Article: Cogeneration and Onsite Power Production Magazine

Author: Jamie Wimberly, CEO, Distributed Energy Financial Group

Title: Meeting The Commercialization Challenge

Date: October 2006

Words: Approximately 2,800

Let me fly like and eagle... to the sea
Fly like an eagle let that spirit carry me, I wanna fly...
Fly right into the future.

-- Seal, “Fly Like An Eagle”

The time would never seem to be riper for increased cogeneration opportunities and onsite power production. The external trends and drivers are all pointing to the need for complements to traditional central power plant production. Customers are asking for alternatives to manage expected high energy costs and reliability needs. Yet, at least in many mature markets, there is a sense that the market for cogeneration and onsite power production is progressing very slowly.

If the value proposition is strong, why are customers not having the expected epiphany – the “aha” moment – to match the trends? What is holding back the cogeneration and onsite power industry?

One could point to the fact that the value of any given project is determined by the site-specific function, economics, regulations and customer needs for that individual project. In other words, each project is unique, tailored and must be evaluated by its own metrics. While there is truth in that observation, the answer is unsatisfying and incomplete.

Let’s be frank, though, about one of the primary reasons for the onsite power industry’s lack of traction and success: The industry continues to grapple with meeting the commercialization challenge.

When the Distributed Energy Financial Group (DEFG) analyzes the sector, especially the financial prospects of publicly traded companies in the sector, what we see over and over again is an immature or dysfunctional sales and marketing strategy and operation. As one would imagine, this is especially true for start up companies, which are attempting to move from the engineering-focused realm of research and development to the market. But even established companies have had a great deal of trouble matching opportunities with the appropriate markets and sales structure.

DEFG’s market research and survey results are increasingly pointing to bullish market demand for distributed energy. However, our research is also showing a clear mismatch between what customers are asking for and the offerings currently being provided in the market. Clearly, for the industry to be successful over the long-term, a re-thinking and optimization of the sales and marketing operation will be required to bridge this gap.

To revamp a company’s sales and marketing strategy, a step-by-step approach is required to assess the market for the offering, understand current business challenges and to optimize sales and marketing spend. DEFG has developed a propriety tool, the Distributed Energy Market Index (DEMI), which utilizes three screens and a fact-based approach to provide an analytical framework and the ability to benchmark progress over time. This framework should prove to be useful to sales and marketing professionals in the cogeneration and onsite power generation market.

Most companies have completed a macro analysis using a framework like the one provided above. However, the marketing models and strategies that DEFG have reviewed usually are limited, tracking a few variables at most, and static in nature. What the DEMI framework makes clear is that new inputs are consistently required to reflect the ever-changing nature of the market itself.

The Distributed Energy Financial Group’s primary focus is on the North American market; however, certain macro trends and buckets of drivers can be found in most major markets that will impact the cogeneration and onsite power generation sector. These trends and drivers include:

• Regulation and Public Policy. Traditionally, governments and policymakers in every market have been very active in regard to energy prices, reliability, and siting, to name a few areas. Given the efficiency profile and flexibility of cogeneration and most types of onsite power, regulation and public policy should prove to be a favorable driver for the onsite market.

• Aging Infrastructure. Aging infrastructure will contribute to increased replacement costs and strain transmission and distribution systems. Siting in congested areas will continue to be problematic if not impossible in some cases. Cogeneration and onsite power generation will be seen as an alternative to defer or avoid capital expenditures for transmission and distribution.

• Environment: The consensus viewpoint is that global warming is real and governments at all levels are beginning to react to that reality. Insofar as efficiency begins to become monetized in the form of emissions credits, environmental policies can help push forward cogeneration and onsite power generation.

• Financial. For utilities and other established companies in the energy sector, the financial environment will reflect increasing pressure as interest rates rise, regulated return rates decline, and fuel prices increase, especially for regulated utilities. When taking a portfolio approach to sound financial management, in other words, managing a fleet of assets, cogeneration and onsite power projects begin to make more sense.

• Fuel and Energy Prices. Escalating fuel prices, the termination of rate caps in some regions, and the replacement of aging infrastructure will continue to drive up costs and prices. While there will be dips and increases, the consensus expectation is that we have entered into a relatively higher energy cost environment worldwide.

• Demographics, Load and Economic Growth. The rate of increase in load will decline in many mature markets, but high-growth pockets will exist, reflecting demographic shifts. For the developing world, demand far exceeds current supply. Rapidly growing nations such as China and India will have to invest in new infrastructure and supply in order to maintain current economic growth rates.

• Customer Preferences and Expectations. Changing customer expectations will be highly correlated with shifting demographics, exposure to service innovations in other industries, and concerns over higher energy prices, increasing expectations in regards to digital customer interfaces, greater choice of service offerings, and new tools. A growing number of customers will choose onsite power.

While somewhat tangential, trends in technological innovation are also important to consider, including innovations in other network industries. Past investments in R&D in the energy sector and other sectors, namely, the communications and transportation sectors, are beginning to converge and form a powerful platform for change. Advanced metering infrastructure (AMI) will be especially important, with the prospect of AMI becoming the next energy trading platform of the future. This, in turn, should drive an increased recognition and ability to capture value at the local, distributed level for cogeneration and onsite power generation.

The above trends and drivers are strengthening and largely positive for the cogeneration and onsite power generation market. However, each driver does not have the same impact on a particular offering, and should not be treated the same. For example, high energy prices will usually have a much stronger impact on market opportunities than demographics and load growth, at least in the short term. Moreover, the trends and drivers are not static. Scenarios should be used to test assumptions on a going forward basis.

By assigning ranks and weightings to inputs, the DEMI macro analysis results in a narrowing of suitable market opportunities on a geographic and segmented basis. Very much like a funnel, it is important to use a macro analysis in order to avoid the common pitfall of being all things to all consumers, and simply throwing darts at a map.

Technical Assessment

The targeted geographic areas and customer segments now must be assessed for technical potential, meaning that data must be collected on demographics and the number of various types of buildings for each of the identified customer segments in those targeted geographic areas. The purpose of the technical assessment is multi-fold, including: 1) Calculating market potential within that geographic area for identified customer segments; 2) Translating data from the macro analysis into dollars for the sake of business case analysis and a pro forma; and most importantly, 3) Further refining focus by discarding geographic areas or customer segments which do not have enough intensity to support marketing and sales operations in those areas or segments.

Critical Customer Success Factors Evaluation

The Distributed Energy Financial Group recently completed the second annual DE market survey with Market Strategies Inc. (MSI). Approximately 550 stakeholders responded to the survey representing all facets of the industry, including utilities, vendors, regulators, developers, investors and other interested stakeholders.

There is one obvious finding, energy prices matter a great deal and that directly leads to total expected rate of return. In the market, there is every expectation that we have entered into a new era of relatively high energy prices, including electricity prices as rate caps come off and a record wave of utility rate case in progress or planned.

Survey respondents also indicated that vendors must continue to improve their technological advantage (23% of respondents) and reduce their cost of production (17% of respondents) in order to be successful in the future.

In addition to improving the technological performance and functionality of the offering, respondents highlighted the importance of the entire offering, which would include the presentation of the offering, the contracting process, implementation, and service and maintenance after the contract is signed. These are all components of the value proposition that technology vendors, eager to sign deals, have somewhat downplayed in the past.

When asked what are the most important issues for customers purchasing DE solutions, respondents clearly stated “economic advantage/ payback” and a “reduction in energy costs” were the most important.

Utility Evaluation Screen

Finally, the DEMI incorporates a utility evaluation screen to assess the market potential in specified geographic areas. Utilities oftentimes offer the best proxy to benchmark the alternative offering against to determine cost competitiveness and market receptivity. In other words, if a customer did not buy your product or services, there is a high probability that they would be covering their power needs through the local utility company.

The utility evaluation screen is comprised of four buckets of drivers: 1) Pricing and tariffs, which refers to the price of power to beat and the various tariff structures that are offered by the utility to specific customer segments; 2) Utility receptivity, which refers to how receptive the utility is either working with or, at least, not hostile too, vendors of cogeneration or onsite power; 3) Utility structure, which refers to how the utility is regulated and structured to meet customer needs, e.g., if the utility has an ESCO as part of the holding company; and 4) Regulatory and environmental, which refers to the regulatory mandates placed on the utility or other policies in place that encourage or discourage cogeneration and onsite power generation in that service territory.

Much of the data for the utility evaluation screen is publicly available; however, DEFG found it necessary to conduct surveys with the utilities themselves to create rules and rank more subjective inputs such as utility receptivity.

The final step in the evaluation process is to bring the screens together to create an optimization matrix. During the screening process, each individual factor has been ranked and weighted within their assigned bucket. For example, the incremental commercial price of electricity in a utility’s service territory would be ranked and weighted within the “price and tariffs” bucket of the utility evaluation screen.

Weights now must be assigned to the overall buckets of factors in the critical customer success factor evaluation and the utility evaluation screens. Then the two screens must be further weighted. For example, an aggregated weighting scheme may look like the following:

Critical Customer Success Factor By Customer Segment (50% weight)

• Customer Awareness, 20%
• Customer Economics, 40%
• Customer Preferences, 40%

Utility Evaluation Framework (50% weight)

• Pricing & Tariffs, 35%
• Utility Receptivity, 20%
• Utility Structure, 10%
• Regulatory/Environmental, 35%

DEFG used the Distributed Energy Market Index to evaluate a number of utilities and customer segments in the Northeast region, Southeast region and Wisconsin. Again, these were the geographic reasons and customer segments that became evident after conducting the macro analysis on this client’s particular offering.

Using the DEMI tool, the optimization matrix is capable of clearly demarcating the geographic territories and customer segments within those territories which should prove to be most conducive to a particular offering, including cogeneration and onsite power production.

In this generic case above, the dark boxes and lower numbers (and thus, being of great interest) point to opportunities in the service territories of Utility A, D, and F. The optimization matrix also highlights the customer segments that show the most promise for this generic offering, with hospitals, hotels/ motels, military, prisons and universities scoring the best.

The output begins to address questions around the appropriate sales and marketing structure and spend. For example, using the generic case above, an optimization strategy would point to having a direct sales organization focused on the highlighted service territories and with direct experience in the targeted customer segments, perhaps having one team with a commercial focus on hotels/ motels, hospitals and care facilities, and another team with an institutional focus on military, prisons and universities. For those territories and segments that were in the lighter gray, partnerships, demonstration projects or other activities would be suitable to build a base for future sales and marketing efforts.

The trends and drivers impacting the cogeneration and onsite power market are favorable and intensifying. However, companies in this market have work to do to meet the commercialization challenge.

The signs of this challenge are abundant. From a financial analyst perspective, concerns arise over the inability of companies to improve their operating margins over time (thus, profitability) and reliance on sales and marketing structures, e.g., OEM distribution partnerships, which may not be appropriate for long-term growth.

From a customer perspective, our surveys and market research is highlighting a possible mismatch between customer preferences and what is being offered. Customers desire a value proposition that meets their needs which are oftentimes defined in somewhat different terms than what is commonly used to sell cogeneration and onsite power. In turn, companies must resist the temptation to be all things to all customers.

To meet the commercialization challenge, companies need to take a fact-based, step-by-step approach to analyzing their market space and customer base. On an ongoing and consistent basis, executive teams must be asking themselves basic questions such as: How do we assess changes in our marketplace? What is the market potential for new products and services? What are the scenarios that we need to test? Who are our customers and how much are they worth to our company? Who are our competitors and what might be disruptive?

The Distributed Energy Market Index (DEMI) provides a framework and methodology for assessing these questions and others to meet the commercial challenge now and into the future.

Jamie Wimberly is the CEO of the Distributed Energy Financial Group (DEFG, http://www.defgllc.com/), a specialized consulting and financial services firm focused on the alternative energy market. For more information on DEFG or the DEMI tool, feel free to contact him at jwimberly@defgllc.com.