Brian Kenny: Pearl Street, in the financial district in lower Manhattan, runs northeast from Battery Park to Brooklyn Bridge. Dating back to the early 1600s, Pearl Street cut through the heart of New Amsterdam, and was named for the many oysters found in the East River. Today it looks like most every other street in lower Manhattan, but on September 4, 1882, Pearl Street shone brighter than any street in New York. I mean literally, because on that day history was made when electrical power began to flow through an industrial-sized, direct-current generator at Pearl Street station, also known as Thomas Edison's first power plant.
By 1884, Pearl Street station was serving 508 customers with 10,164 lamps. In the years since that watershed moment, just about everything in the world has changed, but the way we generate and distribute electricity, is still pretty much the same as it was 133 years ago. Today we'll hear from professor Mark Kramer about his case entitled, Enel: The Future of Energy. I'm your host Brian Kenny, and you're listening to Cold Call.
Mark Kramer is a leading researcher, writer, and lecturer on strategies for social impact. He also cofounded FSG, a social impact consultancy that operates globally. Mark, thanks for joining us today.
Mark Kramer: Thank you, pleasure to be here.
Kenny: It will be helpful for people to understand the landscape of power generation, and how things are changing on that landscape. We'll get into all those details, but if you could start very simply by telling us who's the protagonist, and what's on his mind?
Kramer: The protagonist is Francesco Starace, who is the CEO of Enel, the power company for Italy. What's so remarkable to me about this case is the transition of an old fashioned, state-owned monopoly power company into really one of the leading innovators in renewable energy, and energy services globally. That transition is really due to the leadership and vision of Francesco Starace.
Kenny: What prompted you to write the case?
Kramer: [HBS professor] Michael Porter and I have been working on developing a course on creating shared value. The concept we've developed redefines the role of business in society to think about social issues as opportunities for competitive advantage, not just as a matter of sustainability or corporate social responsibility. We've been building up of a set of cases ... that exemplify how companies are finding new competitive opportunities by helping solve social problems. This was a great example of this in the power industry.
"There are so many power companies, particularly in the US, that have resisted the shift to renewables, even though it's hard to argue this isn't going to be the future"
There are so many power companies, particularly in the US, that have resisted the shift to renewables, even though it's hard to argue this isn't going to be the future.
Kenny: Most often power companies are thought of as culprits with a lot of the global warming issues that we have.
Kramer: Absolutely, and Enel is no exception. It was one of the largest users of coal in Europe, and a very heavy polluter. As there [came to be] more and more regulations, and pressures around carbon emissions, they really had to shift away from that.
Kenny: What are the main pieces of a power generation and distribution [system]?
Kramer: Sure, so there are, as you say, several pieces, there is the actual generation of the power, and that can be thermal, it can be coal or gas-fired turbines and generators. It can be hydro, which is using waterpower, an ancient form of power generation. It can be other renewables, like solar, wind, and of course nuclear. Once the power is generated, then there is an elaborate network to distribute it, first at a wholesale level and then down to a retail level.
When you think about the cost of your power, it's typically one third from the generation, one third from the distribution at a wholesale level, and one third from the actual retail distribution to individual businesses and consumers.
Kenny: You talk in the case about the cost-plus system that power generators use. Can you explain that?
Kramer: Most power generators in the US and Europe have their fees set by a regulatory body, since they are a monopoly, typically in a region, and the fees are set based by looking at the capital expenditures to build the power plant and distribution system, and assume a recapture of that investment over the useful life of the equipment, plus a return on capital. On the one hand, that makes a great deal of sense. These are very capital-intensive industries. A huge investment. So ensuring that the company is able to recoup its investment with a profit makes sense.
On the other hand, that tends to discourage companies from greater cost-effectiveness, or other innovations that might lower their cost base, and it has tended to discourage the investment in renewable power as well, where the cost, the initial investment upfront, is much lower, and the predictability, the return, is much less.
Kenny: So, how do renewables start to surface? They have been around for a long time, probably to the frustration of some people who think, "Wow, it's been a long time, and still they’re only generating a very small percentage of the power that's used."
Kramer: That's right, and that's certainly true in the US, although as you mentioned, Europe is a somewhat different model. I believe Germany is roughly half renewables, and many other European countries have a much larger share of renewable generation. The big story about renewables is the reduction in cost. In 1977, it cost $76 to generate a single watt of electricity from renewable power. Today, that's 57 cents. We just had a major solar installation approved in Germany, the first time there has been a major installation without any subsidy or guarantees.
We really are just now at the point where renewable power is achieving parity with other forms of power generation in terms of cost, and that's a big deal.
Kenny: So in Europe there's a much greater presence and acceptance of renewable energy than there is in the US. What are some of the forces controlling that on either side?
Kramer: The EU has been a very strong proponent of the shift to renewables, and commitments to reduce carbon emissions ... has been a big factor. I think simply the regulatory environment has been much stronger about promoting the shift to renewables in Europe than it has been in the US. There's also been a willingness of governments to step in and subsidize the cost to get to the point of parity that we've not had as much of in the US.
Kenny: Under the new administration in the US, it will be interesting to see where things go there, but it doesn't look favorable—I guess we could say that.
"Instead of one major capital investment with a long term predictable return, you are looking at many, many small investments, many, many competing players"
Kramer: It certainly does not.
Kenny: Let's talk about Enel. How did they emerge on this landscape?
Kramer: Enel is a $90 billion global company. It started as a monopoly, the state-owned power generator for Italy. But over time, as the government liberalized power generation and began to create a competitive market, Enel had to find other ways to grow. The government also shifted from this cost-plus pricing model that we talked about to market-based pricing, so the predictability of the profits was no longer as certain.
This deregulation happened throughout Europe, and so power companies that used to be limited to a particular country started buying power companies in other countries, and become global. Enel now is in 35 different countries as a major global player in power generation. What's interesting ... is that when they acquired a major power generator in Spain they took on a lot of debt, and there was a point in the late 90s where there was a real bubble in valuations for renewable energy.
Some smart investment banker said, "Hey, you know you can pay down the debt that you took on acquiring the Spanish utility if you take all the little renewable operations you have from all the different companies you've bought in all these different countries, and create a new entity that is 100 percent renewables. Call it Enel Green Power, take it public, you'll get the cash to pay down the debt." The consequence of that was that a new entity was created that only focused on renewables, and was staffed by people who were very different from the traditional utility executive in the old Enel. People really committed to renewable power.
One of the fascinating differences [in business models] is that traditional power generation is all about a few massive capital investments, with a decade or many decades long return that is highly predictable. Renewables requires much less capital investment, it is decentralized. There are countless players. Everybody can put solar on their roof, you don't need to build a power plant, so it's a completely different vision of how to operate the company, how to make capital allocation decisions, how to develop strategy, etc.
Francesco Starace, the CEO, has said that you really couldn't develop a renewables company within a traditional power generator. It's just such a different mindset. But because of this happy coincidence that they developed this separate Enel Green Power operation, they were able to create a new enterprise and a new culture that could become really adept at developing and promoting renewable energy.
Kenny: What are some of the challenges that they had in doing that? It's different in what way?
Kramer: Well, it's different in almost every way. Again, instead of one major capital investment with a long term predictable return, you are looking at many, many small investments, many, many competing players. You have to be able to integrate the energy that is coming from multiple different sources; it becomes much more of a software driven enterprise. It's about how you manage and regulate energy services, the flow of energy, optimizing the usage, reducing the cost, and it's much more about the software, and the distribution system, than it is about the capacity to create a major power plant to generate electricity.
Kenny: A lot of the major fuel companies in the US have sustainability programs of one kind or another, but they have been accused in the past of doing greenwashing, and not really making it a part of the culture of the organization.
Kramer: That's right, and it's just fascinating. One of the changes that Francesco did—I should mention he was the CEO of Enel Green Power and then in 2014 was appointed CEO of the entire Enel group, and they reintegrated Enel Green Power back into the group—one of the things he did was combine sustainability and innovation. He said that the answers to sustainability really are about innovation, and you can't innovate unless you're really trying to solve difficult problems. By pairing sustainability and innovation, he's done something I haven't seen any other utility do, to use sustainability not as something peripheral but as the driver of innovation for the company as a whole.
He did a second thing there, which is he recognized that their own research and development department wasn't going to be able to compete in the global economy around software development and power management. So he created this model that he calls open innovation, where instead of focusing on their own research and development team they've set up a website. They've posted all of the problems they're working on, and they've said anyone in the world can submit answers. Their engineering team will review it and respond within 30 days. They don't want to invest in startup companies, but they will commit to buy anything that is developed that is of use to them, and by their scale, they can drive the growth of a new innovation.
It turns out that one of the critical pieces of software they needed was to {figure out] how you create a two-way connection between an electric car battery and the power grid, so that you can not only charge the battery but draw power from the battery to help balance the grid.
Well, they didn't have the answer to it. A six-person startup spun off from the University of Delaware, that had no revenue, actually was the one who had the right technology. They were able to identify through this open innovation system ... Nissan, and with this little startup they are running 500 cars in Denmark with this two-way connection to the grid.
"Enel estimates that they can generate about $10,000 a year of revenue per [electric] car from merely having access to five percent of your car’s battery to balance the grid"
Kenny: I thought that was fascinating.
Kramer: What's fascinating is that one of the big barriers to going to 100 percent renewable power is the fact that it's intermittent. The wind and the sun are not there continuously all the time, and there just aren't adequate storage facilities, or technologies, to handle the volume of electricity that's needed for an entire city. It turns out the storage capacity of Tesla's and other electric car batteries is so tremendous that with literally just about 100,000 Teslas, and the ability to access only about 5 percent of the storage capacity of their batteries, you can actually balance the grid for a major city like Rome.
Kenny: Wow.
Kramer: You actually begin to generate revenue from accessing these car batteries. Enel estimates that they can generate about $10,000 a year of revenue per car from merely having access to five percent of your car’s battery to balance the grid. They can begin to subsidize the sale of electric cars, which can then accelerate the move toward electric cars, which can then accelerate the move toward 100 percent renewables, because you have an adequate storage facility. It's an amazing vision that Francesco Starace has.
Kenny: It really is, and so they are on the ground floor. All of a sudden now electric vehicles are going to be much more popular, and become affordable by more people, so they could really be at the beginning of a whole movement.
Kramer: That's absolutely right, and they are creating an electro-mobility division that will focus on leasing and improving technology for electric cars, and they're doing it in partnership with Tesla, in partnership with Google. Again, what's so amazing is here's this 100 and some-year-old state-owned monopoly, now a public company, that's at the forefront of innovation in renewables technology and electric cars.
Kenny: As they think about the future, do they think about divesting all those capital-intensive assets they used to do traditional power generation?
Kramer: At this point they still have a significant amount of power generation that comes from traditional thermal sources, including coal. They are closing down those plants, but they're not yet at the point that they can eliminate them. They have made a commitment going forward that they will only invest in new renewables, they will not invest in any more thermal power plants. Part of the reason for that is not just environmental, but is that the power industry is changing so rapidly now, the idea of building a power plant and recouping the cost over decades no longer makes sense. Things are changing every year, every six months, and so they have to look at much shorter-term investments, which renewables are.
Kenny: Do they have to shape-shift depending on where they are in the world? The case talks about some of the challenges they face in Latin America, versus in Europe, versus another part of the world.
Kramer: They do, absolutely. One of the interesting things about the power market is that in mature developed countries like Europe and the US, power consumption is declining. For decades, there was a direct relationship between increasing GDP and increasing use of electricity. As people have focused more and more on conservation, efficiency, and reducing the costs of power, they actually are finding that there is less and less need for power to produce the same GDP. The growth [in power consumption] is going to happen in emerging markets, and those are very different kinds of markets to work in than Europe, the US, and other developed countries.
Kenny: Different regulatory bodies that you've got to contend with.
Kramer: Different regulatory bodies, and of course much, much less infrastructure. And so the idea of using renewables in Latin America, in Asia, and other emerging markets, makes tremendous sense, because the investment cost, the infrastructure, the distribution system, is so much lower.
Kenny: That makes perfect sense. Have you discussed this case in class?
Kramer: I have. We had great fun teaching this with the MBAs.
Kenny: This is a generation of MBA students who are in the millennial classification. They are very concerned about the environment. How did they think about what Enel was doing?
Kramer: They were very excited by it. I think all of the cases we studied in this course on creating shared value are really examples of companies that are seizing new opportunities to have a positive social impact and drive the success of their business. A lot of them are interested in social enterprise and impact investment, but most of those deal with very small companies. One of the things that's exciting about Enel is this is a $90 billion company. This is not small, and the fact that they can already be more than 50 percent renewables, and have a commitment of going toward 100 percent renewables, is really dramatic.
Kenny: It gives hope for a brighter future on this front.
Kramer: It does, absolutely.
Kenny: Mark, thank you for joining us today.
Kramer: Thank you indeed, pleasure to be here.
Kenny: You can find the Enel case along with thousands of others in the HBR case collection at hbr.org. I'm your host Brian Kenny, and you've been listening to Cold Call.