1 ELECTRICITY INDUSTRY REGULATION AND INNOVATION: BENCHMARKING AND KNOWLEDGE MANAGEMENT AS APPRAISAL TOOLS J. Rodríguez Pomeda, C. Camacho Instituto Universitario de Administración de Empresas, Universidad Autónoma de Madrid Ctra. de Colmenar Viejo Km, 15, Madrid, Spain Abstract The electricity industry is one of the most strategic sectors in the world economy. Hence, great efforts are implemented by governments, regulators, companies and researchers to run it in the most possible efficient way so that both the overall economy and the single consumer would benefit. In this paper, innovation is presented as a mechanism to enhance the electric market efficiency and competition. We expose the reasons to support that argument, watching through those who have taken actions towards a suitable competition. We analyse the best practices implemented by advanced countries in the deregulation and liberalisation issues through a benchmarking study. Then, we analyse the developments made in those countries, focusing in their innovative activities. As a result, a relationship among regulation and innovation is drawn. Finally, we analyse Knowledge Management as a useful tool in the transfer of best practice and to enhance innovation. Key words: electricity sector competition, innovation, benchmarking, and knowledge management. 1. INTRODUCTION Undeniably, the electricity is crucial for the nations economic development not only as an enduse item, but also as an indispensable factor of production. Electricity contributes to the value of most of the nowadays products and services adding its cost to them. This is why it has been recognized its narrow relation between the electricity consumption and the economic growth (Pokrovski, 2003). Since the beginnings of the efforts to liberalize the electricity sector to introduce competition, in a more formalized way, in the decade of the 90 s; governments, sector players, and researchers have been working to find the best way to make markets run in a more competitive and efficient way. This mean low costs, offering consumers a safer and cleaner electricity power, and consequently to contribute to the economic and sustainable development of nations (IEA, 1999). In that process of restructuring the electricity sector, it is recognized that companies work under market forces, where leading role will execute by the electric utilities.
2 The electricity sector needs to recognize the current challenges of competition, and how to carry then out, creating competitive advantages throughout innovation. Innovation in this kind of though demands a different perspective on how to create value, a perspective developed through the eyes of the market and end customers. To do so, a break of thinking-change of culture is needed. A thinking based on how to create value to the customer and how to leverage internal strengths and capabilities, combining and leveraging internal expertise with external competencies to achieve competitive position. Therefore, in this work we aim to analyse how innovation leads to economic growth, but mainly to attest that innovation is an incentive to the market opening. We based our analysis throughout a benchmarking study, to identify who have been the best in executing a more competitive electricity market. Then, we review their innovation activities to find some relations between the utilities performance, innovation and the economic regulation of the sector. Finally, we expose innovation drivers and sources of competitive advantage through the knowledge management from the micro perspective (inside the organization). By appealing reasons that have led to think that the sector development, in efficiency terms, a part from regulatory matter, (that will not include in our study) could get through a suitable enterprise management. Knowledge management is exposed as a catalyst of innovation, and as a tool to create and exchange knowledge, (at micro level); showing the benefits that this one can offer to the electric industry (at macro level), transferring the information and knowledge flowing and around the industry. 1.1 Some reasons for innovation in the electric industry The liberalisation, globalisation, economic growth electricity demand grown-, environmental issues and the technological developments, are all aspects shaping the electric industry; which affect directly the trends that in innovation should be carry out in the industry. Sector liberalisation has brought a strong need for efficiency, requiring the introduction of more efficient and profitable technologies. Consequently, technological innovation is supported by the need to incorporate the most suitable technology inside the industry. Globalisation generates a greater concentration through companies mergers and markets internationalization. In this process, together with the liberalisation, industry has seen an increased tendency emerging of multiutilities 1. These concentration operations and merges have an impact in innovation activity and in the attempt to get better business alternatives. Furthermore, according to the International Energy Agency forecasts, world electricity demand will double by 2030 (IEA/OECD, 2002). The environmental concern and the need to meet the Kyoto protocol objectives are impelling the development for cleaner technologies. For that reason, technological innovations are and will be lead towards the electricity generation through renewable energies (Scheepers, et al, 2003). In addition, this factor should open bigger possibilities for new technologies to meet those requirements, like those of distributed generation, including fuel cells and CHP. These can have as well a significantly impact in the generation and networks structure. 1 Electricity, gas, water and telecommunication supply together. The Hague - September 2003 AER/CPB/ECN
3 2. INNOVATION AS A COMPETITION DRIVER Market opening leads firms to create, seek and promote innovation, given as a result a race among companies to improve their performance, therefore enhancing competition. In accordance with the theory of innovation, this is the factor responsible for most of the growth that has been observed during a period of depression (Sundbo, 1999). This is justified by the fact that innovation is a survival matter firms must innovate or die (Baumol 2002; Sundbo, 1999). In that direction, Schumpeter (1934) along with these authors, argues that in the free market economy, companies are driven by market forces to use the most efficient production methods available and to offer products or services that satisfy customers in the best way. There is a plausible link between innovation and growth, which can be explained by a profit motive. This lies in the conception of the Penrose s The Theory of the Growth of the Firm (1959). In this theory, firm s innovation profits are driven by competition seeking to be the first to learn how to make better products and offer best services, and to bring them to the market more quickly and cheaply than their rival. It is a profit reason, which results into a process to work more efficiently and effectively, that will generate benefits to the industry. That action is compared by Baumol (2002), as the invisible hand of Adam Smith. From a Schumpeterian point of view, innovation is the recognition of opportunities for profitable changes and the pursuit of those opportunities all the way through to their adoption into practice. If invention is economically viable, firms will do whatever is necessary to bring it to the market and to ensure their effective end-use by other firms. So in parallel, innovations must always be well protected under intellectual property. Innovative activities must be incorporated into day-by-day operations, (phenomenon known as routinization ), diminishing therefore the uncertainty of the process. Especially in the electricity sector, competition requirements and current market pressures must force utilities to systematize the innovation process and attempt to reduce as much as possible the uncertainty caused by the markets opening (Hogan, 2002; Crosswhite, 2003). 2.1 Technological innovation as a knowledge base In the case of technological innovations, where an important and determining base of systematized knowledge lies in the development of those technologies (Rodriguez Pomeda, 1998) there is a practical application of knowledge and the willingness from a group of individuals to solve a certain problem. Therefore, technology and innovation become essential factors of success because they reactivate the transformation process and constitute the main source of firms competitive advantage (Rodriguez Pomeda, 1998). However, not only own innovations can generate competitive advantages. For example, in intensive capital sectors, like the electricity sector, there is a wide co-operation among utilities and other institutions to transfer technology. The adaptation of external technologies demands a high level of learning, where processes of technological vigilance are involved, but mainly processes for the diffusion and creation of knowledge. The main reasons for the diffusion of innovation (paradoxically to the idea to retain them for increase control and generate competitive advantages), are that if a company shares its technological developments with its rivals this will harness the effects of competition. Market forces provide an incentive for technological partnerships, to exchange information, so innovation is once again enhanced. 3. BENCHMARKING APPRAISAL Once theoretical premises are established to justify the fact that innovation enhances competition and economic growth, we analyse what is happening in the electric industry in the Euro-
4 pean Union. We aim, by one side to notice how innovation leads to economic growth, and mainly, to analyse the relation between innovation and competition as an incentive to the market opening. Our analysis has been based on benchmarking reports carried out by the European Commission 2 and by information collected from different European markets. We want to identify who the most advanced countries in the liberalisation matter and introducing competition in the electricity market are, in accordance with the objectives drawn up by the European Commission in the Directive 2003/54/CE 3 : introduction of the competition, market opening for all consumers, economical prices, security of supply, service quality and environmental protection. We will select those markets that have been the best ones in the introduction of competition, based on a certain number of indicators. Then, we analyse those actions that have been carried out to become the best, focusing in their innovation developments. By doing so, we aim to explain the link between innovation as efficiency and economic driver, and consequently as a competition driver. Comparisons may be seen as a driver to improve performance. The superior position of the most developed countries in the electricity deregulation and liberalisation leads to special study and the comparisons help to comprehend how they have performed. Thus, benchmarking here is understood as a mechanism for learning best practice in the electricity sector from others through dynamic exchange of ideas and positions among players. This begins from the analysis of some agreed indicators and through the exchange of experiences and practices on policy measures. We have selected a number of indicators, (see table 1) because we consider that they are the main conditioners to allow competition (Shuttleworth, 2002; European Commission, 2001; Newbery, 2000; Joskow, 1997). Table 1: Electricity Liberalisation Indicators Introduction of the Competition Full market opening consumers (% of market opening, % of changes) Regulators independence Market structure (generation market, structure of generation and supply market, concentration) Access to the electricity networks (System of Access, Establishment of tariffs, Imbalances Management, International Operations cross border tarification, Congestion management Separation of the activities International trade (Capacity of interconnection, % exports and imports) Economic Prices Prices development (industrial and residential consumers) Security of Reserve of capacity Supply Import capacity Incentives for the increase the generation capacity % households connected New generation capacity Universal Service and Service Quality Environmental protection Universal Service (Security and reliability of the service to all the customers at economical prices, Position to the provision by territorial location) Minimum standards on watch (Voltage levels required for networks operators) Continuity of supply Capacity of generation through renewable energies Exchange of renewable energies in the generation market Reduction of the carbon dioxide emissions Source: European Commission (2001, 2003) This benchmarking study allows us to identify the position of the countries in key areas of industry liberalisation, as defined previously by a number of indicators. 2 SEC (2003) 448, and SEC (2001) 1957, Previously, Directive 96/92/CE. The Hague - September 2003 AER/CPB/ECN
5 Figure 1: Level of the Directive disposition fulfilment Declared market opening (%) Unbundling of TSO Unbundling Distribution system operator Regulator Overall network tariffs Balancing conditions favorable to entry Biggest 3 generators' share of capacity (%) Country Austria 100% Legal Accounting ex-ante above averagemoderate 45 Denmark 100% Legal Legal ex-post average favourable 78 Finland 100% Ownership Management ex-post average favourable 45 Germany 100% Legal Accounting NTPA above averagemoderate 64 Sweden 100% Ownership Legal ex-post average favourable 90 UK 100% Ownership Legal ex-ante average favourable 36 Source: European Commission (2003) There is a diverse degree of fulfilment by the Member States in relation to the requirements of the Directive. In some cases they are reluctant to accomplish the full market opening. However, some Member States have gone even further in settling internal dispositions with the purpose of improving their market efficiency and consequently encourage more competition. By the indicators that are summarized in the figure 1, is appreciable that the Member States that in better situation regard to the market opening is Austria, Denmark, Finland, Germany, Sweden and the United Kingdom, which by instance have fully opened their market and who will be the markets of reference to analyse the innovation activities and to establish such a relation between innovation and competition. 4. LOOKING AT THE UTILITIES INNOVATION ACTIVITIES In order to analyse innovation activities of our reference markets and to look at their performance with regards to the opening market, we have collected information from the European Statistic Office. This information relate to utilities (including electricity, gas and water), innovation activity objectives, innovation expenditures, factors hampering the innovation activity, innovation with cooperation and government support. To support this statistics we have also looked at the Eurelectric R&D survey and at utilities annuals reports. A consensus is observed on the innovation development needs in the electric industry, but also we observed what justifies our study- that countries with better marks in the market opening are those countries more engaged in innovation, and with a strong R&D structure (see table 2). UK Sw eden Germany Finland Denmark Austria The main R&D activities consist in a systematic research to find innovative solutions based on technology, to improve the electricity supply quality and the service offered to the consumers. Concretely, those objectives consist on: (1) follow and develop experiences in new technologies and to incorporate them within the plants and processes of the companies so as to increase their
6 efficiency, as well as to environmental protection, (2) the permanent improvement of the quality of the provision of the electricity and the offered service, and (3) to promote and fortify the use of new source of energy, including renewable energies. Many of them are including within the programs of the European Union or national programs, as well as corporative projects (Eurelectric, 2003). Despite that, the exchange of information is finding certain difficulties by competitive intentions. Where the R&D structures have had to adapt to the new conditions of the electric industry, there is a wide cooperation between the utilities in an attempt to share, not even the financial risks, but also the level of expertise embedded in the innovation activities. In most of the cases, long-term R&D activities are financed by governments, because of the high risk involved, and mainly short-term activities are financed by the utilities themselves and incorporated as part of their daily activities. Table 2: Percentage of innovating utilities ( ) with the following issues: Country Engagement in Supported by the Innovation with R&D government cooperation Austria Denmark Finland Germany Sweden UK Source: Eurostat (2002) Besides, in most of the utilities innovation activities are carried out in cooperation, with manufactures (as main partner) and suppliers, utilities within the group, universities and research centres, large costumers, governments, competitors, and consultancy enterprises. This is also an important fact, because it is an opportunity to finance the innovation developments, as well to introduce new technologies developed by other which can improve the utilities efficiency level (Eurelectric, 2003). Moreover, it is broadly seen the importance given to share or acquire technological culture and know-how, through knowledge exchange activities, like participating in national and international congresses or seminars and taking part of electric associations. Indeed, International cooperation is growing. In several countries it was observed that from the restructuring of the electricity markets, the economic efforts in R&D have diminished, due to the liberalisation of the industry (lost of monopoly, new rules of market), forcing utilities to focus its activities short-term outlook, and reducing the human capital investments, and in general its R&D budget. Nevertheless, in Sweden, the opposite effect is observed, where the R&D programs have been increased as means to create new business opportunities, taking advantage of the market opening where utilities are playing the main role in R&D. Involvement in university research is seen as a mean to attract talent. The approach of the R&D activities is to provide a knowledge-based for the economy and industry (Eurelectric, 2003). In agreement with the observed results, it is appreciable that the countries with a bigger effort carried out in the innovation development, are the markets that achieve bigger advances in the introduction of competition. There is a common motivation to engage innovation and R&D, as a mean to improve competitiveness. Finally, it is appreciable that utilities we have considered disseminate knowledge, so it shows that the most utilities share knowledge, internal and externally, the most they will be able to achieve higher performance in their innovation than those that do not share it (Spencer, 2003). The Hague - September 2003 AER/CPB/ECN
7 5. KNOWLEDGE MANAGEMENT AS AN INNOVATION DRIVER In this section, new developments appear from the point of view of business management which can contribute to the utilities efficiency and by consequence of the sector. We refer to the knowledge management, a process to create, disseminate and use knowledge; thus a process to enhance innovation. The current knowledge approach linked to the innovation has led us to analyse the factors that determine the creation, diffusion and absorption of knowledge existing inside and around the electric utility with the aim of stimulate and generate innovation. To comprehend the nature of innovation we can look out through knowledge management since this takes into account the process by which new knowledge is generated, and when it is validated, put it into practice. Hence, innovation is the result of the use of knowledge in a new application. The knowledge management refers to the processes of: - Develop work practices that facilitate the knowledge generation. - Capture information to make the learning possible, and later to facilitate the process of creativity and innovation. - Use knowledge to generate value. Create and Capture New knowledge is generated into Create and generate new knowledge Capture of internal and external knowledge Reuse and Renew Reuses of existing knowledge. Renew of knowledge Obsolete through Measurement Knowledge maps Sources of learning Indicators of intellectual capital Assimilate and Apply Distribute and share Make the knowledge accessible To distribute, to spread and to transmit People need to accede to the knowledge, to interpret it, to assimilate it to Source: Plaz, R. (2003) Figure 3: The Knowledge Management Cycle Since innovation is the result of the use of knowledge on a new application, the firm s transfer, learning, and absorb skills through the interaction between the individuals within the innovation system, is a key factor for the innovation successful (Cohen and Levinthal, 1990). In the electricity sector there is a huge basis of knowledge accumulated through ages, the specific skills that required to be exploited into the industry are no easy to get it. It has been estimated 4 that the term needed for a utility worker to be fully productive is seven year. Current challenges of the industry do not allow taking such a time to train its human capital. Besides the huge amount of information that flows in real time into the industry, there is a call for the industry to capture, learn and share knowledge faster than ever to put it into practice. The innovating 4 See Sapient, 2001
8 utilities will be those who decide to put into action resources and capacities to develop products, processes and management systems able to adapt them to the economic change in successfully. Among those management systems we can include the knowledge management and the set of tangible and intangible resources that create value in the current economy (Rodriguez Pomeda, 2001). To transfer knowledge is not an easy task, (Polanyi 1967; Nonaka and Takeuchi 1995), mainly when we talk about tacit knowledge 5 and we want to apply it into a specific context. Then knowledge management challenge is to make explicit the tacit knowledge that flows in the organization, and to put it into action (Nonaka and Takeuchi, 1995; Bueno 2002). The exchange of organizational knowledge, from the internal (in the own organization) and external dimension (with its agents and environment), even with its competitors, changes the paradigm of who holds the information is the one who has the power, the current paradigm is base on the share of knowledge, know-how and abilities shared among diverse players. Literature around knowledge management, as well as the organizations who have implanted it 6, emphasize the importance of a organisational and cultural change, its require a industrial transformation (Chataway and Wield, 2000). The capacity to acquire, absorb and use knowledge is attainable when suitable structures exists. There is not a structure pattern, an ad hoc structure is that, where exists an open approach and the possibility to increasing the potential to generate new knowledge (Chataway and Wield, 2000). This approach is where the development of the innovation and technology transference could be possible into the electric industry. The activity of innovation is a combination of events but mainly, a cluster of intangible assets 7 that related, produce the wished effects. To understand more about the nature of the intangible and the process by which knowledge is generated and diffused, is a challenge for the enterprise and industrial development, and therefore, is a challenge for the electric industry that must take into account. The sharing and diffusion of knowledge is recognised as an important element in improving innovation. A continuous learning is evident and important. This involves the creation of intangible assets. European governments and the European Commission are already stressing the need to provide a climate favourable to innovation and to firm creation. The consideration of intangible assets in policy-making would lead to the formulation of policies effective in creating such goals. In this direction, the Union of the Electric Industry in Europe (Eurelectric, 2003a) has published a study about the importance of intangibles in the electric industry where it is highlighted their relation with the electric utilities future earnings. Among the most relevant intangibles considered are included: development of strategic alliances, a sound brand image, the quality and extension of customer portfolio, the capability of attracting personnel with high potential and qualification, and a permanent focus in innovation, and personnel strongly committed to the company s strategic goals There are two kind of knowledge: tacit and explicit. The tacit knowledge (is embedded in the individuals and acquired mainly through the experience), is transferred generally of individuals to individuals or groups, through the socialization process. The explicit knowledge is codified, mainly in documents, data bases, manual and equipment. (Nonaka and Takeuchi 1995; Polanyi 1967). See Rudge, S. and Carpenter, S. (2003): Benchmarking KM at British Energy Power and Energy Trading, Special focus KM in the energy sector, in ARK Group, (2003), Knowledge Management, March 2003, Vol. 6, Issue 6. In the business jargon intangibles assets are the practical representation of knowledge and its interaction in around the organization and its environment. The Hague - September 2003 AER/CPB/ECN
9 In accordance with that, a study of intangible assets in the electric industry is been held in my research centre 8 to illustrate the importance of intangibles in the industry and the position of the Spanish electric utilities in this area. This study sets out a framework for examining intangible assets. It adopts the view that, in the new economy, firm value is a set of complementarities between traditional tangible assets (financial and physical) and the increasingly important intangible assets (organisational capabilities, knowledge and external relationships). Because of the electric industry s liberalisation, the need for an accurate assessment and analysis of key intangible assets to detect the best opportunities is increasing. As we have seen, innovation investments may not necessarily rely on previous investments on R&D in the same company, the current knowledge stock inside the organisation could hence the development of innovation. 6. CONCLUSIONS Due to liberalisation, the electric industry is facing new challenges to increase its competitiveness. The rules of the game have changed, but fortunately, there is a wide background on how to carry out the current electric industry requirements, and how to enhance its efficiency and competitiveness. Indeed, innovation is the effort that the electric industry requires to improve its efficiency, creating new business opportunities and skills, and by consequence, an open environment where competition is possible. Innovation through the creation, diffusion and use of knowledge can become a conductive key for economic growth and provides part of the answers to much of the electric industry challenges. Knowledge management is the system that involves that process of new knowledge, which acts as a catalyst for the innovation and creativity into a specific organization, but also as a facilitator to collect and leverage all the knowledge around the industry. There will no be a successful best practices transfer into the industry if there is not the right process to learn them. Thus, knowledge management contributes; at a macro level, to transfer in an efficient way the knowledge embedded into the industry. Efforts towards a suitable electricity sector framework should be accompanied by managerial efforts to compete in right condition. Electric industry and players involved should consider enhance their value through the right intangibles management. Although the electricity sector structure and regulation is a task shaped by many factors, we should strength every matter that reveals basis of performance improvement innovation is a real fact to do so. Thus, we consider further researches to explore how electric utilities are leveraging their internal capacities and knowledge, to strengthen innovation and competitiveness, what are the challenges to face and the effects in the electric industry performance. 8 Intellectual Capital Measurement and Management in the Spanish Electricity Sector [http://www.iade.org/contenido.asp?idm=300&idp=30309&idb=1]
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