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How Can You Reduce Costs and Grow Revenue in North America’s Utility Sector?

by Jim Ellis, B.Sc., P.Log., FCAM, CM

The practice of supply chain management hasn’t been embraced as a discipline in these capital intensive, serviced-based conglomerates. But here’s the secret to more profitable and efficient utilities in North America.

Backgrounders to Supply Chain Management in Utilities
Certainly in my thirty years in the utilities sector,which I’ll define as those businesses that distribute electricity, natural gas and water to the residential, commercial and industrial stakeholders of our communities, I have been exposed to a culture utilities hold dear. Ironically, but for a few exceptions, nothing is more puzzling to me than how this culture of utilities is often cited as the one of the most salient of the myriad of reasons offered to explain why supply chain management has not been embraced by this capital intensive, service-based group.

This article examines why this is a prevalent condition in this sector and, more importantly, will provide those organizations embarking on a supply chain initiative with the tools of understanding required for success

Utility industries are as capital intensive as one could imagine, with wide geographical investments in wire, towers, pipe, control stations, construction depots, service depots,office buildings, vehicles and heavy duty equipment. Specific to supply chain management, however, these investments contain a very large component of inventory and warehouses.

The amount of inventory capital dedicated to supply chain management in the utility industry represents one-to-two percent of revenues, which alone could justify a measured investment in supply chain management.But interestingly, this has not occurred. Certainly, the performance metrics associated with asset performance should likely have been justification as well, with a 3.0 turn average overall.But again, there is a reluctance and, perhaps, disinterest despite the opportunities for growth and savings.

In summary, I believe the most salient reasons for maintaining the status quo are:

  1. “We’re Unique”
  2. Inventory has been a good thing
  3. The Materials Management Group has not earned the confidence of the organization
  4. Managing inventory means get lots…not just enough
  5. Mobile or Field Inventory means “never having to say your sorry…or return”
  6. Controls don’t apply to the Operations Group
  7. Having lots of vendors has been a good thing
  8. Warehouses and lots of storage locations have been a good thing
  9. Supply Chain Management (SCM) is not viewed as a strategic or a corecompetency

Not surprisingly, supply chain professionals in utilities are often frustrated due to their inability to gain traction in their companies to create the results that chain management achieves in virtually every other sector of the economy. In order to mitigate the hurdles to their success it’s important to define these nine key reasons to understand how they act as the barriers to SCM success in this sector.

This article represents the first of a five-part series of articles on supply chain management, specific to utility organizations. Part II of this series will address what’s perceived to be “unique” thing about Utilities, focusing on the paralyzing mystery about the utility industry at large and why supply chain management has had such difficulty in gaining a foothold. In Part III, New and Present Realities, our readers can look forward to a review that shows why utilities are now beginning to explore and consider supply chain management as a means of dealing directly with the realities of revenue, cost and growth. Part IV - High Value Solution Areas for Utilities, will provide insights into those proven supply chain solutions that elicit high value benefit to utilities. Part V – Unleashing the Opportunity, will offer a roadmap to show supply chain professionals in this sector how they can transform their utility company’s performance in supply chain management and impact overall business practices.

We’re unique
This is a particularly paralyzing belief system, as evidenced by utility executives’comments, who traditionally would elaborate:“…due to our uniqueness as a business” and “our responsibilities to the public in terms of continuity of service, stakeholder safety and cost reasonability, some things just don’t work here.” (We will examine the reasonability of this belief in depth in second article of this five-part series.)

Inventory has been a good thing
Up until the noises of deregulation or re-regulation began in the 1990s, a formidable focus on Rate of Return made utilities view their assets as premier revenue generators. Utility companies earn their profits from operating their extensive network of plant and equipment through a percentage rate of return that is applied to the values and assets on their balance sheets. Consequently, a utility, which is wrestling with cost containment and the painful process of filing rate increases, often looks to capital investment to bolster revenues.

Accordingly, items on the balance sheet such as inventories and the warehousing and storage buildings that hold those inventories became a welcome boost for the cause. Coupled with an internalized culture of continuity of service and stakeholder safety, field personnel has developed a justification for holding large inventory caches throughout the organization, resulting in the perception that inventory is a good thing. Not surprisingly, in this environment, diligent materials managers who have attempted to optimize inventory levels and attempted to introduce service levels or implement returns processes have traditionally found their efforts thwarted.

Over an extended period of time this culture has engendered what could be characterized as one of utilities “materials anarchy,” with the user-community dictating the provision of unlimited supplies to meet whatever they perceive to be required, and a materials management group that has retreated into the safety of managing stationary and other office supplies.

The Materials Management Group has not earned the confidence of the organization
With this culture of materials anarchy matured by the 1990s, any incumbent purchasing department, inventory department or warehousing group witnessed a dramatic dilution in their capacity to execute their mandates. In this culture, IT, construction and many other departments and functions took over the procurement for their own separate activities to procure what they believed was required, at least with regard to expensive, big-ticket items.

Interestingly, while all functions wanted their own mandate to source, negotiate and purchase materials, they did not want to provide the levels of accountability that are traditionally upheld by professionals in the discipline of supply chain management. This was especially true when it came to inventory management.

During this period of take-over, many utilities established what could be likened to an internal “peacetreaty” with the official Materials Management, that enabled all functions and departments to buy the big stuff (including items such as transformers, large project construction components) that were high-value individual purchases. The Materials Management Group was relegated to buying and managing those ongoing items of MRO.

While internal clients who were liaising directly with vendors on very high-value purchases, they often developed inappropriately close relationships with them and did not benefit from the techniques and rigour of appropriate purchasing practices. On the other end of the chain, however, havoc was prevalent. Purchases were not coordinated with the inventory management group, or the warehousing group, which quickly became by default the most cited cause for delivery failure and, as a result, these divisions played another role as the expediters and ongoing mediators or envoys to apologize to both end-users and vendors.

Finally, these failures essentially rendered the MRO chain ineffective. The absence of critical controls created inventory inaccuracies and lost transactions that incapacitated any replenishment service levels.

Managing inventory means get lots…not just enough
Attempting to establish an inventory service level for this industry is difficult due to its culture, expectations and belief systems. I cannot remember ever having a logical and mature discussion with an internal user when it came to establishing a service level, unless the value was 100 percent or higher.While supply chain professionals understand the staggering impact of investment cost to chase service levels beyond 98 percent, utility field personnel have been sensitized to “materials are just a cost of doing business...just get it” and “don’t let those guys in the warehouse give you any hassle either.”

It is not the field personnel that should be viewed as the source of the barrier as it is truly the responsibility of line leadership to ensure employees are aware of company policy and standards respecting materials in the organization. However, one must acknowledge the culture’s impact on field leadership who may not consider overall cost when making materials requests.

Mobile or Field Inventory “means never having to say you’re sorry…or return”
Once inventory leaves the warm comfort of the warehouse or distribution center, it is released to field employees that use fleet vehicles and, in some cases, small holding depots around key geographic areas. Curiously, once field personnel obtain their inventory, there is another cultural phenomenon that occurs in the utility sector. I usually refer to it as “possession without accountability.” Some utilities have stepped up to this phenomenon with success, but for the majority of utilities, field staff tends to accept inventory to their various locations but without accepting accountability for it.In many cases,this is due to an absence of control over these locations as separate warehouse codes.

This absence of control tends to perpetuate the “materials are just a cost of doing business” perspective as well as poor inventory accuracy and, as one would expect, poor replenishment performance.This helps to cultivate the perception that the Materials Management Group “never has what we need.”Finally, within this paradigm, typically characterized by this absence of controls and a packrat culture, there is usually a poor to nonexistent returns process. In some cases this absent process is due to a resistance to give anything back (especially since the Materials Management Group never have what we need….). Or, in many cases, because the excess stock is used for personal use or released to the black market.

Controls don’t apply to the Field Operations Group
Herein lies the ultimate conundrum, with the absence of supply chain controls, the user community exercises any and all liberties associated with materials available, resulting in supply chain anarchy. However, in the presence of supply chain controls,the user community will engage a number of tactics to justify its need for “total flexibility”at all cost.

The call for total flexibility is largely predicated on the “uniqueness” element noted earlier. But, by and large, our observations suggest that this “flexibility need” is not required to deal with emergency needs or customer-restoration type work. It pertains more to the need to step up and manage field employees effectively.

A lot of vendors has been a good thing
Long prior to utility companies becoming “investor-owned” or “reinvented” in the new horizons of utilities, they were essentially a municipal service provider with responsibilities to customers, employees, and community.
It was only recently that the word community was replaced with shareholder as the industry redefined itself and its owners.

Accordingly,“doing your thing for the community” was being an active and generous participant in the local economy you served. This responsibility often meant going out of one’s way to do business with the local economy as often as you could. As a result, many utilities have thousands of active vendors in their vendor databases and frequently engage them with purchase orders of amounts that are trivial in dollar value.

Warehouses and a lot of storage locations have been a good thing
This is directly related directly to the prior heading of “Inventory has been a good thing”and,like warehouses inventory, is an important part of utilities’ Rate of Return on the balance sheet.

For the most part, leased facilities were somewhat of an unheard of concept at utilities until the 1990s.The customer perspective was, “why lease a building? We’re not moving anywhere soon, and if we own it, its in rate base for return.”

Whether it involves a stand-alone distribution facility or the justification to build a larger regional office building, warehouses became a very useful tool not only to house inventories, but also as a means to contribute to earnings. Service for the public and maintaining safety of the system, were mantras that easily justified multiple warehouses.

On the surface, at some utilities, there has been progress. But at those utilities where they have reduced or “rationalized” their warehouse sites in the past few years, a curious effect has produced. While inventory levels dropped due to the site reductions, it was not the reduction anticipated. In fact,inventory has grown to reestablish itself to its pre-reduction levels.Analysis has shown that when warehouse sites are eliminated,the culture of the organization responds first by field personnel drawing a lot of stock and stashing it in unofficial locations.

SCM is not viewed as strategic or a core competency
The bottom line to these observations at utilities across the globe, is that in the majority of cases, the supply chain organization within utilities are still viewed as an “evil to contend with” instead of a “strategic peer” in the organization. In fairness to the function itself – what attention and support has it received?

In many organizations, instead of providing the focus and resources on a strong supply chain management organization, we often see “multiple supply chains” operating within the organization at the cost and spite of others.

The encouraging news is, however, that utilities are now beginning to act decisively in this area and they are obtaining the rich benefits of cost savings, inventory reductions, freed-up capital, productivity boosts and many more. Even the executive chambers are beginning to acknowledge the value of supply chain management with dedicated executive positions that respond on behalf of the whole organization.

In the ensuing series of articles on “The Uniqueness of Utilities and their Supply Chains,” you’ll learn how to transform this culture