MidAmerican Energy Company to Keep Their Coal Mines

Case Type: improve profitability.
Consulting Firm: Roland Berger Strategy Consultants first round full time job interview.
Industry Coverage: energy industry; utilities.

Case Interview Question #00969: Our client MidAmerican Energy Company (MEC) is an electricity company based in Des Moines, Iowa. Its service area includes almost two-thirds of Iowa, as well as portions of Illinois, South Dakota, and Nebraska. Here are a few concepts about electricity generation that will help you through this case.

There are several ways to produce electricity:
* Water
* Coal fired power plants
* Nuclear
* Wind

These are some other facts about the electricity industry in US:

* Electricity can be supplied to a wholesaler or to consumers directly.
* Electricity transmission is highly regulated (because the wires used to transport electricity are mostly government controlled). However, electricity usage is mostly deregulated, i.e. the government does not set the price. Instead, the price is set by competitive forces.

Our client MEC has 10 plants that produce electricity using coal. The client obtains coal partly from their own coal mines and partly from 3rd party coal providers. Off late, the client has seen the profitability from their coal generated electricity decline. What could be causing this?

Possible Answer:

1. Suggested Framework

The candidate should take some time to summarize the issue and to process the above information. The appropriate framework to address this issue is the profitability framework:

Profits = Revenue — Cost = (Volume * Price) — (Fixed cost + Variable Cost)

2. Gathering Information

As the candidate goes through the various parts of the above profitability framework, share the following information. Wait for the candidate to ask for this, but share the information even if the candidate does not explicitly ask.

a. Volume

* MEC supplies electricity to over a million customers (a customer is a household or a business) in deregulated markets through wholesalers.
* Volume is generated by demand. The market is fragmented and MEC supplies electricity through wholesalers.
* The market is growing at about 3% per annum.

b. Price

* This is a deregulated industry. Price is set by competitive forces.
* There is one constant price that applies throughout the year (i.e. no peak pricing, etc.)
* As a simplification, consider that the some price is charged to all customers, be they residential or industrial.

Good candidates will deduce that since the market sets the price and this is a mature industry, currently the supply meets all the demands, i.e. there is not much opportunity in terms of volume and price.

c. Fixed Cost

* The client MEC runs 10 plants around the US.
* MEC pays a fixed cost to lease transmission lines to transmit the electricity produced.

d. Variable Cost

* As a simplification, consider the main raw material to be coal.

3. Detailed Analysis

The candidate should consider looking deeper into the cost side (because it was already deduced that there aren’t any opportunities in the revenue side).

Interviewer: Let’s explore the cost side in more detail. A simplified supply chain for electricity consists of 3 parts:

Acquiring the coal –> Generating the electricity –> Transmitting the electricity

What potential issues may lie in each of the above 3 parts?

Allow the candidate to brainstorm at least 3 potential issues for each of the above issues. Prompt the candidate to brainstorm more by persistently asking “What else?” after each response till the candidate provides at least 3 issues for each part of the supply chain.

Note that this case is about brainstorming and generating ideas and not about numbers.

Here are some possible responses that candidates may provide:

I. Acquiring the coal

* The coal may have to be transported across some distance. This could be done through rail or road. There are potential savings here in optimizing the transport channel.
* The coal is received from several sources: MEC’s own coal mines and 3rd party mines. The quality of coal (its energy content) is likely to be different in different mines. Hence, processing different type of coal probably takes different processes and machines. This diversity could be a potential cost generator and this could be handled by sourcing for more similar coal varieties.
* The coal mines could be in a geographically separate region, subjecting MEC’s coal supply to other regions’ risks (e.g., climatic factors such as hurricanes, political turmoil, etc.)
* The coal mines are probably unionized, and that may add to volatility in our coal supply.

II. Generating the electricity

* The electricity generators may be old and not functioning as efficiently, inducing waste in the system.
* There are 10 different plants in the client’s company. Differences in operations of these plants may induce volatility in the system.
* The availability of labor may have changed by the arrival of other industry or competitors in our plants’ vicinity.
* Given that MEC generates electricity through coal, some new environmental laws may have come into force increasing the cost of electricity generation.

III. Transmitting the electricity

* Transmission could be streamlined by finding more customers closer to the electricity plants themselves.
* MEC could look into a bandwidth sharing contract so that their lease may be cheaper.
* MEC can look into checking the transmission lines for repairs etc that may be required so that there is less electricity loss in transmission.

Interviewer: MEC is primarily an electricity generating company. Do you think they should keep the coal mine?

Additional Information:

Here is some information that can be shared with the candidate if the candidate asks for it.

* MEC gets coal at 30% cheaper rates when it gets coal from its own coal mines as compared to 3rd party coal mines.
* There is a large market for coal. Coal customers are diverse, electricity producers are just one of many. As a simplification, assume that all coal customers pay the same market price for coal when they purchase coal from coal mines.

With the above info, candidates may be tempted to deduce that MEC should keep the coal mine because they get coal cheaper from their own coal mine. If candidates say this, remind them that:

Interviewer: Yes, MEC is getting coal cheaper from their coal mines. But they can also sell the same coal to other customers and make the same profit. So what is the advantage of using the coal for their electricity generation operation?

Potential responses are:

* Having their own coal mine reduces supplier power for MEC. MEC’s electricity generation operations have the advantage of encountering lesser volatility in the supply of their core raw material, coal. MEC can control the coal production and can hence have lesser volatility in coal quality and labor issues.
* MEC’s business is more diversified through the coal mining operation.

Interviewer: On an average, MEC operates at 80% utilization. MEC’s CEO saw this statistic and asked your consulting team if he should look into increasing the utilization from 80% to 90%. How would you approach this problem? By the way, the industry average is to operate at 77% utilization.

Tell the candidate that the demand for electricity is cyclical. Ask the candidate what that might imply.

Possible response:

Candidates should point out that that means there are peaks and troughs in electricity demand (e.g., air conditioners working over time during summer). As an electricity company, MEC is committed to meet the peak demand and so, it is normal to operate at less than 100% utilization. MEC is already operating at close to the industry average and it may be unrealistic to expect the utilization to increase to 90%.

4. Recommendation

Interviewer: The CEO of MEC would like to hear a summary of our analysis. Please provide a final recommendation.

Possible response:

Good candidates will take a minute or two to gather their thoughts. The initial question was about what might be causing the decline in profitability of coal generated electricity. Candidates should be able to point out that this is a cost issue. Specifically, candidates should talk briefly about the supply chain analysis, showing potential issues and cost saving opportunities. Candidates should also recommend continuing the use of MEC’s own coal mine and ignoring pressure to increase utilization to 90%.