Linking risk to results
Balancing risk with reward is a challenging goal, made even more complex for regulated utilities. Multiple stakeholders present conflicting priorities that the utility is expected to meet. Matt Chambers reports.
Against a backdrop of uncertain demand, increased regulatory scrutiny, evolving policies and disruptive technology, utilities must develop a clear risk strategy.
Successful utilities manage risk for better performance using three interrelated levers:
1. Value creation
This is about utilities creating incremental value for all stakeholders for the risks they assume. It may include:
- Better articulating their risk profile to regulators and other stakeholders. Utilities need to be forthcoming about the risks being managed, the proposed action and the possible consequences. Providing transparency will enable stakeholders to share a common understanding of the nature and amount of risk.
- Using riders and trackers that tie to risk drivers in rate cases. Riders and trackers are contentious. Some argue cost trackers create a perverse incentive to be inefficient, while a similar argument could suggest not having "risk" trackers could create an incentive to delay certain risk mitigation activities. A regulator will need to balance the risk premium to the reduced business risk, resulting in an adjustment to the return on equity.
- Repurposing operating expenses to capital expenses for consideration in the rate base. Operating expenses focus on maintenance of current operations, while capital expenses represent investments in improvements. To determine when to move from a “maintain” strategy to an “improve” strategy, utilities need to make a risk-informed decision that considers the value delivered to all stakeholders and the particular conditions of the jurisdiction in which they operate.
2. Risk mitigation
Utilities must determine how they will mitigate risk and to what acceptable exposure level. Strategies may include:
- Shifting from a compliance culture to a risk culture. Utilities must shift from using a largely qualitative prioritization process to make replacement decisions and instead make risk-informed decisions that are coordinated with regulatory recovery. Utilities that focus on regulatory compliance as a risk in itself may avoid fines and penalties but may not be adequately protected from the actual financial consequences of the risk materializing.
- Data integrity in reporting to regulators. Utilities face challenges in effectively responding to a regulator because of the number of people and systems involved, the volume of data and, often, multiple jurisdictions. A mistake can impact credibility, leading to greater scrutiny.
- Capital project management. To achieve cost containment and certainty, utilities must have processes and controls to forecast, manage and track performance. They also need effective governance and oversight protocols to confirm compliance and performance against stated goals.
- Identifying, evaluating and responding to emerging risks. Understanding the effect of rapid or extreme impact events can help avoid, survive or even exploit unexpected events. Environmental scanning continually seeks out, analyzes and disseminates critical information that impact key areas of business and operations.
- Responding to the new security threats. Industrial control systems that provide automation for critical infrastructure have recently come under increased scrutiny. The need to protect current infrastructure and integrate security into new system design is a top priority.
3. Cost reduction
Utilities need to take an enterprise approach to cost reduction that is both actionable and sustainable. Examples of areas often overlooked in cost reduction initiatives include:
- Coordinating and optimizing risk monitoring functions and lines of defense. Utilities face increasing regulations around governance, risk management and internal controls. It is necessary for businesses to improve risk monitoring activities and set up an efficient internal control system.
- Reducing cost of control spend by automating controls. Often, the most significant driver is ineffective use of existing information systems. Failure to leverage the automation capabilities of the ERP system is the biggest culprit.
Three key factors should drive utilities’ cost reduction:
- The need to cut operating costs to allow for an increase in capital expenditure
- Improving capital spend efficiency to allow for repurposed capital expenditure, making sure that money is being spent in the right places
- Ensuring all is being done to manage costs and moderate the need for rate increases
The risk lens
Regardless of which levers a utility pursues, its strategic choices should be evaluated through a risk lens. Utilities should:
- Enhance risk strategy through effective strategy and governance
- Embed risk management into all aspects of the business
- Optimize risk monitoring functions by aligning and coordinating risk activities across all risk and compliance functions
- Improve controls and processes by optimizing controls around key business processes
- Enable risk management, communicate risk coverage by reinforcement through training, communication, reporting, and the use of technology
By instilling risk principles into all aspects of the business, utilities can reduce the uncertainty of outcome in whichever strategy they are pursuing.
Rise of the super model
As stakeholder scrutiny of the sector continues to rise, so does the need for utilities to adopt a “super model” for governance, risk and controls. Utilities need to continue to excel at the basics: keeping the lights on and delivering the gas or electricity, safely and efficiently.
But achieving competitive advantage will require utilities to undergo a fundamental shift in corporate culture — one that moves beyond compliance and toward initiatives that are risk-informed, innovative and customer focused to accelerate business performance.
There is no better time for utilities to find a balance among managing risk, reducing costs and creating sustainable value for all stakeholders.
How we can help
The relationship between risk and performance improvement is an increasingly complex and central business challenge, with business performance directly connected to the recognition and effective management of risk. Whether your focus is on business transformation or sustaining achievement, our advisory professionals use proven, integrated methodologies to help you achieve your strategic priorities and make improvements that are sustainable for the longer term.
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|Turning risk into results: Americas Power & Utilities|