Pacific Gas and Electric Prepares for Upcoming Deregulation

Case Type: industry analysis; competitive response.
Consulting Firm: Bain & Company final round full time job interview.
Industry Coverage: utilities; energy.

Case Interview Question #00766: The client is The Pacific Gas and Electric Company (NYSE: PCG), commonly known as PG&E. It is an investor-owned utility that provides natural gas and electricity to most of the northern two-thirds of California, from Bakersfield almost to the Oregon border. PG&E was founded in 1905 and is currently headquartered in the Pacific Gas & Electric Building in San Francisco.

Over the past several decades, many U.S. states have moved to deregulate their electric markets, with 24 states allowing for at least some competition among retail electric providers (REPs) including California, Texas, and New York.

The year is 2009. As a combination gas and electric utility (regulated monopoly), the client Pacific Gas and Electric Company was preparing for an upcoming change in the state regulatory environment when electric power generation would become a competitive business. A new VP of Marketing and Sales was put in place to prepare PG&E for the competitive marketplace. As part of a Bain case team retained by PG&E to advise the new VP of Marketing and Sales, how would you go about this case?

Additional Information: (to be provided to candidate upon request)

Composition of PG&E’s customer base:

Possible Answer:

Step 1: Identify the critical issues

Interviewer: “Given this information, where do you think the case team should focus?”

1. Good Initial Questions

Are the gas and electric businesses inter-related?
- Do they serve the same customers? (some overlap)
- Will the de-regulation of electric power generation impact the gas business? (no)
- What is the relative size of the electric power businesses? (electric = 80% of revenues and 85% of profits)

Is it therefore safe to assume that the composition of the overall customer base reflects the electric business as well? (yes)

Good Answer:

Given the size and the dynamics of the electric power market I will focus on that part of the business. With the emerging deregulation, the key marketing issue is customer retention.

Since the client will likely lose some customers with the upcoming deregulation (starting with a monopoly they only have one direction to move) the key question is which segments of customers the client should invest in retaining.

For extra credit articulate additional questions which drive to actions: what are their needs, how is the organization aligned to meet those needs today and what organizational and strategic changes should be made to improve the way we serve target segments.

Potential Pitfalls:

• Getting caught up in trying to understand dynamics of gas and electric businesses. a few simple questions can make it clear that the electric business is what matters.
• Digging into detailed regulatory issues.
• Not identifying retention as the critical issue.
• Trying to develop strategies to retain all customers rather than focusing on segments.

Step 2: Specify an analytic framework

Interviewer: “How would you determine on which segments the client should focus?”

Useful frameworks:

a. Customer segments should be ranked based on two criteria:
- Value: profitability of power generation to the client.
- Vulnerability: risk of losing the customers (segments) to competitors.

b. “Value” should be based on lifetime value of the customer segment. This incorporates the investment required to acquire the customers, their annual profitability, and the expected “life” of a customer.

c. Vulnerability would capture the likelihood of different segments of customers switching to competitive offerings once deregulation occurs.

d. Extra Credit Observation: there is likely to be some correlation between value and vulnerability as new entrants will probably attempt to target the highest value customer segments first.

Potential pitfalls:

• Trying to apply a “standard” framework to this fairly focused question–Keep it simple.
• Not considering all components of lifetime value (e.g., acquisition costs and lifetime) as that ranking can vary considerably from a ranking based on current margin.

Step 3: Prioritize/Develop Hypothesis

Interviewer: “What is your hypothesis of which segments are highest priority?”

Good hypothesis:

a. The first step would be to further segment the customer base. Specifically, I am most interested in understanding any sub-segments within major I&C customers (avgerage revenue of $300K) where needs probably vary dramatically by industry (i.e., government, retail, process industries, etc.) There are probably not major distinctions in the needs of residential customers by segment.

b. I would therefore hypothesize the following customer prioritization:

- Large Industrial customers should be the initial focus because they will be most valuable (high electric usage in one location for a long time translates into low acquisition costs, high margins and a long life) and the most vulnerable (easy to target and valuable to competitors).
- Large Commercial customers will rank second because large commercial customers (e.g., grocery chains) are heavy users but harder to serve because of multiple locations and higher turnover (high acquisition costs and shorter customer life).
- Small I&C and Residential customers are of lower value and are less vulnerable to competition because their usage is relatively low, they are more costly for a competitor to target and for most individuals, the electric bill is a relatively small expense so they will not go out of their way to seek an alternative provider.

Potential pitfalls:

• Failing to further segment customers misses a lot of the potential richness of the case.
• Digging into residential customer issues because that is what you understand best.
• Forgetting to consider the acquisition costs and customer life issues.
• Not clearly explaining any assumptions you are making.

Step 4: Structure/execute analysis

Interviewer: “What analysis would you have the case team perform to test your hypothesis?”

Good response:

a. Conduct customer research to further segment customers by needs and to assess the vulnerability of segments based on propensity to switch/loyalty behavior.

b. To prioritize segments the case team must first estimate each of the major elements of the value equation:

- Acquisition cost based on sales and marketing costs devoted to that segment (either tracked directly or estimated through interviews/surveys of sales and marketing depts.)
- Volume based on usage for that segment (or in the case of 1000 Major I&C customers can track actual historic usage by specific customers).
- Profitability margin based on usage patterns (peak loads, timing of peaks, etc.) developed in conjunction with technical and finance resources from the client.
- Customer life based on industry research regarding the typical life of that type of business.

c. To assess vulnerability utilize output of research and supplement with an assessment of the attractiveness of segments to likely new competitors (qualitative assessment).

d. Create a 2X2 matrix plotting segments based on value and vulnerability.

Potential pitfalls:

• Not being creative in places and ways to gather data and conduct analysis.
• Not attempting to get actual data or at least samples of actual data wherever possible and instead relying on assumptions for critical drivers of value.
• Not articulating framework for visually capturing output of analysis to articulate/demonstrate the answer.

Step 5: Drive to recommendations

Interviewer: “Based on your analysis, what should the client do?”

Good response:

Now that we have prioritized customer segments, the issue is how the client should apply sales, marketing and potentially technical resources differentially against the highest priority segments.

Definite recommended actions:

• Focus marketing activities against developing programs that meet critical needs identified in research (i.e., devices/programs to increase energy efficiency).
• Dedicate more sales/non-technical service support to highest priority segments (e.g., improved billing services).

Potential recommended actions (evaluate cost/benefit tradeoffs):

• Invest more to deliver higher technical service (less downtime) to highest priority segments.
• More backup generators/systems where high priority customers may be clustered (areas with a lot of process plants, for example).
• More technical personnel on duty to make repairs whenever system does go down.

Potential pitfalls:

• General/non-specific recommendations (e.g., improve service without describing how)
• Not distinguishing with actions you can definitely recommend now vs. actions that would require additional research because of the investment required.
• Being unrealistic in recommendations.

Keys to the Case:

The background slide to the case does not clearly state the issue to be addressed. You must decide where the leverage is without getting distracted by the existence of the gas business or delving into regulatory concerns.

There is really only one framework that works for this case and it is not a “standard” framework. The critical variables to prioritize customers are value and vulnerability (or risk of defection). A simple 2 X 2 matrix works best.

There are not a lot of numbers to use in this case but they can help you develop your hypothesis.

Be comprehensive and creative in the approach for analyzing the value of a customer. It is critical to consider the lifetime value vs. just the margin. A methodology can be created where you calculate actual inputs for most variables of the equation.

Driving recommendations to discussion on deploying actual sales, service and marketing resources is the point of the case. The prioritization is interesting but the question is what do you do once you understand how to prioritize.