to the forms of payment, payment deadlines, service level, self-service trend, contact chan-nels, and the degree of meeting specific needs.

expected price reduction is about 20-30%.

In the case of Poland, new players are able to offer signifi-cant price discounts, and this is what they base the value of their proposals on. An analysis of market tariffs sugge-sts that the price offered by new players is lower, not only than the standard tariff, but also than the acquisition offers of the incumbent players directed at the same segment


The development of the product offer on the energy market – product’s layers

Layers of the value proposal for customers

Electricity Additional products and services Customer experience

Customers’ needs maybe addressed by a proper construction of every layer


(e.g. about 10-15% discount in tariff C11). This also results from the fact that in comparison to the incumbent players, the new entities lack a strategic advantage in the form of a strong brand.

Although, low price is potentially the major value driver for customers, it leads to margin erosion. Owing to the deve-loped wholesale market, the costs of electricity as such are very similar for all market players. Therefore, in order to be able to compete in this product layer, energy compa-nies will need to put more emphasis on the optimization of customer service and acquisition costs, so as to ensure for themselves the possibility of price decreases while maintaining a positive margin. This is particularly impor-tant as the competitive battle involves consumers with increasingly lower consumption levels (lower margin), and offers are directed at customers who have already swit-ched their supplier (price discount).As early as 2-3 years ago, the incumbent players laun-ched actions aimed at increasing loyalty (signing contracts for a fixed term) in the customer base of the mass custo-mer segment. It can be estimated that several dozen per-cent of customers consuming from several tens to hun-dreds of MWh per year or more (in particular, consumers from the C2X group and large consumers from the C1x

group) were loyalized (i.e. they were permanently bonded with the company). Nonetheless, there is still a group of companies consuming up to 19 MWh annually, and a vast majority of the tariff G market (households), where, as stu-dies show, the number of customers with loyalty program-mes is lower, and which will probably be the area of incre-ased competition. As energy consumption in this group is lower (lower margins), it will be essential to reduce service costs, and this can be implemented, for example, by mi-grating services to electronic channels and optimizing processes. New market players, however, will certainly attempt to win those customers whose contracts signed 2-3 years ago are now expiring. When signing these contracts, the cu-stomers received 10-15% discounts from tariff prices. Now, ”the second wave of discounts” is approaching, which will make it more difficult for the suppliers to offer attractive discounts while maintaining a profit margin for themselves. Therefore, the offer will be improved, so as to raise the quality of customer experience in contact with the brand, and supplemented with additional products and services.

ADDITIONAL PRODUCTS AND SERVICES – BUILDING UP THE MARGIN

Taking into account the above circumstances, the deve-lopment of additional products and services may fulfill three fundamental roles that improve the economics and efficiency of the customer acquisition process:• providing an opportunity for building additional margin;• constituting an offer-distinguishing element, which the

customer perceives as creating value, equivalent to a specific amount of money;

• forming a possible basis for marketing communications.

Source: Analysis by PwC based on market research

Source: Analysis by PwC

Comparison of the price offer of market players in Poland in tariff C

The funcitons of an extended product offer

New players

~ 15-20%

Discount of incumbent players

~ 10-15%

Additional discount of new players ~ 25-35%

Discount of new players for non-loyalized customers of incumbent

players

Acquisition tariff

Standard tariff

Incumbernt players

Acquisition tariff

Extended product portfolio – functions Customer

Basis of marketing communication

Offer-distinguishing element

Building up additional margin

Mass and direct marketing

Price discount equivalent

Lack of knowledge

Fear of change

Additional sale of new products


An analysis of offers available on the Polish and foreign markets shows that additional products and services can be developed around energy competences, they may be based on metering information, as well as originating in other mass customer industries.

For example, additional margin building elements which can be observed on the Polish market include support in the installation of photovoltaic panels and the sale of legal services or medical packages, while foreign markets offer the installation of gas boilers. The element on which mar-keting communications on the Polish market are based is assistance (e.g. the support of an electrician) or support in the installation of photovoltaic cells.

Other examples are new solutions resulting from the co-operation of energy companies with banks. They offer be-nefits for both energy companies and for consumers (energy consumers). One such product is the distribution and payment of electronic invoices through the consume-r’s internet banking system. The main added value for the consumer is convenient settlements (the ‚click & pay’ rule), while the supplier benefits from improved liquidity and re-duced costs connected with the invoicing and posting of receivables.

The above-mentioned list indicates that individual pro-ducts and services can fulfill more than one role, e.g. they can form the foundation of marketing communications

and simultaneously build additional margin, depending on their design and the sales strategy of market players.

The main mid-term objective for players fighting for the customer base in Poland will be to use it to build additional margin. The method of margin re-creation and further di-rections of offer development will depend on the role which energy companies assign to themselves in the new reality. Will they become a broker platform offering the products of other industries, or will they try to develop the-ir own competences and use their energy knowledge and experience in the development of offers for customers?

An analysis of the products available on the Polish market indicates that additional products and services are still at an early stage of development, and are mainly used in the area of acquisition. They are based on competences ta-ken from the energy industry as well as other industries, which suggests that a decision on the role of energy com-panies on the Polish market has not been taken yet.

CUSTOMER EXPERIENCE – A NEW AREA OF COMPETITION

Creating customer experience at touchpoints with the com-pany or the brand can be interpreted as all the activities of the company affecting the customers’ positive perception of the company and its offer. Customer experience is created during every contact with the company, starting from the acquisition process, through the use of its products and se-rvices, to the process of terminating cooperation.

Traditionally, customer experience is perceived through the level of customer service (hotline waiting time, timeliness of issuing invoices, etc.). However, what also contributes to cu-stomer experience is the authenticity of the promises made, based on a coherent proposal of value, and supported by marketing communications that build the brand image.

Owing to a relatively recent liberalization, expectations con-cerning the service level in the mass customer segment of the Polish energy market are not high, and the results of sa-tisfaction surveys indicate that energy companies, even limi-ted by a lack of modern tools, are able to meet them. Howe-ver, what may be treated as a warning is the situation in the UK, where alternative players not only offer the lowest price, but they are also rated higher in the category of „customer satisfaction” than the incumbent suppliers.

Categories of additional products and services development


Microgeneration

Categories of products and servicesCompetences

Energy competences

Device management, new technologies

Other mass services

Energy efficiency audit

Green energy

Energy installations, assistance

Banking, insurance

Telecommunications

Gas

Medical, legal services

Consumption management

Consumption monitoring


According to an analysis of the British market, what is also necessary in mature markets is to actively communicate the steps taken. The best example is the success of Bri-tish Gas, which by creating a dedicated offer for house-holds and actively communicating it as „Planet Home”, reversed the downward trend in its market share, while the campaign itself has become the most recognizable in the sector.

In 2008, the customer base shrank by approximately 0.45 million. In 2010, only two years after the launch of the mar-keting campaign, the company experienced an increase in its customer base by 0.25 million.

In addition, the creation of products dedicated to house-holds seems to be a very attractive strategy in the context of developing additional services. British Gas offers a full range of services connected to the installation and service of gas, electrical, and plumbing systems, microgenera-tion, optimization and control of energy consumption, ho-use insulation, etc. The offers are presented not only in a package with energy or gas, but also separately. The company bases its activities on the authenticity of the pro-mises made, and all the systems in the customer’s house are installed by the company’s own group of specialists (over 6,500).



Customer acquisition/loss dynamics at British Gas during 2008-2010 (in thousands)

Value proposal of British Gas

2008

2.200

2.650

-0,45 m customres

Start of the ”Planet Home” campaign

1.950 2.1001.750

2.000

2009 2010

+0,25 m customersLeaving customers Acquired customers

Mass marketing communications

Wide product offer Own group of specialists

British Gas will take care of your world now and in the future

Value offer of British Gas

Identified vital need

Strong message, positive experience

Authentic offer based on real activities, fulfilling the promise made to the customer

My home is all world to me. I want someone to take care of it

British Gas

Energy

Gas

Microgeneration

Installation and service of systems

Optimization and control of energy consumption

...

6500 engineers

The foundations of new market strategies


Generation market

In the power generation sector, two major trends constitu-ting the core of changes in this market have been identi-fied:

• reducing space in the system for conventional power plants,

• pressure on the decrease in wholesale electricity prices.

Both of these trends, separately as well as jointly, lower the profitability of electricity generation from conventional so-urces and may even lead to significant financial losses in a short-term. Thus, producers of energy from such sour-ces are forced to take action in order to restore the profita-bility of power generation in conventional units within a mid- and long-term time frame. Below are three strategies whose implementation may help achieve the above goal:

• certain work in the ”base load,”• ”good-bye base load,” or how to survive in the system,• ”must run”.

The strategies differ from each other in their approach to the optimization and reduction of the fixed costs and va-riable costs of production, and effective management of capital expenditures (e.g. on new investments, moderni-zation, repairs). In each of these strategies, control and supervision of the level of costs are important. However, the stress (a specific concentration of the energy compa-ny’s efforts) is different for each individual strategy.

It should be noted that the above strategies can be ap-plied to individual generation units. In consequence, an energy company may use all of them at the same time.

CERTAIN WORK IN THE ”BASE LOAD”

This strategy is dedicated to energy companies which have or will have modern generation units and / or units based on fuels that are attractive from an economical po-int of view.

The goal of the described strategy is the maximum utiliza-tion of the technological advantage (e.g. in terms of the efficiency and emission level of a given unit) or the location advantage of an energy company (e.g. the proximity of fuel supply sources), as well as the provision of a genera-ting unit with a permanent place in the system and work in the base load.

An energy company using the strategy „certain work in the base load” focuses its optimization activities on varia-ble costs, in particular fuel costs (reducing the costs of purchase, transport, etc.) and the cost of CO2 emissions. At the same time, as part of this strategy it is essential to maintain a reasonable level of fixed costs.

Thanks to these measures as well as the technological advantage and the location advantage of a generating unit, an energy company will be able to offer an attractive electricity price on the market, which in turn will guarantee it adequate working time in a year, and a high volume. Such a source will enter the system immediately after the „must-run” sources (which are of higher priority in terms of working in the system).

”GOOD-BYE BASE LOAD” OR HOW TO SURVI-VE IN THE SYSTEM

Due to the limited room in the system for conventional po-wer producers, attributable to the higher priority of the „must run” sources, not all existing producers will have the ability to place the volumes coming from their actual ge-neration potential. A reduced number of working hours in a year, with the same level of fixed costs, may make it impossible to cover the costs of one’s operating activity – thus the average unit cost of production increases. In such a situation, the producer faces a choice between one of two options:

• decommissioning the unit,• reducing fixed costs.

It must be stressed that such producers have only limited possibilities of reducing variable costs (e.g. through tech-nology), so the only way to improve their situation against their competitors is cutting the fixed costs.

This strategy maximizes the producer’s chances of rema-ining on the market - it must be assumed that the first producer to fall out off the market will have similar variable costs, but higher fixed costs.

Implementing the strategy of „good-bye base load or how to survive in the system” the energy company focuses on fixed cost adjustment by taking steps to optimize its own resources necessary for conducting generation activities (e.g. with regard to grid operation and repair services,)


and minimizing its own and external costs connected with production-related activities (e.g. in terms of support func-tions).

”MUST RUN”

The inevitability of the fact that there will not be enough space in the system to fit in all the producers motivates the search for strategies that would guarantee such a place. One such strategy is the above-mentioned „certain work in the base load” - but it requires excellence at the level of variable costs and is dedicated to large sources with a stable profile of supply.

An alternative strategy is to secure the „must run” status for oneself, i.e. the status of a source that must work. Such sources include renewable energy installations and CHPs. However, only those investors who still have to de-cide which investment direction to take in the generation segment have the comfort of choosing this strategy.

A guaranteed place in the system is a rather simplistic concept, because in the era of the auction system for RES, power limitation for prosumer installations with the right to support, or a limited number of locations for coge-neration, the potential for „must run” sources is also limi-ted. Therefore, these investors also must make sure their projects are competitive.


Distribution System Operators

Owing to the DSO’s natural monopoly in the area of elec-tricity distribution, the discussion about „winning the mar-ket” has no real importance for it, compared to the com-petitive segments of the energy market. Nevertheless, it is possible to identify three groups of business activities / strategies that differ the efficient and modern DSOs from the distributors that rely on their historical position only. With the introduction by the Energy Regulatory Office the remuneration scheme to the tariff system when DSO achieves the business effects, higher efficiencies should translate into better results in the mid-term perspective. Three identified strategies are as follows:

• smart DSOs,

• efficient DSOs

•DSOs as distributors of information, not only of energy.

SMART DSOS

Besides the postulated above new roles of the DSO and the business models necessary to perform them, the technical aspect of the work of distributors is also impor-tant. The described change in approach from primarily reactive monitoring of the distribution grid (mostly at the low voltage level) to the approach of active management of the distribution system requires a transformation in the area of data acquisition and management in the DSO. The data, so far acquired and processed in an „insular” fa-shion in various systems, are becoming a key resource for every DSO (in particular, the data in the low-voltage grid, which currently lacks the tools and features which would make it possible to monitor and manage the grid in real time). Therefore, in terms of the technological systems of companies (SCADA, GIS, metering data management systems), it is necessary to create joint data models and to plan their development in an integrated manner.

Such an approach enables the achievement of 3 goals, which are currently the priorities of large European DSOs:

• increased observability of the grid,

• implementation of functionalities supporting voltage control,

• implementation of functionalities supporting the identifi-cation and fixing of failures.

At the level of business results, the implementation of the described functionalities will create a much greater oppor-tunity for companies to impact power and electricity con-sumption from the grid, and thus the costs and revenues of the OSD. Another consequence will be the improved quality of the supplied energy and continuity of supply. Obviously, the exact schedule and list of functionalities im-plemented by the DSO may be different for every distribu-tion system operator. However, a good practice taken from other markets (e.g. the UK) is conducting a business costs / benefits analysis of the implementation of specific func-tionalities in the local conditions of a given distribution grid.

EFFICIENT DSOS

In the light of the „more for less” challenge, DSOs can expect growing pressure from the Regulator to lower ope-rating costs. In this situation, the natural trend would be to create operational efficiency comparisons of various DSOs, as well as to start a discussion about basing the remuneration of a given DSO on the results of these com-parative analyses. This can be confirmed by international examples. Namely, according to the annual reports of E.ON or RWE, their business model principle in the area of distribution is a high degree of outsourcing and continu-ous adaptation of efficiency by comparison with the com-petition.

When analyzing the initiatives taken in the area of impro-ving the efficiency of Polish DSOs, one should first of all note the actions aimed at organizing operations, namely the creation of competence centres and the optimization of processes distribution across different levels of the or-ganization. In certain cases, companies responsible for grid maintenance were separated from the structures of operators in order to increase efficiency.

In the context of the described trends connected with the developing mass prosumer energy market, one should expect the emergence of an additional segment, where the competencies and resources related to installation works and the grid maintenance task will be of key impor-tance. For the DSO, it may mean, on the one hand, gre-ater ease of ensuring a portfolio of orders for the potential-ly separated companies, and on the other hand, the need to maintain key staff who gain the possibility of working in a market unrelated to the traditional distribution market.


DSOS AS DISTRIBUTORS OF INFORMATION, NOT ONLY ENERGY

In discussions about the transformation of the energy mar-ket, entities working in the commercial part of the market - both traditional suppliers as well as new ones of the ESCO type (Energy Service Company - companies provi-ding services related to energy management) or aggrega-tors (intermediaries between consumers on the one hand, and the market, the DSO, and the transmission system operators on the other) - are assigned roles connected with active communication with the customers. Meanwhi-le, according to a model valid in most European Union co-untries, where the DSO is the owner of the meter installed at the end customer’s premises (except for the UK market, for example), quick switching of suppliers, the introduction of new tariffs, or the settlement of the production in the prosumer’s source - in other words, the introduction of new “market” elements in the energy sector - depend on the actions taken by the DSO. On the other hand, because of the neutral role of the DSO, which is a „public trust” en-tity in the area of acquiring customer data and providing it to authorized entities, the distributor is obliged to maintain technical standards in the processes of customer data processing.

The above-mentioned conditions are objective needs of the market / customer, but it is the DSO that has to imple-ment the necessary investments in increasingly more ad-vanced solutions in the area of data exchange as part of creating the foundations that enable development. After obtaining social acceptance of these investments, the DSO should focus on excellence in the methods of pro-cessing data and providing access to it for commercial purposes. At the same time, using customer data jointly with the data from technical systems, the distributors sho-uld improve the grid operation processes, and thus incre-ase their own efficiency.


Supply

In the supply segment, a change in customers’ behaviour and the intensification of competitive wars indicate three major challenges that electricity suppliers face: loss of cu-stomer base, margin erosion, and the acquisition of new customers.

The changing customer base and deterioration of the bu-siness’s profitability force companies to develop tools and take actions aimed at securing their current position, on the one hand, and at using the available market opportu-nities, on the other.

Three strategies that help one win on the market are:

• understanding and managing the customer base,

• smart partnerships,

• developing an „energy” value proposal.

UNDERSTANDING AND MANAGING THE CUSTOMER BASE

Currently, the competition on the Polish electricity market is entering the mass market - households as well as small and medium-sized enterprises (tariff C and G) - creating the need to develop a value proposal for this segment, which is different from large customers with tariffs A and B (large customer), where the dominant strategy is price competition and individual service, often with an account manager.

Although the new players are testing the market using va-rious elements of the value proposal for the customer, not every new area of competition should become „mandato-ry” for the market. The incumbent players should, first of all, get to know their own customer base and develop only those elements which have a real impact on customers’ behaviour. One can identify a 3 step strategy for „Under-standing and managing the customer base”:

• Step 1: Take care of the „hygienic” (basic) factors The results of customer surveys show that because of customers’ fear of change and their low level of know-ledge, the decision to switch suppliers requires a strong stimulus. This is good news for most traditional sup-pliers, at least in the mid-term perspective. Taking care of the „hygienic” factors should enable keeping the ma-

jority of the customer base. The hygienic factors include: 1) a competitive price level (not necessarily the lowest one) 2) an acceptable level of service.

• Step 2.: Get to know your own customer baseAlthough the incumbent players have a large group of cu-stomers, their knowledge about their preferences is limi-ted. It is necessary to introduce a systematic process of collecting customer data through different contact chan-nels. Moreover, constructing tools in the form of CRMs and billing will enable effective use of these data, which will make it possible to identify only the particularly attrac-tive segments and develop a consistent value proposal around them. Therefore, the process of loyalizing one’s own customer base should be adjusted to the customer’s value or risk of leaving.

• Step 3.: Manage your customer base effectively Separating the customer base into segments which are distinguishable in terms of important factors, such as: volume, level of knowledge, attitudes to energy compa-nies, and needs, for example, will help design a plan to manage these segments and match them to appropriate tools:

a. Information channel – it is important to control the in-formation channels for the customer and to better un-derstand their decision making process with regards to switching. For instance, it is vital to understand which channel is the trigger for the decision (adverti-sements, friends, etc.), and then to identify and use the most effective ones, e.g. if customers start to use electricity price comparison functions on a large sca-le, market players should implement pricing strategies which take into account the algorithms used in such functions.

b. Acquisition channel – the mass market requires a mass acquisition method. The traditional direct acquisition is a natural choice on a market with uninformed custo-mers. However, it will not be economically viable in segments with low consumption (low-margin). There-fore, in the mid-term perspective, energy suppliers should pay more attention to the development of ef-fective remote channels e.g. a well-functioning call center or online acquisition. Nonetheless, the develop-ment of effective remote acquisition channels on the mass market may be difficult, as it requires a much more informed customer and a strong brand. Therefo-re, the development of such channels in the mid-term perspective may be much easier for the incumbent players.


c. Management of the value proposal – the size of a seg-ment and its specific needs profile will determine the level of advancement of the tool developed to manage that segment and to create a value proposal for it – from a specific product line up to the creation of a se-parate brand.

For a sufficiently large segment that requires specific treatment, e.g. a segment where low price and higher standards of service are of key importance, a strategy worth considering is the creation of a separate brand. This solution makes it possible to individually manage the value proposal, does not cause erosion of the value of the other segments (the lower price is offered only under the separate brand), and enables higher opera-ting efficiency. Of course, such a strategy entails large expenditure on marketing and advertising, but can also be a good solution that facilitates the management of individual segments.

SMART PARTNERSHIPS

Customers in the energy market are universal - everyone is an electricity consumer. Thus, every customer of ano-ther mass customer industry is also a customer on the electricity market.

Therefore, a properly structured partnership can help an energy company achieve its goal connected with the pre-sentation of a value proposal that supports customer acquisition and loyalization. Because the customer bases are common for various sectors, a natural tendency emer-ges to seek synergy in terms of the cost of customer se-rvice and acquisition. This is especially important when creating a value proposal for tariff G, where the margin is regulated and there is no place for a large price reduction.

The universal character of the energy customer is an op-portunity for companies from the sector, but it can also be a factor giving rise to material risks. The customer bases of the incumbent players on the electricity market are well defined, at least in terms of territory, which constitutes a va-lue for companies from other mass customer industries interested in expansion in a given region.

Understanding and managing the customer base – illustration of the concept


Seg

men

t’s

attr

acti

vene

ss

(mar

gin,

incl

inat

ion

to b

uy n

ew p

rodu

cts/

serv

ices

)

Inclination to switching the supplier High

High

DON’T LOYALIZETake care of the hygienic factors

Customer base of an energy company

LOYALIZECreate a separate brand to manage the segment

DON’T LOYALIZETake care of the hygienic factors

LOYALIZEValue proposal to meet the needs of the segment under

the current brandOR

Transfer the segment to the cheap brand (low-cost model)

DON’T LOYALIZE DON’T LOYALIZE

LowLow

The universality of the customers on the electricity market


Electricity

Banking Telecommunications

...


Competences appropriate for mature mass industries, such as banking or telecommunications, are very difficult to reproduce for the energy companies. However, the electricity market does not have any significant barriers at the entry point, besides the necessity of high employment of working capital in order to trade on the wholesale mar-ket. Therefore, energy companies should cautiously ap-proach all kinds of partnerships with companies from more mature markets of mass customers. In the long-term perspective, the „partner” may become an active player on the electricity market and a rival in the battle for the customer. Providing access to one’s own customer base may be a strategy that allows one to increase the profita-bility in the short term, but threatens the market position in the long run.

Thus, perhaps, from the point of view of an energy com-pany, the synergy (lower cost of sales and customer servi-ce) should be implemented by combining several energy-related products, e.g. with gas. It is easier for customers to accept the purchase of electricity bundled with other types of energy than with products from other industries;

and even in the case of establishing a partnership, the risk associated with working with an entity that is not radically far ahead of the energy company in the area of customer processes is lower. That is why energy companies should try to develop a value proposal based on a package of various types of energy, and sell products from more ma-ture industries selectively.

It is thus important to selectively direct partnership offers to one’s own customer base, e.g. to the segments parti-cularly vulnerable to leaving, and not on a mass scale. It is vital to understand one’s own customer base and its preferences well in order to build a partnership model that would be favourable to the energy company and minimize the risks mentioned above. Obviously, the possibility of selective targeting of offers will be viable only if one knows one’s own customer base well and has created tools to manage the individual segments.

DEVELOPING AN ”ENERGY” VALUE PROPOSAL

The decrease in margins resulting from the price war on the electricity market requires parallel sales of other new products. As has been described in the section on „Smart partnerships”, the sale of products from other mass cu-stomer industries, even though it has the potential to im-prove profitability, can be a dangerous strategy in the long run.

Mass industries meet the specific needs of customers: the telecommunications industry sells innovation, the banking industry sells financial security, so, the energy sector sho-uld also find a unique customer need that it is able to sa-tisfy. Energy companies should develop a value proposal around energy competences or around competences as-sociated with energy.

A „technical” brand as well as the connotations of energy with security and stability can be used to develop a wide range of products. An energy product is much more than the supply of energy (electricity, gas, heat). It can be a comprehensive service connected with the manage-ment of the utilities. It is, however, important to find a mar-ket large enough for the “energy product”. On mature markets, such services are built around services for ho-uses.

Customers living in houses are characterized by higher energy and gas consumption, and have some kind of au-

”Smart partnerships” – illustration of the concept


Seg

men

t’s

attr

acti

vene

ss (

mar

gin,

incl

inat

ion

to b

uy n

ew p

rodu

cts/

serv

ices

)

Inclination to switching the supplier High

High

Customer base of an energy company

Don’t share this segment with mature industries

Selectively sell additional products (the products

of mature mass industries only in a limited scope)

Selectively sell additional products (the products of mature mass industries only in a limited scope)

Make additional sales of whatever

you can

LowLow


tonomy over the management of their household installa-tions. Therefore, an energy company can develop a wide range of products supporting the maintenance of not only the electric installations, but also the gas and hydraulic sys-tems. Moreover, it can support the customers in optimizing the energy intensity of their houses by, for example, provi-ding house insulation services or installing photovoltaic pa-nels.

Owing to the fact that the offer of additional products and services will be a natural element of competition on the energy market, the question ‘how to stand out’ will arise in the mid-term perspective. Technical services require a major engagement of staff, so one of the methods is to build a hi-ghly specialized service based on the resources of capital groups of energy companies. This will enable an energy en-terprise to guarantee the authenticity of the promises made, providing it with control over the quality of the customer experience. Of course, such a solution is characterized by higher costs. Thus, the question remains whether custo-mers will appreciate such a value proposal, and if they will be ready to pay more for it.


Developing an „energy” value proposal – illustration of the concept

Electricity

Detached houses

”Energy” value proposal Model attributes of the category/connotations

Energy

Management of the energy intensity of a house

Service of systems

Telecommunications

Banking

...

Energy industry

Innovation, new solutions

Financial security

...

Security, care, technology

Gas

Microgeneration

Electric system

Gas system

...

Hydraulic system

...

Consumption monitoring

House insulation


Contact

Piotr ŁubaPartner, Advisory, Energy Group Leader,PwCTel.: +48 22 746 4679e-mail: [email protected]

Dorota Dębińska-PokorskaDirector, AdvisoryPwCTel.: +48 22 746 7150e-mail: [email protected]

Sebastian JandaDeputy Director, AdvisoryPwCTel.: +48 22 746 7283e-mail: [email protected]

Joanna ErdmanDeputy ChairmanING Bank ŚląskiTel.: +48 22 820 4232e-mail: [email protected]

Kazimierz RajczykManaging DirectorING Bank ŚląskiTel.: +48 22 820 4229e-mail: [email protected]

This publication was prepared by PwC Polska Sp. z o.o. with its registered office in Warsaw, Al. Armii Ludowej 14, and ING Bank Śląski S.A. with its regi-stered office in Katowice, Ul. Sokolska 34, established by the resolution of the Council of the Ministers on 11th April 1988 on the establishment of Bank Śląski in Katowice (Journal of Laws 1998, no. 21, position: 141). PwC Polska Sp. z o.o. and ING Bank Śląski S.A. assured the due diligence in order to guarantee that the published information was not mistaken or untrue on the day of publication, but PwC Polska Sp. z o.o. and ING Bank Śląski S.A. and their employees are not responsible for the truthfulness and completeness of this information, as well as for any damage caused by the usage of this pu-blication or the information it includes. This publication has been prepared only in the informative purposes and is not any kind of investment recommen-dation or offer concerning the purchase or sale of any financial instrument, as it is understood in the Act on Public Offer and the Conditions of introducing the financial instruments to the organised trading system and Public companies from 29th July 2005 (Journal of Laws 2005, no. 184, position: 1539) or an Act on the financial instruments trading from 29th July 2005 (Journal of Laws 2005, no. 183, position 1538). ING Bank Śląski S.A. and PwC Polska Sp. z o.o. do not, particularly through the information included in this report, advise on any transactions concluded by the recipient of the report and do not give any kind of investment advice or recommendations concerning such transactions. The recipient of the report, concluding any transaction, acts on their own account and at their own risk, making the independent and autonomous decisions on concluding transactions and being fully aware of the given transaction’s relevance or appropriateness for them, basing on their own judgment or an independent professional advice.

Translation: Dorota Pilas (p. 3-17), Barbara Maliszewska (p. 18-33)

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