Building a Business vs. Controlling Costs

I missed this post from Lynne Kiesling last week but it certainly sounds a chord:

The cost saving-focused mindset has prevailed in regulated industries for over a century, slowing innovation in the process. In electricity, regulation that bases firms’ profits on cost recovery erects market barriers by recognizing only a business model that involves providing a specified product (110v power to the home) transported over a monopoly network. Even in 2011, well into the third decade of the digital revolution, this narrow focus and cost-saving mindset persists, and it fetters smart grid-enabled economic growth by emphasizing cost recovery and ignoring value creation.

In fact, one of the main reasons why smart grid investments face regulatory and political opposition is that focus on cost recovery (among others). I think this Greentech Media article gets the story right: the ways that smart grid investments can lead to cost savings are limited. We’ve discussed this idea here at KP quite a bit — a limitation on the benefits of transactive technologies and dynamic pricing is the fact that for most people, electricity bills are not a large share of their annual expenses, so even saving 15% on the electricity bill may not be a salient enough benefit to induce a lot of people to make technology investments. In other words, smart grid may or may not lead to cost savings for a lot of residential customers.

She then makes the argument that the better reason for smart-grid technology is value creation.

As I mentioned in another context last week, can anyone think of a company or an industry that propelled its way to greatness via cost control? I can’t.

6 comments… add one
  • I think there is a fallacy of composition in Kiesling’s argument, and mind you I usually tend to agree with here. Yeah, 15% per household isn’t much, but at the same time 15% off the domestic annual bill here in our service territory is pretty big, over $660 million using 2010 as a basis. Going for the whole customer group, and 15% is probably a bit too much to ask…, we are talking $1.67 billion. That is likely money that would be spent elsewhere too, for those of you who are into multipliers and what not.

    So while the savings for the “constituent parts” is relatively small, for the system as a whole its pretty hefty.

  • Also, I’m not totally persuaded by here “create value” argument. If anything the smart grid concept is piggy backing off of the development of the digital infrastructure that gave us the internet, smart phones, etc. It isn’t something “new” it is an application of an old technology. I can see integration of household electronics making smart grid better and there might be some increasing returns there, but, IMO, she has to do better than what she has in her blog post.

  • And to answer your question: Standard Oil.

    While Standard was also innovative Rockefeller was practically obsessive-compulsive about reducing costs…in fact that is what lead to some of the innovations.

    So chalk up an either-or fallacy there too.

  • sam Link

    I once read this story about Henry Ford. He contracted with a company to supply batteries for his cars. He stipulated that the batteries be shipped to the factory in wooden boxes of specific dimensions. Upon receipt of the batteries, the boxes were broken down and, lo, the constituent pieces were exactly the size needed for the floorboards in the cars.

  • I’m not claiming that cost control is not good or necessary. My point is that it’s not sufficient.

    Let’s look at Standard Oil a little more closely. Did it grow strictly through cost control? No. What might be termed war profiteering helped quite a bit.

  • War profiteering? Wha…?

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