This article originally appeared on Forbes.com.
Rising energy efﬁciency has ﬂattened demand for electricity, even as operating costs, living expenses and pension liabilities continue to rise. At the same time, utilities are investing to modernize their infrastructure and operations. And all of this is happening at a time when regulatory and competitive conditions make rate increases unlikely, while utilities still aim to deliver earnings-per-share growth of 4% to 6%.
The challenge is daunting. Analysis by Bain & Company indicates that over the next ﬁve years, North American utilities will need to remove more than $15 billion, about 20% of operations and maintenance costs, to meet earnings growth targets—and that number could grow if electricity loads decline.
Executives see the need, but many bear the scars of previous cost-cutting programs, which often panned out as mere deferrals of work or other one-off efforts. These limited successes have made skeptics of executives, who have come to believe that signiﬁcant cost reductions are impossible without sacriﬁcing reliability, customer satisfaction, safety or other aspects of operational effectiveness.
However, a few utilities are leading the way, showing how to operate while spending about 25% to 40% as much on operations and maintenance as their least-efﬁcient peers. And they get better every year, reducing administrative costs by about 1.5% annually.
So how can other executives learn from their success?
Lead from the top and set ambitious targets. The $15 billion that will need to come out of the North American utility industry will require cost reductions of 15% to 20% for each utility—on top of cuts already made. Senior executives will have already heard from their business unit heads that reductions at this scale are impossible without unintended negative consequences, including greater risk in key operational areas, lower reliability and the loss of vital talent. But the risk of not acting is even more daunting: Utilities will be unable to meet the necessary demands in infrastructure development and customer engagement unless they improve their cost performance.
Successful senior executives will approach the effort with a strong conviction that these reductions are essential, and that armed with industry performance data on costs and other metrics, they can lead their organizations toward the goal. Setting cost-reduction targets of 30% can help hedge against worsening ﬁnancial conditions, one-time costs, or implementation challenges such as delays in IT systems or resistance from regulators.
Identify root causes of cost. Questioning every expense, reexamining spending habits and viewing budgets from various perspectives—functional, organizational, resource type—can uncover new opportunities to reduce costs. Sometimes senior staff members continue to do work that could be more cost-effectively assigned to junior staff, simply because of time and grade promotions. Old reports and paperwork are often generated long after processes have changed and their value should have been questioned. Or, work is needlessly gold-plated: One utility’s IT organization treated all requests as urgent, spending millions of dollars to outsource work to expensive contractors in order to hit artificial deadlines.
To change behavior, senior executives may need only to push a bit harder. After holding operations and maintenance spending ﬂat for several years, the CEO of one North American utility believed that further cuts would be difﬁcult, if not impossible. But a 16-week assessment of cost-saving opportunities, applying some of these principles, revealed another $400 million available, a number that the line organization reviewed and validated.
Create momentum with early wins. While reductions in external spending on materials and services can be signiﬁcant, headcount reductions are also likely—which can be very difﬁcult for organizations. At one North American utility, executives focused ﬁrst on managing suppliers more closely and simplifying the organizational structure (primarily at the top) to reduce costs by 2% in one ﬁscal year. The changes were well received by the rank and ﬁle of the organization, which helped build momentum and conﬁdence to make the hard choices necessary to move closer to long-term reduction targets of 15% to 20%. They then identified redundancies in finance at the parent and operating companies, rationalized IT’s portfolio and invested in technology that boosted operational productivity.
As these programs unfold, executives should be evaluating longer-term decisions, such as whether to shutter uncompetitive assets, how to use capital to reduce ongoing operations and maintenance costs, and where to switch from archaic customized systems to standardized solutions that reduce long-term maintenance and upgrading costs.
Develop a long-term roadmap to build the right culture and team. Setting clear internal targets and holding teams accountable for results helps utilities build a cost-conscious culture that delivers continuous improvement along the lines of the 1.5%-a-year reduction demonstrated by the leading quartile. Successful programs transcend budget cycles and become a permanent part of the organization’s DNA. They are also an ideal learning platform for future leaders in the organization, and senior executives should view them as an opportunity to develop their talent pipeline.
No utility executive sees this as optional anymore; the trends are clear and the numbers unforgiving. Starting sooner is better than later, since it allows more freedom in cost-reduction decisions and taps greater enthusiasm than when one’s back is against the wall. Leaders have shown that taking a multiyear, cross-functional approach to reducing costs yields meaningful and sustainable results, while also building a lean culture focused on performance.
Jason Glickman and Joseph Scalise are partners with Bain & Company in San Francisco, and Pratap Mukharji is a partner in Bain’s Atlanta ofﬁce. All three work with Bain’s Global Utilities & Renewables practice, which Jason and Joe colead in the Americas.