Week One Discussion 1

2012 ACADEMIC CASE STUDY SERIES

Managing the Network of Supply and Demand at AGL Energy

By:

Tim Coltman

Institute for Innovation in Business and Social Research, University of Wollongong, NSW,

Australia

Peter Reynolds

Center for Information Systems Research, Massachusetts Institute of Technology (MIT),

Cambridge, MA, USA

Frank Schlosser

Department of Information Systems and Services, University of Bamberg, Germany

Alan Thorogood

Australian School of Business, University of New South Wales, Australia

Council of Supply Chain Management Professionals

333 East Butterfield Road, Suite 140

Lombard, Illinois 60148 USA

+ 1 630.574.0985

[email protected]

cscmp.org

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Introduction

AGL Energy operates in one of the most fiercely competitive markets in the world. On the

supply side, real time energy production (coal, hydro, and wind) is traded in five minute

intervals across states with prices ranging from $25 to over $10,000 per megawatt hour. On the

demand side, the business is volatile with high customer churn rates and new competitive offers

in a largely deregulated environment. Customers are also becoming increasingly energy

conscious and concerned about high electricity prices leading to the installation of new smart

meters into homes to provide greater visibility and control over electricity usage.

As Chief Information Officer at AGL, Owen Coppage is responsible for supporting the flow of

information across the energy supply chain. For Owen, accurate and timely customer

information is key to customer service and retention, to increased accuracy of demand

forecasting, and to drive growth in supply and minimize market risk.

AGL Energy has grown by acquisition to be one of the Australian market’s leading energy

providers. However, its systems have been developed separately to meet the needs of diverse

business units one generates and delivers power and the other looks after customers.

Information was entered and stored in different ways in many different customer and billing

platforms. The haphazard arrangement of data and fragmented infrastructure meant that the

information technology (IT) systems at AGL were buckling under the pressure to meet staff and

customer expectations.

Never one to back away from a challenge, Owen knew that something had to be done to provide

better information to predict demand, manage supply and hedge against unforeseen weather and

other natural events. How can data be used more effectively to match supply with demand?

What role should the IT function play in improving the supply chain and managing risk at AGL?

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“Understanding our customer base is important to us, customer service and retention is critical.

Being able to accurately forecast demand is critical. Our customer base enables us to make

investments decisions about electricity supply. We have to be able to manage that volatility.”

- Owen Coppage, CIO AGL

AGL Energy

AGL Energy is Australia’s leading integrated renewable energy company and Australia’s largest

private owner, operator, and developer of renewable generation assets. AGL’s heritage began as

The Australian Gas Light Company which was formed in Sydney in 1837. It supplied gas for the

first public lighting of a street lamp in Sydney in 1841 and was the second company to be listed

on the then Sydney Stock Exchange (AGL annual report 2011). In October 2006, the Australian

Gas Light Company demerged its energy business and AGL began trading on the Australian

Securities Exchange. Today, AGL Energy is one of Australia’s top 50 listed companies with an

underlying net profit of AUD$431.1 million (FY2011). The company is structured into three

strategic divisions: Retail Energy, Merchant Energy, and Upstream Gas. The upstream gas

business is far smaller than the others, with operating earnings before interest and tax (EBIT) of

AUD$13.6m (as compared to AUD$373m for retail and AUD$378m for merchant). The

customer base at AGL for natural gas, electricity, and energy-related products and services is

over 3.5 million across New South Wales, Victoria, South Australia, and Queensland. AGL has

around 2,000 employees and its market capitalization is approximately AUD$8bn (as of October

2012). Figure 1 illustrates the company structure, with an expanded view of the operations

management function within merchant energy.

AGL Energy

Retail Energy Merchant

Energy

Energy Portfolio

Management

Power Development

Merchant Operations

Energy Services

Upstream Gas

Figure 1: AGL Company Structure (2011).

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The Upstream Gas business is focused on acquiring long-term gas assets for supply to power

stations and customers. Upstream Gas is a capital intensive business and a critical hedge in the

volatile energy market with interests in a number of companies. However, the Upstream Gas

division does not currently contribute significantly to AGL’s revenue stream and the

organization’s profit, and it represents a longer term investment in future gas supplies.

The Merchant business runs power stations, sells power through contracts and spot markets, and

buys power through contracts and markets. This is a high risk activity where considerable

importance is placed on ways to manage the risk of procuring and delivering gas and ensuring

that the supply of electricity is available for large wholesale customers such as BHP Billiton,

Santos, Esso, Caltex, and Alcoa. The merchant business also manages AGL’s compliance with

mandatory renewable energy targets, and controls the dispatch of owned and contracted

electricity generation assets that complement a portfolio of electricity hedge contracts.

Retail Business sells natural gas, electricity, and energy-related products and services to more

than 3.5 million customers. High rates of customer churn (approximately 26%) are

commonplace in certain regions of the national electricity market, creating strong pressures for

innovation and continuous improvement. The retail business at AGL has launched a number of

new services including: an online service “AGL Energy Online” which allows customers to set

up and manage their account in a similar way to internet banking; smart meters, which have

provided new opportunities for energy consumption analysis; and capabilities built to support

solar energy, which is anticipated to become more attractive as technology improves.

The vertical integration strategy shown in Figure 1 is critical to AGL to ensure that risks are not

disproportionally allocated. For example, if a downstream retailer lacks upstream capacity then

it becomes vulnerable and subject to wholesale price variability. Wholesale supply prices can

range from $25 to over $10,000 a megawatt hour at different times of the year. Alternatively,

when the focus is only on supply, the firm will lack the necessary earnings profile to raise equity

in the market or to support investment in additional capacity with low interest loans (based on

Standard & Poor’s debt rating).

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Energy Industry Supply Chain

The energy industry supply chain begins with the exploration and extraction of resources and

ends with the transport, residential, commercial, and industrial consumption. Resources such as

oil, gas, coal, uranium, solar, water, and wind are upstream. For electricity, a power station

transforms these resources into high voltage electricity. Gas production is a simpler process and

moves almost immediately from the gas field into the distribution network. Inside each town is a

grid of cables and pipes to distribute the power. Retailers sell the power to consumers and raise

bills to collect payments. At AGL the firm relies heavily upon the ability to retain its customer

base. The customer base provides the platform to make upstream investments in gas and

electricity generation. From a strategy perspective, the primary goals at AGL Energy are to grow

the customer base, achieve higher profit margins, and deliver superior customer service levels.

The division of strategic goals between upstream and downstream business operations is shown

in Figure 2.

Resources (e.g., coal, gas, thermal, solar, wind)

Transmission (e.g., gas, electricity )

Distribution (e.g., gas, electricity)

Retail Markets (e.g., gas, renewables,

electricity)

Upstream Supply

Increase direct ownership of gas to meet a

substantial proportion of AGL’s long term

domestic demand for gas

Invest in gas storage to provide security of

gas supply for our customer during periods

of peak demand

Increase control of base, peaking, and

renewable electricity generation to cover

critical risk positions in wholesale markets

while meeting customer needs and

mandatory, renewable energy targets

Downstream Customer Demand

Grow electricity and gas base

Expand the range of energy efficiency

services we can offer to our customers

to help them manage their energy

costs

Focus on managing and growing

margins

Figure 2: Upstream Supply and Energy Demand Strategy (Source: AGL Annual Report, 2011).

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Supply Chain Volatility

Uncertainty is a constant feature of the energy industry supply chain. Uncertainty arises at AGL

in many forms and operational performance never benefits from uncertainty. For example, the

merchant business is dependent upon the capability to validly forecast short- and long-term

demand. Profit maximization is dependent upon an ability to eliminate energy excess or

shortfall. In other words, it is dependent on the ability to align supply with the forecasted

demand. Electricity excess refers to capacity or contracts that the company owns or holds but is

not required by the market at any point in time. The capability to minimize excess capacity is

critical because electricity cannot be easily stored once it is in the grid. On the other hand,

electricity shortfall can result in a situation in which an energy company has to buy additional

electricity from the short term wholesale market at uncertain and volatile spot and contract

prices. Significant volatility in wholesale prices due to severe weather conditions, or a

breakdown in energy production or transmission can easily blow away any profits for a month.

In a service supply chain, managers are continuously required to make a trade-off between

avoiding excess capacity on the one hand, and circumventing any shortfall in production that

will require expensive wholesale contracts, on the other hand. To align supply and demand,

AGL collects huge amounts of data and undertakes advanced analysis to generate the insight

required for high quality decision making. For example, resource exploration and extraction

activities utilize highly sophisticated systems to minimize situations where excess capacity is

generated. This is achieved by forecasting energy demand based on weather and other historical

data on a daily and half-hourly basis. Mid- and long-term forecasts are also undertaken to allow

for a well-balanced match between supply and demand at all times.

In retail, uncertainty is centered on the customer. Customers have become increasingly energy

conscious and feel strongly that they need to do something about rising energy bills. Traditional

customer segmentation based on current energy use and demographics that have been the

mainstay in the energy industry will likely provide limited understanding about what the

customer of the future might look like. For example, the advent of electric vehicles could

dramatically impact the retail business as the homes of the future become charging or battery

storage points. Smart meters will offer enormous opportunities to manage demand. These meters

use IT networks to send consumption data every 15 minutes rather than the traditional reading

every three months. The increase in data will be significant, placing pressure on the analysis

skills within the business units.

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Data and Information to Support the Supply Chain

Energy companies rely heavily upon data and IT to support business activity throughout the

supply chain. For example, in both upstream operations and downstream retail, the business

units are heavily reliant upon access to data (e.g., energy consumption through meters, weather

forecasts). Equally important is the possession of capabilities to analyze data in an efficient and

effective manner. Figure 3 shows the real-time trading room at AGL that displays electricity

flows and prices across Australia.

Figure 3 – AGL Real-time Trading Room.

Not surprisingly, IT is a key enabler within AGL, providing the data foundation for a variety of

value-added services. However, the IT systems have grown in a haphazard way as the company

acquired new companies and their customers. At any one time, there were 12 to 15 different

customer billing platforms, the distribution business was not well connected and costs were

increasing. Service delivery and engagement by the IT department (a separate business within

AGL) was suffering.

“AGL had grown by acquisition, it had acquired customer bases and it hadn’t really

integrated any of those customer bases and its IT systems had grown almost in that

haphazard way as it acquired customers.”

- Owen Coppage, Chief Information Officer

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Move to a Single Billing System

In 2007, a major $200m IT transformation program, called Project Phoenix, was initiated to

migrate the retail and merchant business arms to a single billing platform. Expected benefits

included: a reduction in the high number of system outages, reduction in the number of back

office personnel, a consistent organization-wide database for all customer-related data, and

delivery of a single-instance billing platform. This transformation program was necessary to

meet AGL’s strategic goals of expanding the range of services to customers. In developing an

enterprise-wide data platform, AGL also recognized the need to develop a core capability

around governance and control of data. Phoenix was based on SAP software and operated on a

Microsoft platform. The basic technology services architecture is shown in Figure 4.

U se

rs R

e ta

il

B u

si n

e ss

A p p

li ca

ti o

n

In te

g ra

ti

o n

S e rv

ic e s

B u

si n

e ss

S y st

e m

s

Customers, 3PLs, Internal AGL Users

Phone Fax Mail Email Online

AGL

SAP

Client

Web

Client

Market

Hub

Retail Energy Systems

(Customer Relationship Management, Business Warehouse)

Messaging, Batch, Gateway Services

Business Systems and Databases

Figure 4 – Technology services architecture.

Further Consolidation of the Retail and Merchant Platform

A second major IT project worth $100m, called Spectrum, soon followed the Phoenix program.

This project was based on SAP technology. A primary function of the Spectrum program was to

deliver a platform that could collect, analyze, and use large data sets coming in from both retail

and merchant. Consolidation of fragmented IT systems is critical to better position AGL for the

challenges of an uncertain future. Leveraging a well integrated IT platform makes good business

sense.

“For the first time now we have two separate business units on the same platform.”

- Ken Hodgson, Group General Manager Retail Business

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Leveraging the Data–Role for Data Analytics

AGL has always been a data and information business. Data is used to manage customers and all

decisions within the business are based on data. Data and information are constantly gathered to

take a position on fuel contracts and to test propositions. Smart meters represent an enormous

explosion in the amount of data that will be available to AGL. For example, a smart meter gets

read every 30 minutes instead of one per quarter, resulting in around 17,000 reads per annum as

opposed to just four in the past. Hence, data is competitive gold for AGL, but the company

recognizes the need for appropriate governance controls to ensure data integrity, supported by a

data-driven culture throughout the supply chain.

“We have really given a lot of energy in recent times to smart meter analytics.”

- Anthony Fowler, Group General Manager Merchant Energy

“We’re a data and information business. It all comes back to data.”

- Glenn Page, Head of Service Management

Strategic Importance of Data and Analytics

As a business AGL competes in a commodity market. A commodity is considered to be a non-

differentiated product offering that holds few, if any, intangible components, and is sold

primarily on the basis of price. The core components of a commodity are well known, mostly

stable, and widely shared amongst competing firms. However, AGL is confident that there are

factors other than price that will enable it to differentiate itself in the market. According to the

Chief Technology Officer:

“A lot of that differentiation will be driven by data and the ability to manage and use

the data that is coming in from new channels such as smart meters.”

- Marc Anderle, Chief Technology Officer

Recent developments in smart metering infrastructure and the large amounts of data generated

enables energy companies to provide individualized data to customers in an appropriate way.

The capability to help customers better control electricity and gas consumption will be key to the

future competitiveness of AGL. Data is expected to play a key role in this area, leading to

significant investments into data analytics capabilities and corresponding IT systems.

Developing a data analytic capability will be challenging because, historically, the business has

not been terribly successful at making sense out of the vast amount of data that comes into the

company’s data warehouse systems.

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“At this point we are good at capturing and measuring the data but we really don’t

have a clear strategy at this point for how we will use the data to differentiate

ourselves. I don’t think anyone has got it right in the industry.”

- Marc Anderle, Chief Technology Officer

Building a data analytics capability is the one point of focus that AGL is trying to build. There

will be first mover advantages for those companies that can use “Big Data” to co-create value

with customers and improve industry performance. At the same time, Owen is aware that

investment in analytics can be a huge sunk cost unless employees are willing to incorporate the

data into what they do and think critically about the decisions that are being made on the basis of

data.

The changes in the competitive environment together with new opportunities (e.g., smart

meters), and developing the capability to make sense out of the vast amounts of data are critical

challenges for the AGL supply chain. The extent to which AGL Energy is successful will

influence customer satisfaction, which, in turn, will influence profitability.

If you were in Owen’s position, how would you go about delivering the tools needed

to manage a network of supply and demand?

Consider:

1) Why is it difficult to align supply and demand at AGL Energy?

2) What data challenges are facing the upstream (merchant) and downstream (retail) parts of

the business? In your answer, consider the core data required to manage the supply chain

(e.g., customers, usage, generation, prices) and the advantages and disadvantages of data

consolidation (merchant and retail) onto a single IT system/platform.

3) Why might it be difficult to move supply chain work practices to a data analytics

strategy?

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