Digitalization is the buzzword used to discuss many different developments in several sectors, often by mistake used synonymously with Energy 4.0, Big Data, Artificial Intelligence etc.
German Utilities changed their strategy in 2015
The electricity sector is also currently trying to move towards a digital business case, but under very specific circumstances. Till the early beginning of this millennium, energy business was dominated by long-term planning and long-term strategies accordingly. Due to high investment costs (e.g. in generation or network assets) and highly concentrated markets dominated by integrated utilities, a business case could be preserved over decades once it was established. This has changed, due to liberalization, unbundling and the diffusion of renewable electricity supply (RES). The traditional long-term business cases in generation (coal or gas power plants) were challenged by RES diffusion, with conventional power plants in Germany struggling to achieve the targeted return on investment (ROI). Liberalisation unleashed competitive forces in retail, resulting in reduced margins for the incumbents. Unbundling led to a more efficient regulation of the networks, reducing the annual rate of return from network ownership and operation. Incumbents from the energy business have had difficulties to address these developments within the last two decades. In Germany, the year 2016 was very important as the two largest energy utilities, RWE and E.ON, split up into different companies to address the challenges evolving from liberalization and RES diffusion. If you want to know more about the specific effects of these three developments on incumbents business in Germany, take a look at these papers here and here.
Digitalization: Will the utilities pick up this challenge or try to sit it out like they tried with RES?
Today, digitalization is the next topic that challenges the incumbents’ business model. You can say that the energy sector is at a crossroad again: Either the energy sector will be capable to be part of digitalization starting now, or it will again take decades till incumbents adapt to the new development, just as it took them 20 years to adapt to RES diffusion.
German Utilities have increased venture capital and acquisition activities since 2015
Which directions do Germany utilities take? Currently, we can find evidence for two scenarios. In scenario one, some incumbents are actively involved in the development of new digital business cases. For example, Innogy (the “greener” company that evolved from the split of RWE) has an accelerator program (Free electrons) hosted by its own innovation hub, they cooperate with startups like slock.it to apply – among other thing – the blockchain technology to the billing of electric vehicle charging. Other incumbents in Germany, e.g. E.On with the agile accelerator, develop similar approaches. Furthermore, large demonstration projects like the enera project by EWE try to develop new business cases based on digitalization. Actually, there is a lot movement in the energy business, which is why we will pick up the current developments in the startup sector in Germany in our next post on 30st March. For now, let’s acknowledge that incumbents have started some initiatives to address digitalization, at least when it comes to new innovation strategies to develop new digital business cases.
Cooperation with start-ups and innovation processes are one important aspect of the digitalization process. Currently, implementing new innovation processes is a hot topic in energy companies due to prominent examples from other sectors where new digital business models (uber, AirBnB etc.) currently challenge, in some cases even disrupt, existing business models. Recently, GTM published a report claiming that utilities in the US and Europe have invested about $3 billion into renewable energy-related businesses. Among these investments are probably some digital business models as well. These initiatives make us optimistic about the energy incumbents’ willingness to address digitalization from the beginning.
Smart Meter Roll-out: 10 years for 10% of connected customers – is this pace fast enough in the age of digitalization?
If we go beyond the initiatives addressing innovation processes, the picture becomes less optimistic in the case of Germany. Let’s for now focus on the backbone of digitalization in the energy sector, which is smart metering. While some European states (80% rollout in Sweden and Italy) as well as the US (50% of all households) and Canada (full rollout nearly completed) have already finalized a full rollout or at least supplied more than 50% of customers with smart metering, Germany is taking it slow: it will take 10 years for only 10% of the connected customers.
In Germany, the smart meter rollout starts this year. Only larger electricity consumers with an annual demand of more than 6000 kWh will be equipped with smart meters. Furthermore, all electricity producers above 7 kW will be part of the smart meter roll-out as well. According to the government’s roadmap this rollout will take till 2028. In 2028 about 10%-15% of all network users will be equipped with intelligent metering systems. Till 2032 all other households will shall be equipped with modern metering systems that can not communicate data outside the households. While one decade used to be a common timeframe for strategic planning in the electricity sector, it is quite a long shot in the digital world.
Obviously, there are many (good) reasons why the Federal Government in Germany did not support a full and faster rollout. A detailed cost-benefit analysis (which is required by the EU from each member state) did not show a huge potential for benefits that can be achieved by smart metering in Germany. Importantly, in Germany smart metering is divided into two categories: Intelligent metering systems (smart meters with a standardized interface to exchange data with external parties) and modern measuring systems (smart meters that are not able to directly communicate with external parties). While the latter are quite cheap systems (maximal annual costs of around 20 Euros in Germany), intelligent metering systems can be quite expensive (between 100-200 Euros per annum).
If we take a closer look at the numbers, the main hurdle for smart meter roll-out in Germany gets very obvious (calculations are only illustrative): On average, a German household consumes roughly 2850 kWh annually. If we take into account that the price per kWh equals about 29 €cent/kWh, then a German household spends roughly 830 € annually on electricity. Therefore, a business case based on smart metering needs to recover at least 3% (in case of a modern measuring system) or more than 10% (in case of an intelligent metering system) of the average electricity bill to recover the costs for the smart meter infrastructure. For now, it is not clear which business case could cover these costs. Therefore, it seems reasonable why Germany focused on the larger electricity consumers, where the annual investment costs for intelligent metering infrastructure are rather low compared to the total costs for electricity consumption.
From this we can derive three obstacles for the digitalization in the German electricity sector:
- Only large consumers (and small producers) will have the equipment to participate in digital business models
- Even these large consumers will only be equipped till 2028 with the necessary smart meter infrastructure
- The annual costs of 100€-200€ for the smart meter infrastructure will be relatively high in Germany (compared to for example 25$/a in the US), which increases the customers’ expectations for high returns from any digital service or product to recover these costs.
As a result, the potential for digital businesses to enter the German energy sector is not very promising. This seems to be true at least for those digital companies that require smart meter data for their business case. Compared to other markets like the US, Canada or Italy, Germany might offer less attractive conditions to new companies, at least for now.
However, that does not mean that digitalization might not prosper in Germany: So far, our analysis focused on the smart meter rollout required by the government but there are three things special about the German smart meter model that might support digitalization by making customer data available after all.
- The metering market in Germany is market-based, allowing every interested party to enter the metering business (i.e. to become a meter operator) if they like. In addition, the German market for meter operation along with the UK market is the only one in Europe not being limited to the regulated DSOs.
- While the mandatory intelligent metering system roll-out focuses only on 10 % of the market, the German law allows every metering operator to provide their customers with modern measurement systems as well as intelligent metering systems, as long as the annual costs do not exceed the limits defined by law. So if a company has a business case, it can provide their customers with metering systems. We know from other digital platform businesses, e.g. amazon, that the platform providers are willing to sell hardware for prices lower or at least not above production costs. Rather, platforms like amazon or google have different business cases that require access to consumer data. Companies with similar business models for electricity consumption might start a market-based rollout of intelligent metering systems or modern measurement systems on their own. If companies start the voluntary roll-out of smart metering infrastructure, then we can refer to the rollout defined by the government as the indicator for the lowest limit for the rollout, while market parties are free to extend the rollout under the limitations defined by law.
- A meter operator that sells a modern measurement system to its customers needs to secure that the data from the measurement system is externally accessible via the standardised interface (smart meter gateway). It is possible to use one smart meter gateway to access a larger number of measurement systems, which offers potential for cost reduction.
Together, these three aspects open up a window of opportunities for digital business cases supporting the digitalization of private electricity consumption. Actually, it seems possible to us that the “non-mandatory” market for smart metering might play a huge role in the digitalization of the energy transition. Why that is? It’s because of platform-economics.
Most digital business models that currently challenge global markets are digital platform businesses (Facebook, AirBnB, Uber, Amazon, Google). One aspect is especially relevant for the success of digital platforms: positive network externalities.
„Positive network externalities arise when a good is more valuable to a user the more users adopt the same good or compatible ones. The externality can be direct (a telephone user benefits form others being connected) [...]. It can also be indirect; because of increasing returns to scale in production, a greater number of complementary products can be supplied – and at a lower price – when the network grows [...]” (Tirole 1988, 405).
We all know from our daily experiences that digital platforms are most valuable for us, if we can access a large community or dataset via the platform. This is true for Facebook or Google, but also for other platforms, e.g. ResearchGate, which brings together researchers from all around the globe. Importantly, most platforms are multi-sided, meaning that you attract more customers, the more suppliers you have, which again attracts more customers, which leads to an increasing number of suppliers etc.
When it comes to the digitalization of the electricity sector, positive network externalities might be the game changer. Our thoughts about smart metering in Germany in the above part of this post revealed that it will get difficult to attract enough customers who provide their data to a platform, basically because the market is quite small (only 10% of all network users will have an intelligent metering system in 2028). However, the “non-mandatory” market for metering systems might offer the potential to attract such a large customer base, so that a platform might prosper. This potential can only be exploited if there are services or products offered by the digital platform that offer real additional value to the customers. So far, businesses in the digital landscape are still searching for this service. Nevertheless, with the “non-mandatory” market there is a chance that digital business models (e.g. in form of platforms) might evolve within the next years, while this is less likely for the mandatory market, just because of its size. Whether or not this last statement proves to be right remains to be seen. Even the mandatory-metering market might offer enough potential for digital business models, but then for a smaller market (with higher electricity consumption).
Digitalization beyond smart metering: What could happen within the next 10 years before the smart meter rollout is finished?
Importantly, the discussion above focused on the existing technology that is applied today for smart metering and the resulting data exchange. However, we need to keep in mind that new technologies are on the rise that might alter within the next ten years, e. g. technologies to exchange data on energy consumption or production in the future. Two trends might change the whole digitization process in the energy sector: Artificial Intelligence (AI) and the blockchain technology. While AI provides a new interface for the customer to interact with different services provided via internet, the blockchain technology changes the way we exchange data and execute transactions. We do not know yet whether, when and to what extent these technologies will enter the mass market. Still, imagine how user experience will change with AI. We could think of a system in which AI learns to meet your preferences with respect to energy consumption and the willingness to pay for this service. Based on this knowledge, the AI could make it very convenient for you to actively participate in the data exchange and related services, like flexibility provision from your photovoltaic power plant, battery storage, heat pump or electric vehicle, to an extent that we do not imagine today. Additionally, blockchain technology offers the potential to operate a distributed data exchange system that executes transactions within seconds at low costs. Based on the blockchain technology, micro-transactions could become profitable within the future, allowing us to exchange and trade energy on a local level, e.g. with our neighbours.
Discussing the potential of these technologies for the energy transition and digitalization in the energy sector in general is beyond the scope of this post. Still, we should keep in mind for further discussions that – within the next 10 years that the German energy sector plans for the smart meter roll-out – many things might change in the digital realm, even in the metering technologies themselves (e.g. based on blockchain).
Utilities in Germany are standing at a crossroad: Will they accept the challenges that evolve from digitalization and strive to adapt to these requirements? Or will the utilities apply the same “wait-and-see” strategy as they did with renewables? We discuss different aspects in this post that support both scenarios. On the one hand, the utilities engagement with startups as well as their new acquisition policy make us optimistic that they are willing to pick up the challenge of digitalization. On the other hand, the long-term planning for the smart meter rollout in Germany that aims at 10% of all customers till 2028 indicates that the industry wants to take it slow with the digitalization process. However, digitalization often changes how we do business within several years, not decades. Planning in decades might therefore not be the right strategy for digitalization in the energy sector, at least as long as you want to be a part of this process. We will see how it turns out and which way the industry in Germany will take. For now, the incumbents are standing at the crossroads and are taking a look in both directions. Which one is it going to be?
What are your experiences or expectations concerning the digitalization of the energy sector in Germany?