Electric utility mergers and acquisitions (M&As) are forged in the boardroom and fueled by Wall Street. But their success or failure is determined at power plants and depends largely on whether plant managers embrace or resist the inevitable changes that a merger or acquisition produces.

With activity heating up in the industry, utilities large and small are considering jumping on the M&A bandwagon to achieve one or more of the following business objectives:

• Mitigating risk. Expanding its customer base and diversifying and growing its generation portfolio help immunize a company against becoming too small to compete.
• Surviving. As in a game of musical chairs, no utility wants to be the last one standing when the M&A music stops. That’s why even some smaller, cash-strapped companies are actively seeking a suitable suitor.
• Achieving economies of scale. Reducing costs by leveraging core capabilities across a larger generation fleet is the most common utility M&A objective.

Wall Street analysts expect that America’s 65 remaining investor-owned utilities will combine into five to 20 large companies over the next five to 10 years, much as integrated oil companies have consolidated to form five "majors." This will represent the acceleration of an existing trend; according to the Edison Electric Institute (EEI), the U.S. had 98 shareholder-owned electric utilities on December 31, 1995.

Merger mania augurs profound changes and high anxiety for plant managers. If their company merges or is acquired, they will have to adopt new ideas and new approaches for increasing profits. All of the business processes that they have fine-tuned over the years to make production, procurement, and administrative systems run like clockwork will be scrutinized from a new perspective: their compatibility with the new company’s business model and operating practices.

As next-generation utilities define and implement new strategies for maximizing efficiency, reducing costs, and wringing every available dollar from their bigger fleets, some "tried and true" processes will be phased out. Many plant managers won’t have time to lament the losses, however, because they will be busy accepting a corporate vision whose elements may run counter to beliefs, practices, and accepted wisdom that served them well in the past. Some managers may equate this imposition of a new culture with a loss of their status, power, and esteem—although that is never the intent.

In reality, changes brought on by utility M&As create as many opportunities as challenges for plant managers. Their expertise and skill—while remaining key ingredients in the recipe for a profitable plant operation—now will also be valued as drivers of the merger’s, and the new firm’s, success.

Plant managers are in a unique position to lead the way in implementing innovative new business practices—enterprisewide asset optimization, integrated supply chain optimization, and business process outsourcing, to name just a few. By doing so, they will encourage all plant employees to buy in to the marriage. Realizing the importance of this new role of plant managers, top management of the new company would be wise to lavish on them a full suite of new resources and benefits, to facilitate getting the job done.

The new landscape

Ironically, plant managers have created the M&A-friendly environment that makes many of them anxious. Their consistent efforts to improve plant efficiencies, leading to the sector’s profitability, have made utilities attractive to investors seeking to exploit recent changes in laws governing the U.S. electricity sector.

In 2005, Congress passed the Energy Policy Act, effectively repealing the Public Utilities Holding Company Act of 1935 (PUHCA). The repeal of PUHCA, which severely limited the types of ownership structures permissible in the utility industry, eliminated geographic and operational restrictions on utility holding companies seeking to enlarge and integrate their service territories. Having been freed from these constraints on maximizing economies of scale, U.S. investor-owned plants are now more attractive to investors.

As a result, we’ve seen companies such as FPL, a Florida-based generation company (genco), seek to merge with Constellation Energy, a Maryland-based expert in energy trading. Although the deal has stalled because of local political issues in Maryland, it represents the type of corporate M&A activity that the U.S. electric utility industry is already experiencing and can expect to see more of in coming years.

At another level, the Energy Policy Act is likely to accelerate companies’ desire to make their generation portfolios more fuel-diverse, with the goal of minimizing price and supply risk. For example, Duke Energy arguably acquired Cinergy as much to diversify its generation base as to achieve economies of scale.

Obviously, large utilities find themselves at an advantage in the new environment. No longer constrained to a specific geography—and with the help of Wall Street advisors—they are freer to make strategic decisions to accelerate their growth. And growth has generally been difficult to achieve organically in the U.S., except in pockets of rapidly growing demand.

That’s not to say that smaller utilities were severely disadvantaged by the repeal of PUHCA; in fact, they should consider themselves fortunate that it happened. Instead of facing possible irrelevance and formidable competition from larger companies, they can now position themselves for acquisition—and survival.

With a few notable exceptions (TXU Corp. of Dallas, for one), utilities are adding new generating capacity much less frequently than in the past. A recent EEI report found that most of the more than 8,600 MW that came on-line in 2005 represented upgrades of existing plants’ ratings, rather than new facilities.

Why have utilities become more likely to invest in old plants than to build new ones? Stagnant load growth and the difficulties of getting a new facility permitted are factors, but so was the electricity sector’s paradigm shift, which put a premium on operating efficiency. Since deregulation began ushering in competition and open access to regional transmission grids a decade ago, a power plant’s production cost has largely determined how often it is dispatched. Accordingly, gencos have increasingly turned to asset optimization as a strategy and tool for becoming one of a region’s low-cost producers. Strategies for maximizing the benefits of a merger or acquisition are expected to strengthen this trend.

Accepting the inevitable

Plant managers will be expected to spearhead, at the rank and file level, the drive for the even greater efficiencies and economies of scale that are the rationales of most M&As. Managers’ willingness to accept new realities will be essential to the success of new operating models that merged entities will develop. Most, if not all, of these models assume that the destination—profitability—can be reached via three paths: the development and implementation of "lean" operating strategies, cost-cutting, and maximizing plant reliability and availability.

However, several studies show that M&A deals often come up short on delivering anticipated revenues, predicted cost savings, and successful integration of disparate IT systems and operational structures. In fact, research proves that most past mergers have not worked as expected. And the much-sought "synergies" between companies with similar business missions have all too often failed to materialize.

Why, then, should plant managers be excited about having to make sweeping changes to their daily routine that aren’t likely to produce good results? Simply put: M&As are going to happen. The money men of Wall Street—and their overseas counterparts—aren’t afraid of missing out on the perfect by foregoing a chance at the good. They embrace risks, especially those they can control. They would like nothing better than to replicate the rewards that shareholders reaped from the mega-mergers of the integrated oil companies—Exxon and Mobil, Chevron and Texaco, and Conoco and Phillips.

Change will be challenging . . .

Because M&As are inevitable, plant managers need to prepare for them. In Capgemini’s view, the management challenges managers will face will test their skill sets, which were entirely suitable for the past but not necessarily so for the future. Among the key issues that plant managers may have to deal with are those that follow.

Asset optimization management (AOM). Merged utilities must create business value and reduce their operating costs by maximizing some plant metrics, such as reliability and availability, while minimizing others, like equivalent forced outage rate and unit heat rate. Fortunately, AOM is compatible with predictive maintenance (PdM), a strategy that many plants have used successfully to anticipate and plan for plant and equipment failures. If integrated with an enterprise asset management and/or an integrated supply chain management (ISCM) system, AOM techniques offer even more opportunities for reducing O&M costs and driving inefficiencies from the plant’s operations and supply chain.

Portfolio management. As utilities consolidate, fewer plants will operate independently. At standalone utilities, all O&M decisions are made by the plant manager, engineers, and on-site planners, who typically enjoy considerable freedom—as long as the plant meets its financial targets. Once one utility merges with or is acquired by another, this approach will be shelved; maintenance and run/no-run decisions will be made at the fleet level, on a holistic basis.

Supply chain management. Large retailers like Wal-Mart and Dell have proven that there are tremendous savings to be realized from integrated, rationalized supply chains. To succeed, any new mega-utility will have to integrate its supply chain as tightly as possible.

Optimizing inventory. Does every plant in a fleet need to have on-site replacements for parts that rarely fail or break? Wouldn’t it be more cost-effective to store such parts at a central location, rather than scatter them among plant warehouses? ISCM systems will revolutionize the theory and practice of plant inventory management.

Even more "back to basics." Encouraged again by Wall Street, merged utilities will rely even more heavily on business process outsourcing (BPO)—a common practice in other industries—to help meet their financial goals (see box). Front-, mid-, and back-office operations will be scrutinized even more closely for value. Non-core (necessary, but not mission-critical) functions such as billing, customer service, IT operations and support, and human resources will be farmed out to BPO providers. Their state-of-the-art technology platforms and expertise will execute those functions at a lower cost than the utility could.

Workforce management. In most cases, a merger or acquisition makes it even harder for a utility to keep its experienced hands from retiring or moving elsewhere. The exception would be an acquisition by a company with a reputation as a great place to work. Because older employees are inherently more resistant to change, plant managers whose company has merged may find themselves scrambling to make sure that their staff has the size and expertise to keep the plant running. Retraining may help, but the wholesale changes and the emphasis on cost-cutting and plant productivity will make the plant manager’s lot an unenviable one.

M&As will definitely require plant managers to change how they do business. The distractions of coping with rapid and fundamental organizational change and uncertainty will make it difficult to keep their plant running at peak form. As leaders, they will also have to address the significant cultural and operational changes impacting their employees and redefining their operation. As if that weren’t enough to deal with, plant managers may be asked to produce near-real-time reports using metrics that may be foreign to them but that are vital to decision-making in the new organization.

. . . but rewarding as well

Having listed that litany of downsides, the authors believe that plant managers who decide to embrace the inevitable (with a minimum of kicking and screaming) can expect a host of rewards. Here are just a few.

A fresh start. Becoming part of a larger company gives employees an opportunity to become excited again about a job or workplace that may have become hamstrung by fiscal constraints and limited investment and opportunity. The new company will reward leaders who step forward and become champions of the new order of business.

New knowledge. New learning opportunities will give plant managers and their staff increased access to best practices and better systems and technologies. In many cases, the new knowledge will be delivered by BPO organizations and hosted service providers, via advanced planning and scheduling applications.

World-class resources. Smaller utilities typically cannot afford the hardware and software that give their larger peers a competitive edge. Becoming part of a larger organization typically gives plant managers access to world-class resources that previously could not be cost-justified on any basis.

Fewer distractions. Because most merger plans call for increased BPO, plant managers can expect responsibility for non-core functions (such as IT system integration) to be taken off their plate. This will allow them to use their core skills and competencies to focus on the job at hand—generating electricity inexpensively, cleanly, and reliably.

Improved reliability. Sophisticated systems and technologies able to track equipment and performance both plantwide and fleetwide in real time—and even to predict failures before they occur—will become standard at large, merged utilities for a positive impact on costs and efficiency. Exemplifying the industry’s transition from reactive to predictive maintenance, these centers of excellence will deliver the right information at the right time to all of the utility’s decision-makers—including plant managers.

What’s ahead

The same investment bankers who created the oil majors could well be the folks who trim the ranks of U.S. investor-owned electric utilities to single digits. Though they may not have any skin in the game after the deal is completed, the bankers still will have to convince their clients that "bigger is better" actually benefits utility shareholders. To do so, they will undoubtedly point to the returns that shareholders of the oil companies have reaped and emphasize that the models on which those mergers were based are valid across the entire energy-industry spectrum.

Also look for this trend: plant managers partnering with management and IT consultants for state-of-the-art technology and outsourcing platforms through which plants can access and leverage knowledge and best practices from other industries. This will achieve two goals:

• Making outsourcing even more effective. Few utilities have systems as capable as those of BPO providers at executing enterprise resource planning, billing, customer care, IT management, and supply chain management. By outsourcing these functions to a BPO provider, a generation portfolio can be run at maximum efficiency while minimizing the culture clashes between the acquiring and acquired companies. This also offloads from fleet and plant managers the responsibility for migrating their IT systems to a best-in-class platform.
• Making asset optimization a core competency of merged utilities. Investors in a mega-utility deal will want to know that the savings realized will be sufficient to fuel the operations of every plant within a fleet environment. This will require leveraging ISCM capability to optimize shared resources and services. The integration of business processes and technologies with predictive asset optimization technologies will raze the information silos that prevent many large organizations from achieving their full profit potential today.

Innovation unleashed

In the electric power industry, plant management is where the rubber meets the road. Without a doubt, day-to-day O&M practices have the greatest bearing on a plant’s ability to generate electricity and revenue. Given their leadership role in this process, it shouldn’t be surprising that plant managers have been responsible for conceiving and field-testing many of the innovations that have made the U.S. generation industry the envy of the world for its reliability.

Yet the traditionally close regulation of the utility industry has occasionally served to restrict plant managers’ ability to bring innovative ideas to the table. Bound by PUHCA and other legislative handcuffs, utility and plant managers have been forced to play on what is, at times, a tilted playing field, where the resources enjoyed by one company are either denied to or unattainable by another.

Those days appear to be numbered. The new regulatory environment—one that is expected to bring about an unprecedented level of M&A activity—promises to unleash an equally unprecedented level of innovation in the industry. Although it’s not yet clear whether the promised benefits of the mega-utility mergers will pan out, it’s easy to predict who’ll continue to lead the way in innovation—plant managers.

—Paul Halpin is a senior manager at Capgemini; he can be reached at 713-213-2708 or [email protected]. Amin Bishara is a vice president of the firm; he can be reached at 972-556-7189 or [email protected].