Accountancy: Five steps to freedom and stability: The transformation of public utility to private company follows a difficult path. Roger Trapp reports

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FOR those involved, the privatisation of the gas, electricity and other utilities was probably enough of a shock. But, according to a new study, passing out of public ownership is only one step on the way to becoming a true commercial entity.

Arthur Andersen, the accountancy firm, has developed a common model for US and British utitilities transformed through deregulation. Its study looked at telecommunications, electricity and gas in the US and Britain, water in Britain, and railways and airlines in the US.

Central to 'Predictable Patterns: Navigating the Continuum from Protected Monopoly to Market Competition' is the idea that all such industries pass through five stages from one end of the spectrum to the other.

Stage one, 'Equilibrium', is what Lawrence Gilson and his staff at Venture Associates, Andersen's specialist utility consulting unit, call 'the state of regulatory innocence'. It is characterised by companies being vertically integrated and having their business strategy determined by regulatory policies. They cross-subsidise the markets in which they operate with the aim of providing an equitable and universal service. Customers are passive and generally content while engineers, regulatory lawyers and accountants assume leadership roles internally.

Then, some combination of technological change, the emergence of market substitutes, or changes in public policy leads to competitors emerging at the periphery of the industry - typically in areas where margins are high, markets attractive and underpricing easy. Once this occurs, the industry has entered stage two, 'Rumblings in the Provinces'.

The dominant mood is denial of any great change. Managers who warn of competitive threats are told that the economies of scale, barriers to entry and the like will preclude any serious erosion of the incumbents' position. But, with new competitive offerings, customers are beginning to be confused.

This stage is short-lived. Once these marginal incursions occur, the structure quickly crumbles. Once the high-margin customers are drawn away, the burden of cross-subsidy becomes greater, the number of vulnerable market areas grows and the appeal to would-be entrants increases. When all this changes the economics of the industry, stage three, 'Identity Crisis', has been reached.

Andersen describes this as 'a tumultuous stage which challenges all traditional assumptions about the industry'. Faced with large losses of customers, the incumbents respond by appealing to regulators and, when that fails, with

defensive price-cutting and aggressive cost reductions.

Incumbents and challengers may over-reach and miscalculate the situation. Bankruptcies, mergers and acquisitions are the order of the day, with the corporate culture shifting from the bureaucratic approach towards becoming 'lean and mean'. Regulatory lawyers assume greater importance, while hardheaded managers good at 'downsizing' come into their own. Customers and some of the more valued employees are unsettled. Concern about financial performance leads to investors becoming more involved in management.

When the survivors of this period begin to find ways of providing economic value in the competitive market, stage four, 'Refocus', has arrived. It is characterised by companies unbundling their services and products and segmenting their markets. Companies tend to move away from unrelated activities to concentrate their forces, and to invest in horizontal expansion and mergers that put them in a better position to serve customers. These customers start to develop loyalty to a collection of services but not to any particular providers. The concern for simple cost reduction gives way to a push for customer-driven growth and efficient use of resources. People with marketing and financial management experience become more prominent.

The final stage is 'Dynamic Competition'. This is a point of equilibrium, 'not because it is quiet but because it represents the full adjustment of the industry to a competitive marketplace'.

The company's success depends on how it adapts to supply and demand. It focuses on creating economic value by matching its capabilities to customer needs, with distinctions between challengers and incumbents no longer appropriate. Indeed, the challenges facing the managers are much the same as those executives face in any commercial undertaking, except they have the added problem of not generally having grown up in this sort of environment.

In addition, these formerly stolid organisations - particularly those in telecommunications - are operating in fast-evolving markets. In the US, for example, AT&T has seen its market share slip from 90 per cent to 60 per cent. But, says Mr Gilson, it has 60 per cent of a larger market, and the 60 per cent is the 60 per cent it wants.

In Britain's electricity industry, the opportunities are different. Both National Power, one of the generators, and Yorkshire Electricity, one of the regional electricity companies, want to be international companies because they want to grow.

Graham Walker, a partner with Andersen, believes there is potential for the export of the expertise associated with the transition from regulatory system to competitive market. 'If Britain could lead the world and be known like Japan is for manufacturing, that's a pretty powerful export base,' he says. But for now, he admits, no privatised companies have reached stage five. Most are stuck in two and three - all of which is good for Andersen.

Not having been involved in any of the privatisations, it is playing what Mr Gilson calls a 'sweeping-up' role, and reports great interest in the analysis from companies trying to find 'a way through uncertain and choppy waters'.

(Photograph omitted)