With the pending restructuring of the North American electric power industry, can a prospective power marketer profitably operate as an electric power retailer? Specifically, how will a power marketer, generally out of the natural gas industry, be able to compete against the incumbent electric utility and its unregulated affiliates in competitive retail markets?

What functions make up the retail segment of the electric power industry? Can they be segregated practicably? In which segments can a prospective power marketer expect to be profitable?

How can a prospective power marketer optimize its current retail assets? Should it contract out a segment of the work currently done in that segment?

Should a prospective power marketer add in other complementary businesses, particularly natural gas? How should this be done?

BACKGROUND

From it’s inception, the electrical supply industry could simply be divided into three basic components:

1. Generation
2. Transmission
3. Distribution

Initially, all these assets were owned by the utility and found within it’s franchise area. With the evolution of the industry and it’s enormous growth, it became sometimes more economical to buy peaking and reserve capacity from neighboring utilities and with it the means of transporting the electricity between utilities. Therefore to some varying degree most utilities became involved in the business of wholesaling electricity to each other, often as both buyers and sellers.

However, the customer base which formed the retail market remained intact until PURPA. This act opened the retail market although in a limited way. The largest independent generators were primarily wholesalers selling a small amount of power to the host facility and the bulk to the local utility at "avoided costs". The smaller independent generators could indeed attack the retail base with "inside the fence" generation, specifically designed to meet the requirements of the host. A number of companies were set up specifically to attack this market with packaged equipment. However, these only had moderate success. Some sectors of the retail market such as hospitals with their good load factors were obvious targets, while others, such as schools and other customers with poor load factors, or which were not thermal energy users, were not. Therefore, very large segments of the industrial and commercial markets were never even approached by this type of retailer.

The largest problem with the "inside the fence" generation business was that although the engineering costs could be reduced through the packaging of power generation facilities as ready-to-install units, the legal, financial and other development costs were the same for a 5 mw plant as a 50 mw plant. The economies of scale worked heavily against the market. Even the manufacturers of the generating equipment, e.g. Caterpillar, Waukesha, and Kawasaki have had only limited success in this market place, whether attempting to enter it directly or through agents. The final result of all the marketing activity under PURPA was that the utility retail monopoly remained largely intact.

The retail market which is currently developing through the deregulation process is quite different in both it’s structure and in the services required. Deregulation to permit "retail wheeling" provides the opportunity to garner the economies of scale impossible when limited to the inside-the-fence generator model—one does not have to build a power plant for every customer. This eliminates the economic constraints associated with the inside-the-fence market. The developing market will be one of sales and commodity marketing, not one of engineering, permitting and financing.

In it’s fundamental concepts the retail sale of commodity electricity should follow to a large extent that of commodity natural gas.

One of the best laboratories for studying the developments of a dynamic and evolving retail gas market is in the state of New Jersey. In New Jersey, deregulation of natural gas sales to retail commercial and industrial customers was ordered by the Board of Public Utilities (BPU), the state’s regulatory authority, in late 1994.

While individual residential customers do not you have access to the market, the BPU is studying this for near-term implementation. Meanwhile the current order deregulates natural gas sales to some 260,000 customers.

There are now some 40 marketers , of various size and resources, marketing natural gas in the state. Most of them are also portraying and positioning themselves to be a marketer of electricity when deregulation takes place. While one of our major practice areas is in negotiating rates and transmission tariffs for retail customers, this has been a one-up type of business. Each transaction is different, and costs are high. We have gained real retail marketing experience with our natural gas operations in New Jersey, and it is from this beachhead that we plan on launching our effort towards market share in the retail electric markets. The base of natural gas retail customers can be readily approached for contracts for electricity, using the same sales force and same techniques. Our company is in the natural gas retail business so that it can be in the electric retail business.

THE RETAIL MARKETING COMPANY: ITS STRUCTURE AND FUNCTIONS

The customer in the electric power market has two basic criteria which are fundamental and are given in order of priority:

1. Security of Supply
2. Price

If the marketer cannot satisfy the customer that it can meet both of these criteria, then it cannot make the sale. It is therefore from these concerns that the successful marketing company must be structured. The following discussion consists of two parts: a discussion of the fundamental criteria listed above, and a breakdown of the retail marketing operation into subfunctions, so that each can be considered for expansion or outsourcing by a prospective power marketer.

Security of Supply

Brand Name
Brand name is paramount. The customer is very unlikely to entrust his electricity supply to a company he’s never heard of.

Generally, in a deregulated market, the local utility forms a deregulated operation, and immediately dominates the market. The brand name power of the incumbent is very powerful. In recognition of this, it is not uncommon for such subsidiaries to be under some kind of constraint imposed by the regulatory commission to try to ensure a level playing field. This can be as simple as a general understanding regarding market share permissible for the deregulated affiliate operation, or as complex as operating rules requiring "comparable" service and virtual disaffiliation of commodity and monopoly businesses.

Irrespective of the constraints imposed, the local utility subsidiary has a number of major advantages in its home market. It is usually staffed with the utility’s Customer Representatives, it has an already-established seller/customer relationship and the association with the utility overcomes all security of supply fears.

There will also increasingly be a number of other companies with names which are recognizable to the customer. Some of these will be local companies from other industries. However, increasingly, there will be national and international firms establishing a branded product.

In the New Jersey gas market there are a number of companies with recognizable names which instill a similar degree of comfort, Chevron (for whom our firm is the exclusive broker) being the most dominant. Other companies which are very well known in the industry, such as Enron Capital and Trade, have no such name recognition and have to spend sales and marketing time and money on the customer to overcome this drawback.

One notable effort "Energy One" is being introduced vigorously into the marketplace by its parent company, Utilicorp. The initial marketing name was Broad Street, but this is being rapidly phased out in favor of the new nationwide all-energy brand. We understand the marketing people behind this are the same who invented Cellular One, and they obviously realize the importance of name recognition.

The smaller companies with unrecognizable names and without the resources to create a name are not taking any noticeable market share.

It is interesting to note that mistakes are also made where they should not be. Orange and Rockland (a local prospective power marketer), and Shell Oil have joined forces. They market under the name Norstar, which is as non-recognizable as any of the smallest marketers. It would not be surprising if they did not have their phone calls accepted by the customer for that reason, and they certainly have to expend additional time, effort and money to even get to this first base.

In discussions with customers on this subject we asked them "Would you purchase gas or electricity from say Microsoft or AT&T?." The answer was inevitably "No" but often with the caveat that should either of these companies purchase an electric utility and become part of the business, they would be certainly be considered.

The creation or utilization of a recognizable brand name is imperative. A utility has a very good name in its service territory, and it can be readily utilized there. In other regions, the fact that a utility does not have a recognizable brand name at present is not an insurmountable drawback-- the vast majority of marketers are in this position.

Generation Ownership and Delivery

The ability to demonstrate the capability to deliver the at all times is of paramount importance. The ability to demonstrate ownership of generating capacity is important but only becomes of paramount importance during times of shortage.

Having the commodity is one thing. Being able to deliver it to the customers’ meter is another. Again, the New Jersey gas situation offers some insight. Under deregulation, the local utility still maintains control and operation of the intrastate distribution system and carries out meter readings and all the normal maintenance and safety functions of the system. The marketer brings its supplies to the City Gate (the local utility) where the title is transferred to the customer from the marketer. The customer then transmits its supplies to the site of use through the local utility’s lines. For all intents and purposes the local electric utility becomes a common carrier. However, the customer still must be made comfortable that the commodity will be delivered continuously to the local utility.

Three General Rules seem to define the customers concerns, these are:

1. In a sellers’ market, gas or electricity capacity ownership will become a significant factor in security of supply terms. In a sellers market, price concerns are relegated to a distant second place.

2. In a buyers’ market ownership of the gas or electricity capacity has a smaller advantage, price is elevated.

3. In either a buyers’ or sellers’ market how you get from here to there that is a major customer concern. In terms of the security of supply, it is the supplier’s ownership and access to the interstate transportation system capacity which becomes the focus of the sale.

For example, Chevron , Shell and Enron all have gas reserves but have very little position on the Interstate system into New Jersey. The local utility subsidiaries do not have any gas reserves, but in a buyers’ market are able to exploit the fact that the weakest link in the chain is the pipe that brings the gas from the Gulf of Mexico to New Jersey. Marketers have to purchase this on the open market. However, the utility’s subsidiary is often assumed to have access to its parent utility’s pipeline capacity. Encouraging this assumption on the part of the customers, even when it is untrue, provides a great marketing advantage to the utility affiliate. This practice is now being frowned upon and scrutinized by the New Jersey Board of Public Utilities (BPU).

Any organization entering the competitive market must have the expertise and capability to purchase transportation on the major transmission systems. This capability and expertise, together with generation capacity ownership, leasing or at a minimum certain access must be demonstrable to the customer to his satisfaction.

Although some organizations owning cogeneration capacity or even a merchant plant may only market to the limit of their own capacity, it is unlikely that successful marketers can constrain themselves to this type of ownership limit. Indeed, in the gas industry, the vast majority of marketers only briefly own the bulk of the gas they sell. However, the ability to demonstrate to the satisfaction of the client that one owns or has title to large volumes of diverse sources of capacity is of importance and could certainly make the difference between a sale and non-sale. It becomes of paramount importance if shortages occur.

Therefore, a staff of professionals with the skills to physically trade and manage risk is fundamental to the electricity commodity business. These skilled personnel will also deal with the purchase price of the commodity and by extension serve to support the sales and marketing effort with alternative pricing mechanism and agreements that could be offered to the client.

Price

Price is always a concern, but the more the electric power industry moves toward being a buyers’ market, the greater the emphasis on price. In the developing stages of the market, a marketer can never escape the competitive pressure of price. Whatever sector of the market the marketer may choose to attack will almost certainly have several other marketers competing for that customer.

It may be thought that bidding processes, such as RFP’s may be limited to the larger and more sophisticated buyer. Experience in New Jersey has show this not to be true. Once even the smallest consumer realizes that there is competition for his business, he will take multiple bids. In the course of publicizing deregulation and customer choice, the utilities published a list of approved marketers. While this may differ in other jurisdictions, in New Jersey, the approval process is not very strict and basically anyone who is willing to post a $10,000 bond can be approved. It is often the practice of the smaller customer to pick as many recognizable names and a few non recognizable names off the list to obtain a quote.

Furthermore, large numbers of businesses are members a trade association, The Restaurant Owners Association, or the Hotel and Motel Association or the Nursing Homes Association. Large apartment complexes and office buildings are often managed by professional management companies who control many buildings—often in the hundreds. For the purpose of this report we call this the "non-fragmented" sector. These associations and management groups form and act as buying cooperatives and work to get the lowest price possible for their constituents.

In recent years a consulting business has arisen wherein the consultant performs services to bring down overhead and utility costs, including phone, gas and electricity. These consultants primarily serve small businesses and often perform their services on the basis of sharing whatever savings they achieve for the client. Obviously, deregulation has opened up new vistas for these consultants and price competition is elevated through their efforts.

Finally, as discussed below, in a market where the intrastate tariff structures are set high, the marketer is not only competing with other marketers, he is also still competing with the utility.
Initially, there is no escape from intense price competition in all sectors of the marketplace, particularly in a buyers’ market and when all are vigorously competing for market share. As the market matures it is expected that brand loyalty and conservatism will start to develop, and as discussed later, this appears to start to develop in the first year.

However, in these early stages, with all things being equal, even the smallest price differential may win the day. For example, if Brand "A" and Brand "B" meet all the customers criteria equally a fraction of a cent may determine the outcome.

Although being able to offer the customer a variety of price and tariff options has marketing value and a Price Menu should be developed, it must be assumed that virtually all marketers will offer similar menus. Therefore, in terms of price, a prospective power marketer’s ability to win market share would largely depend upon it abilities to obtain supplies and setting it’s pricing policy based upon first class market intelligence.

Corporate Strategy: Pricing, Sales and Marketing

The Corporate strategy will dictate pricing and the sales and marketing approach. In any embryonic market, the battle will be for market share, not maximization of profits. It is anticipated in New Jersey that the "no name" financially weak companies will be the first to fall, but this will eventually extend to even the largest company that does not secure a market share which supports a long term marketing effort.

The overall market available will first be dictated by the rates and tariffs for intrastate transportation and ancillary services provided by the utility. In New Jersey, the marketers took the position that it was of primary importance to ensure that the deregulation went through as quickly as possible. As a result the tariffs presented to the BPU by utilities went unchallenged. It is doubtful that this will happen again where the now-experienced marketers are involved.

Of the four gas utilities in the state, only one has a rate structure which enables the vast majority of it’s customers to participate in the deregulation program. The tariffs formulated by the others have numerous cost impediments which effectively disenfranchise a very high percentage of customers. For example, while it may cost $2.25/Dth including the commodity to bring gas to the City Gate, the intrastate transmission charges under the tariff can be as high as $5.25/Dth for a total of $7.50/Dth. Under his existing tariff, the customer is paying less than $7.00 Dth to the utility, so there is no economic benefit to change. In one utility area, with 35,000 potential customers, less than 5,000 can economically switch to a marketer. Obviously, this has implications for the design of electricity transportation tariffs in a deregulated environment.

Although this situation will change as the New Jersey Board of Public Utilities forces the utilities to revise their tariffs, it can be seen that the retail transportation tariffs set the "First Cut" for marketing purposes.

Transportation and ancillary service tariffs can make customer analysis fairly complex. For example, different seasonal transportation rates and ratchet structures will likely require the ability to analyze customer load profiles with increasingly fine distinction, and with the ability to provide rapid reply to customer queries regarding price offers in a fluid pricing environment.

We anticipate that this will apply almost universally and it is therefore necessary to have as part of the staffing arrangement expertise in computer modelling and tariff analysis.

The computer models that the marketing company must develop run through the full spectrum of the companies’ operations, from pricing policy, market sector determination, sales support, market intelligence manipulation, nominations and billings. For example, they allow management to compare City Gate prices plus interstate transportation rates against the existing tariffs used by the type of customer in each class to determine if that class has potential. A tariff class may serve many types of customer, including, for example, restaurants and apartment buildings. Even though the load in the apartment building may be much larger than that of the restaurant, the better load factor of the latter may be able to take advantage of deregulation while the apartment building cannot, due to the tariff structure. However the reverse can apply: The utility may decide to get rid of the poor load factor apartment building and keep the high load factor restaurant and structure a retail transportation tariff which favors the larger load.

These computer models are also naturally extended to carry out comparative analysis to assess the profitability of particular market segments down to the individual customer level. As price and market data comes back from the field they are also effective in determining the competitiveness of the company’s pricing policy and monitoring the pricing policy of other marketers.

The models are also fundamental in preparing presentations for sales purposes and offerings to clients. They are a very effective sales tool, readily personalizing correspondence and data analysis sheets. They are also naturally extended to the nomination and billings process and other after-sales support.

The importance of the gas market in electricity sales

The initial objective in any marketing plan is to obtain market share, but although all marketers are likely to adopt this strategy, the formulation of sales and marketing policy and their implementation will probably vary widely. Nevertheless, on the basis that for every gas dollar spent the customer spends between 7 and 12 times that amount on electricity, it is the electricity market that is the prize, and the ultimate objective of virtually all marketers is to obtain maximum market share in this commodity sector.

It is for this reason, to obtain customers now, that all the marketers in New Jersey are selling gas at the marginal cost level. The basic premise being that if you are the customer’s gas supplier, then the chances are very high that you will also become his electrical supplier. It is CPM’s belief that "He who wins the gas battle will win the electricity war". As gas deregulation appears to be on a faster track than electricity deregulation, the gas market will evolve first in many jurisidictions. Therefore, one could readily conclude that if a company wishes to be in the electricity market, it must first participate in the gas market, or purchase a gas marketer who has obtained a level of market share and has a customer base.

The Cost of Sales and Brand Name Develoment

In any event, when striving for market share, when the potential customers number in the tens of thousands, the cost of sales and the efficient use of the sales force becomes of vital importance. Each marketer will have decided which sectors he wishes to attack and how he wishes to proceed. As wise men often agree and fools seldom differ, the chances are that a number of marketers will be attacking the same sectors. It is therefore the "How" which becomes important and where name recognition becomes a major asset. The name Mobil or Chevron gives those companies immediate credibility and opens the door to their salesman, whereas a Garden State Gas Co. or AGF Direct Gas Sales, Inc. leaves these companies with a credibility problem which is a major added burden.

Therefore, as a Brand Name can both dramatically cut the cost of sales and improve the chances of completing the sale, the development of the brand name must be adequately budgeted for as part of the Marketing and Sales cost.

However, even with a brand name, one must limit the number of times that the sales personnel have to visit a customer. One marketer with a national brand name was on average visiting the potential customer at least 8 times and phoning him at least 12 times before making the sale. In an efficient marketing and sales operation, the number of visits can be kept down to two and it is possible to achieve sales with just one visit. We actually have cases on record where the sale was made without a visit and carried out entirely on through phone, fax and mail communications.

A detailed description of a full marketing and sales operation is beyond the scope of this report. In general, the number of sales personnel and the modus operandi are tailored to suit the initial objectives. Advertising, seminars and public relations operations would be fundamental in any marketing plan. The prospective power marketer name (or other selected name) must become recognizable to the customer as a major provider of commodity in the markets to be broached.

The fact that the prospective power marketer does not have a household name for supplying electricity into the deregulated retail market is not as major a deterrent as it may first appear. The fact is that there are no household names in this business at the moment. As previously stated, companies such as Mobil, while having instant credibility in the gas business, are not known as electricity suppliers, and electricity suppliers such as Utilicorp are in the primary stages of developing a brand name. An Enron, Louis Dreyfus or Williams Company, who are extremely well known inside the industry atthe wholesale level, have the same difficulties with this problem in the retail market. A utility is in a similar position to Utilicorp, with a track record as a retail electricity supplier but virtually unknown outside it’s own geographic area.

Apart from creating brand name recognition, an advertising, public relations and seminar program serves to support the sales effort in a cost effective manner. It is cheaper for 100 potential customers to come to see the sales people than the reverse. Other support functions such as trade shows, from experience in the gas market, do not appear to be very effective sales tools but are fairly effective in supporting the name recognition program.

Contract Development and After Sales Service

Unlike the gas market, which deals in contracts for as short as a month, the retail electricity market will deal in longer term contracts. The gas market customer that can afford to go month to month are limited to that sector who have oil as an alternative back up fuel: Very few companies have the luxury of another back up source of electricity.

In terms of both cost efficiency of sale and long term customer relationships, the longer the contact length the better. In the retail gas market, it is the customer who has set the tone with a bias towards a one year contract, the "let’s see what happens" approach. However, although contracts of up to three years have been signed, it is unlikely that the vast majority of customers will go beyond a five years duration. Most marketers therefore design contracts with "Rights of First Refusal" or "Last Look" or "Continues Unless Canceled Within a Certain Period" clauses. Although there is some customer resistance to this type of clause and a doubt about their enforceability, they often achieve their objectives of extending the contract life beyond it’s initial term and should be included in the contract.

In the gas market, brand loyalty seems to be partially established within the first year of operation, with a customer unwilling to change supplier for a cent or two. It would appear from this limited data that long term brand loyalty can be established with a large segment of the marketplace within a three year period.

The key to this appears to be the "No Problem" ethic. As the utility is still the provider of all intrastate services, the only real interface between the marketer and the customer is the commodity bill and in some cases balancing. If the customer’s bill is well designed so that he understands it, if it shows him his savings, if one meets special requirements such as leveled billing and add other little personal touches, and if the marketer acts efficiently and corrects all out of balance problems without causing the client an undue amount additional work, the "No Problem" objectives will be basically achieved.

In the area of billing, a utility with it’s hundreds of thousands of customers is no stranger to this concept. This experience is a major plus from both a sales and operational viewpoint. Balancing problems are part of the supply aggregation and risk management groups’ functions and problems arising here should be minimal as they are part of the stock in trade of this business.

The Public Utilities Commission, regulation and utility tariff formation are integral parts of the gas and electricity commodity business. The largest companies often have full time staffs dealing solely with these matters. Although it is necessary to become involved in public hearings, and supply comment and testimony, it is certainly not necessary for a marketing company to treat this as anything but a part-time function, usually shared between management, marketing and legal support staff, the latter being itself is a part-time requirement.

THE PROSPECTIVE POWER MARKETER AND THE RETAIL MARKET

When viewing the possibilities of expanding into the retail market, CPM cannot presume to understand the strengths and weaknesses of a prospective power marketer, in anything but a superficial manner. However, by defining and categorizing the various skills and expertise required in the retail marketing business, and from purely a subjective viewpoint, we attempt to assess a prospective power marketer’s potential for success.

a) Management

Function: The basic role of management is to establish purchase price and contracting policies, marketing and sales price policies, personnel and staffing policies, Utility Commission interface, high level sales meetings and negotiations with the largest customers and suppliers and legal and contract development, and coordinate both these and the delegated functions described below into an efficient operation.

The prospective power marketer: A utility has probably more understanding and management skills within it’s organization to operate an electricity commodity business than the majority of potential entrants. In areas in which additional or supplementary staff is required, the company should be able to define these requirements accurately, and staff to suit.

b) Commodity Supply Acquisitions

Function: To obtain reliable supplies of product at commercial prices. The premise is that the profit on the commodity is made when you buy it rather than when you sell it certainly applies in the commodity electric and gas industry. Purchasing at the right time, in the right way is fundamental to success. Understanding the commodity market with skills in risk management and supply aggregation are absolute and necessary required skills.

The prospective power marketer: Although the company may not have all these skills totally in-house, the most important factor is that the management understands the concepts and operation of a department of this nature. The skills can be acquired in the labor market and we do not see this as a drawback to entry.

c) Transmission Capacity Acquisitions

Function: To obtain capacity on the transmission system at competitive costs. This may at first appear to be an extension of the commodity supply acquisition function, however in practice it is a cost and profit center in its own right. As in the gas market we would anticipate "capacity" itself becoming a commodity, readily tradable on a bulletin board system operated by separate and skilled professionals.

The prospective power marketer: Again as with b) above, a utility management has an above average understanding of the process and the in-house skills required can be supplemented by outside recruitment.

d) Brand Name Development

Function: To create a brand name which is recognizable to the customer. As discussed, a brand name is essential to the total sales process. Without this, the chances of success are greatly diminished.

The prospective power marketer: The company has a recognizable brand name within it’s province. Whether this name should be used in any geographically extended marketing program is outside the scope of this report. However, whatever name is chosen, virtually all marketers are in this position. In the gas market, only the oil companies had this attribute and although it is assumed that they could enter the electricity business, it is by no means certain that their names will have the same influence in the electricity market, or give the same amount of comfort as would the name of an experienced electric company. As all marketers are going to have this problem, we do not see it as a major drawback. If the company decides to enter the market this whole topic should be given top priority and the name development process should begin at the earliest possible time.

e) Customer Analysis and Price Determination

Function:This fully computerized operation is the heart of the marketing and sales program. The operation develops and operates a variety of software models designed to:

(1) determine the customers’ present costs under the existing LDC tariff structure,
(2) establish a price based upon policy guidelines and usage information,
(3) prepare offering letters, data analysis information for both internal use and for the customer,
(4) prepare contracts,
(5) obtain and process competitive pricing information from the sale personnel,
(6) inform and advise management on pricing issues, and
(7) designs and operates customer nomination and balancing programs and interfaces with the billing department.

The prospective power marketer: The understanding of transportation costs is stock in trade to the company and the extension to the other software development activities, if not in-house can be readily acquired. However, the personnel staffing this department should have experience in a competitive industry. Although gas marketers have already established this type of operation and have more experienced than a utility, we do not see this as a major drawback. However, this aspect of retail operations, when coupled to the additional benefits of the established customer relationship and additional market share which may thus be garnered, gives impetus to the idea of acquiring a gas marketer as a prelude to entering the electricity market.

f) Marketing and Sales Program

Function: To promote the company and sell its products. It is envisaged that the marketing program would be the focal point for establishing brand name and publicizing the company’s products. In this instance the word "product" refers to the menu of pricing options and other services provided by the company to it’s customers. The Marketing and Sales operation would be staffed to suit and carry out programs to meet management’s policies and objectives. The marketing and sales programs designed would use familiar tools and services to achieve their objectives, including but not limited to telemarketing, fax-marketing, direct sales calls, advertising, trade shows seminars, public relations, etc.

The prospective power marketer: The company may not now have all the skills required but they can be readily obtained in the labor marketplace. It would not be necessary to purchase a gas marketing company to obtain these skills and experience, but if one was purchased the necessary personnel should be in situ.

g) Billing and After Sales Service

Function: To bill the client for the commodity consumed under the contact. This department would also be responsible for recommending and approving bill design and customer interface. It would also be responsible for the very important function of Credit Checking. Although actual credit check would be subcontracted to a specialized company such as TRW, the coordination responsibility would be in this operation.

The prospective power marketer: The utility has as much if not more experience that most marketers in billing large numbers of customers. We see this as a plus in the electrical commodity business.

The Addition of Complementary Businesses

A utility has inherent strengths in the electrical industry which would serve it very well in the retail commodity markets and is far better suited in a number of ways than the gas marketers that are positioning themselves for the market. However, in two major areas the gas marketers would be in a far stronger position than the company when the retail market emerges. These areas are:

a) Established customer base
b) Infrastructure and experience in marketing to the retail customer in a competitive marketplace.

Here we define the "retail customer" as all but the residential consumer.
If market share is fundamental to the long term profitability of the business, then establishing a customer based is of extreme importance. Those gas marketers who have obtained a customer base will have the inside edge in converting them to electricity customers. Electricity marketers entering the field, just to satisfy the electrical market as and when it opens up, even with better credentials in the supply and transmission business, will be hard pressed to overcome this disadvantage.

Furthermore, by entering the field through the gas market one can start to establish brand name very early in the business. Utilicorp, and their ‘Energy One" brand name, which has even been advertised on television and in full-page ads in the Wall Street Journal, has begun to take hold as a company with the right credentials to be a comprehensive energy supplier of the future.

There is also very little substitute for experience and it is certainly not desirable to enter any market lacking the experience of one’s competitors. Not all things are parallel between the gas and electricity commodity business, but sales, marketing and the supporting infrastructures are very close indeed. This type of experience cannot be readily found outside the gas marketing industry. The acquisition of a gas marketer would position the company to be fast out of the gate when the electrical market opened up.

Finally, in a business that will have both it’s ups and downs, feasts and famines it would seem logically advantageous to be able to sell two commodities, gas and electricity, which do more to complement each other rather than compete.

In reality, individual companies may enter the electricity market in different ways, CPM concludes that if one is to enter the market, the most logical way would be through the strategic acquisition of a gas marketer.

Electric Power and Natural Gas Retailing

A. A prospective power marketer should establish a retail natural gas sales operation.

1. Electric power and natural gas retailing are highly synergistic in an open and competitive retail environment.

2. The "sales pipeline" used for gas sales can and is readily used for electric sales also. The person responsible for natural gas procurement is in almost all cases the person responsible for electricity procurement.

3. In other regions, in which competition in retail natural gas sales are permitted, marketers are regularly soliciting electric sales as well, even before such sales become legal. This is done through contractual "rights of first refusal," options to sell, and statements of intent.

4. Its service territory will permit retail natural gas sales competition beginning in 1996. With the opening of retail, a utility will be vulnerable to a flank attack on its customer base by natural gas marketers.

5. A utility should establish its own retail natural gas sales operations in its own service territory. The best defense is a good offense.

B. A prospective power marketer should act immediately. In the early stages of market development, market share is critical.

1. The customer attains its largest savings in the first transition from regulated rates to market-based rates. After the first cost reduction, small increments of additional savings may be available due to intensifying competition and reduced margins, but the gross dollar savings will not be compelling enough for customers to switch suppliers. It will be much more difficult to obtain market share after the first blush of competition.

2. The incumbent supplier, after the initial blush of competition, will be able to attain higher prices than new challengers, as customers will not bear the transaction costs of changing suppliers for small incremental savings.

3. A high profit natural gas retailing operation is an ideal platform for launching an attack on the electric power retail marketplace.

Right-Sizing and the Retail Franchise:

1. The major functions of the power industry have been expanded from the traditional divisions of "generation, transmission and distribution," to include "wholesale marketing" and "retail marketing."

2. In this context, proposed mergers have recently fallen under increased scrutiny by both the U.S. Department of Justice, and by the Federal Energy Regulatory Commission.

3. Concern that excessive market power through control of generation will impede competition are at heart of these concerns. Wholesale marketing is looked upon by regulatory authorities as an adequate mechanism for attaining economies sought by mergers.

4. Retail marketing may itself be subfunctionalized for analysis of appropriate scale and the most cost effective means of their provision.

5. Subfunctions of retail marketing include:

a) Management
b) Commodity Supply Acquisitions
c) Transmission Service Acquisition
d) Brand Name Development
e) Customer Analysis and Price Determination
f) Marketing and Sales Program
g) Billing and After Sales Service

Each of these functions may be assessed to determine if they should be (a) outsourced or (b) retained.

6. Outsourcing example: Economies of scale may favor outsourcing of billing and after-sales service. Large banks, among others, have developed highly sophisticated billing systems which serve millions. Attempting to compete with such operations would likely add little shareholder value.

7. Retention example: There are diseconomies of scale in management. Smaller companies are often better able to rapidly react. Many of today’s most successful large companies are run as if they were a collection of small companies.

8. The decision to retain or outsource subfunctions is a pragmatic one, based upon assessment of the available alternatives.

9. Among the main functions, (generation, transmission, distribution, wholesale marketing and retail marketing), the key benefit of continued integration is the knowledge gained by top management of each market sector.

10. While this knowledge, and the concommitant ability to devise overall market strategy is a compelling reason to maintain positions in each market segment, the arguments in favor of continued vertical integration is weakened by the rise of the market.

11. Each of the main functions should be required to stand on its own: the retail marketing segment should be able to purchase from any wholesale marketer. Distribution should be provided equally to all retail marketers. Transmission should be provided equally to all wholesale marketers. Generation should seek the highest available price. Regulatory impediments to market forces should be vigorously opposed, not just for the benefit of the shareholder, but for that of the ratepayer as well.