The advent of the Smart Grid will bring a new driver for value creation to the electric power industry: economies of connection. In the future, the Smart Grid may offer our industry improved returns more typical of Internet-based businesses like eBay, Amazon, and Google to replace the diminishing returns typical of traditional “steel in the ground” projects that relied on economies of scale.
The Internet fundamentally changed the way people did business, and so will the Smart Grid. To understand the coming changes, it is important to understand the significance of economies of connection.
Economies of connection are related to Metcalfe’s Law, which states that the value of a network grows proportionally to the square of the number of active nodes on the network. Kevin Kelly, author of New Rules for the New Economy, explains, “As the number of connections between people and things adds up, the consequences of those connections multiply out even faster, so that initial successes aren’t self-limiting but self-feeding.”
The changes that have transformed the telecom industry are an example. Just as the rise of the Internet created new opportunities for innovative switch companies (Cisco) and entirely new businesses (AOL, Google, and eBay), we might expect analogous innovation when every generator, transmission line, substation, consumer, and wholesale market is connected through the Smart Grid. The consequences for the power industry are profound. Google, founded 10 years ago, has a larger market capitalization than the five biggest U.S. utilities combined.
The U.S. electric grid—tens of millions of wired miles connecting thousands of generators—is a marvel of engineering, but it is a marvel of the last century. When it was constructed, economies of scale ruled and the grid was a spectacular success. Today, economies of scale in the power industry have largely run their course due to physical, environmental, and societal constraints. Economies of scale result in arithmetic increases in value in good times but, ultimately, they obey the law of diminishing returns. Paradoxically, recent efforts to increase the scale of the grid by increasing the interconnections between our balkanized transmission networks has increased the likelihood of domino-effect blackouts, as we saw in 2003.
North America urgently needs a Smart Grid capable of processing and transmitting information among physical assets on the grid and energy consumers. A new market will emerge. To realize the promise of the new economies of connection, it will be imperative that utilities, regulators, and suppliers allow information from the grid to empower consumers and producers.
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