ESMT INNOVATION INDEX 2014 ELECTRICITY SUPPLY INDUSTRY

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1 BB ESMT Business Brief ESMT INNOVATION INDEX 2014 ELECTRICITY SUPPLY INDUSTRY THE BIG BEYOND CHRISTOPH BURGER, ESMT SHIRISH PANDIT, ESMT JENS WEINMANN, ESMT ISSN ESMT European School of Management and Technology

2 Citation Burger, C.*, S. Pandit and J. Weinmann (2015). ESMT innovation index 2014 electricity supply industry: The big beyond. + ESMT Business Brief No. BB * Contact: Christoph Burger, ESMT, Schlossplatz 1, Berlin, Germany Phone: , christoph.burger@esmt.org. + The first and second releases of the ESMT Innovation Index received widespread feedback from companies included in the index as well as those not yet analyzed. The raw data underlying the third release of the Index has been sent to all utilities for clarification and, if necessary, corrections. We want to express our gratitude to all those who have helped to establish and improve this unique dataset of innovation efforts of major European electricity companies. Copyright 2015 by ESMT European School of Management and Technology, Berlin, Germany, All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means - electronic, mechanical, photocopying, recording, or otherwise - without the permission of ESMT.

3 3 Contents Executive summary... 4 Findings of the ESMT Innovation Index Utilities at the crossroads: From managed to diverse innovation Innovation outlook: The Big Beyond Appendix 1: Input data Appendix 2: Notes on data and methodology Appendix 3: Key assumptions... 28

4 4 ESMT INNOVATION INDEX 2014 ELECTRICITY SUPPLY INDUSTRY Executive summary The ESMT Innovation Index 2014 Electricity Supply Industry measures innovation activities of 16 major European utilities in the years 2007 to In addition to expenses on research and development (R&D), patents and research areas, it also takes indicators for process innovation into account, in particular the utilities performance regarding productivity and sustainability. For the first time since 2011, the aggregate R&D spending of the sample shows an upward trend in 2014, mainly triggered by French utility EDF. EDF achieves the highest score in the overall ranking of the ESMT Innovation Index 2014, followed by Spanish company Iberdrola. While EDF is identified as a research leader within the sample, Iberdrola rather follows the strategy of a dissemination leader, implementing innovations made elsewhere to improve its operations. Fourteen out of 16 electric utilities were able to increase their overall innovation performance, in particular with respect to sustainability indicators. It can also be observed that utilities readjusted and focused their research activities between 2012 and 2014, while new patent registration substantially declined since Meanwhile, a new type of innovation emerges among European energy utilities: Many of them have started financing or initiating corporate incubators, accelerators, venture capital units, or co-investments in startups. Following other industries, they move from the classical model of managed innovation to diverse innovation with a larger variance in the output of new ideas and business models. Even though these new innovation strategies are a positive signal to internal and external stakeholders, they may not be sufficient to cope with the challenges ahead that will disrupt the utility sector even more. We call them the Big Beyond : Startups develop low-cost, hands-on solutions via frugal innovations, thereby building an Internet of Things beyond the reach of utilities; cryptocurrencies replace conventional payment methods, for example in the use of smart meters, and the underlying blockchain technology enables decentralized communication with drastically reduced transaction costs; founders promote their business ideas on crowdfunding websites to raise capital, while neighborhood communities implement and practice the sharing economy with jointly owned and profitable renewable energy installations.

5 ESMT Business Brief BB Findings of the ESMT Innovation Index 2014 The ESMT Innovation Index 2014 Electricity Supply Industry measures innovation activities of 16 major European electricity utilities in three dimensions: research, productivity and sustainability. French company EDF and Spanish company Iberdrola score highest in the overall ranking. While 14 out of 16 utilities were able to improve their innovation performance over the last 8 years, it can also be observed that utilities readjusted and focused their research activities between 2012 and 2014, and new patent registration substantially declined since The decline in aggregate R&D spending of major European energy utilities has been reversed in 2014 For the first time since 2011, the aggregate R&D spending of our sample of 16 major European electricity suppliers shows an upward trend in While expenditures declined by 10 percent per year between 2011 and 2013, they rose by 4 percent, or 60m, from 2013 to Additional expenses of 107m by French utility EDF were the main trigger for this development, but Engie (formerly GDF- Suez) and Iberdrola with increases of 28m and 10m acted as contributors, too. By contrast, most other major European incumbents kept their budget stable or even reduced it, in particular CEZ, E.ON, and RWE. Figure 1 depicts the development of R&D expenses of the utilities in our sample over the years Appendix 1 provides an overview of all data used in the Innovation Index, including R&D expenditures.

6 R&D Expenditure of European Utilities (EUR million 6 ESMT INNOVATION INDEX 2014 ELECTRICITY SUPPLY INDUSTRY Figure 1: R&D spending of major European energy companies EDF Engie Iberdrola RWE E.ON Dong Enel Vattenfall Fortum EDP EnBW CEZ Statkraft SSE Axpo Source: ESMT analysis (2015). Note: Companies are sorted by total R&D expenses in The differentiation between research leaders and dissemination leaders becomes blurred In the previous editions of the Innovation Index, we were able to identify two innovation strategies that were pursued by European utilities: The most advanced utilities of the sample could either be classified as research leaders, that means, utilities with a high R&D budget and a large number of patent registrations, or as dissemination leaders, which increase their productivity and sustainability by the efficient implementation of innovations made elsewhere, for example by OEMs such as manufacturers of gas turbines or providers of smart grid equipment. The transformation matrix in figure 2 shows the combined scores of the productivity and the sustainability subindices on the vertical axis and the research subindex on the horizontal axis.

7 Sustainability and Productivity Subindices (Output) ESMT Business Brief BB Figure 2: Company clusters based on ESMT Innovation Index EDP [in 2012] 40 Dong [4] Statkraft [7] Iberdrola [in 2012] Dissemination Leaders Transformation Leaders 30 EDP [8] Iberdrola [2] Enel [in 2012] 20 SSE [12] Verbund [13] E.ON [10] Axpo [9] Enel [3] Fortum [5] Research Leaders EDF [1] 10 CEZ [15] Vattenfall [14] EnBW [16] Engie [11] Hesitants RWE [6] Fortum [in 2012] Research Subindex (Input) Source: ESMT analysis (2015). Note: Numbers in [brackets] denote the overall rank in the ESMT Innovation Index The group of companies in the quadrant research leaders on the bottom right side has increased since the 2012 edition of the Innovation Index. It still contains EDF, RWE, and Fortum, but Enel has joined the cluster. Four utilities form the group of dissemination leaders: Iberdrola, Dong, Statkraft, and EDP, located in the top left quadrant with a high combined ranking of the sustainability and productivity subindices. While Dong and Statkraft pursue a pure dissemination strategy, Iberdrola shows a tendency towards a stronger emphasis on research and development similar to Enel, which has moved into the quadrant of research leaders. Meanwhile, Finnish utility Fortum moves from its position as one of the research leaders towards higher dissemination scores. These

8 EDF Iberdrola Enel Dong Fortum RWE Statkraft EDP Axpo E.ON Engie SSE Verbund Vattenfall CEZ EnBW Innovation Index ESMT INNOVATION INDEX 2014 ELECTRICITY SUPPLY INDUSTRY movements could be interpreted as an attempt of some utilities to combine the benefits of both research and dissemination in hybrid strategies. The remaining eight companies are still located in the quadrant of hesitants, although at least some of them already pursue to improve their innovation performance and invest in new forms of innovation, which will be described in the following section of this policy brief. EDF and Iberdrola lead the overall ranking Electricité de France (EDF) receives the highest score in the overall ranking of the ESMT Innovation Index 2014, clearly outperforming all other European players in the sample. Iberdrola comes second, while Enel, Dong, and Fortum obtain fairly similar scores on ranks three, four and five. Figure 3: Ranking and composition of ESMT Innovation Index Research Productivity Sustainability Source: ESMT analysis (2015).

9 ESMT Business Brief BB With a research budget of 650m in 2014, EDF accounts for more than 40 percent of all R&D expenditures in the sample. Meanwhile, Iberdrola scores high in the sustainability and research subindices. As its positioning in the transformation matrix (figure 2) shows, the company has moved from a relatively straight-forward dissemination leader to a hybrid innovator with a strong emphasis on R&D. Over the time period 2007 to 2014, its research expenditures almost tripled and exceeded 170m in The strategies of the two companies leading the ESMT Innovation Index 2014 are strikingly different, though: EDF successfully defends its domestic market and remains by far the largest energy utility in Europe, whereas Iberdrola operates most of its business outside Spain, predominantly with low-carbon or renewable energy generation in the Americas and Eastern Europe, and has become the world leader in wind energy. Fourteen out of 16 energy companies have improved their overall innovation performance The weighted performance changes across the three subindices show that most European energy utilities were able to improve their performance from 2007 to Only German utility EnBW and Engie, formerly known as GDF-Suez, are the two outliers in the sample with a negative performance change, albeit because of differing reasons: Of all German utilities, EnBW had the highest share of nuclear generation in its portfolio. The nuclear phase-out, combined with the rise of decentralized energy, hit the company hard. In addition, EnBW has few operations outside the state of Baden-Württemberg, which could compensate for the losses in the home territory. By contrast, Engie s negative performance record may be linked to a decisive and relatively successful internationalization strategy 2. The financial resources spent on acquisitions are inevitably lost for R&D, and often acquisitions abroad lead to a decline in overall productivity and sustainability, because the acquired assets may not match high European quality standards. 2 For a detailed discussion, see Burger, C. and J. Weinmann (Forthcoming). European utilities: Strategic choices and cultural prerequisites for the future. In Utilities of the future: Future of utilities ed. F. Sioshansi, Waltham, MA: Academic Press.

10 Fortum Enel Iberdrola Statkraft SSE Verbund EDF EDP RWE Vattenfall Axpo Dong CEZ E.ON EnBW Engie [Percent (weighted)] -3.9% 5.6% 3.9% 3.6% 3.0% 1.7% -3.6% 0.4% 8.0% 4.9% 1.1% 4.9% 1.5% 21.8% 4.5% 1.4% 10 ESMT INNOVATION INDEX 2014 ELECTRICITY SUPPLY INDUSTRY Figure 4: Performance changes (% from , weighted) 40% 30% 20% 10% 0% -10% -20% -30% Research Sustainability Productivity Total Change (%, weighted) Source: ESMT analysis (2015). In line with our analysis in the last Innovation Index, 14 out of 16 utilities have made progress in the sustainability subindex, while the research and sustainability subindices convey a more heterogeneous signal. From universalists to specialists: Utilities start streamlining their R&D activities In the Innovation Index, research diversity is an indicator that counts the number of research fields in which a utility operates. In total, 15 relevant research fields were identified. Over the observation period, it is interesting to observe that a peak of research fields was reached in Since then, the average amount of research fields per utility has decreased. Figure 5 shows the development in detail.

11 ESMT Business Brief BB Figure 5: Average research fields (maximum 15) from 2007 to Source: ESMT analysis (2015). This tendency could be interpreted as a positive signal: Utilities narrow down their research portfolio to concentrate on specific areas which they consider promising, or focus on their core capabilities. For example, companies such as Axpo, EDP, or EnBW have ceded their R&D investments into carbon capture and sequestration (CCS), after both general public as well as European policy-makers remained skeptical about the potential pitfalls of the technology. At the same time, many European utilities experiment with new forms of innovation, which increase the diversity of ideas: They establish corporate incubators, participate in accelerators, found venture capital units, or co-invest into promising startups. These efforts are only indirectly captured in our index, via the output subindices of productivity and sustainability. To properly acknowledge this new type of innovation, the next section will take a closer look how European energy utilities move from managed innovation to diverse innovation.

12 12 ESMT INNOVATION INDEX 2014 ELECTRICITY SUPPLY INDUSTRY Utilities at the crossroads: From managed to diverse innovation The way how the electricity supply industry understands innovation is currently redefined, compared to the model that dominated the sector until recently, requiring a change in the corporate mindset and organizational setup of R&D efforts. In the old world, innovation was a targeted effort of a utility to reach a clearly defined goal; it was managed innovation, as Barnett, W. (2014) 3 coins it. For example, reducing losses in the transmission or distribution grid, or increasing the operational efficiency of a coal-fired power plant was defined as an objective. A high degree of certainty in the expected outcome, combined with an institutional structure embedded in the matrix organization led to clear responsibilities and legitimacy of a centralized R&D unit in charge of finding a technical answer to a specific problem set. Almost all major European utilities have realized that generating kilowatt hours will not remain the cash-generating venture that it used to be. Their over-arching objective is to find out how to secure a steady stream of revenues despite the erosion of their traditional business model. Unfortunately, there is no single solution to the challenge. Hence, managed innovation may fail to generate a sufficiently large pool of ideas. Only if utilities increase the variance of input and enlarge the circle of people generating new ideas beyond their traditional business units and long-time employees new streams of revenues may be tapped. Figure 6 shows the old and the new approach to innovation, adapted from Barnett, W. (2014). 3 Barnett, W. (2014). Leading innovation by design. Stanford Graduate School of Business webinar. May 7 (accessed November 6, 2015).

13 ESMT Business Brief BB Figure 6: Increasing the variance: From focused to diverse innovation Managed innovation Diverse innovation Source: Barnett, W. (2014). While managed innovation may be useful to facilitate incremental improvements, increasing the variance may be the right answer in periods of uncertainty and disruption. According to Barnett, W. (2014), the disadvantage of the latter approach is that one great idea (depicted by a smiley on the right side of the curve) is necessarily accompanied by a similar or larger amount of failures, though. Increasing the variance of innovation implies taking a greater risk in the expected outcomes. Typically, the idea behind increasing innovation variance and financing new forms of innovation has three key motives: First, increasing the likelihood that out of ten or twenty startups that are financed by a corporation, at least one will provide the killer app that compensates for the losses made by other, less successful ventures. This one successful startup should be of real and lasting value to the existing operations of the firm, sooner or later being integrated into a regular business unit. Second, financing new forms of innovation serves as an external signal to stakeholders, such as investors, shareholders and the general public that the company is on the right track to pro-actively embrace the challenges of a dynamic and uncertain market. Third, they also provide an internal signal to middle management and employees. A new mindset and mentality should trickle down from top management by embracing these new forms of innovation. This cultural change may be even more important than actual, tangible results from the experiments, because the change exemplifies a further move from a public service-oriented utility to a player in a highly competitive market environment.

14 14 ESMT INNOVATION INDEX 2014 ELECTRICITY SUPPLY INDUSTRY The last couple of years saw a mushrooming of new organizational forms of innovation. In particular corporate incubators and accelerators have experienced unprecedented growth. Although the definitions within the startup community are not fully consistent, incubators are typically considered a breeding place or an in-house service of corporations to enable internally created ideas to develop without any intrusion from other departments. Incubators may recruit external management teams, or accept ideas and teams from outside the corporation. By contrast, accelerators are seen to set in later than incubators, namely when a prototype is already built, or the website purpose and functionality is clear, and key stakeholders or customers are convinced that the product or service will become successful. The main purpose of an accelerator is then to provide mentorship and guidance to the founders, help them to develop a proper business plan and, at the end of a period of several months, get investors on board at the so-called demo day. Many European utilities are involved in some form of diverse innovation. They somewhat bandwagon strategic changes that they observe in other industries. For example, RWE participates in GTEC, the German Tech Entrepreneurship Center, hosted on ESMT s premises. Fortum is involved in the Nordic Innovation Accelerator, EnBW co-finances the Berlin branch of global accelerator Startup Bootcamp, which specializes on energy and transport solutions. EDP, Enel, and E.ON have set up their own incubators and accelerators. Other companies focus on venture capital. For example, Perseo is Iberdrola s corporate venture capital program, in which the company has spent 50m in disruptive technologies and businesses since its start in CEZ, EDF, and Engie also maintain their own venture capital subsidiaries, whereas E.ON bets on co-investments into promising startups. E.ON and RWE also opened offices around the Silicon Valley to be closer to the hub of digital innovation. Figure 7 shows a timeline and sequence of those initiatives. 4 Iberdrola. Reputation and sustainability. iberdrola.es. reputation-sustainability/innovation/iberdrola-ventures-perseo/ (accessed November 6, 2015).

15 ESMT Business Brief BB Figure 7: Timeline of exemplary initiatives of selected European utilities in the field of diverse innovation (in alphabetical order) Autumn 2013 VC 180m May 2013 June VC 60m May VC 100m May 2014 Jan 2014 Oct VC 80m RWE Israel Innovation Center Jan Source: ESMT analysis (2015). The rise of digitalization is a fortunate coincidence that benefits cash-constrained European energy utilities. The costs of developing and commercializing an application for a smart phone are negligible compared to the manufacturing of, say, a combined-cycle gas turbine. Diverse innovation can be done at much lower expenses than ever before. At the retail end of the energy value chain, new business models that shift from selling energy to managing energy can be developed and tested without major financial commitment.

16 16 ESMT INNOVATION INDEX 2014 ELECTRICITY SUPPLY INDUSTRY The emergence of incubators and accelerators does not imply that the old world of innovation disappears, though. In fact, for most European utilities these two worlds of innovation coexist. For example, French utility EDF constructs a new research center in Palaiseau on the Paris-Saclay campus, which will be the largest industrial research and vocational training center in Europe, standing on a 12 hectare site. At the same time, the utility sets up its own innovation competition to attract new talent and promotes open innovation. For example, the company launched the EDF Pulse program to support innovation in society and incentivize progress in the areas of smart living, health, and science. European energy utilities will not completely dismantle their R&D departments. In line with many other industries, they diversify their innovation efforts. Consequences for the ESMT Innovation Index Despite these changes in innovation activities of the electricity supply industry, we have decided to keep the ESMT Innovation Index Electricity Supply Industry in the same composition of indicators as in the previous edition two years ago. First of all, we want to ensure comparability over time in the performance of the utilities. Second, we understand innovation as an activity that is reflected in productivity and environmental performance. These indicators constitute half of the inputs of the Innovation Index. If investments in the new world of innovation are successful, they should be reflected in these indicators. But how long does it take to translate the new forms of innovation into tangible financial and operational results? Will European energy utilities be able to transform themselves before other players will capture and dominate new markets as well as old and new customer segments? The next section provides an outlook where innovation in the electricity supply industry may be heading.

17 ESMT Business Brief BB Innovation outlook: The Big Beyond Digitalization has led to an explosion of business opportunities. The barriers to entry of the old system are dismantled. All across the globe startups and founders develop apps as well as technical devices that close the gaps on the way to a fully digital society. The digital revolution pushes our daily routines towards the Internet of Things (IoT). Household devices, vehicles, and industrial and commercial machinery will soon be able to communicate independently from human interference. The energy sector will be an integral part of that connected world. Three phenomena, we call the Big Beyond, will shape this new era and can already be observed today: Internet of Things and frugal innovation: Machine-to-machine communication, connecting control systems to household device to smart meters, cars to traffic lights, or robots in manufacturing to components that they produce, will soon become common in our daily lives. In the energy industry, often innovations feature expensive high-tech solutions, unaffordable in many parts of the world. Frugal innovation follows the opposite approach: It reduces the complexity and cost of a good and its production to a minimum without major loss of quality. US startup Envio Systems developed a smart box called Cube that can be installed in existing building stock to monitor and optimize energy use. As opposed to many other new devices that enhance building efficiency, carbon dioxide sensor detects whether people are in a room, and adapts its heating or cooling signals accordingly. The box and its software cost a fraction of comparable products made by current manufacturers. Blockchain: The blockchain is a transaction database that records all transactions ever executed in the blockchain in a transparent, decentralized internet protocol. It is best known as the digital technology that underlies transactions in cryptocurrencies such as Bitcoin. Startups such as South-African Bankymoon have introduced a system that allows users of smart meters to do their payments via Bitcoin, thereby bypassing banks. Especially in developing countries many inhabitants have no bank account and could potentially use Bitcoins as a means to pay their bills 5. 5 Prisco, G. (2015). Bankymoon introduces Bitcoin payments to smart meters for power grids. Bitcoinmagazine, April 23 (accessed December 6, 2015).

18 18 ESMT INNOVATION INDEX 2014 ELECTRICITY SUPPLY INDUSTRY New venture Grid Singularity intends to use the blockchain to introduce a decentralized energy data exchange platform, offering services that enable forecasting for grid balancing, facilitate investment, trade of green certificates and eventually energy trade validation. Grid Singularity s founders expect immense infrastructure cost savings compared to standard technical solutions that require a fully independent vertical integration for each energy market operation. The platform may also render some of the current key entry barriers to energy trade obsolete, such as a need to have special accounts and deposits, or a certification with an intermediary financial institution. Crowdfunding and the social sharing economy: In Western societies, exclusive ownership of goods becomes less important. Car-sharing services are on the rise, startups such as Uber for taxi services and airbnb for private accommodation prove to be highly successful. In the energy sector, founders promote their business idea on crowdfunding websites to collect money. Companies such as crowdener.gy, econeers, Trillion Fund or SunFunder establish a parallel market that relies on the financial commitment of many individuals instead of any bank or single investor. Berlin-based startup Sunride goes one step further and implements software solutions to optimize neighborhood-level photovoltaic installations that are jointly owned and used by inhabitants.

19 ESMT Business Brief BB Figure 8: The Big Beyond Sharing economy Blockchain Internet of Things Source: ESMT analysis (2015). The Big Beyond combines sensors to monitor and steer devices with a decentralized communication and payment technology thereby drastically reducing transaction costs to allow cost efficient and new sharing business models. The pace with which other industries develop new products and services may be different to the electricity supply industry. If power plants, transmission, and distribution grids, more generally the entire supply infrastructure is built on longterm forecasting scenarios that stretch over twenty to forty years, product cycles of less than a year are difficult to reconcile within one company. As Siemens went out of the manufacturing of cell phone, because it could not keep the same pace as its competitors in new product releases, the business model of utilities has to adapt to rapidly changing tastes of digital natives. If the grid is operated by independent operators, maybe even split into autonomous micro-grids and island systems, if electricity is generated and managed by private residents, energy associations and niche players, and if internet giants such as Google and Apple target the final customer with bundled solutions where is then the role of the traditional energy utility? Most European players have realized that only innovation can rescue them from a slow and painful vanishing.

20 Axpo CEZ Dong E.ON EDF EDP EnBW Enel Fortum Engie Iberdrola RWE SSE Statkraft Vattenfall Verbund Total Average 20 ESMT INNOVATION INDEX 2014 ELECTRICITY SUPPLY INDUSTRY Appendix 1: Input data Figure 9: Summary of key input parameters of ESMT Innovation Index, , by company (1/2) Electricity Production Total (TWh) , , , , , , , , Thermal , (TWh) , , , , , , Nuclear (TWh) Hydropower (TWh) New Renewables (TWh) CO2 Emissions (mt CO2)

21 Axpo CEZ Dong E.ON EDF EDP EnBW Enel Fortum Engie Iberdrola RWE SSE Statkraft Vattenfall Verbund Total Average ESMT Business Brief BB Figure 10: Summary of key input parameters of ESMT Innovation Index, , by company (2/2) EBITDA ( m) ,712 1,282 13,649 16,549 2,628 2,336 9,800 2,298 12,539 5,280 7,915 1,774 1,108 4,188 1,099 86,113 5, ,557 1,683 11,836 14,240 3,155 2,540 14,318 2,478 13,886 6,412 8,773 1,730 2,215 4,201 1,322 93,184 5, ,440 1,187 17,767 15,929 3,363 2,748 16,371 2,292 14,012 6,815 9,165 1,658 1,119 5,752 1, ,583 6, ,512 1,892 17,704 14,156 3,698 3,315 17,480 2,271 15,086 7,528 10,256 1,712 1,827 6,790 1, ,048 6, ,555 2,093 6,324 14,939 3,756 1,810 17,605 3,008 16,525 7,651 8,460 1,700 1,256 6,355 1,070 96,902 6, , ,787 15,998 3,628 2,307 15,809 2,538 17,026 7,727 9,314 1,938 1,403 6,349 1, ,307 6, ,102 3,161 1,904 10,276 16,099 3,598 2,000 16,691 2,129 14,223 6,757 7,904 2,026 2,056 4,637 1,301 95,864 5, ,635 2,728 8,082 17,279 3,642 2,137 15,757 3,954 12,138 6,965 7,131 2,195 2,110 4, ,452 5,778 Employees ,369 30,565 4,962 85, ,033 13,270 20,499 60,229 8, ,381 23,159 65,645 15,777 2,187 32,396 2, ,003 47, ,698 28,330 5,347 93, ,931 12,671 20,357 75,027 14, ,653 28,096 67,942 18,196 2,460 32,801 2, ,092 49, ,092 30,768 5,820 90, ,072 12,148 20,914 78,103 13, ,714 32,711 71,584 19,308 3,329 36,593 2, ,746 51, ,386 32,937 5,800 87, ,764 12,047 20,450 79,913 11, ,116 31,344 73,801 20,266 3,414 38,459 3, ,638 51, ,415 31,805 5,966 83, ,804 12,106 20,851 76,266 11, ,303 31,885 74,919 19,647 3,329 37,679 3, ,127 50, ,368 31,272 6,735 76, ,730 12,222 20,098 74,610 10, ,156 31,338 74,038 19,795 3,417 33,059 3, ,475 49, ,509 26,746 6,692 65, ,874 12,227 19,921 72,022 9, ,012 28,212 67,552 19,894 3,675 32,374 3, ,537 45, ,477 26,248 6,416 60, ,024 11,989 19,968 69,652 8, ,185 28,021 62,340 19,965 3,733 30,827 3, ,532 46,283 Total Investments ( m) ,183 1,397 6,623 7,261 2, , ,999 4,967 3,953 1, , ,439 2, ,819 1,286 8,806 9,489 4,337 1,188 7, ,997 7,333 4,348 1, , ,166 3, ,579 2,103 7,522 11,576 3,415 1,216 7, ,310 4,645 5,810 1, , ,176 4, ,414 1,916 7,662 12,053 2,918 1,579 7,187 1,127 8,887 4,238 6,203 1, , ,976 3, ,096 2,136 5,956 10,637 2,262 1,051 7,589 1,270 8,731 4,542 6,040 2, , ,768 3, ,994 2,207 5,915 12,638 2, ,149 1,409 8,992 4,473 4,684 1, , ,369 3, ,626 2,287 3,906 12,813 2, , ,251 3,370 3,470 2,039 1,185 3, ,117 3, , ,676 13,407 1,723 1,510 6, ,549 3,563 2,703 1,990 1,051 2, ,684 3,043 R&D Budget ( m) , , , , , , , , No. of Patents

22 Thermal Process Optimization Energy Efficiency General Renewable Energies Wind Power Ocean Power Solar Energy Biofuel Nuclear Decentralized Generation Smart Grid E-Mobility Energy Storage Carbon Sequestration / CCS Clean Coal / IGCC Biodiversity, reduction of nuisances, etc. Total 22 ESMT INNOVATION INDEX 2014 ELECTRICITY SUPPLY INDUSTRY Figure 11: Summary of R&D activity areas, , by company (1/2) Axpo CEZ Dong E.ON EDF EDP EnBW Enel

23 Thermal Process Optimization Energy Efficiency General Renewable Energies Wind Power Ocean Power Solar Energy Biofuel Nuclear Decentralized Generation Smart Grid E-Mobility Energy Storage Carbon Sequestration / CCS Clean Coal / IGCC Biodiversity, reduction of nuisances, etc. Total ESMT Business Brief BB Figure 12: Summary of R&D activity areas, , by company (2/2) Fortum Engie Iberdrola RWE SSE Statkraft Vattenfall Verbund

24 24 ESMT INNOVATION INDEX 2014 ELECTRICITY SUPPLY INDUSTRY Appendix 2: Notes on data and methodology The ESMT Innovation Index is based on publicly available data, in particular annual reports as well as sustainability reports of the 16 companies for the years 2007 to Data tables were sent to all companies to receive feedback, in particular with respect to activities in different research areas. We applied the ESMT Innovation Index to European electricity incumbents, in total 16 companies from the following countries and/or regions: Central Europe: Verbund and CEZ France and Belgium: Electricité de France (EDF) and Engie (formerly GDF- Suez) Germany: EnBW, E.ON and RWE Italy: Enel Scandinavia: Dong, Fortum, Statkraft and Vattenfall Iberian Peninsula: Iberdrola and Energias de Portugal (EDP) Switzerland: Axpo United Kingdom: Scottish and Southern Energy (SSE) The selection of companies is motivated by the fact that they occupy an incumbent position in their domestic electricity market. Niche players are excluded. One major condition to enter the sample is that they are not mere subsidiaries of (another) multinational company, but have their own research and development strategy. Figure 13 on the following page shows the individual companies in the sample and their respective annual power generation. 6 Of the 16 companies, Axpo and SSE do not have a January to December reporting financial period. For example, the financial period of SSE ends on March 31. We have recorded the entries of its latest, for instance, 2013/14 annual report under 2013, since 9 out of the 12 months are in Please see appendix 3 for further details.

25 ESMT Business Brief BB Figure 13: Companies covered in the ESMT Innovation Index and their respective annual electricity generation (in TWh) Statkraft 56 Vattenfall 173 Fortum 73 SSE 28 EDF 624 Engie 280 Axpo 35 Dong 14 RWE 208 EnBW 58 E.ON 215 CEZ 63 Verbund 34 EDP 60 Iberdrola 139 Enel 283 Source: ESMT analysis (2015). Note: Bubble size proportional to total annual power generation (TWh), which is shown below the company name. Location of companies is only meant to be indicative of the country they are headquartered in. To specifically operationalize and adapt Schumpeter s categories of innovation to the electricity supply industry, we used valuable inputs from industry, academia, and consulting to identify three distinct attributes of innovation activities within an organization: The research subindex monitors the importance, efforts and diversity of R&D undertaken by electricity utilities. It includes five indicators: (1) absolute R&D budget, (2) relative R&D importance as measured by the ratio of the overall R&D budget to EBITDA, (3) research diversity, (4) number of patents, and (5) number of patents per thousand employees. The sustainability subindex evaluates efforts to integrate new and environmentally sound sources of energy and to minimize CO 2 emissions. It consists of three indicators: (1) climate performance, as measured by the company s specific carbon dioxide emissions in MWh per ton of CO2, (2) new (i.e., non-hydro) renewable electricity generation in GWh, and

26 26 ESMT INNOVATION INDEX 2014 ELECTRICITY SUPPLY INDUSTRY (3) new renewable electricity generation as a percentage of total generation (in percent). Similar to the addition in the research subindex, the last indicator was integrated to account for differences in size of utilities. The productivity subindex measures the operative and sales performance of the companies: (1) output productivity in EBITDA per energy output ( /MWh), and (2) employee productivity in EBITDA per employee. Among those three categories, 50 percent of the weight is given to the research subindex, thereby valuing efforts to improve the innovation position of a company and enhancing its long-term prospects as a market leader. The remaining 50 percent are allocated in equal terms to the sustainability and productivity subindices, which represent efforts to environmentally and economically optimize processes within the firm. Figure 14 shows the relative contribution of each of the factors to the overall score. Figure 14: Composition of the ESMT Innovation Index Sustainability Subindex Climate Performance [MWh/ton CO2] New Renewables as % of Total Generation [%] New Renewables Generation [GWh] Absolute R&D Budget [EUR] Relative R&D Importance [%] Research Diversity [w/o Unit] Research Subindex Employee Productivity [EBITDA ( '000)/Employee] Productivity Subindex Output Productivity [EBITDA ( )/MWh] Patents per '000 Employees [Number] Patents [Number] For the composition of the overall index, the individual indicators are normalized. To account for the dynamics of the transformation, each criterion is measured based on the current status (stock) and the changes that occurred during the sample period (flows). More recent changes have a greater weight than past efforts. Further details on the methodology for the computation and the justification of input variables can be found in the first release of the ESMT Innovation Index Burger, C. and J. Weinmann (2012).

27 EDF Iberdrola Enel Dong Fortum RWE Statkraft EDP Axpo E.ON Engie SSE Verbund Vattenfall CEZ EnBW ESMT Innovation Index 2014 Score ESMT Business Brief BB To test the overall robustness of the index and the effects of different weightings on the index scores, the weights allocated to the research subindex (currently 50%) were varied between 40 percent and 60 percent. The balance weight was split equally (30%/30% and 20%/20% respectively) between the productivity and sustainability subindices. Simultaneously, the weight allocated to the data parameters from the most recent year (currently 75%) was varied between 60 percent and 80 percent. The changes over the preceding period, that is, from inception of the ESMT Innovation Index to the second most recent year, correspondingly received weightages varying between 40 percent and 20 percent. The results of this two-way sensitivity analysis are shown in figure 15 below. For each company in the sample, the graph shows the current index value, the bandwidth of the current value plus/minus one standard deviation, as well as the maximum and minimum values according to this sensitivity. Figure 15: 100 Sensitivity of the ESMT Innovation Index 2014 values to simultaneously changing weightages of research subindex and stock/flow variables Source: ESMT analysis (2015). The results indicate that changing the weightage scheme does not substantially alter the ranking among the leading companies, and has little impact on the remainder of the sample.

28 28 ESMT INNOVATION INDEX 2014 ELECTRICITY SUPPLY INDUSTRY Appendix 3: Key assumptions 1. Information sources: Input data of the companies is primarily based on the information provided in the respective published documents like the annual report and sustainability report. Other sources used (e.g., for patents) are mentioned below. 2. Patents: Information on the number of patents has been gathered from the information databases of sources like the German Patent and Trade Mark Office (DPMA) and the European Patent Office (EPO). 3. Superiority of updated information: For any given parameter, the information has been treated as superior if it was available in a more recent or updated publication than in the original one. Companies in our sample have made retrospective adjustments to figures previously published in their own annual reports, so wherever available and possible, we have used the latest published figures for any given parameter. For example, if a company, in its 2014 Annual Report, has reported (retrospectively) adjusted figures for, say, its own EBITDA in the previous year 2013, then the EBITDA figures reported in the 2014 Annual Report have been used in our calculations, as we have treated these figures as superior to the EBITDA figures reported originally in the 2013 Annual report. 4. Superiority of non-adjusted figures over proforma ones: To the extent possible, for any given input parameter, we have used figures that are better comparable across all companies than proforma figures which a company may have reported after making certain adjustments. For example: E.ON (Adjusted) EBITDA: Instead of EBITDA, E.ON has reported Adjusted EBITDA, that is, EBITDA after making adjustments for one-time and extraordinary items. To make the comparison like for like with other companies, we have used figures for a comparable entry in E.ON s income statements: income/loss from continuing operations before financial results and income taxes. RWE R&D expenses: The R&D figures that we have used for RWE only include the R&D expenses for that year. They exclude capitalized development costs (which are approximately as high as the R&D costs) and are disclosed alongside the R&D expenses. 5. Reporting period: The reporting period is considered on a last 12 months (LTM) basis rather than on the calendar year basis (January through December). For example, Axpo s financial year ends on