Primer: Subscription Pricing for Regulated and Competitive Energy Providers

New Energy Pricing Constructs for the Subscription Era

Subscription pricing is pervasive. With examples in news, music, movies, internet service, and mobile phones—subscription offerings are seemingly everywhere but the energy sector. It is time to earnestly explore the value of adapting this pricing trend to the highly regulated energy industry. Guidehouse uses the term energy service subscription pricing (ESSP) to describe energy services that are priced to customers with a multiyear fixed bill. Guidehouse’s Energy Cloud Transformation team is developing a whitepaper that explains the drivers shaping new and innovative subscription pricing models and how those models may benefit the incumbent utility, the third-party retailer, and customers with distributed generation.

Why Subscription Pricing Changes the Game

The playbook for subscription business models is simple—convert short-term transactions into outcome-based, long-term relationships that create sustained revenue streams. Companies like Amazon, Netflix, and Verizon rely heavily on investments in customer data analytics to maintain and refine customer relationships and foster long-term revenue and growth.

To develop happy and loyal customers, energy providers should invest in technology to secure and analyze invaluable customer data. The next step is to leverage the data-driven insights into bundled lifestyle-based products that satisfy customers while growing revenue opportunities—similar to tech companies.

A subscription pricing framework applied to energy services can shift financial incentives from volumetric to customer-centric. Two options for implementing an ESSP model include:

• Cost of service ESSPs centered on an incumbent service provider

• ESSPs Service carriercentered on a third-party provider to enable it to offer a true energy service subscription plan

Both options, deployed independently, are viable. However, there are some benefits to parallel deployment. While both are intended to achieve the same outcomes of expanded customer choice, each option approaches the problem from a fundamentally different direction—one focused on embedded cost of service and the other on value capture. 

Drivers for pricing innovation encompass three principle factors: shifting customer preference, enabling technologies, and service provider evolution.

Shifting Customer Preferences

Customers are shifting their focus toward purchasing customizable products and services, with notable preferences for convenience and environmental stewardship. As a result, a growing number of industries are developing tiered offerings, with varying packages and perks, to meet changing customer expectations. Media companies like Netflix and Hulu evidence this strategy. Customers are also gravitating toward subscription-style pricing, as seen in Amazon’s success and other ecommerce companies. In fact, subscriptions have boomed across a range of industries.

Enabling Technologies

Technologies like machine learning and predictive analytics combined with infrastructure, such as fiber networks (or soon 5G), are driving new pricing constructs by lowering transaction costs and providing innovative ways for customers to acquire products and services. The energy industry is also seeing its share of new customer-centric technologies—such as advanced meters, smart thermostats, distributed generation—that yield greater customer choice, data, control, and satisfaction. Further, non-fuel-based production technologies like large-scale wind and solar have plummeted in price and offer zero marginal cost energy at certain times of the day.

ESSP will make some of the most innovative energy technologies accessible to the everyday energy consumer while allowing the provider to take advantage of low transaction costs, valuable data, and zero marginal cost energy, a win-win according to surveys.

Service Provider Evolution

From energy analytics startups to publicly traded rooftop solar companies, the players in the energy sector are evolving. European utilities are buying US energy storage companies, big tech firms like Oracle and Google are jumping into the space, and traditional oil companies like Shell are expanding into the sector. Both utilities and seasoned third-party energy providers are experiencing a major change, with increasing competition in the energy service space from new or traditionally non-energy focused companies. With innovation comes challengers, forcing incumbents to react.

This shift does, however, provide an opportunity for wires-only utilities to add a greater level of value by participating as network orchestrators to connect new service providers to the customer with service options. Meanwhile competitive service providers must scramble to arm themselves (as witnessed through recent acquisitions) with the latest software and hardware to meet customer needs. While creative destruction is generally a maturing process for an industry, the electric sector serves a foundational public interest that is infrastructure-heavy. Fair and accurate infrastructure pricing is a necessity in this industry and regulated rates must rapidly evolve to ensure social compacts are upheld. 

Cost of Service versus Service Carrier Pricing

Differentiating Embedded Cost Recovery and Value Capture

Cost of Service ESSP: A fixed monthly rate offered by the incumbent utility with revenue needed to cover the cost to serve this sub-class of customers.

Service Carrier ESSP: A real-time or sophisticated time varying multi-part rate linked to market cost allocation that a third party assumes when it takes over a customer’s bill.

An incumbent utility delivers cost of service ESSP in the form of a price, or set of prices, informed by customer preferences and the utility’s cost to serve. Enrollment requires customers to opt-in to a regulator-approved pricing agreement for services rendered, meaning they subscribe to their preferred energy service plan. While the plan may center on services related to energy, the pricing structure itself could include bundling with additional services like unlimited EV charging and renewable energy linkage. The price charged by the utility would cover its cost of service with symmetric financial treatment in the event of a shortfall or overage. 

For regulated utilities, the ESSP demands a laser-like focus to reduce a customer’s cost of service while not penalizing the utility financially or leading to improper cost shifts between customers. The utility will deploy measures that reduce customer demand at key times and/or have a high hedging value. Since the subscription offering is formulated in the regulatory sphere, measures would have to pass a cost test, such as a modified utility cost test, that takes into account how home upgrades reduce cost allocators from the cost of service study and/or wholesale markets. In other words, a utility can optimize which home upgrades they offer to ensure the subscription does not lead to improper subsidization for nonparticipants, meets the subscriber’s needs, and give the utility financial upside.

A third-party provider delivers a service carrier ESSP with services intended to capture value for both the provider and customer. Enrollment is similar to cost of service ESSP plans; however, instead of enrolling with the utility, the customer opts-in with a third-party provider. In cases where the third-party provider already has mechanisms in place for subscription e-commerce, avenues would already be in place to smooth enrollment. Cost of service would be communicated to the provider via a three- or four-part rate in line with wholesale market allocation methods and distribution of cost service study techniques. The customer’s current rate design would not be carried over to the third-party provider. For example, take a wholesale market where wire costs are allocated on a four-coincident peak basis. Currently, if a provider can take over a typical residential customer’s bill, wire charges would be assessed volumetrically each month. Third-party providers and new customer-sided technology have advanced to the point where simple volumetric rates are suboptimal and counter to new technologies like energy storage. Under service carrier ESSPs a third party could directly take over a customer’s bill with their consent and have access to true price signals (sensible consumer protection policies should also be in place to ensure proper handling of a customer’s bill). If the third party deploys technology to reduce the four-coincident peak wires charge on behalf of the customer, then on an ex-post basis they get to capture that value. In this arrangement it is crucial that the cost allocation method accurately reflects how cost are incurred or else one runs the risk of unjustified cost shifts.

Three Primary Stages to ESSPs in the Energy Sector

(Source: Guidehouse, Inc.)

Cost of Service ESSPs

Stage 1 Cost of Service ESSP Rate Structures: Yearly Certainty

Considered the base case, Stage 1 subscription rate structures have an established history of delivering value to involved parties. In the US, a multitude of customers are on tariffs with bills that are fixed for a year and then are recalibrated upward or downward at a set anniversary date to align a customer’s previous usage with their cost to serve. Georgia Power has been a leader in this space for over 15 years.

Stage 2 Cost of Service ESSP Rate Structures: Multiyear

Stage 2 ESSP rate structures involve multiyear fixed bills, adjusted after each rate-case cycle, and include moderate additions to base service offerings. Additional services may include smart thermostats and some energy efficiency upgrades.

Stage 3 Cost of Service ESSP Rate Structures: Enhanced Multiyear

Stage 3 ESSPs have longer-term fixed bills beyond the time between a regular rate-case cycle. This offering includes heavy onsite customer technology and control (e.g., programable and controllable thermostats, water heaters, pool pumps). Products and services outside the traditional utility offering can also be layered on such as home monitoring and smart appliances. Further, longer-term investments can be added to qualified customers for increased monthly premiums like rooftop solar or energy storage.

Service Carrier ESSPs

Stage 1 Service Carrier ESSP: Renewable Energy Credit Bill Swap

At stage 1, service carrier ESSP is usually simplistic, focusing on one or two aspects of energy service (e.g., supply and renewable energy credits). Arcadia Power, for instance, assumes a customer’s account while providing renewable energy options. Many third-party retailers/suppliers provide this service today for residential customers. This stage includes many wind and community solar subscriptions as well.

Stage 2 Service Carrier ESSP: Multiple Service Subscriptions

This stage provides more customer options, and for residential customers it provides third-party suppliers with a more sophisticated rate to manage as opposed to a flat volumetric rate typical of residential customers. Stage 2 would likely manifest itself through a volumetric time-of-use rate with an on-peak demand charge. In terms of subscription offerings, Inspire provides an example through its multiservice subscription model, known as the Smart Energy Subscription Model. It is a subscription-driven, flat monthly fee in exchange for an integrated smart home experience, energy management services, and a fully bundled/delivered renewable generation mix. Many third-party suppliers/retailers are here today for commercial and industrial customers. For residential, there is more and more progress and partnership in this space. For example, Arcadia Power recently partnered with Amazon and Audi to offer new product packages similar to Centrica Hive’s smart home offerings.

Stage 3 Service Carrier ESSP: Managed Service

Stage 3 involves third-party suppliers managing their customer’s usage on new rates in line with cost of service. For states like Texas with full retail competition, nearly all the pieces are in place for this to occur, except perhaps for the distribution rate on which a retailer’s customer accrues expenses. Although cost mismatch is not as large of a concern with most commercial and industrial distribution rate designs, simple flat volumetric distribution rates for residential customers expose a mismatch to cost of service-based price signals. When a supplier takes over a residential customer’s bill, much is the same as today except the underlying distribution rate is more advanced and includes demand-based price signals linked to the distribution company’s cost of service (e.g., 12 coincident peak charges). Next, the supplier/retailer would offer longer-term subscriptions like a stage 3 ESSP. Just Energy now offers both gas and electric service with multiyear plans, but underlying rates are still linked to the customer’s past rate design. Finally, this stage also encompasses customers that seek to self-generate. These customers should be on to the same advanced rates linked to cost causation and system cost allocation as third-party providers. Ex-post compensation (e.g., bill credits) based on actual system performance would be delivered to the distributed generation customer or aggregator acting on the customer’s behalf.

Concluding Thoughts

Cost of service and service carrier ESSPs bring balance to the customer and utility cost/risk swap. Both develop brand loyalists and compel utilities and energy service providers to use advanced metering infrastructure investments and take advantage of customer data to create value. The focus of subscription services will be on turning data about customers and system cost drivers into customer benefit. The ESSP puts the utility in a position to gain by lowering its customers’ costs of service, and service carrier ESSPs offer third parties access to pure price signals that have been off-limits for many customer classes in the past. With greater amounts of zero marginal cost electricity and lower cost demand reduction technology a new era in rate design can emerge to meet evolving customer expectations and preferences.