Powerful changes
Company A EG A in the liberalising electricity markets of an expanding European Union
Thijs Slot
Powerful changes
Company A EG A in the liberalising electricity markets of an expanding European Union
Author: Thijs Slot
Student number: 1074954 University of Groningen
Faculty of Management & organisation Specialisation: International Business
Tutors at the University of Groningen: Dr. E. O. De Brock/ Mr. W. W. Wijnbeek
Organisation: Company A EG A
Tutor at Company A: Mr. Henk De Vries
The author is responsible for the contents of this report; the copyrights of the report are held by the author.
Cover: an unknown fossil power plant, photographer: unknown
Preface
This report was written as a final stage in my study Management & Organisation at the University of Groningen, the Netherlands. It is intended to offer an insight into the
‘Powerful changes’ influencing the electricity markets, and especially the fossil power generators, throughout the European Union. These changes have an impact upon the competitive forces that determine the profit potential for Company A EG A and its competitors. The fact that the European Union is expanding step by step, increases the area that is subject to these changes. Being faced with these changes, Company A EG A, as one of the five large suppliers of Instrumentation & Control systems for fossil power plants in the European Union, could make adjustments in their organisation to create a better fit with their changing environment, and thereby increase their potential for earning above average returns.
I would like to thank a few people that have played an important role during the process of writing this report. Besides all the people at Company A EG A in Brussel, I would like to thank some of them more specifically. First of all, mister Johannes Jansen, director of EG A12, who offered me the chance of performing this research for him and who has helped me with his feedback based on his overall knowledge of the issues that are discussed in this report. Furthermore, I owe a lot of gratitude to misters Höllig and De Vries. I performed more than half of my research from the department that is headed by Harald Höllig. During this period of about four months, he was constantly prepared to help me and discuss issues that were unclear to me, or about which I had certain thoughts. These discussions have helped me a lot in developing ideas for this report. Henk De Vries has over thirty years of experience in working for Company A. He was my coach within EG A and he guided me and showed me how to take the right paths for finding a lot of the information used, based upon his years of experience and his contacts within the company.
In addition, there were three other people that were crucial to the writing of this report. Misters de Brock and Wijnbeek have both provided me with valuable feedback from a scientific point of view. These feedback discussions have helped me a lot in setting up structure for this report and discussing some of the issues from an
‘outsiders’ point of view, not bothered by certain mindsets or company cultural influences. Last, but not least, I thank Ruud Willemsen. As manager engineering of NUON, a Dutch power generator, he has been involved in buying decisions surrounding AUTOMATION systems for quite some time and could therefore provide me with very important insights considering the AUTOMATION systems suppliers from a customer’s point of view. In the past, he performed a similar role for UNA and Reliant1. From this background, he was also able to point out important differences for power generating companies between the periods before and after liberalisation.
Thijs Slot
1 UNA and Reliant are both former power generators in the Netherlands, Reliant took over UNA during liberalisation of the Dutch market, but sold its Dutch assets to NUON shortly after
Contents
Page Management summary
Introduction………..……….. 1
Competitors and product 1
Customers 1
Research objective 2
Research question 2
Sub-questions 2
Method……..………. 4
Conceptual model for the research 6
Part 1 – Current situation
The industry and competitor environment
7 Chapter 1 - The Industry environment………...81.1 Industry definition 8
1.2 Tender regulations 11
1.3 Structural analysis of the Industry 12
1.3.1 Threat of entry 13
1.3.2 The threat of substitute products 16
1.3.3 Bargaining power of suppliers 16
1.3.4 Bargaining power of buyers 18
1.3.5 Intensity of rivalry among existing competitors 22
Chapter 2 - The Competitor environment………. 24
2.1 Generic strategies 24
2.2 Strategic mapping of the competitors 27
2.3 Future intentions 30
Concluding the analysis of the current situation 33
Part 2 – Changes
Changes in the general environment and their impact
upon the industry environment
35Chapter 3 - Introduction to the changes in the general environment ………36
Chapter 4 - The political/ legal segment………38
4.1 The Common rules 38
4.1.1 Objectives 38
4.2 The ‘electricity flow chart’ 40
4.3 Implications for end consumers 42
Page
4.4 Implications for the networks 43
4.4.1 Unbundling 43
4.4.2 Interconnections 44
4.5 Implications for power generating companies 46
4.5.1 Unbundling 46
4.5.2 Competition 47
4.5.3 Market concentration 49
4.5.4 Privatisation as a consequence of liberalisation 51
4.6 The Emissions trading scheme 51
4.7 Different Energy agendas 52
Chapter 5 - The remaining segments………54 5.1 The technological segment - Future of fossil power plants 54 5.2 The technological segment - Power exchanges 55
5.3 The economic segment 56
5.4 The global segment 58
5.5 The demographic segment 59
Chapter 6 - Emerging regional electricity markets within the EU………..60
6.1 The different regional markets 61
6.2 Different developments in the different regions 62 Concluding the analysis of the changes in the industry’s general environment 65
Part 3 – Opportunities and threats
Identifying the opportunities and threats
67 Chapter 7 - Impacts of the changes upon the industry environment………68 7.1 The political/ legal segment - the common rules 68 7.2 Power generators/suppliers and end consumers 697.2.1 How about the recent black-outs on newly
liberalised markets? 71
7.3 Unbundling of power generators/suppliers and the networks 73
7.4 Market concentration 73
7.4.1 Low market concentration levels – more competition among
power generators 75
7.4.2 High market concentration levels – fewer competition among
power generators 75
7.4.3 Large power generators that drive market concentration
ahead 75
7.5 Changes in buying behaviour as a consequence of privatisation 76
Page
7.5.1 Three different types of efficiency gains in purchasing 76 7.5.2 The findings in British power generators 78
7.6 Centralisation of buying decisions and changing purchasing
preferences 79
7.7 Centralisation of buying decisions across different regions 80
` 7.7.1 Frost & Sullivan research and findings 80 7.7.2 EG A’s practical experience with centralisation 81
7.7.3 Linking these findings with the three phases of
efficiency gains in purchasing 82 7.7.4 What about the other regions/ companies? 82
7.8 Impacts of these changes in buying behaviour upon the industry 83 7.9 The political /legal segment – emissions trading scheme 83 7.10 The political /legal segment – energy agendas 84 7.11 The technological segment - Future of fossil power plants 84 7.12 The technological segment - Power exchanges 84
7.13 The economic segment 85
7.14 The global segment 86
7.15 The demographic segment 86
7.16 The sociocultural segment 87
Chapter 8 - Threats and opportunities………...88
8.1 Changes in buyer power 88
8.1.1 Changing focus of large power generators 89
8.2 Changes in the threat of new entrants 90
8.3 The sociocultural segment – emerging regional markets 90 Concluding ‘Identifying the opportunities and threats’ 91
Part 4 – Future
EG A’s future intentions and suggestions for further adaptation
94 Chapter 9 - Company A EG A’s future intentions and their fit withidentified changes……… 95
9.1 Strategic intentions 95
9.1.1 Tools = improved solutions 95
9.2 Fit with the changing Industry environment 97 Chapter 10 - Suggestions for further adaptation……….99
Final conclusions
102Page
Reflections on the research and report
105Appendices
107Appendix 1 107
1.1 - Organisational structure of Company A AG 107 1.2 - Operations - The operational groups of Company A AG 108 1.3 - Organisational structure of Company A Electricity generation 109 1.4 - Structure of L: Instrumentation and Controls;
Electricity generation 110
1.5 - Structure of L1, New plants and Modernisation, Fossil Power Plants; Instrumentation and Controls 111
1.6 - Structure of L12 and L13 112
Appendix 2 AUTOMATION systems/ equipment for power plants 113 Appendix 3 Porter’s model of five forces that drive industry competition 114
Appendix 4 The unbundling regime 115
Appendix 5 Implementation of the Electricity Directive 116 Appendix 6 The dominant generation companies per region/ country 117 Appendix 7 ‘Comprehensive solutions for cost-optimised plant
operation’- Electricity generation management 118 Appendix 8 Labour productivity growth in the utility sector between
1979 and 2001 119
Appendix 9 Breakdown of the interviews for the Frost & Sullivan study 120
References
121Interviews
124E-mails
125Internet resources
126Management summary
In the external environment of the industry of ‘AUTOMATION system suppliers to fossil power plants owned by power generating companies in the European Union’, a lot of significant changes are taking place. The aim of this report is to identify these changes and their resulting impacts upon the industry environment, up to around 2012. Out of the impact that these changes have on the industry environment, it should eventually be possible to identify opportunities and threats for the industry competitors.
The analysis of Company A EG A’s external environment has its foundations in the Industrial organisation (I/O) model, which explains the dominant influence of the external environment on firms’ strategic actions. The external environment can be split up into three different environments, which are the general, the industry and the competitor environment.
These analyses started off with an analysis of the current state of the industry and the competitor environment. It proved to be difficult to address the future intentions in this industry of all the competitors. From Competitor C, there was no information at all to be found, that considered this industry. The available information on Competitor D was very scarce and only gives indications of the company focussing upon particular(?) customers in the EU.
The next step was to address the changes that are taking place in the six segments – political/ legal, technological, economic, demographic, global and sociocultural – of the external environment. These changes especially involve the consequences of the implementation of the common rules throughout the EU, in the political/ legal segment of the external environment. Other important changes are a greater focus upon reductions of the exhaust of greenhouse gasses, the emergence of power exchanges, and the growth in generation capacity in response to a rising electricity demand across the EU, which will be largely fulfilled by an increase in ‘cleaner’ fossil generation capacity, because of the fact that other technologies are likely to remain much more expensive up to 2012.
The impacts of these changes upon the five competitive forces that make up the industry environment are the focus of chapter 7. Out of these impacts and consequent changes in the industry environment, several opportunities and threats for the industry competitors – among which Company A EG A – could be identified:
• Due to the implementation of the common rules and the implications of this for power generating companies, changes in buyer power of the industry’s customers, are imminent. Part of these changes result in decreases in buyer power (chances) and others in increases (threats).
• Due to privatisation of power generating companies and the competitive goals to which they have to adhere after the liberalisation of their country markets, the potential efficiency improvements that can be reached with more modern AUTOMATION systems, tools that can be linked to AUTOMATION systems to establish a smoothly running coordination between emissions trading markets, power exchanges and the power generator’s operations, and increasing fuel
efficiency and consequent fuel savings that can be established through the use of more modern AUTOMATION systems, the factor ‘importance of the industry’s product for the buyer’s operations’ is likely to increase. This will result in a reduction of buyer power, which increases the profit potential for the industry competitors and are therefore labelled as opportunities.
• Market concentration among power generators and centralisation of purchasing decisions in their organisations, are likely to result in an increase of the factor ‘buyer purchases relatively large proportions of seller’s sales’. This is because companies that own a larger part of the total generation capacity on a particular (country-) market and that have installed a centralised purchasing department in search of efficiency gains after privatisation, are likely to be responsible for a large number of orders that consider multiple power plants. This is contrary to the situation prior to privatisation in which predominantly engineering personnel of the individual power plants were responsible for purchasing decisions. This is likely to result in increases in buyer power, consequent reductions in profit potentials for the industry competitors, and thus these changes can be labelled as threats. This shows that expected changes in buyer power entail both opportunities and threats.
The extent of these opportunities and threats may vary in relation to the amount of market concentration and in relation to the assessed regional markets, which are expected to emerge throughout the following years.
• Expected growths in demand for electricity and thus in generation capacity across the EU, and increasing demand for modern ‘cleaner’ fossil power plants, are an opportunity for the industry, in the sense that the demand for (more modern) AUTOMATION systems for fossil power plants will increase. At the same time however, entry barriers will be reduced, due to an increasing attractiveness of the industry. This will increase the threat of new entrants.
This threat will also vary in line with the development of competition across regions and its consequences for the amount of company cultures with which the industry competitors have to deal on the emerging regional markets.
Successful development of competition, and consequently more different company cultures and complexity to cope with, could reduce the threat of new entrants and therefore enlarge the opportunities for an industry competitor that knows how to deal with increasing complexity in this industry.
The future intentions of EG A (becoming more of a ‘solutions provider’ aided by newly developed tools, such as Tool 1 and Tool 2) seem to fit the changing conditions in its industry environment quite well. However, without more information on future intentions of competitors, one can not determine the (potential) success that can be achieved with these intentions.
In response to the identified threats and opportunities, I have given some suggestions as to what Company A EG A might do in the light of the identified threats and opportunities. On a strategic level, EG A (as well as other EG parts), should present themselves more as being one. This could reduce the impact of increasing buyer power, that results from an increasing factor ‘buyer purchases relatively large proportions of seller’s sales’. Presenting yourself as a larger entity may convince the buyer of the fact that you are not solely dependent upon him for buying your product.
This may result in the fact that the buyer gets the perception of having less power as opposed to the seller. A more integrated approach of the customer, under the name Company A or Company A Electricity generation, also means offering counterweight against, and maybe even discouraging potential new entrants.
On the middle management/ tactical level, EG A should try to appoint account managers in combination with other Company A (EG) parts that function as a central spokesperson for Company A EG, based upon his/ her know-how regarding a wide range of power plant processes (he or she knows which Company A departments/
products are required to fulfil the customer’s desires), and close customer contacts.
Such account managers could become a point of initial contact for EG A on a particular country market. But, EG A (in combination with other EG parts) could also consider creating such functions for particular large power generating companies that are centralising their decisions considering orders across multiple country markets.
On an operational level, EG A must ensure that new AUTOMATION systems offer their power generating customers increasing levels of efficiency improvements and cost reductions. One way of doing this is by offering tools with their AUTOMATION systems, for the coupling and coordination between emissions trading markets, power exchanges and operations on customer’s power plants. Identifying and monitoring purchasing preferences of power generating companies and developments (e.g. of market concentration) on regional markets will enable EG A to asses what companies and regional markets are attractive from their point of view, what companies or markets may become attractive in the future, and which will not.
My final suggestion concerns the instalment of something like a central database in which changes in the general, and – especially - the competitor environment are registered. This information will be required to be able to develop a deep understanding of what is happening in a company’s external environment. This is crucial to the development of industry foresight, which may allow EG A to “get to the future first and stake out a leadership position”.
Introduction
With the forming of an internal market for electricity in the European Union (in the following: EU), the related liberalisation of its country markets for electricity and the further expansion of the EU with ten new countries, a lot of radical changes in the European electricity markets are imminent.
As a part of the operating Group Company A Electricity generation (EG), the division Automation (in the following: EG A2) is faced with these changes and their accompanying challenges.
Competitors and product
Company A EG A is one of five big competitors - Company A EG A, COMPETITOR A, Competitor D, Foxboro/ Invensys and Competitor B - that provide instrumentation and controls services and products (in the following: AUTOMATION systems) to power generating companies in Europe.
Instrumentation & Control systems in this report, consist of a (company specific-) automation system (the control system), together with the required instrumentation that allows the control system to be effective. This required instrumentation consists of things like pressure-, temperature- and flow meters. EG A develops and supplies the control systems themselves, the instrumentation is supplied by Company A Supplier B(A&D) and companies like Supplier A. If needed – to optimise/ modernise processes – EG A also includes somewhat larger equipment, like for example electrical systems, transformers, pumps, boiler parts, or additional IT systems for electricity generation management. This other equipment - called field equipment – is bought from related company parts within Company A EG or from other suppliers, such as Company A A&D3.
Customers
These AUTOMATION systems are used for building new or modernising old power plants. In this report the focus will be on this building new, or modernisation of already existing power plants for power generating companies. Power generating companies are often diversified into more energy sources, such as gas or water distribution next to electricity generation and supply. The overall term for such companies is ‘multi utility’. In this report however, the term power generating companies relates to the electricity generation activities of these companies, only.
These power generating companies often sell their power to end consumers as well.
This is then referred to as ‘supply’. Because of the supply function that a lot of generation companies fulfil as well, the supply function will be mentioned next to the generation function a number of times. This will predominantly be the case when the relation between end-consumers and generation companies is discussed.
EG A performs orders regarding AUTOMATION systems for communal works, and so-called Independent Power Producers (IPPs) as well. These clients however, are
2 EG A stands for Electricity generation Leittechnik. Leittechnik is German for Instrumentation and control systems
3 See appendices 1.1 to 1.6 for the precise structure of the entire company Company A and the division into operational groups, that are split up into twelve independently operating organisations
not the focus of this research. Next to this, this research only concerns fossil power plants, which means: power plants that generate power by burning fossil fuels. Fossil fuels in this respect are coal4, oil or gas. This means that waste-burning installations, nuclear, water (hydro-) powered or renewable energy sources also fall outside the definition of the power plants that are subject to this research. In spite of the fact that a power generating company may use a variety of fuels (for example nuclear and hydropower next to fossil generation) for the generation of electricity, the term ‘fossil power generating companies’, which is used a number of times in this report, refers solely to the fossil generation activities of these companies. Throughout the report, fossil power plants are also referred to as thermal, or conventional thermal power plants.
Research objective
The liberalisation of the EU’s electricity markets and the forming of an internal market poses the companies supplying these AUTOMATION systems with a large number of important changes. These changes will result in a number of threats and opportunities for all the companies in this business. The emerging opportunities and threats, due to changes in the external environment of the industry in which Company A EG A operates, will be the focus of my research. The timeframe of this report will consider the short- to middle term future, which means up to about 2012. This results in the following research question:
Research question
What opportunities and threats emerge for Company A EG A, and the other AUTOMATION system suppliers to fossil power plants in the EU, due to the changes in this industry’s external environment up to 2012?
Sub-questions
Out of the following sub-questions, the first three questions relate to the different parts of Company A EG A’s external environment that are addressed throughout this report. These parts of the external environment are:
• the Industry environment (related sub-question number 1 is answered in chapter 1)
• the Competitor environment (related sub-question number 2 is answered in chapter 2)
• the General environment (related sub-question number 3 is answered in part 2, throughout the chapters 3 to 6)
These environments and the relationships between them, as well as the further build- up of this report, are presented under the heading ‘Method’ after this introduction of the sub-questions.
The fourth sub-question (addressed in chapter 7) refers to the impact of the changes in the general environment, upon the industry environment. Consequently, the fifth sub-question (answered in chapter 8) addresses the opportunities and threats that evolve out of this impact. Sub-question number 6 relates to the fit between Company A EG A’s intended future direction and the signalled changes in the industry
4 On http://www.tva.gov/power/fossil.htm, you can read about and see an illustration of how a coal- fired power plant works. You can get to the illustration by clicking on the link ‘Coal-Fired Power Plant Diagram’
environment. This last sub-question will be answered in chapter 9. The sub-questions are presented here:
1. What is the current state of Company A EG A’s industry environment?
2. How do the different competitors in this industry stand in relation to each other and how will they change their behaviour in the future?
3. What changes in the industry’s general environment?
4. How do the changes in the industry’s general environment impact upon the industry environment?
5. What opportunities and threats emerge as a consequence of the signalled changes in the industry environment?
6. How well do EG A’s intended strategy and products fit the signalled changes in EG A’s industry environment?
Finally, in chapter 10, I will present some suggestions on how EG A could adapt to the varying threats and opportunities.
Method
This report presents an analysis of Company A EG A’s external environment. The foundations for the external analysis come from the Industrial organisation (I/O) model5, which explains the dominant influence of the external environment on firms’
strategic actions. This model specifies that the industry in which a firm chooses to compete has a stronger influence on the firm’s performance than do the choices managers make inside their organisations6. The external environment can be split up into three different environments, which are the general, the industry and the competitor environment7:
1. The general environment is composed of elements in the broader society that influence an industry and the firms within it
2. The industry environment is the set of factors – the threat of new entrants, suppliers, buyers, product substitutes and the intensity of rivalry among competitors (Porter’s five forces for industry analysis8) – that directly influences a company and its competitive actions and responses
3. Competitor analysis focuses on each company against whom a firm competes directly
By studying the external environment, firms identify what they might choose to do9 in the face of certain changes in their external environment. The different elements of this external analysis and the relationships between these factors are illustrated in figure 1 on the next page.
I have chosen to start with a description of the current situation of the industry environment. This also functions as an introduction to the industry and the forces that play a role in this industry, in which Company A EG A operates. After this, we will take a deeper look into the industry by addressing EG A and its competitors in the analysis of the competitor environment. The general environment is where the changes take place, which are among the major reasons for the performance of this research, such as the implementation of the common rules for the internal electricity market.
After these changes have been addressed, I can asses their impact upon the industry environment and where there are opportunities and threats for industry competitors and thus for EG A as well. By combining the identified threats and opportunities with EG A’s future intentions, it will be possible to say something about how these future intentions fit the identified opportunities and threats. From this, I will
5 Hoskisson, R. E., Hitt, M. A., Wan, W. P. and Yiu, D., 1999, Swings of a pendulum: Theory and research in strategic management, Journal of Management, 25: 417-456
6 Schendel, D. ,1994, Introduction to competitive organizational behavior: Toward an organizationally- based theory of competitive advantage, Strategic Management Journal, 15 (Special Winter Issue): 2
7 Hitt, Michael A., Ireland, Duane R., Hoskisson, Robert E., 2001; Strategic Management:
Competitiveness and globalization (Concepts), Edition 4, South-Western College Publishing, Cincinnati, Ohio (in the following: Hitt, et al., 2001)
8 Porter, Michael E., 1998, ‘Competitive Strategy – techniques for analyzing industries and competitors’, New York, USA, The Free Press (in the following: Porter, 1998)
9 Hitt, et al., 2001
come to a number of suggestions considering what Company A EG A might choose to do in the face of the signalled changes.
This ‘Method’ is illustrated by figure 2: the conceptual model for the research, which is presented on the next page.
Figure 1: The external environment10
10 Adopted from: Hitt, et al., 2001
Competitor environment Industry environment
• Threat of new entrants
• Threat of substitutes
• Supplier power
• Buyer power
• Rivalry among industry competitors
Demographic
Sociocultural Technological Political/ legal
Economic Global
Figure 2: Conceptual model for the research Industry environment
• Threat of new entrants
• Threat of substitutes
• Supplier power
• Buyer power
• Rivalry among industry competitors
(Chapter 1)
Competitor environment
(Chapter 2)
Competitor’s future intentions
(Chapter 2) Changes in the general
environment
- political/legal, technological, economic, demographic, global
and sociocultural segment - (Chapters 3/4/5/6)
Impact upon the industry environment
(Chapter 7)
Changes in the industry environment
(Chapter 7)
Threats and opportunities for industry competitors
(Chapter 8)
Suggestions for Company A EG A
- on operational, tactical and strategic
level - (Chapter 10) EG A’s fit with
its changing environment (Chapter 9)
Part 1 – Current situation
The industry and competitor environment
I will start by presenting the analysis of the industry environment, which shows us the current state of competition between the AUTOMATION system suppliers that operate throughout the EU, and the competitive forces that determine the amount of competition between them. After this - in the analysis of the competitor environment -
I will present the information about competitors that I was able to gather, and the scarce information on the future intentions of these competitors.
Chapter 1
The Industry environment
The industry environment is the set of factors – the threat of new entrants, suppliers, buyers, product substitutes and the intensity of rivalry among competitors – that directly influences a company and its competitive actions.
This first chapter deals with the companies that supply AUTOMATION systems for new fossil power plants or the modernisation of already existing ones throughout the EU. The industry environment – as part of EG A’s external environment - of this group of companies is the focus of this chapter. The picture of the industry that is painted in this chapter is a picture of the current situation (2005). The expected changes in the industry environment will be addressed after the changes in the competitor and general environments have been described. The resulting sub- question, which will be answered in this chapter, is:
What is the current state of Company A EG A’s industry environment?
How this question is answered will be clarified here. First, I will start by defining the industry of ‘AUTOMATION system suppliers to fossil power plants owned (now, or in the short to middle term future) by power generating companies in the European Union’, in paragraph 1.1. This industry definition is needed because it shows us which companies and products and/ or services are inside and which are outside the boundaries of the industry. In the following, to avoid needless repetition, the term
‘product’ rather than ‘product and/ or service’ will be used to refer to the output of the industry.
After a short discussion of Tender regulations, to which the companies in the industry are subject in almost every transaction with large power generators (dependent upon the price of the order) in paragraph 1.2, a ‘structural analysis of the industry’ is presented in paragraph 1.3. This analysis entails a discussion of five forces that influence the competition within an industry. It describes the impact of these forces, which are closely related to the industry (buyer- and supplier power, threat of potential entrants and substitute products and the rivalry between competitors)
The frameworks for studying the current state of the industry as a whole in the
‘structural analysis of the industry’ and the differences between the industry competitors in the analysis of ‘the competitor environment’ (chapter 2) are provided by Michael Porters theory of ‘Competitive Strategy’, presented in his book with the same name.
1.1 Industry definition
“Any definition of an industry is essentially a choice of where to draw the line between established competitors and substitute products, between existing firms and potential entrants, and between existing firms and suppliers and buyers. Drawing these lines is inherently a matter of degree that has little to do with the choice of strategy”11
11 Porter, 1998, page 32
The lines discussed in this citation from Porter, surrounding the formulation of an industry definition, are drawn in this paragraph. This process will be based upon the wide array of products that EG A and its competitors supply to their customers who want to build or modernise a fossil power plant in the European Union.
As mentioned in the introduction, this research considers the companies that supply AUTOMATION systems for new fossil power plants or the modernisation of already existing ones throughout the European Union. Here, the first boundary is drawn, that helps define the industry. This means that other supplying companies (e.g. the ones that provide turbines, generators, and so on) are left out of this discussion, and fall outside the boundaries of the industry that is the focus of this report.
Appendix 2 illustrates some of the products that these AUTOMATION system suppliers use to serve the needs of fossil power plants. Although only COMPETITOR As product package is shown in this figure, it gives an indication of the systems and equipment that the five big AUTOMATION system suppliers offer to their customers.
What fails in the picture are the different services that play an important role in the contracts between customers and suppliers and in the business of ‘providing AUTOMATION systems solutions’ (see figure 3, below), at least from a EG A point of view.
EG A is faced with five broad types of orders (also referred to as: Contract Cases) regarding all kinds of power plants. Since this report only considers fossil power plants, this is the second boundary that is drawn regarding the industry definition.
The fact that fossil power plants are the only power plants that are looked at in this report does not change the types of contract cases that EG A serves. They are faced with roughly the same array of orders for each kind of power plant, and thus for fossil plants as well. The third boundary that is drawn is that the companies have to be active throughout the EU to be part of this industry.
The different ‘contract cases’ that EG A serves range from entire ‘customer solutions’
(in German: Lösungsgeschäft) for modernisation and building of new plants to the delivery and implementation of standardised AUTOMATION systems, according to precise customer requirements (in German: Systemgeschäft). These different cases range from C0 to C4 (C stands for ‘Contract Case’). They are described in figure 3, below. This figure shows the different customer orders that may occur regarding AUTOMATION systems. The customer requirements differ - in line with the differences between the contract cases - from providing the customer with only AUTOMATION systems according to specifications by the customers (C3 and C4 in figure 3) to providing ‘AUTOMATION systems solutions’ (C0, C1 and C2).
Providing solutions starts with the creation of a plan regarding the required AUTOMATION systems and additional equipment, based upon rather general customer requirements, such as “We want to reduce our personnel and overall costs”, up to implementations including the required equipment, such as flow meters and cables, and the proofing of whether the finalised system fits the initial demands that caused the customer to look for the solution. This process (‘Solutions providing’) may involve other issues concerning the processes on the plant as well. An example could be the signalling of problems regarding the generator (if the customer has not yet recognised this himself), that is spotted during a site survey of the power plant in a C0 Contract Case, and which may hinder the full ‘customer problem solving’
through a new or revised AUTOMATION system only. EG A is able to signal and solve such problems additionally, because of the close contacts between all the different Company A Electricity generation divisions12, and the widespread know-how about all the processes in a fossil power plant, which is present in the minds of Electricity generations employees, including those of EG A.
In the C3 and C4 contract cases, customers are much less interested in the ‘solutions providing’ capabilities of an AUTOMATION system supplier. In these cases, the customer’s main priority is to buy a ‘Distributed Control System’ (DCS) to control the operations on a particular power plant. They are not interested in a solution as described above, with added equipment (Instrumentations) to optimise the workings of the new DCS, or control system (Controls).
Solution oriented
System oriented
Figure 3: Contract Cases, EG A’s ‘product package’
In this report, the companies that are after winning such orders (or Contract Cases, in line with the definition by EG A) with power generating companies in the EU, together form the industry of: ‘AUTOMATION systems suppliers for modernisation and building of new fossil power plants for power generating companies in the European Union’. In the following, I will refer to this definition of this particular industry as ‘the AUTOMATION systems suppliers’ or ‘the industry’. Although not all of the competitors are able to fulfil every contract case as mentioned above, EG A usually competes with four other competitors for winning an order. This does not mean that
12 See appendices 1.3 and 1.4 for the different divisions within Company A Electricity generation C0: Providing AUTOMATION solution for modernisation of plants
Site survey/ creating of AUTOMATION task description up to proofing of plant parameters
C1: Providing AUTOMATION solution for new plants
Creation of AUTOMATION task description with input from process supplier up to optimisation of the process
C2: Providing AUTOMATION solution
Providing AUTOMATION concepts/ implementation of AUTOMATION task description and complete plant integration
C3: AUTOMATION System provider (Partnering Model)
Adaptation of purchaser provided “AUTOMATION task description system conformity” in DCS
C4: AUTOMATION System supplier
all five competitors are involved in bidding13 for every contract case, but it does mean that EG A has to compete with a number of these competitors for every order that they try to win. The differences between the companies regarding the contract cases that they can fulfil and the ones that they can not fulfil are discussed in ‘the competitor environment’ (chapter 2).
The competitors that are involved in the industry of AUTOMATION systems suppliers in this report are:
• Company A EG A
• Competitor D
• COMPETITOR A
• Competitor C
• Competitor B
The real competitors that EG A is faced with are the (sub-) divisions of these companies that are involved in selling their AUTOMATION systems to fossil power plants. The exact names of these divisions and how deep in the organisation we have to go in order to find out where they are located is not clear. To illustrate this:
see appendix 1 and look at how deep we have to go into the Company A organisation, before we reach the level about which we are talking here. Much of this information is confidential and hard to research. There are some levels to be discovered when exploring different home pages on the internet, but they may be just as well focussed on customers that visit them, instead of reflecting the true divisional structures of these companies. To avoid speculations and guessing, I will use the overall names of these companies.
1.2 Tender regulations
The orders for AUTOMATION systems, as discussed in this report, are subject to EU regulations which determine that an order like this should first be made public, defining the required product characteristics. This ‘invitation to tender’ is published in a medium that is available throughout the EU. Based on this invitation, the customer normally receives a number of offers from AUTOMATION system suppliers, out of which they make a selection based on their own criteria. Examples of such criteria are: Financial backing, expertise that is promised and overall reliability14. As a final step in this process, the customer enters into negotiations with the selected potential suppliers about things like: more exact product requirements, quality and prices.
When an AUTOMATION systems supplier has additional questions to the invitation to tender, these have to be posed - to the customer that wants to buy a system - in written form. The question as well as the answer than must be made public, so that every potential bidder is able to make an offer based on an equal amount of knowledge.
By keeping close contacts with customers, companies like EG A and COMPETITOR A try to identify certain problems with which customers are faced or could be faced in the future. Such an approach offers possibilities of finding out more about certain requirements before the invitation to tender is received. One of such requirements
13 See the paragraph on ‘Tender regulations’ (paragraph 1.2)
14 Ruud Willemsen, manager engineering of NUON, a Dutch electricity generation and supply company in an interview on August 20th, 2004
could be the budget that a customer has in mind for an order. Furthermore, personal contacts could play an important role in final decisions for a customer15.
1.3 Structural analysis of the Industry
This will be a structural analysis of the industry, based on the theory behind the
‘Structural analysis of Industries’ by Michael Porter16. This theory entails an analysis of five competitive forces. See appendix 3, for an illustration of these forces. Four of them:
• threat of new entrants
• threat of substitute products or services
• bargaining power of suppliers
• bargaining power of buyers are seen as drivers of the fifth force:
• rivalry among the existing firms in the industry
The collective strength of these forces determines the ultimate profit potential (in terms of long run return on investment) and thereby the possibilities for establishing a stronger position within the industry. The goal of this report is not to identify the earnings in absolute numbers that can be made in the EU or any specific country market; in stead I will try to identify possibilities of a long run positive return for EG A.
These possibilities will eventually be based on favourable market conditions in certain regions (on an EU level, e.g. east-Europe or Iberia), specific countries or with specific companies in the EU. The separation between parts of the EU is inherent to the situation of the generation companies (customers of EG A) and the fact that the EU, regarding electricity and electricity generation, still consists of mainly country markets. Nonetheless, the industry that is discussed here is an EU wide industry:
Competition takes place between members of the same group of companies, EU wide.
All the five competitive forces are addressed in the following. But, we must be aware of the fact that one force may be more influential than the other in shaping competition in a certain industry. Porter gives the example of the steel industry, in which the key forces are foreign competition (rivalry among existing firms in the industry) and substitute materials (threat of substitutes)17, such as aluminium. For the AUTOMATION systems suppliers, one force influencing the competitive structure is of particular importance in this report. That force is the bargaining power of the buyers (power generating companies) and the changes that are taking place here under the influence of the ‘common rules’ that are dictated in the EU Directives on the forming of an internal electricity market.
Important in the following analysis is to note that it concentrates on the industry as a whole. This means that the common general characteristics of all competitors within
15 Examples of this were discussed with Peter Pietersen, responsible for sales in north and parts of east Europe, and his experiences with the importance of having a good relationship with customers, especially in east Europe.
16 Porter, 1998
17 Porter, 1998, page 6
the industry are discussed. To illustrate some points, concrete examples of individual companies will be given. These illustrations however, only function as illustrations of how the different forces impact on the industry as a whole. For more detail and differences regarding the competitors within the industry, I refer to chapter 2.
1.3.1 Threat of entry
The threat of entry into an industry depends on the ‘barriers to entry’ that are present, coupled with the ‘reaction from existing competitors’ that the entrant can expect.
The first entry barrier that is of importance in possibly deterring firms from entering the industry, are the economies of scale that most of these AUTOMATION system suppliers have. First of all, most of them have a service network that spans across the EU, although not all offer the same quality of service (mainly in terms of width of the service package).
Second, all the companies in the industry are parts of larger ‘multi-business’ firms, which allows them to share operations or functions with other parts of these companies. Most of the AUTOMATION systems namely, can be used in other (than electricity generation) sectors as well. This sharing of operations or functions is also an economy of scale, just like the one discussed next: joint costs.
The sharing of functions also leads to the advantage in most companies, of joint costs, for example for maintaining a service network. Service personnel may be used by units that serve paper mills as well as power plants, because the AUTOMATION systems that control operations in these installations are similar.
Product differentiation (not to be confused with ‘differentiation’ as a generic strategy, discussed in chapter 2) means that the established firms in a particular industry have brand identification with the customers and customer loyalties. This entry barrier is of importance to the Industry in this report. When buying an AUTOMATION system, customers want their suppliers to stick to the deals that are made. For example:
regarding financial backing, expertise that is promised and overall reliability. Being faced with problems regarding these factors can be very costly for most power generators. This is in line with what Ruud Willemsen18, manager engineering of NUON in the Netherlands, told me: “We do not want to get ourselves involved with
‘adventurers’”. By this he addressed the initial distrust that NUON has against potential entrants into the industry of AUTOMATION system suppliers, based on problems that may occur in their products, without having the security that the
‘adventurer’ can correctly solve them.
Capital requirements for new entrants are high if they have to develop and work out a completely new AUTOMATION system to serve fossil power plants. For other companies already active in automation or AUTOMATION systems for other businesses, capital requirements for the development of such a system are not that high. Because of the wide applicability of most AUTOMATION systems (most of them can be implemented into a variety of industrial processes), it will not be costly to make a design for implementing the entrants system into the processes within a fossil power plant. A company that tries to enter the industry by diversifying its product line through additional applications of its AUTOMATION system that fit the needs of
18 In an interview with the author on 20 August 2004
operators of fossil power plants, is however still faced with something like failing brand identification with customers. Above (under ‘Product differentiation’), we have seen the importance of this issue and why. To be able to establish a ‘good name’
among customers of the industry, a new entrant will be faced with significant capital requirements, even if it has proven to have a good system which works for other businesses.
Furthermore, the companies that diversify into the industry may not have large difficulties when serving C3 and C4 contract cases. For C0 to C2 cases however, extensive amounts of ‘power plant know-how’ are required, to be able to serve the customer with a satisfying ‘solution’. Building up such know-how may require large investments, because of the dedication to electricity generation (not so much to overall AUTOMATION systems) that is required from employees. If companies are not prepared to make these investments, they will become dependent upon engineering firms that do have such know-how and that put together consortia of firms to serve cases C0 to C2. In chapter 2, these differences are discussed as well, when discussing the differences between COMPETITOR A and EG A (both with extensive amounts of power plant know-how among their employees) and the other three companies (which lack such extensive know-how).
Switching costs of changing to a new AUTOMATION system are normally very high, because customers have to train their personnel and adopt their standards to the new system. The current AUTOMATION systems of the different competitors within the industry differ among each other, and so far, it remains impossible to modernise a power plant with a new system from a different supplier, without totally removing the former suppliers system and (re)training personnel for working with the new system.
Nevertheless, switches to another system do occur, predominantly when the order considers a C0 or C2 contract case, which involves rather thorough and far-reaching changes in the customers operations and employee requirements (through training) with the aim of providing a solution that solves a certain problem for the particular customer, with the help of a more modern AUTOMATION system.
Possible switching costs for the customer, will thus form a high entry barrier.
Especially if the new entrant into the industry chooses to serve the C0 to C2 contract cases. The height of the entry barrier is reduced however, when the switching costs for the customer (from an ‘established’ system to a new entrants system) are not significantly higher than the costs that are required to switch from one established supplier to another (especially if the entrant chooses to serve C3 and C4 contract cases).
Access to distribution channels. Companies in this industry are trying to more or less establish their own distribution channels, by maintaining close customer contacts.
The goal of these contacts is mainly to establish goodwill with the customer and to be able to identify the customer’s requirements and budget for an upcoming order, before a competitor gathers such knowledge. The idea behind early identification of exact customer requirements is to be able to offer the customer tailor-made solutions once the invitation to tender is received, more speedily. Such contacts give the companies in the industry advantages as opposed to new entrants, because they are more familiar with the customer’s bottlenecks and the exact requirements of the desired product.
The reaction from existing competitors is another issue determining the threat of entry. I could not find evidence of strong retaliation directed at a new entrant that tried to enter the industry. Therefore, I assume that possible new entrants do not have to fear strong reactions from existing competitors.
To sum this up, entry barriers for the industry are high for companies that have no further experience in related industries. Companies that do already have an AUTOMATION system, which originally was not developed for fossil power plants will face lower barriers. If they already have experience in building these systems into for example, paper mills, it will not be a big step to start offering them to fossil power plants as well. Acquiring the relevant ‘power plant know-how’, which is required for the more ‘solution oriented’ contract cases however, is another matter. Developing such know-how requires extensive investments and a sole dedication to electricity generation (of at least part of the company) like COMPETITOR A and Company A EG A (as part of Company A EG; further discussed in chapter 2) have done.
An example of a company that tried to take a ‘sidestep’ is Yokogawa. With ‘sidestep’, I mean: Offering AUTOMATION systems to fossil power generators in the EU, whereas this company formerly only sold these systems to companies that needed these systems for other industrial applications, like for example, in cement making.
Yokogawa did manage to get at least one order with NUON in the Netherlands. They could however not live up to the expectations that the client had: ”Everything had to be verified with the bosses in Japan. This was frustrating and also cost a lot of time.”19
The box below provides an additional discussion of particular entry barriers of the industry, regarding three particular country markets within the EU.
BOX 1.1
VGB guidelines
Although this chapter is intended to offer an EU wide overview of the industry, there is one, more detailed issue that needs to be pointed out here, because of its close relation to particular entry barriers. This issue concerns the differences in guidelines to which power plants and the AUTOMATION systems in these power plants have to adhere, across the EU.
The so-called VGB guidelines are the highest standard in the EU, determining the standards for the Dutch, German and Austrian market. These markets are the home markets for both EG A and COMPETITOR A, because the AUTOMATION systems of these companies are produced, and function, according to these guidelines. The systems of the other suppliers however, do not comply with these requirements.
Consequently the entry barriers for the three remaining companies on these particular country markets are high.
19 Cited from: Ruud Willemsen, manager engineering, NUON Nederland in an interview on 20 August 2004.
Johannes Jansen, director of EG A12, makes the following remark about this20:
“Market entrance costs for Competitor C, Competitor B and Competitor D in the VGB market (Germany, Austria and the Netherlands) are very high because of their lack of power plant knowledge. They have to add additional Engineering Systems for producing the required documentation.”
1.3.2 The threat of substitute products
Substitute products could be the closely related AUTOMATION systems that are used to serve other industries than electricity generation. In this form however, this issue is very closely related to the threat of entry. Whether a company from outside the industry takes the decision to offer such an alternative system to a power generator, is up to the company itself. This is inherent to the tender regulations with which the industry is faced. A company with a potential substitute for the other systems in the industry decides for itself whether it makes an offer based on this invitation to tender, or not. The customer publicises the invitation to tender and sometimes approaches certain suppliers for making additional offers (e.g. by pointing out the publicised invitation to desired suppliers). It is however, very unlikely that a customer will approach an alternative AUTOMATION systems supplier when it has not proven itself in the fossil power plants-business yet, because of the expected high extra costs in the event of a failure (see ‘Product differentiation’ in 1.3.1).
It is hard to think of other products that could take over the role of an AUTOMATION system in a fossil power plant. Therefore, the only pressure that may be present is the pressure of a related AUTOMATION system - originally applied in other industries - that enters the industry, because the company selling it decides to enter. Or, of course, technological improvements in current systems could mean that these systems become substitutes for older systems that do not have the newly developed technological requirements. This however, is an issue with which all the AUTOMATION system suppliers are very much involved themselves. As a result, it will be very difficult for a new entrant to come up with a new technique, that is new to the industry as well, and that helps the entrant in establishing itself among the industry’s competitors.
1.3.3 Bargaining power of suppliers
“Suppliers can exert bargaining power over participants in an industry by threatening to raise prices or reduce the quality of purchased goods and services.”21
An interview with Uwe Stollmayer22, EG A’s head of Process management, Methods and Tools and contact person for Purchasing, provides the basis for this part of the analysis. Failing information on competitor’s suppliers and relationships with them, results in the assumption that his statements reflect the relationship between the industry and its suppliers.
20 In an e-mail to the author of 12 March 2005
21 Porter, 1998, page 27
22 Interview with Uwe Stollmayer, head of EG A SM-PM. Interview took place on 11 October 2004. Mr.
Stollmayer is presented on the Company A intranet as EG A’s contact person of the purchasing department.
Three important statements that he made regarding EG A, their competitors within the industry and the relationship between the industry and its suppliers, are:
1. All industry participants have – for a considerable part of their supplies – the same market dominating (in terms of quality, reliability and costs) suppliers. An example of such a market dominating supplier is Supplier A, ‘supplier of control devices and systems for industrial measurement and automation technology’23.
2. There are no large differences between the different competitors, regarding vertical integration. Vertical integration refers to the required products that are needed to serve the customer and whether these are produced by the companies self or bought from suppliers. When an AUTOMATION systems supplier produces more products that it needs to fulfil customer demands by itself, it is more vertically integrated. Companies in this industry, buy the required parts from suppliers depending upon the specific order that they receive from their customer, they hardly keep any inventory and are therefore not highly vertically integrated.
3. All the companies have similar problems with suppliers. “We all have to deal with the pressure of suppliers costs on our own earnings and the desire to buy the right quality at the right moment.”24
These points provide us with clues regarding the bargaining power of the suppliers to the industry. Porter names five conditions that signify whether a supplier group is powerful or not. Here, I shall discuss the ones about which I can make clear statements based upon the interview with mister Stollmayer. The first characteristic of a powerful supplier group is when the supplier group is dominated by a few companies and is more concentrated than the industry it sells to25. The fact that all industry participants have the same market dominating suppliers (point 1 of the statements that are formulated above), illustrates that this is probably the case.
The next condition that applies to the relationship between the industry and its suppliers is the fact that the supplier’s product is an important input to the buyer’s business. This point needs some explanation, because it applies to specific components of the AUTOMATION systems supplier’s product. All the companies in the industry have their own specific AUTOMATION system (Competitor D has Ovation, like EG A has TXP and PCS 7, the newest COMPETITOR A system is called Industrial IT, and so on). For specific components of these systems, the different competitors have different suppliers. Most of the time, these suppliers are other parts of the larger firm. EG A for example, buys its cubicles of electronic equipment from the subdivision ‘Schränkbau’ (English: ‘Cubicles building’) which belongs to the Company A operational group Automation and Drives (A&D), which is an operational group just like Electricity generation, the group to which EG A belongs (see appendix 1). Such suppliers of specific equipment from other parts of the larger company can not exert large amounts of pressure on the industry competitors, because the dependency is mutual: in the same way that EG A depends on
‘Schränkbau’ for its control cubicles, ‘Schränkbau’ depends on EG A for their sales of
23 Source: http://www.endress.com/
24 Uwe Stollmayer, head of Company A EG A SM-PM in an interview with the author on 11 October 2004.
25 Porter, 1998, page 27
these exclusively for EG A fabricated control cubicles. This however, does not mean that the entire Supplier Bgroup - as a supplier of more general instrumentation equipment, such as pressure- and temperature measurement equipment - is dependent on EG A for its sales. Regarding the more general equipment, SUPPLIER Bbelongs to the group of dominant suppliers.
An important factor in the relationship between the industry and its suppliers are the switching costs. Switching costs signify the dependency of a buyer upon one particular supplier or, the other way around, of the supplier upon the buyer. In the case of the relation between EG A and ‘SUPPLIER BSchränkbau’, both parties are faced with considerable switching costs regarding the supplier, respectively the buyer. The fact that there are no considerable differences regarding vertical integration (mentioned in point 2 on the former page) suggests that there will be more competitors in the industry that have a similar relation (as the one between EG A and
‘SUPPLIER BSchränkbau’) with suppliers of products that are specific to the AUTOMATION system of these competitors. This does not mean that the supplier will be inclined to use its bargaining power against the buyer, because the supplier is just as dependent on the buyer for its sales.
The bargaining power of the suppliers of the more general products required by the AUTOMATION systems suppliers, is bigger. These market dominating companies have obtained this power, because the AUTOMATION system suppliers are not the only buyers of their products, they sell to a multitude of other industries as well. An example from which you can see this is found in the broad definition of the products that Supplier A produces (consider the rather broad definition of the company under point 1, above).
Overall bargaining power of ‘suppliers of general equipment required by the AUTOMATION systems suppliers’ as opposed to the industry is considerable.
Considering the fact that almost no inventory is kept and that most of the competitors in the industry buy their required products from ‘dominating suppliers’ shows how dependent the industry is upon these suppliers. They have to rely on their suppliers for the correct and timely delivery. This gives the suppliers a powerful position as opposed to the industry, especially if you consider that this is not the only industry to which they supply their products. Dependency of the AUTOMATION system suppliers upon their dominant suppliers therefore is considerable, whereas these dominant suppliers have different industries to which they can sell their products. A different relationship is the one with the ‘suppliers of the equipment that is specific to the different AUTOMATION systems of the different competitors in the industry’. This is a more exclusive relationship, in which the supplying company depends just as much on the specific AUTOMATION system supplier as the other way around.
1.3.4 Bargaining power of buyers
The bargaining power of a buyer group, in this case the power generators that are planning to build or modernise a fossil power plant, depends on a number of characteristics of its market situation and on the relative importance of its purchases from the industry compared with its overall business. A full account of the issues determining the buyer’s bargaining power is provided by Porter26. In this part, I will only discuss the issues out of this list that apply to the industry and its buyers. A
26 Porter, 1998, pages 24-26
