Utilities are standing on what they describe as a burning platform, where their once-regulated monopolies designed around selling more of a necessary good are facing technological change and potential upheaval in their strategic goals.
It is, however, still often the regulators rather than customers that are driving the latest wave of interest in external innovation and corporate venturing by electric, gas, water and phone utilities. Cultural barriers mean there have been few long-term, committed corporate venturing divisions in the sector, with most created and then effectively wound down within a five-year period.
Telecommunication operators have moved furthest to embrace corporate venturing and engage with their smaller customers. They make up the majority of the 40 most influential organisations managing in aggregate more than $4bn, as analysed by Global Corporate Venturing. Korea Telecom leapt in the past month to near the top of the list by dint of the sheer size of its venture.
At KRW1 trillion ($830m) to invest to support the development of smart phones and keep Korea’s telecoms equipment companies and nascent support network supplied with risk capital, it is the largest corporate venturing fund announced for a decade.
Few utilities’ venturing units survived the implosion of this dot.com bubble after the millennium. These survivors include venturing units at France Telecom (Innovacom) and Bell Canada (Summerhill), which have been operational since the mid-1980s after the phone industry was one of the first to start to be deregulated and face the impact of the internet and digital revolution on technology providers.
However, energy companies and electric utilities had been among the organisations in the first iteration of corporate venturing in the 1960s and Centrica (under its previous name of British Gas) also set up a £30m venture fund in 1986 as a result of its privatisation by the UK. The fund returned a profit but Centrica said its current minority investments were funded from its balance sheet.
Despite being backed by stolid businesses investing in infrastructure projects over decades, both energy and telecom utilities’ corporate venturing units have traditionally been highly procyclical.
The phone sector was part of the technology, media and telecoms (TMT) bubble of the late 1990s that burst after the millennium and led to a retrenchment in venturing activity.
The procyclicality of the energy sector has also been surprising as all of the energy sector corporate venture capital funds had strategic goals as their main reason for being launched between 1999 and 2001 (see table).
Between 2003 and January 2006, 11 of the 13 energy utilities’ corporate venturing funds in Europe and the US were either spun off, not actively investing or had been closed down altogether, according to the academic paper
Why corporate venture capital funds fail – evidence from the European energy industry’*, by Tarja Teppo, co-founder of Cleantech Invest in Finland, and Rolf Wüstenhagen, Good Energies professor for management of renewable energies at the University of St Gallen in Switzerland.
The academics added this indicated "a significant failure rate" and followed previous research showing electric utilities as having a strong organisational culture that is more conservative than other industries and so potentially stifling innovation.
This "sudden death syndrome" came about five years after most of the units had been founded, between 1999 and 2001, according to the academics, who said their qualitative research suggested parent firm organisational culture was an overlooked factor in the relatively high failure rate.
Academics said it was not that incumbents lacked creativity and ability to invent new things, but rather it was "the inertia of past actions, the stifling effects of bureaucracy, and the inflexibility of collective mindsets that inhabit large firms" (see related content – why corporate venturing funds fail).
The stifling corporate culture towards innovation and corporate venturing has also been seen in cuts to internal research and development (R&D).
Investments into energy R&D by US companies fell by 50% between 1991 and 2003 and in aggregate was less than the comparable budgets of individual biotech companies, such as Amgen or Genentech.
Teppo and Wüstenhagen said the energy sector had not perceived innovation and quality to be the main competitive factors but mainly concentrated on market power and price as the important factors, obtained by the economies of scale, and so during the previous decade had an average of their direct R&D expenditure as a proportion of production of less than 1%.
In telecoms, a fall in R&D over the first half of the decade was reversed in the second half, according to academics and a survey of 327 companies in the sector by the Economist Intelligence Unit two years ago.
Though some telecoms utilities continued to invest through the economic cycle, most venturing groups have only in the past few years started to recover after rethinking their strategies.
Omeer Chohan, chief financial officer at Summerhill Venture Partners, which became independent in 2006, said Bell Canada had run its venturing operation, originally called BCE Capital, in different forms since 1987 but in the mid to late 1990s it invested in later-stage deals where independent venture capital (VC) firms led the rounds and decided term sheets.
He added: "This was fine then, as all ships [the valuation of portfolio companies] were rising but became a problem after the [TMT] bubble burst when it became clear the corporate venturing funds were not close to the portfolio company or had board seats.
"So Bell looked to change to a traditional VC model after 2001 and brought in Gary Rubinoff [managing director at Summerhill] who hired the team here now. BCE Capital became a long-term career, rather than a revolving door of R&D people, and compensation in line with a VC’s. Through the change, Bell still had its eye on innovation and gained financial returns."
In 2006 there was a further change, as Bell became the sole strategic investor out of a number of limited partners (LPs) in Summerhill’s $175m fund it raised after becoming independent and being renamed from BCE Capital.
Although Bell had reduced its financial commitment, as the BCE Capital team had managed about $200m to $250m, Chohan said, it retained its close links between the venture capital team and Bell’s business unit senior and vicepresidents.
This model of managing venture investments through an independent manager has been followed by other utilities, although the majority, such as Bharti Airtel Innovation Fund, Swisscom Ventures, T-Venture and DTE Energy, are managed in-house. Korea Telecom is using independent VC Woongjin Capital to manage the $830m fund it launched last month.
Novusmodus acts as the investment adviser to Irish utility ESB’s €200m ($261m) venture fund. And Nuon, a Dutch subsidiary of Germany-based energy group Vattenfall, set up a €40m independent VC, Yellow&Blue Investment Management, in 2008.
Albert Fischer, managing director of Yellow&Blue, said it would start to look for other LPs in its fund having completed a number of clean-tech deals, including an investment in generator Tri-O-Gen last month.
Although Nuon was its sole LP currently, Fischer said Yellow&Blue had been set up with an independent board and investment committee above the investment team he managed.
The unusually strong corporate governance at a VC firmmeant Nuon, which has its staff on the committees, retains oversight without imposing its culture of a large organisation.
Fischer said Nuon needed to find innovative, clean technology as it was committed to being carbon neutral as a company by 2050 (30% by 2025), as encouraged by the European Union’s Renewable Energy Directive. This push to energy efficiency and renewable sources of power requires building the infrastructure over the next few years, he added.
Scott Smith, accountancy firm Deloitte’s clean-tech leader in the US, said after he had worked for 15 years with utilities some still had no interest in renewables and conservation as their regulator and customers wanted to keep the price down. This was no different from 20 or 40 years ago, he added, but in other states, such as in California, the regulator was pushing change and renewables (see illustration).
He said: "Utilities do not do anything unless the regulator is on board, and some regulators are now worried utilities will not hit their renewables targets fast enough. This means some regulators are allowing utilities to invest in venture capital to ensure start-ups succeed. Utilities can make investments, offer contracts at prices above market rates or be a customer and buy equipment.
"However, it is a difficult model dealing with a regulated utility and entrepreneurs – frustrating for both sides as there is a culture clash, which is leading power utilities to hire from telecom operators which have already undergone a transformation, and restarting their corporate venturing programmes."
One of the best-known moves from telecoms to energy utilities has been Peter Darby, head of California’s PG&E, who joined as chief financial officer – having previously worked at Advanced Fibre Communications and Pacific Bell – before being promoted in 2005 after the power crisis. In December, PG&E relaunched its venture division, which had been originally started in the 1999 to 2001 bubble era, and in May renamed it Pacific Energy Capital.
Utility companies that have set up venture divisions are backing internet exchanges for oil, gas, and power, online utility bill consolidators and alternative energy sources, particularly fuel cells and other types of distributed power generation.
But the Teppo and Wüstenhagen paper said: "The large electric utilities have a strong hold of their customers, but not on energy technologies.
"They are in the business of generating and supplying electricity, but they are not in charge of bringing new technological innovations to the energy sector."
This view was summed up by one VC, who told the academics: "[Energy technology companies] are the ones that ultimately are much more focused on innovation [than electric utilities] because they know how to absorb it and turn it into a value proposition."
US-listed conglomerate General Electric last month announced a €200m corporate venturing fund to work with four VCs to invest in smart-grid companies, while a number of its peers, such as Robert Bosch, Fluor, Dow Chemical and Siemens are also investing in the area from their venturing funds.
The groups are often LPs in independent VCs as well, with Teppo and Wüstenhagen noting Ballard, BASF, BOC, Boeing and Mitsubishi had been investors in Canadabased Chrysalix’s fuel cell fund.
Corporate venturing units are an increasingly important part of clean-tech venture consortia. Boutique consultants Cleantech GroupT and Deloitte said corporate investment reached a new high of $5.1bn in the first six months of the year, a 325% increase from the same period last year.
Intel Capital, GE Capital, Shell, Votorantim, Alstom, and Cargill Ventures all contributed, the latter two for the first time publicly, in the 10 largest clean-tech deals of the second quarter. In total, clean-tech venture investment was $2bn across 140 companies between April and end-June, up 43% from the same period a year ago.
Smith said: "The significant strengthening of corporate and utility investment into the clean-tech sector, relative to 2009, is very encouraging, given the role they will play in enabling broader adoption of clean technologies at scale.
"US utilities are increasing direct investments in wind and solar due to improving cost scenarios, favourable tax credits and incentives, and evolving pressure to meet renewable standards.
"Meanwhile, the largest global companies are seeing the business case for operational clean-tech integration, leading to record corporate investment.
This uptick was driven by companies looking to improve energy efficiency and reduce carbon emissions in order to reduce operational costs, mitigate energy price volatility risk, drive sustainable growth, and comply with existing and pending regulations around carbon and climate change risk disclosure."
Business model changes in power utilities, therefore, could follow the pattern set in telecoms. The Economist Intelligence Unit survey of telecoms bosses in 2008 asked:
"Has your company revised its revenue model over the past two years, or does it plan to do so within the next two years, to reflect the rapidly changing telecommunications landscape?" Forty percent had already made changes and a further 27% expected to do so by the end of the decade.
Technologies, such as voiceover- internet protocol, have been used by software company Skype and others to encourage the shift from fixed line to mobile data, voice and video services and undercut traditional revenue streams (Swisscom Ventures profile).
For other utilities this would be a substantial shift as even five years ago the perceived wisdom uncovered by Teppo and Wüstenhagen’s survey was: "There is very little an electricity company can innovate on because ultimately they are just in the core business of selling electrons. And there are no big changes that have happened … since the beginning of the last century that have really changed the way that wholesale power has been delivered to customers."
Five years after this interview by Teppo and Wüstenhagen, homegenerated renewable power, smartgrid technology and energy-efficiency have affected utilities thinking. Utilities are starting to worry that their link as incumbent utility to the end customer could break, as it had in telecoms in the move from fixed to mobile phones.
E.On, which is looking at other ways to discover external innovation having closed its corporate venturing unit, last month said it was now grappling with the "classic burning platform" issue of how to earn money despite asking customers to use less power (DTE Energy Ventures profile).
Smith said California last July had grasped this issue of "decoupling" – delink usage from revenue – by offering utilities a set revenue but where the customer pays more for greater use (with the extra revenue parked in an escrow account) and incentives for conservation and investing in infrastructure.
Thirty US states now have renewable standards while, elsewhere in the world, China is regarded as moving aggressively to promote cleantech even as Germany has scaled back some of its pricing tariffs to promote renewable energy, such as solar power. California, through its established VCs in Silicon Valley, remains a top innovation area in clean-tech and telecoms.
Liz Kerton, co-founder of the networking group Silicon Valley Telecom Council, said: "Operators that are actively engaged with entrepreneurs have people on the ground here in Silicon Valley. They are scouting for new products and services for the networks, ventures, business development and strategic alliances and R&D."
However, this meant that more investment in innovation by carriers was not necessarily seen in dollars provided to start-ups between 2007 and 2009.
Kerton said during the credit crunch VCs "turned down flat any start-up wanting to work inside a carrier in favour of those that could go to market by circumventing the carriers, such as app stores or equipment sales sold directly".
She added: "This was because working with a carrier means taking a long time, up to 18 months, to get to market because of the time taken in testing that would have potentially meant the venture funding would have run out.
Then there is the issue of carriers taking companies in for trial and not testing and they are tough to work with as they want five-nines [99.999%] uptime, whereas entrepreneurs say ‘that will be good enough’. VCs only came back in Q2 as wanting to work with carriers."
However, she recommended initially working mid-ranking, so-called tier-two, phone companies as "they have been most aggressive in adopting new technologies and trialling entrepreneurial products" compared with tier-one operators that "might have a venture fund but is hamstrung unless product groups sign it off".
In other utilties Teppo and Wüstenhagen found there was a tendency for them "to really only want to work with more mature companies and not with companies that they are concerned would disappear," unlike the healthcare or information technology sectors (Ostara case study).
However, Georg Schwegler, managing director at T-Venture, Germany-based Deutsche Telekom’s corporate venturing mdivision, which is the most influential corporate venturing group in the utilities sector, said its strategy was adjusting as VCs in the sector shrank.
He said: "In the past we looked to co-invest with VCs in series B and C rounds but recently that has changed and now we are also looking into earlier stage deals and taking the lead if we get positive feedback from a business unit, especially in Germany where there are not many VCs.
He said T-Venture remained focused on supporting its core business units with investments into start-up companies that bring strategic value to these business units.
Schwegler added: "The first generation of funds had not a synergy with business development while the third generation of funds has 80% of portfolio companies having a business relationship with Deutsche Telekom. This is the engine of our success.
"Our existing funds made new deals even in the crisis [T-Venture made 10 investments last year and 19 in 2008] and there are still very valuable assets in our old funds.
But even a two-times return on our investment is small money to Deutsche Telekom so of more importance is to find the right deals for the network."
* Why corporate venture capital funds fail – evidence from the European energy industry, World Review of Entrepreneurship, Management and Sustainable Development, Vol 5, No 4, pp353-375