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Category: COST OPTIMIZATION On the eve of deregulation, Carolina Power & Light plugs away at its cost structure, with startling results.
Russ Banham, CFO Magazine
October 1, 1999
When Carolina Power & Light Co. (CP&L) unveiled its new customer-service center in 1996, a component of the Raleigh, North Carolinabased utility's monumental cost- cutting initiative, it never expected such a challenging test. "We introduced the customer call center on the eve of Hurricane Fran," recalls Glenn E. Harder, executive vice president and CFO of CP&L, with $3.13 billion in 1998 revenues.
Power outages caused by the storm, which ravaged the Carolinas, resulted in a flood of customer calls. The new service center responded efficiently, pinpointing exactly where the problems were. "In the past, we'd have had a service technician driving around for hours trying to figure out the source of the outage," Harder says. "The new system was able to diagram within seconds the most likely location."
Altogether, the centralized customer-service center has saved the company $4.5 million annually since its introduction, allowing CP&L to close the 37 local service offices that previously performed this service. The cost- saving initiative is just one of the many similar prudent decisions that have cut operations and maintenance (O&M) costs 12 percent, or $90 million, from 1996 to 1998, and fulfilled CP&L's stated corporate objective: "To exceed our customers' expectations while reducing our costs to serve them."
Few industries, after all, are as pressured to reduce costs as the rapidly deregulating utility industry. "This is the challenge for companies like CP&L, which spent a lot of money building its generating assets--high- dollar investments like nuclear plants. If the market went immediately to competition, many of them wouldn't be able to sell their basic product, electricity, at a price that would recover their fixed and variable costs," says Jay Dobson, electric utility research analyst at Donaldson, Lufkin & Jenrette Securities Corp.
In short, CP&L and other utilities "would lose a lot of money," Dobson explains. "Although North and South Carolina have not yet moved to free and open competition, Glenn and CP&L have moved purposefully to cut costs, yet keep earnings growing. Not all utilities are as fortunate. [Glenn's] success in this regard sets him apart." It also won him this year's CFO Excellence Award for Cost Optimization.
CP&L delivers electrical energy to more than a million customers across 30,000 square miles of North and South Carolina. In 1997, William Cavanaugh III, the company's chairman, president, and CEO, set an ambitious target of doubling net income by the end of 2001. Such growth, however, could be attained only with simultaneous expense reductions. "The product is a commodity, so the business comes down to the quality of our service and our costs," Harder says.
To prepare a reengineering of functional operations, the 48-year-old Harder began by benchmarking other utilities in late 1995. The effort, which was guided by UMS Group Inc., a Parsippany, New Jerseybased management consultant, indicated CP&L had to reduce costs by more than $80 million to rank with the top performers in its industry. The benchmarking also identified variable performance among departments and processes, he adds. "IT spending, for example, was high relative to our revenues -- about 3 percent in 1995."
To get the house in order, says CEO Cavanaugh, "Glenn established a game plan for the three years ending in 1998, in which we would enhance our various operations and maintenance functions to be in the top quartile compared with other investor-owned utilities."
The plan called for systemwide cuts overseen by each department. To motivate employees, CP&L developed three compensation programs triggered by departmental cost cuts below budgeted figures. These included an employee incentive compensation plan expected to pay out $13 million in 2000, a 401(k) matching program that paid out $8 million in 1998, and a management incentive plan that paid out $5 million last year.
"Glenn was the architect of the entire cost- cutting strategy and related incentive plans," says Ruth Landers, a financial projects manager. "He was also a significant force in cutting costs in his own department by about 51 percent in 1998. He set an example."
"Altogether, we saved $100 million in the three-year period," says Cavanaugh, adding, "Our employees were instrumental in redesigning their work processes to absorb less cost."
One of the main focuses of the effort was in information technology. Beginning in 1996, for example, all local area network and desktop operating systems were replaced by a centralized corporate infrastructure for desktop computing. The yearlong project required the migration of 6,500 workstations to a standard Microsoft Office Suite. "We elected not to modify software to fit different work processes, but to modify work processes to fit a standard software," says Harder. "When you modify software, it costs money to maintain experts to deal with those modifications."
Since the new system was introduced, IT spending has been down 11 percent companywide. Part of the savings is attributed to staff reductions within departments, enabled by the new technology platform. For example, accounting employed more than 160 people in 1996; today, it employs 105. In addition, the new platform has led to the outright elimination of several departments, such as the rates department, which was folded into treasury and legal. Harder estimates roughly $11 million in annual savings from both staff and department reductions.
Then came the mild winter of 1997, which caused revenues to drop. "Glenn challenged CP&L managers to make additional cuts in expenses to offset the revenue shortfalls," Cavanaugh says. "They responded by cutting an extra $34 million from costs." And the next year, a whopping $39 million was sliced. "We did it by living with staff vacancies and by employing technology as a catalyst to get more efficient," Harder notes.
Wall Street reacted positively, pushing the stock from the low $30s in 1997 to the mid $40s this past summer. "They made these aggressive reductions in budgets to keep the unexpected losses to a minimum," comments Steven Fleishman, first vice president and utility analyst at Merrill Lynch & Co. "They not only did the right thing, they did it with the right processes."
To take cost control to a new level within CP&L, Harder also split the vertically integrated utility into three business units with profit-and-loss responsibility. Unit heads no longer would be focused just on their own direct operations and maintenance costs, but could see how they could influence all the other indirect costs of running the business. For example, shared services, such as accounting, legal, and human resources, now have their costs allocated to the business units, and business managers can see the costs of the services they receive from these areas. "It allows them to be more creative," Harder says.
"Moreover," he continues, "as the CFO, I find it is much more effective to take things like corporate earnings and returns on capital- growth goals and translate them into business- unit goals with P&L accountability. Everyone is on the same page knowing the bottom line is important, because they're accountable for it. We all use the same measurements and speak the same language."
Harder, a long-distance runner when he's not running finance, says he and CP&L have not "hit the wall" as far as cutting costs. "We will continue to provide incentive compensation based on more-cost-efficient operating targets," he says. "We're just beginning."
A good thing, too. Legislators in both North Carolina and South Carolina are studying deregulatory initiatives governing the retail sale of electricity. Says analyst Dobson: "It's coming."