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Sector spotlight: Energy (p2) - the opportunity for energy providers

Abdi Azimi
Feb 8, 2013 9:53:00 AM

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Abdi-New

With consumers becoming increasingly sceptical of their energy providers, more mobilised by the value for money they achieve on their household costs and more able to take their business elsewhere, energy companies must do what they can to ensure that their business is match fit.

There is currently a mismatch between energy companies’' need to keep pace with fluctuating wholesale prices and their customers'’ threshold for tariff increases.  Energy providers argue that tariffs must remain in line with pricing movements so that they can reinvest in their infrastructure and adapt to the growing pressures on the grid. Customers retort that growing costs, which include above-inflation hikes, are unreasonable and are exerting pressure on living standards.

It is an old-fashioned impasse, particularly as the cause of the cost rises are external pressures brought about by commodities pricing internationally.  Short of an out-and-out charm offensive, what can energy providers do to convince consumers that these inflation-busting price rises are truly merited?  Are they doing all that they can to maximise the profitability of their day-to-day business?

Proxima recently published research into the spending habits of the UK FTSE-350 index and found that comparatively modest reductions in non-labour costs - that is, a company’s third party/supply chain costs - could boost underlying profitability exponentially.  At an index-wide level, the research showed that a one percent reduction in non-labour costs increased EBITDA (earnings before interest, tax, depreciation and amortisation) by 3.6 percent.  For the energy industry, the same reduction would lead to an increase in profits of 11 percent.

The call to action, is clear.  There is an untapped opportunity for energy companies to make their ongoing activity inherently more profitable, which provides a number of benefits:

  1. Adaptabilitymore efficient and effective cost structures allow operations to readily adapt to fit with prevailing market conditions, including insulating  financial performance from external cost pressures
  2. Agilityensuring that a company is at optimum fitness, in terms of personnel and supply chain costs, means that it has added financial firepower to deploy investment into areas of the business that require urgent and/or unexpected intervention
  3. Supply chain de-risk - a tighter focus on supply chain costs inherently drives performance and value for money achieved.  Energy companies are among the most reliant on external, specialist technical and service providers, so regular reviews of supplier performance and cost are essential to ensuring that operations are at their most effective

Ultimately, energy providers face two options.  Either they rely on customers accepting the inevitability of cost rises amid challenging market conditions, or they accept that customers are going to be encouraged to shop around for their energy provision.  For the former to be effective, they must articulate the investment case for those cost structures, which are about to become much more transparent due to the government’s introduction of a four-tariff standard. 

The regulatory environment is uncertain and the implications of new policy directions have yet to become fully understood. How, in the interim, do providers ensure that they have capital available for reinvestment, that they can continue to improve their internal practices and, crucially, that they maintain their licence to operate, while delivering value for shareholders?

The top priority has to be bringing third party costs under control.  If the level of profits outlined above continue to be squandered, progress will be severely impeded.  Improvements to supply chain costs go straight to the bottom line and thus make the process of doing business intrinsically more effective.  Those improvements also lead to better buying behaviours from procurement and finance teams, a better view on a company’s cost structure, better risk profiles and a reduced reliance on an ability to ramp up costs every other quarter.

Abdi Azimi

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