Address to IBC Conference on Contracting Out Utility Services,
Melbourne, 30 April 1998
OUTSOURCING AS A GENERAL TREND
The original and still most important factor in outsourcing is cost saving pure and simple. The rule of thumb used by former head of the Victorian Premiers Department, Elizabeth Proust, was that outsourcing saves about 20% of labour costs. Various painstaking studies have shown the outcome to range between the negative and 50% plus savings -- topical in this respect is the present wharves dispute where savings at the top end of this range are confidently expected.
These labour cost savings are as a result of several factors:
- much of the labour resource is not needed all the time and the people involved can effectively handle more than one job
- by giving the contractee flexibility, it offers much greater scope for the discovery of more cost effective ways of doing things; piecework and other incentive systems attempt to do the same thing but contracting out where the contractee is replaceable by someone who is cheaper offers the ultimate means of discovering and capitalising on cost savings in many situations
- outsourcing avoids the on-costs which are often hidden but always present
- it allows greater flexibility of labour use, particularly where job tasks have been ossified in closely defined descriptions sometimes referred to by union leaders as "hard won rights"
- in some heavily unionised industries like the ports, the coal mines the pre Robe River dispute iron ore mines, the ambulance service and elements of the electricity supply industry, it allows management to re-assume control of the process of production
- it circumvents the heavy penalty payments employers are obliged to make when they wish to restructure workforces or downsize with inevitable redundancies.
Contracting out has always been a feature of manufacturing and service industries. Often it has taken the form of vast numbers of sub-contractors. Such methods, used by the Japanese transformed the motor industry from the previous archetype where steel and leather went in the factory at one end and a finished car rolled off the other.
A further variant, franchising has proven immensely successful in galvanising the self interest of a quasi employee and turning him or her into a self motivated entrepreneur who seeksout economies in achieving customer satisfaction.
A long standing example has been the UK retailer Marks and Spencer. Renowned for the high quality of its brand, Marks has all production undertaken by suppliers. It employs a very strict control system to ensure quality. The major US sports shoe firms have followed suit in this respect. This leaves them vulnerable to political pressures from among others the First Lady who rage against low wages being paid in developing countries.
THE ELECTRICITY INDUSTRY
The industry comprises not only the production and distribution elements but ancillary functions in servicing it. In terms of staff it has been considerably downsized over recent years -- in Victoria from 25,000 to less than 10,000; in South Australia from 8,000 to 3,500 with comparable reductions in other jurisdictions. At the same time its reliability has been considerably enhanced.
In the power stations, for example availability to run has been increased from 70-80 per cent in Victoria and New South Wales to over 90 per cent, a level that approaches world best practice. Victoria's brown coal stations have demonstrated, especially since privatisation, how operations can be efficiently conducted with low quality fuel. Queensland and some of the New South Wales stations have achieved very high efficiency levels with their integrated mines using variable quality coal.
Similarly, the distribution businesses have been streamlined by new management techniques and much closer customer orientation has been developed out of the market system being introduced.
Victoria is the most advanced in terms of privatisation. Under the Kirner and Kennett Governments, the manning at the power stations was reduced from 12,000 to 3,000. At the same time availability to run, the best proxy for reliability, was increased from something like 70% to 90%. Since privatisation, direct employees have been further reduced to under 2,000 and availability has also been lifted a couple of notches.
In distribution, numbers were reduced from about 14,000 in the bad old days to rather less than this at privatisation. Since then numbers have been further reduced and are rather less than half their pre-reform levels. One CBD distributor now employs only 40% of the staff it employed at the time of its sale, prior to which numbers had already been reduced. Its rule of thumb has been that the employment saving has yielded a 30% cost saving with about 70% of the jobs being essentially outsourced. Another Victorian business has outsourced much of its maintenance to an electrical contractor and made comparable savings.
As with generation, the measures of reliability, notwithstanding misinformation published in the Age, especially by Kenneth Davidson, have generally improved. These measures are monitored by the Office of the Regulator-General and show outages to be lower than under the old SECV. In this respect, the power disruptions in Queensland and Auckland have often been erroneously attributed to privatisation. In neither case was one share of the businesses concerned owned by a private investor.
RESTRUCTURING PRIOR TO PRIVATISATION
In Victoria, and to a lesser extent NSW and Queensland, restructuring was implemented so that the businesses provided plenty of competition. There is always the temptation of Treasurers to restructure in ways that leave major elements of the previous monolithic businesses intact and thereby obtain a higher price. Of course, for the most part such a higher price is extracted on the basis of some monopoly power on the part of the incumbent. With this comes some increased costs to customers and a blunting of the incentive to seek out cost savings and better ways of meeting customer needs.
As discussed, the restructuring process also went a considerable distance towards rationalising staffing levels. This has been less the case in NSW, especially among the distribution businesses. In the case of the largest, energyAustralia, the reaction of the State Government appointed board to the downsizing and outsourcing proposals of the CEO was to fire the CEO. The board itself was later replaced by the Government.
COMMONLY OUTSOURCED FUNCTIONS
In general the outsourcing trend has been in full swing for about the past six years. Like most other firms, electricity distribution businesses started by contracting out activities on the periphery of their core business. Among the first such candidates were workshops, civil engineering and construction activity. These have been followed by undergrounding, meter installation, public lighting and in some cases line workers.
Most of the power stations have outsourced maintenance, catering, cleaning and security functions. Some of these have been brought back in, in some cases -- for instance procurement. Most of the power station outsourcing took place prior to privatisations and efficiency gains have been made since then by paring down on excess staffing and better management generally.
For the power stations a major driving force for cost cutting generally and outsourcing in particular was the coming national electricity market where the Victorian generators estimated they needed to cut at least 35% of direct costs if they were to be competitive with NSW and Queensland. The generation business reflected all the poor symptoms of union control: restrictive work practices, over-manning, poor performance leading to major outages all stemming from an ingrained antipathy towards management.
In the case of maintenance, considerable pre-conditioning was necessary. The first step was to establish a profit centre. Some early successes in outsourcing, included Siemens taking over the electrical workshops in 1991 and Linfox taking over transport and stores at the same time followed by a consortium taking over part of the coal cutting business. These early outsourcings presented a demonstaration effect. Although the unions fought to retain existing staffing levels, the gains were plain to see and the Kennett Government was particularly ill-disposed to union featherbedding. The contracting out of maintenance entailed 2,200 jobs with about 1,000 of those displaced finding work with the contractors.
Many assets with a specialised role, like milling and boring machines for turbo-generator overhauls were not sold but leased out to the new contractor. Such a move carries some risk that the new contractor will stint on maintenance of an asset he does not own. This carries particular risks where the contractor feels he won't win the next round of contracts. Although not followed in the SECV case, a strategy for combating this is to have an independent appraisal of the value of the asset pre-contracting and a further appraisal at the end of the contract with an agreement for payment where the asset has depreciated beyond an agreed point.
As with many other businesses, there are fears that the "emaciated corporation" will just become a bundle of contracts that nobody in the corporation itself is capable of overseeing properly. Keeping core competencies and contracting skills is essential but the concept of core competencies is often elusive. Western Mining, for example, outsources all its work at two of its biggest mines. The Victorian Government outsourced its policy functions in the privatisation of the electricity industry. Envestra in South Australia represents a business with substantially no employees. However, it bought the assets of its leading shareholder, Boral and outsourced the operations back to Boral.
THE FURTHER STAGES OF OUTSOURCING
IN THE ELECTRICITY INDUSTRY
While other States are also embarking on the sort of processes that the Victorian industry pioneered, we have not yet reached the end of outsourcing. In fact there is unlikely ever to be an end. What is likely is that the internal/external sourcing decisions will ebb and flow as needs change. Already in this respect some elements of power station maintenance have been brought back into the generators.
In some respects the distribution businesses are like property management companies, which have very few staff and simply call on known services to perform maintenance. For existing lines, it is possible to envisage virtually all direct staff being outsourced. For new extension, distribution businesses resemble construction businesses like Leightons or Grollo. Again these firms have very few direct employees.
Other changes with regard to outsourcing will occur as a result of the electricity business evolving into a market, from the much discussed multi-utility and as a result of technology changes.
These stages of outsourcing are likely to involve competitively forced divestment of functions and those brought about by consolidation of utility functions.
COMPETITIVELY FORCED OUTSOURCING
Traditionally, the distributors of electricity have also been the retailers. With successive bands of customers being opened to competition, we have seen an intensive marketing struggle. To date, this has largely been between the existing rival retailer/distributor business. This may change.
Already in Australia, with the smaller businesses constituting the 160 MWh per year tranche (roughly one fifth of the total load) we are seeing aggregators like Lincolne Scott searching out loads that match each other in profile and offering better deals. With the 750MWh per year customers (typically the supermarkets) another firm, Essential, brought together a large body of users and succeeded in negotiating even more favourable terms than the tender process had offered. In the US these aggregators appear to be making considerable headway. New Energy Ventures in California claims to have signed up 5,000 mw or 10% of the State's load.
Load profiling that aggregators pursue undermines cross subsidies and leads to cherry picking. Both of these outcomes tend to make the market more competitive. They are made even more effective with accurate time of day metering. It seems inevitable that meter costs will fall dramatically. Those gaining the steadier load customers have a cost advantage that will be shared. Those losing them have a considerable cost disadvantage.
Many aggregators act as business agents for particular groups. They arrange not only the best prices but also service. Much of the approach rests on buying scale -- thus Enron supplies gas to many McDonald franchises, Duke supplies many banks.
Aside from cost savings, advantages are likely to be
- simplified billing
- easier invoicing
- improved information manipulation
Marketers can assist users in analysing their use and seeking economies by comparing this against benchmarks.
Beyond this tentative trend to aggregators getting into the act, there are real likelihoods that the future retailers to households will be supermarkets, banks and other institutions. These are skilled at handling large numbers of transactions, at obtaining goods and services at competitive prices and conveniently situated for bill paying.
CONVERGENCE
Water, electricity, gas and telecommunications have all been called "flowing-content businesses". All require seemless delivery. Once the conduit is in place, the delivered product can only rise above the pure commodity by the seller adding valuable features. Switching by smaller consumers is presently, in the UK gas trials, spurred purely by price. The same is true of the switching from host retailers that has been observed in NSW and Victoria with the larger customers.
But with integrated businesses, another dimension, convenience, is added.
Growing affluence brings a premium on quality. Consumers will pay for things that liberate their time. Telecommunications is the key. The telecommunications industry operates in digital and cyberspace. This means that mass customisation is cheap it means cheap metering and billing that is an integral part of marketing. In addition, the ducts and wires that water, gas and electricity businesses control offer pathways for telecommunications. And one particular feature, which may still turn out to be a mirage, is the possibility of selling electricity and other products with a service that, for example, allows remote lighting and heating controls.
The integrated bill will be one feature forcing convergence. It offers customers a single payment, offers marketers information to target other offerings, gives a one stop shop. Co branding is an aspect of this and it is significant that Solaris in Victoria is now simply AGL. Other Victorian distributors and their overseas shareholders are examining gas assets to be sole in Victoria later this year and several are seeking alliances with telecommunications businesses. EnergyOne which is franchised by the majority owners of United also seeks to offer an integrated system.
Integration offers both economies in the customer liaison, billing and liaison fields but also offers opportunities to build up better profiles of customers to match their needs more effectively. A great spur is the single bill.
Metering itself is an area already being outsourced. Whether or not we see integrated utility services, with smart meters that can be read remotely, the economics is certain to force the meter reading of all utility services to be done by one concern -- either it will be outsourced to an independent or one of the host retailers will perform the tasks for the others.
SUMMARY
We are currently seeing a massive boost to outsourcing as the privatised and competitive market is forcing electricity businesses to cut costs to remain competitive. The high prices paid for assets in Victoria and with the gas pipelines in South Australia and Western Australia are adding impetus to this process.
Much remains to be done even within conventional outsourcing. But technology and marketing innovations are likely to bring new frontiers for outsourcing. These will be driven by a combination of factors including:
- the need to avoid taking on in-house employees with the contingent costs this imposes on flexibility
- opportunities to make savings through sharing common facilities like call centres, maintenance and customer liaison
- sharing of transmission/distribution lines
- opportunities to offer improved services like a single bill
- the possibility of offering an integrated package of goods, especially where gas and electricity are concerned
- combining the use of telecommunications with energy services in ways that are not yet known
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