Competition in electricity: New markets and new structures

mass production was the best w a y to manufacture large, standardized quantities of any product, whether it be automobiles, washing machines, television sets, or computers. Academic research concentrated on the undesirable side effects of mass production, such as m o n o t o n y and tedium (sometimes referred to as the "blue-collar blues"), not on redesigning the production system itself. Beginning in Chapter 3, the authors discuss the rise of lean production, the n e w approach to manufacturing that has shaken the mass production system to its very foundations. The system is based on two assumptions quite contrary to those used by U.S. auto makers. First is the use of labor. In the U.S., assembly-line labor has long b e e n assumed to be both unskilled and a variable cost. Unions emphasized job security in contract negotiations to minimize the effect of layoffs. In lean production, pioneered by Toyota and n o w used by virtually all Japanese auto makers both in Jap a n and their U.S. assembly plants, all laborers are assumed to be skilled workers and a fixed cost (no layoffs). Second is the use of machines. In the U.S., fixed or Detroit automation became the norm, w h e r e b y each machine was dedicated to performing a single task. Although this method optimized machine usage by minimizing setup costs, it also meant the buildup of inventory as parts m o v e d from one machine to the next. In the Toyota system, the same machine was used for several operations. This increased the n u m b e r of setups but reduced both the n u m b e r of machines needed and inventory holding costs for batches of parts awaiting processing. There was also a savings in labor, as production workers, not die change specialists, were utilized to do the setups. The results could be impressive: By the late 1950s, he [Taiichi Ohno, Toyota's production manager] had reduced the time required to change dies from a day to an astonishing three minutes and eliminated the need for die change specialists. In the process, he made an astonishing discove r y - i t actually cost less per 82

part to m a k e small batches of stampings than to run off enormous lots. (p. 53) In Chapters 4-8, the authors discuss the major c o m p o n e n t s of lean production, comparing each to its equivalent in the mass production system. These components are running the factory, designing the car, coordinating the supply chain, dealing with customers, and managing the lean enterprise. The entire system is designed to meet seemingly contradictory goals: pleasing the customer by offering a wide variety of models while reducing costs. The solution is to find a w a y to m a k e smaller quantities of a product without increasing cost. This is done by relentless dedication on the part of all employees to reducing costs. For example, inventory holding costs are kept to a minimum through the k a n b a n or just-in-time delivery system. Time spent retooling for a n e w model is reduced by starting to build major pieces of production equipment before the design of a n e w car has b e e n completed. As a result, about one-third fewer labor hours are required to produce a Japanese car than a similar American car. Can American automobile manufacturers learn the n e w techniques of lean production? The authors feel they can. Indeed, they conclude on an optimistic note, "the fundamental ideas of lean production are universally applicable anywhere b y a n y o n e . . , and m a n y non-Japanese companies have already learned this" (p. 9). Among U.S. auto makers, Ford has done the best job so far, especially with its very successful Taurus and Sable models introduced in the mid-1980s. In 1990 GM introduced its n e w car, Saturn, designed and built specifically to compete with Japanese e c o n o m y cars. Anyone w h o wonders w h y the United States is losing its competitive edge should find this b o o k stimulating reading. It gives substantial evidence to back up its contention that mass production is no longer the best method of production. Just as important, it explains the main premises behind both mass production and lean production, showing h o w each system is made up of m a n y interdependent parts, m u c h like an automobile itself.

The authors end with the provocative thought that lean production, taken to the extreme, would lead to a lot size of one, effectively returning to the craft production system w h e r e b y each car was m a d e to the buyer's specifications. References

Greg Gardner, "GM Wields the Ax: 74,000 Jobs Being Slashed, 21 Plant Closings by 1995," Detroit Free Press, December 19, 1991, p. 1A.

James P. Womack, Daniel T.Jones, a n d Daniel Roos, The M a c h i n e T h a t Changed the World. New York: Rawson Associates, 1990. 323 pp.

Competition in Electricity: New Markets and New Structures Edited b y James L. Plummer and Susan T r o p p m a n

The reviewer, Clark I~. aellings, is Vice President o f the Customer Systems Division at the Electric Power Research Institute, headquartered in Palo Alto, California. The electricity marketplace has always b e e n represented b y a secure, captive arrangement. Utilities built as m u c h capacity, and invested as m u c h capital, as they felt was needed. And, albeit with some difficulty, they raised rates to earn a sufficient return on the investments they made. A changing e c o n o m y and purturbations in the world price of oil led to increased pressures to change the marketplace. Plummer and Troppman, along with a star-studded cast of contributors, introduce the reader to changes in one part of the electric utility marketplace: electric-to-electric competition. They discuss the n e w players entering the game and h o w the rules are changing. The evolving electric-toelectric market will force utilities and Business Horizons / May-June 1992

other suppliers to stay ahead of their competitors. The book's primary contribution is to describe these changes, introduce the reader to the n e w players and n e w terminology, and reveal several opposing views as to what it means for the future of the U.S. electricity business. Unfortunately. the b o o k is n o w already two years old, and is based on 1987-88 data. The changes since then are equally as great as those b e t w e e n the first edition in 1983 and the second in 1990. Plummet theorizes that there are three kinds of electricity competition: 1) bulk p o w e r market competition a m o n g utilities; 2) regulator-initiated competition, such as the formation of non-utility entities with access to portions of the electric utility market; and 3) competition for large industrial and commercial facilities historically served by the utility that "owned" the franchise area (often called industrial bypass). P l u m m e t does an excellent job of segmenting the marketing a m o n g the traditional regulated utility sellers, Canadian sellers, cogenerators (both qualifying facilities and others), and independent p o w e r producers. He further describes the m o v e by some utilities to restructure and form business units or ultimately to separate the generation, transmission, and distribution related areas of their business. Plummer's m o d e l allows for the evolution of electricity competition to follow different paths in different states. He describes an evolution that implies near-open transmission access depicting cross-service territory competition of all types of diversified utilities with cogenerators and independent p o w e r producers wheeling to their affiliated utilities and to utilities and customers in other areas. The only minor failing in P l u m m e f s model is that he does not recognize that the potential change in electricity markets is likely to c o m e first from the gas to electric end-use competition and the environmental pressure to change h o w electricity is used. One of the best contributions to the b o o k is a chapter b y Denning and Mead. These authors discuss a study to assess the benefits and costs of public utility rate regulation. A numFocus on Books

ber of issues are addressed in this study. T w o of the most critical are: 1) Does state regulation cause electric p o w e r rates to be lower than without such regulation? 2) Do the important subsidies received by g o v e r n m e n t - o w n e d utilities (compared to investor-owned utilities) translate into lower rates? The most interesting conclusions are that state regulation has no significant effect on electricity rates, that investor-owned utilities do not have significantly higher rates than publicly o w n e d systems in spite of subsidies, and that only rates of very small residential customers m a y have b e e n held d o w n through regulation. Although the b o o k ignores growing retail electricity competition issues, it does highlight the needs of large

"The evolving electric-toelectric market will force utilities and other suppliers to stay ahead of their competitors." industrial customers to contain electricity costs. It suggests four actions these consumers are taking: 1. Increase political pressure to allow o p e n transmission access. 2. Establish alliances with nonregulated utilities to gain access to cheaper power. 3. Build p o w e r lines on private property to get around franchise rights issues. 4. Move to service areas with lower electricity cost. The b o o k includes an extensive review of competitive procurement principles for both supply- and demand-side m a n a g e m e n t (DSM) resources. For years now, third parties have b e e n used to help utilities implement DSM programs. However, bidding for DSM resources has b e e n a recent outgrowth of interest in supplyside and all-source bidding. To date, more than 20 DSM solicitations have b e e n developed. Though most of the issues raised in bidding programs are pertinent w-hen dealing with any contracted DSM, m u c h uncertainty sur-

rounds the future of third-party DSM. The b o o k describes such issues as the long-term viability of energy service companies, level of customer acceptance, and proper pricing of DSM. Only in the last five years has DSM bidding come into prominence as a significant means of meeting n e w utility resource needs. This development has resulted from the convergence of m a n y forces: increased concern about the environmental impacts of electricity production; d e v e l o p m e n t of new, more efficient electrical technologies; heightened interest and involvement in integrated resource planning; and a desire to app!y the apparent successes with supply-side bidding to DSM. Current DSM competitive procurement activities do not come from a vacuum, however. Rather, they have evolved from earlier forms of "shared savings programs" and "performance contracting," w h e r e b y third-party developers undertook DSM efforts with utility customers. Payment for such efforts was based on some measure of estimated or measured performance. Competitive procurements for DSM are currently being implemented with increasing frequency in various parts of the U.S. and Canada. They demonstrate enormous diversity in attributes such as project selection methods, approaches to integrating DSM with supply-side resources, and the relationships a m o n g the utility, third parties, and participating customers. Although the competitive purchasing procedures are m u c h more complicated than a simple auction, these solicitations are often referred to as DSM bidding. Competitive procurement methods for n e w generation resources are themselves relatively new; the same is e v e n more true of DSM procurements. DSM introduces a n e w and especially challenging set of considerations into the utility resource planning process. At the same time, utilities have b e e n using third-party contacting firms to design, deliver, and evaluate DSM since the inception of utility-sponsored DSM efforts. The use of competitive procurement to purchase DSM is an outgrowth of two recent trends in the electric utility industry. The first is the increased use of DSM programs to meet future needs of utility customers. 83

As utilities devote larger and larger efforts to demand-side programs, new ways of acquiring, producing, and delivering DSM services attract interest. Some utilities view DSM bidding as a means of uncovering innovative or unique bidding opportunities, while others see it as a way of leveraging additional human and technical resources for meeting their DSM commitments and goals. The book addresses DSM competitive procurement in the context of the overall integrated resource planning (IRP) process. Without delving into the technical details of IRP, it addresses the generic question of how much DSM to acquire, how such determinations are made, and the implications for the use of DSM competitive procurement methods. It discusses the concept of iterative resource planning, whereby the new information on resource price, supply, and technology introduced by bidding serves to refine the planning assumptions used in the prior IRP cycles. Some reference is made to the basic types of procurement in terms of the scope, the types of resources, the determination of the resource block, and the way in which competitively procured DSM and generation resources are integrated. Sections on Federal Energy Regulatory Commission (FERC) electricity competition initiatives and wheeling present an excellent overview of these complex issues as they stood in the spring of 1988. FERC's initiatives were based on the premise that restructuring the electricity industry to rely less on regulations and more on market forces to determine prices and capacity in the generating sector had significant potential for improving both the economic efficiency of the generating sector and' regulatory pricing policies in the transmission and distribution sectors. The contributors argue that this conclusion is based on the cessation of increasing economies of scale for generation that formed the basis for previous oversight regulation. Economic regulation of the generating sector may now, in their view, be more easily obtained in optimal amounts by market-energized and market-disciplined gencos (generating companies). 84

Existing transmission access allows a great deal of exchange. The country enjoys a reliable and efficient electric system based on voluntary exchanges. In his own contribution to this section, Plummet presents a neat paradigm for FERC activity in five topic areas, including: the need for policies toward Independent Power Producers (IPPs); identification and regulation of producers lacking market power; rate regulation of IPPs; utility ownership of IPPs; and the division of state/FERC jurisdiction. Contributions from the public power section include strong political arguments for open transmission access, without acknowledgment of the costs and complexity of wheeling power. Plummer concludes that competition can play a useful role in the electric industry, but he asserts that choosing competition over regulation in the policy arena can be a false choice. Given the industry's current configuration, regulation is essential for competition. Contributors highlight the actions already taken by utilities to permit open access to transmission corridors and examples in which utilities have allegedly refused to wheel power. There seems to be some acknowledgment that if systems are built correctly, mandatory transmission access will primarily result in a shifting of cost burdens between electricity users. To achieve real efficiency gains, the focus must be on the long-term constraints to increasing the level of economic exchanges and wheeling services (transmission bottlenecks, transmission pricing that allows incentives, and institutional/regulatory barriers). The last section of the book deals with some views regarding restructuring. It explores the allegation that by 1993 there should be only 50 major investor-owned utilities, instead of 150. It describes the break-up of utilities into business units and raises issues regarding any possible gains that result. The final chapter is Plummer's attempt to review the Electric Power Research Institute's (EPRI) inability to survive a competitive electricity market. Here in 1992, with EPRFs revenues, its market share, and its value to the industry at an all-time high, it is

easy to criticize his well-meaning descriptions of what he characterizes as the institute's inefficiency and inflexibility.

James L. Plummer and Susan Troppman, eds., Competition in Electricity: N e w M a r k e t s a n d N e w S t r u c t u r e s . Public Utility Reports and

QED Research, Inc., 1990. 612pp.

Airline Deregulation Edited by Kenneth Button

The reviewer, Michael W. Pustay, is professor of management and director of research, Center for International Business Studies, Texas A&M University, College Station. Few industries have been as radically transformed in the past ten years as the U.S. domestic airline industry. Few are likely to undergo more rapid change in the next ten years than the international airline industry. By the turn of the millennium, the international industry, which is currently typified by state-owned flag carriers w h o jealously guard their home markets, will likely be ruled by a dozen or so mega-carriers whose national identities will increasingly be obscured. The evolving revolution in the global airline industry can be traced to one event: deregulation of the U.S. market in 1978. Whereas most of the policy debate has focused on the impact of deregulation on domestic consumers, U.S. deregulation has also affected the competitiveness of American carriers in international markets, particularly through the development of hub-and-spoke networks. The growth of hubbing has affected international competition in at least two ways. First, strong domestic hubs confer competitive power in international markets just as they do in domestic markets, thereby strengthening the ability of U.S. carriers to compete for international traffic. Second, as a result of the hub-related domestic competitive failures, international operating authority has gravitated away Business Horizons / May-June 1992