Business models in an evolving industry : the view of a former practitioner.
Date: 2019-03-10
Institutions: European University Institute
Subjects: business model, economic model, electrical energy, energy consumption, energy grid, energy production

Issue 2019/13
July 2019

Business Models in an Evolving Industry: 
the view of a former practitioner 

By Olivier Lavoine, 
Florence School of Regulation, Policy Advisory Council member 

Highlights 

•  The  electricity  network  business  model  that  emerged  during 
the liberalisation era is not optimal in the context of the current 
transformation  of  the  electricity  system.  An  evolution  towards 
an  “insurance-type”  business  model  is  necessary,  where  the 
network is remunerated on the basis of the services provided and 
not only on the ground of the physical investment performed.

•  The  present  organisation  of  the  wholesale  market  reflects 
a  financial  approach  to  generation  and  does  not  ensure  the 
long-term  signals  necessary  to  induce  the  investments  in  the 
generation capacity needed to cover demand. In this context, the 
provision of ancillary services is an increasingly important outlet 
for non-subsidised electricity generators.

•  Despite  frequent  claims,  energy  storage  and  demand  response 
are two businesses that still struggle to emerge and prove their 
economic profitability.

•  New business models based on the processing and exploitation of 
massive amounts of data on electricity generation, consumption 
and  network  usage  are  promising.  Building  on  these  data, 
innovative services can be developed and offer the optimisation 
of energy consumption and expenses, the management of local 
grids, etc. 

The  author  would  like  to  thank  Jessica  Dabrowski,  Piero  Carlo  Dos  Reis  and 
Nicolò Rossetto for their assistance in the drafting and revising of the paper.

fsr.eui.eu

POLICYBRIEF 
 
 
Introduction

to 

The  developments  following  the  decision  by  the 
introduce  effective 
European  Union  (EU) 
competition and reduce carbon emissions have led to 
profound changes in the energy sector, particularly 
in  electricity.  New  business  models  have  emerged 
and will continue to evolve in the coming years.

In this policy brief, we try to reflect on such evolution 
objectively and by taking history into account, since 
our  electric  systems  were  not  created  ex-nihilo  by 
the  layers  of  regulation  that  have  accumulated  for 
more than 20 years.

For  the  sake  of  simplicity,  we  address  first  the  case 
of transmission and distribution networks. Then, we 
look  at  generation  and  supply.  Finally,  we  consider 
other emerging businesses in the sector.

Transmission and Distribution

Electricity  transmission  usually  consists  of  high 
or  extra-high  voltage  networks  (225  and  400  kV), 
while  electricity  distribution  covers  medium 
and  low  voltage  networks.  However,  a  universal 
distinction between the two does not exist and some 
transmission  networks  also  include  voltage  levels 
down to 63 kV, as in France.

The traditional business model set up for electricity 
networks is relatively simple and can be summarized 
as follows: cost coverage euro per euro for operational 
expenses (OPEX) and remuneration of the regulated 
asset  base  (RAB),  generally  evaluated  as  the  net 
book value (differences exist in this respect, but the 
principle remains the same in all European countries, 
and even on other continents).

This  leads  to  the  fact  that  investments  in  capital 
(CAPEX) are remunerated on the basis of a weighted 
average  cost  of  capital  (WACC)  established  by  the 
regulator,  according  to  market  rates  and  the  debt 
structure.  Generally,  the  WACC  is  higher  than  the 
rates  available  in  the  bond  market,  which  explains 

the interest of many investment or pension funds for 
such type of infrastructure.

Remunerating investments in such a way is perfectly 
adapted  to  the  kick-off  of  the  transmission  and 
distribution activities during the unbundling of the 
formerly  vertically  integrated  electric  utilities.  It 
is  increasingly  so  when  massive  investment  needs 
arise, as for instance due to the necessity to increase 
interconnections  with  neighbouring  electricity 
systems or to integrate renewable energies. However, 
it also provides an incentive to over-invest, because 
by  expanding  the  RAB  the  network  operator  can 
increase  its  remuneration  and  is  able  to  pay  more 
dividends to its shareholders.

To analyse the business models that can be applied in 
particular to transmission networks, it is necessary to 
consider some basic facts. An electricity transmission 
network  provides  its  users  with  the  capacity  to 
transfer  energy  –  in  fact  electric  fields  –  from  a 
place to another. Therefore, what is important is the 
MW  made  available  and  not  the  MWh  delivered 
(to be fair, you could say that the delivered MWh is 
marginally relevant due to the variable costs related 
to the amount of energy transited over the network). 
The  role  of  a  transmission  network  is  to  physically 
connect generators and consumers and to enable the 
business  of  traders  and  aggregators;  in  this  regard, 
the  network  provides  valuable  balancing  services 
(primary, secondary and tertiary reserves).

Next to these basic facts, we must take into account 
the  likely  evolution  of  electric  systems  with  the 
development  of  distributed  generation, 
self-
consumption, storage facilities, the creation of micro-
grids  and  local  loops,  etc.  Thus,  the  transmission 
network becomes the backbone to which local loops, 
some large power plants and a few industrial sites are 
connected.

Under  these  conditions,  transmission  networks  are 
going to perform a backup and risk pooling function. 
Thereby, their business model should evolve towards 
that of insurance.

2 ■  Robert Schuman Centre - Policy Brief ■ Issue 2019/13 ■ July 2019

In  any  case,  it  does  not  seem  sustainable  for  the 
networks  to  be  remunerated  solely  on  the  level  of 
investments made and not on the services provided. 
The  recovery  of  costs  and  the  remuneration  of  the 
network company should be structured in a way that 
clearly  differentiate  the  incurred  costs  and  depend 
on the achievement of a few main objectives.

The  largest  share  of  incurred  costs  are  fixed  and 
connected  to  the  construction  and  maintenance  of 
the infrastructure itself. Next, there is a variable cost 
linked  to  the  energy  transited  on  the  grid  and  the 
resulting losses. Finally, there are costs related to the 
provision of balancing and congestion management.

The  remuneration  of  the  network  should  be  based 
on  the  achievement  of  a  set  of  objectives  in  terms 
of  quality  of  supply,  availability  of  some  specific 
lines, optimisation of reserves and losses, and other 
measurable technical or financial output. 

As  a  result,  the  business  model  profile  becomes  of 
the  “insurance”  type,  with  a  network  access  ticket 
that covers the investment and maintenance costs of 
the network (including a share of productivity) and a 
remuneration that is indexed to the quality of service 
objectives  (quality  of  supply,  network  availability, 
optimization of balancing costs, etc.). In particular, 
it is possible to design an initial fixed remuneration 
based  on  a  reasonable  WACC,  representative  of 
the  bond  market  rates,  which  is  applied  to  the 
infrastructure.  Such  remuneration  is  then  adjusted 
within  an  interval  depending  on  the  achievement 
of the quality of service objectives (the achievement 
of  the  targets  increases  the  remuneration  of  the 
network,  while  the  failure  to  do  so  reduces  the 
remuneration correspondingly).

In  case  of  separation  between  the  infrastructure 
ownership  and  the  operation  of  the  system,  the 
solution proposed maintains its validity. On the one 
hand, there is an infrastructure business model based 
on  an  access  ticket  to  the  physical  infrastructure 
and a remuneration based on the quality of supply 

and  the  availability  of  the  infrastructure  –  the 
interconnections  for  example.  On  the  other  hand, 
there is a system operator business model based on 
an access ticket to the electronic infrastructure and 
a remuneration based on system performance, as for 
instance the cost of balancing.

the  distribution 

A similar approach can be adopted for distribution 
networks.  Nonetheless,  because  of  the  current 
changes  in  the  structure  of  our  electric  systems, 
level, 
particularly  visible  at 
distribution  companies  can  develop  new  service 
offers as local balancing operators and potentially as 
micro-grid  operators.  If  the  competent  authorities 
decide so, distribution companies could also become 
storage operators, managers of electric vehicle (EV) 
charging stations, or even managers of EV fleets.

Generation and Supply

The  evolution  of  the  electric  systems  and  the 
establishment of markets, although imperfect, have 
led to significant changes in the business models of 
generators and suppliers. One of the most important 
aspects underpinning these developments is the shift 
from an economic approach to a financial one.

Before  the  opening  of  the  market,  an  economic 
approach based on long-term marginal costs made 
it  possible  to  finance  the  generation  investments 
needed to cover demand over time while recovering 
the  incurred  costs.  It  also  allowed  the  adoption  of 
long-term  contracts,  suitable  for  the  flourishing 
of  a  productive  industrial  sector,  reliant  on  the 
consumption of large quantities of electricity.

The  establishment  of  so-called  wholesale  markets 
changed  the  world  of  generation  while  retail 
markets  still  do  not  really  exist.  Final  electricity 
customers usually receive offers based on wholesale 
or generation prices; and in some countries they still 
face regulated tariffs.

3 ■  Business Models in an Evolving Industry: the view of a former practitioner

Generators have several outlets for their output:

•  Wholesale market;

•  Ancillary services;

•  Trading and retailing.

The  wholesale  market  is  in  fact  just  a  merit  order 
dispatch that makes it possible to balance commercial 
portfolios the day before delivery or intra-day. The 
wholesale  market  is  currently  disrupted  by  two 
major  malfunctions.  First,  the  distortion  in  prices 
due  to  the  subsidisation  of  some  generators  (e.g., 
renewables)  or  the  application  of  price  regulation 
to  others  (e.g.,  ARENH  in  France)  undermines 
the  level  playing  field.  And  second,  the  wholesale 
market,  at  least  in  Europe,  remunerates  exclusively 
energy and not power. The introduction of capacity 
mechanisms, which could be assimilated to a sort of 
planning based on guaranteed prices, is expected to 
mitigate this second malfunction.

The  wholesale  market  only  operates  in  the  short 
term,  because  it  is  impossible  to  have  real  futures 
prices, due to the absence of any physical underlying 
in  the  medium  or  long  term  (in  the  hydrocarbon 
markets,  for  instance,  a  physical  underlying  is 
frequently available in the form of oil or gas storages 
or  underground  proven  reserves).  Only  price 
hedging  contracts  or  contracts  for  difference  really 
make  sense  under  such  conditions  in  the  medium 
and long term.

The  provision  of  ancillary  services,  whose  single 
buyer is generally the system operator, requires the 
specialisation of dispatchable generation units. The 
development of variable renewable energies, which 
are  not  controllable  and  unable  to  provide  such 
ancillary services, will make the provision of services 
an  increasingly  important  source  of  revenues  for 
generators.

Suppliers  currently  compete  mainly  on  price  and, 
even more importantly, on the provision of additional 

services, like the possibility to control consumption 
and  billing  through  digital  applications,  energy 
efficiency  and  energy  management  solutions, 
aggregation of demand response, etc. It is not an easy 
business since all suppliers face the same wholesale 
price  and  the  provision  of  services  represents  a 
financially weak part with respect to the total price 
of  the  delivered  kWh.  Successful  suppliers  actively 
trade  on  the  wholesale  market  in  order  to  balance 
their portfolio day-ahead.

Other Businesses

The  changes  in  the  structure  of  electric  systems, 
partly  because  of  a  greater  interactivity  between 
consumers  and  market  players,  will  necessarily 
lead to the emergence of new businesses. They can 
initially be divided into three broad categories:

•  Aggregation of consumption sites;

•  Storage;

•  Data processing.

Aggregators  offer  end  customers  the  possibility  to 
perform demand response and offer it in the markets 
for  ancillary  services  (major  industrial  consumers 
are already actively participating to the provision of 
ancillary  services).  Aggregators  also  offer  solutions 
for the management of the load curve and billing.

From a physical point of view, storage is a necessary 
complement  to  the  uptake  of  non-dispatchable 
energy sources like wind and solar PV. 

Data  processing  covers  load  and  generation  data 
and  is  based  on  the  development  of  hardware  and 
software to optimise electric consumption according 
to  the  energy  needs,  both  at  the  domestic  and 
industrial level (in a world more and more electric, 
the  optimisation  of  energy  consumption  will  be 
increasingly relevant). Companies offering solutions 
for data processing could also compete with system 
operators  for  the  performance  of  local  or  global 
balancing of the electricity network.

4 ■  Robert Schuman Centre - Policy Brief ■ Issue 2019/13 ■ July 2019

3.  The  business  models  of  storage  and  demand 
response (industrial or distributed, in the case of 
measurable  offers  through  electronic  metering) 
presently  do  not  seem  viable  for  the  following, 
simple  reasons:  major  malfunctions  in  the 
electricity market that do not provide long-term 
price  signals  for  energy  and  capacity;  feed-in 
tariffs  for  renewables  that  encourage  the  sale 
of electricity rather than its storage; and highly 
meshed  electricity  networks  that  do  not  incite 
neither storage nor demand response. 

4.  There  are  genuine  opportunities  in  the  massive 
processing  of  network,  consumption  and 
generation  data,  allowing  the  development  of 
local  loops,  micro-grids  and  the  competition 
between network operators for the provision of 
balancing services.

One  of  the  most  important  questions  raised  by 
these new business models is whether a sustainable 
model  for  aggregation  and  storage  really  exist  or 
not.  Indeed,  despite  the  regular  declarations  and 
announcements,  and  despite  the  needs  caused  by 
the  uptake  of  renewables,  very  few  solid  projects 
are  spontaneously  emerging.  Among  the  reasons 
there are the availability of dispatchable generating 
units  already  connected  to  the  grid,  the  fact  that 
most of the grids, at least at the transmission level, 
are well meshed, and the level of feed-in tariffs for 
renewables,  which  incite  their  owners  to  maximise 
the injection of the electricity output into the grid.

Beyond  the  case  of  individual  storage  facilities 
linked  to  domestic  PV  units  and  in  the  absence  of 
public subsidies, the only profitable business model 
today would be that of a regulated tariff for the use of 
storage facilities (this approach was once envisaged 
in France for demand response). 

Finally, with regard to demand response, especially 
that  provided  by  distribution  network  users  and 
residential  customers,  it  is  essential  to  have  a  real 
measure  of  the  response  and  avoid  the  use  of 
conventional  methods  to  estimate  it.  This  is  what 
happens today for industrial sites. Thus, it is better to 
wait for the full deployment of smart meters before 
developing  demand  response  at  the  distribution 
level.

Conclusion

From our analysis, four points clearly emerge:

1.  In  the  current  organisation  of  the  European 
electricity  sector,  only  regulated  or  subsidised 
business models are profitable;

2.  The business models of electricity networks must 
evolve towards an “insurance” model, where the 
remuneration is no longer exclusively based on 
the  RAB,  but  it  depends  also  on  the  services 
provided;

5 ■  Business Models in an Evolving Industry: the view of a former practitioner

Florence School of Regulation
Robert Schuman Centre  
for Advanced Studies

European University Institute
Via Boccaccio, 121
50133 Florence
Italy 

Contact:
email: fsr@eui.eu  website: fsr.eui.eu

Robert Schuman Centre for Advanced Studies
The Robert Schuman Centre for Advanced Studies, created in 1992 and directed by Professor Brigid Laffan, aims to develop 
inter-disciplinary and comparative research on the major issues facing the process of European integration, European socie-
ties and Europe’s place in 21st century global politics. The Centre is home to a large post-doctoral programme and hosts major 
research programmes, projects and data sets, in addition to a range of working groups and ad hoc initiatives. The research 
agenda is organised around a set of core themes and is continuously evolving, reflecting the changing agenda of European inte-
gration, the expanding membership of the European Union, developments in Europe’s neighbourhood and the wider world.

The Florence School of Regulation 
The Florence School of Regulation (FSR) was founded in 2004 as a partnership between the Council of the European Energy 
Regulators (CEER) and the European University Institute (EUI), and it works closely with the European Commission. The 
Florence School of Regulation, dealing with the main network industries, has developed a strong core of general regulatory 
topics and concepts as well as inter-sectoral discussion of regulatory practices and policies.

Complete information on our activities can be found online at: fsr.eui.eu

6 ■  Robert Schuman Centre - Policy Brief ■ Issue 2019/13 ■ July 2019

Content © Olivier Lavoine, 2019© European University Institute, 2019Views expressed in this publication reflect the opinion of individual authors and not those of the European University InstituteQM-AX-19-013-EN-Ndoi:10.2870/046914ISBN:978-92-9084-734-2ISSN:2467-4540