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Enel, Italy’s State-owned power company founded in 1962, started out as one of Europe’s largest coal users and polluters. But by 2019, it was recognized as a leader in renewable energy and had integrated sustainability into its business model and its operations. How did it make that enormous strategic change? Today we bring you a conversation with former Harvard Business School’s senior lecturer MARK KRAMER. He studied Enel’s transformation into a renewable energy leader for a business case study he wrote.
In this episode, Kramer shares Enel’s tactics for strategic change, long-range planning and tackling the dreaded innovator’s dilemma. This episode originally aired on Cold Call in April, 2018. Here it is.
BRIAN KENNY: Pearl Street in the financial district in Lower Manhattan runs northeast from Battery Park to Brooklyn Bridge, dating back to the early 1600s Pearl Street cut through the heart of New Amsterdam and was named for the many oysters found in the East River. Today it looks like most every other street in Lower Manhattan, but on September 4th, 1882, Pearl Street shone brighter than any street in New York. I mean, literally because on that day history was made when electrical power began to flow through an industrial-sized, direct current generator at Pearl Street Station, also known as Thomas Edison’s First Power Plant.
By 1884, Pearl Street Station was serving 508 customers with 10,164 lamps. In the years since that watershed moment, just about everything in the world has changed, but the way we generate and distribute electricity is still pretty much the same as it was 133 years ago. Today we’ll hear from Professor Mark Kramer about his case entitled NL, The Future of Energy. I’m your host, Brian Kenny, and you’re listening to Cold Call.
SPEAKER 3: So, we were all sitting there in the classroom.
SPEAKER 4: Professor walks in.
SPEAKER 5: And they look up and you know what’s coming.
SPEAKER 6: Oh, the dreaded cold call.
BRIAN KENNY: MARK KRAMER is a leading researcher, writer, and lecturer on strategies for social impact. He also co-founded FSG, a social impact consultancy that operates globally. Mark, thanks for joining us today.
MARK KRAMER: Thank you. Pleasure to be here.
BRIAN KENNY: So, I enjoyed reading this case. It got a little technical for me at times, but we’re not going to delve into the deep technologies around power generation so much, but I think it’ll be helpful for people to understand the landscape of power generation and how things are changing on that landscape. So we’ll get into all those details, but if you could start simply by telling us who’s the protagonist and what’s on his mind.
MARK KRAMER: Well, the protagonist is Francesco Starace, who is the CEO of Enel, which is the power company for Italy. And what’s so remarkable to me about this case is the transition of an old-fashioned state-owned monopoly power company into really one of the leading innovators in renewable energy and energy services globally. And that transition is really due to the leadership and vision of Francesco Starace.
BRIAN KENNY: What prompted you to write the case? How did you hear about Enel?
MARK KRAMER: Well, so Michael Porter and I have been working on developing a case, actually a course on creating shared value. This concept that we’ve developed that kind of redefines the role of business in society to think about social issues as opportunities for competitive advantage, not just as a matter of sustainability or corporate social responsibility. And so we’ve been building up a set of cases and a course that exemplify how companies are finding new competitive opportunities by helping to solve social problems. And this was a great example of this in the power industry. There’s so many power companies, particularly in the US that have really been resisting the shift to renewables, even though it is hard to argue that that isn’t going to be the future.
BRIAN KENNY: And I think probably most often power companies are thought of as culprits in a lot of the global warming issues that we have and the climate change issues that are going on.
MARK KRAMER: Absolutely. And Enel is no exception. They were one of the largest users of coal in Europe and a very heavy polluter. But as there were more and more regulations and pressures around carbon emissions, they’ve really had to shift away from that.
BRIAN KENNY: And we’ll talk a little bit about how Europe is looking at this versus the US too, because I think that’s an interesting dimension that surfaces in the case as well. What are the sort of the main pieces of power generation and distribution?
MARK KRAMER: Sure. So there are, as you say, several pieces. There’s the actual generation of the power, and that can be thermal, it can be coal or gas-fired turbines and generators. It can be hydro, which is using water power, an ancient form of power generation. It can be other renewables like solar and wind, and of course it can be nuclear. And once the power is generated, then there is an elaborate network to distribute it first at a wholesale level and then down to a retail level. And so when you think about the cost of your power, it’s typically one-third from the generation, one-third cost from the distribution at a wholesale level, and one-third from the actual retail distribution to individual businesses and consumers.
BRIAN KENNY: Yeah. And you talk in the case about the cost-plus system that the power generators use. Can you explain that?
MARK KRAMER: Sure. So most power generators in the US and in Europe have their fees set by a regulatory body since they are a monopoly typically in a region. And the fees are set based on looking at the capital expenditures to build the power plant and distribution system and assume a recapture of that investment over the useful life of the equipment, plus a return on capital. So on the one hand, that makes a great deal of sense. These are very capital-intensive industries, a huge investment. And so ensuring that the company’s able to get back and recoup its investment with a profit makes sense.
On the other hand, that tends to discourage companies from greater cost-effectiveness or other innovations that might lower their cost base. And it has tended to discourage the investment in renewable power as well, where the initial investment up front is much lower and the predictability, the return is much less.
BRIAN KENNY: So, how do renewables start to surface? They’ve been around for a long time. This is nothing new, I guess, and probably to the frustration of some people who think, “Wow, it’s been a long time, and still they’re only generating a very small percentage of the power that’s used.”
MARK KRAMER: That’s right and that’s certainly true in the US. Although as you mentioned, Europe is a somewhat different model. And at this point, I believe Germany is roughly half renewables, and many other European countries have a much larger share of renewable generation. The big story about renewables is the reduction in cost. In 1977, it costs $76 to generate a single watt of electricity from renewable power. Today that’s 57 cents.
BRIAN KENNY: Wow.
MARK KRAMER: We just had a major solar installation approved in Germany, which is the first time there was a major installation without any subsidy or guarantees. We really are just now at the point where renewable power is achieving parody with other forms of power generation in terms of the cost, and that’s a big deal.
BRIAN KENNY: So, in Europe, there’s a much greater presence and acceptance of renewable energy than there is in the US. What are some of the forces that are sort of controlling that on either side?
MARK KRAMER: Well, the EU has been a very strong proponent of a shift to renewables and commitments about reducing carbon emissions. And that has been a big factor. I think simply the regulatory environment has been much stronger about promoting the shift to renewables in Europe than it has been in the US.
BRIAN KENNY: Yeah.
MARK KRAMER: There’s also been a willingness of governments to step in and subsidize the cost to get to the point of parity that we’ve not had as much in the US.
BRIAN KENNY: Yeah, and under the new administration in the US it’ll be interesting to see sort of where things go there, that’s anybody’s guess at this point, but it doesn’t look favorable, I guess you would say that.
MARK KRAMER: It certainly does not.
BRIAN KENNY: Yeah. So, let’s talk about Enel. Where did they come from and how did they sort of emerge on this landscape?
MARK KRAMER: So, Enel is a 90 billion global company. It started as a monopoly that was the state-owned power generator for Italy. But over time, as the government liberalized power generation and began to create a competitive market, they had to find other ways to grow. And the government also shifted from this cost-plus pricing model that we talked about to market-based pricing. So the predictability of the profits was no longer as certain. And this deregulation happened throughout Europe. And so power companies that used to be limited to a particular country began to start buying power companies in other countries and become global.
And so, Enel now is in 35 different countries as a major global player in power generation. What’s interesting in their history is that when they acquired a major power generator in Spain, they took on a lot of debt. And there was a point in the late ‘90s where there was a real bubble in valuations for renewable energy and some smart investment bankers said, “Hey, you can pay down the debt that you took on acquiring the Spanish utility if you take all the little renewable operations you have from all the different companies you’ve bought in all these different countries, and create a new entity that is a hundred percent renewables, call it Enel Green Power, take it public, you’ll get the cash to pay down the debt.”
Well, the consequence of that was that a new entity was created that was only focused on renewables and was staffed by people who were very different from the traditional utility executive in the old Enel, people who are really committed to renewable power. And one of the fascinating differences is traditional power generation is all about a few massive capital investments with a decade or many decades long return that’s highly predictable. Renewables requires much less capital investment. It is decentralized. There are countless players. Everybody can put solar on their roof. You don’t need to build a power plant.
And so, it’s a completely different vision of how to operate the company, how to make capital allocation decisions, how to develop strategy, et cetera. And Francesco Starace, the CEO has said that you really couldn’t develop a renewables company within a traditional power generator. It’s just such a different mindset, but because of this happy coincidence that they developed this separate Enel Green Power operation, they were able to create a new enterprise and a new culture that could become really adept at developing and promoting renewable energy.
BRIAN KENNY: So, what are some of the challenges that they had in doing that? What makes it’s different in what way?
MARK KRAMER: Well, it’s different in almost every way. Again, instead of one major capital investment and a long-term predictable return, you are looking at many, many small investments, many, many competing players. You have to be able to integrate the energy that is coming from multiple different sources. And it becomes much more of a software-driven enterprise. It’s about how you manage and regulate energy services, the flow of energy, optimizing the usage, reducing the cost, and it’s much more about the software and the distribution system than it is about the capacity to create a major power plant to generate the electricity.
BRIAN KENNY: And a whole different view, I guess, of where sustainability sits within the organization. You look at some of the major fuel companies in the US and a lot of them have sustainability programs of one kind or another, but they have been accused in the past of doing sort of green-washing and not really making it a part of the culture of the organization.
MARK KRAMER: That’s right. And it’s just fascinating. One of the changes that Francesco did, and I should mention, he was the CEO of this Enel Green Power. And then in 2014, he was appointed CEO of the entire Enel group, and they reintegrated Enel Green Power back into the group. And one of the things he did is combine sustainability and innovation because he said that the answers to sustainability really are about innovation, and you can’t innovate unless you’re really trying to solve difficult problems. And so, by pairing sustainability and innovation, he’s done something that I haven’t seen any other utility do, but really to use sustainability not as something peripheral, but as the driver of innovation for the company as a whole.
And he did a second thing there too, which is he recognized their own research and development department wasn’t going to be able to compete in the global economy around software development and power management. And so, he created this model that he calls open innovation, where instead of focusing on their own research and development team, they’ve set up a website, they’ve posted all of the problems they’re working on, and they’ve said, “Anyone in the world can submit answers,” and their engineering team will review it and respond within 30 days. They don’t want to invest in startup companies, but they will commit to buy anything that is developed that is of use to them. And by their scale, they can drive the growth of a new innovation.
And so, it turns out one of the critical pieces of software they needed that they didn’t have an answer for was how do you create a two-way connection between an electric car battery and the power grid so that you can not only charge the battery, but you can draw power from the battery to help balance the grid? Well, they didn’t have the answer to it, but a six-person startup that was spun off from the University of Delaware that had no revenue actually is the one that had the right technology, and they were able to identify it through this open innovation system and now have a partnership with Nissan, and with this little startup that is running 500 cars in Denmark with this two-way connection to the grid.
BRIAN KENNY: So, I thought that was fascinating.
MARK KRAMER: What’s fascinating is that one of the big barriers to going to a hundred percent renewable power is the fact that it’s intermittent. The wind and the sun are not there continuously all the time. And there just aren’t adequate storage facilities or technologies to handle the volume of electricity that’s needed for an entire city. Well, it turns out the storage capacity of Tesla’s and other electric car batteries is so tremendous that with literally just about a hundred thousand Teslas and the ability to access only about 5% of the storage capacity of their batteries, you can actually balance the grid for a major city like Rome.
BRIAN KENNY: Wow.
MARK KRAMER: And so, you actually begin to generate revenue from accessing these car batteries. Enel estimates that they can generate about $10,000 a year of revenue per car from merely having access to 5% of your car’s battery to balance the grid. And so they can begin to subsidize the sale of electric cars, which can then accelerate the move toward electric cars, which can then accelerate the move toward a hundred percent renewables because you’ll have adequate storage facility. It’s an amazing vision that Francesco Starace has.
BRIAN KENNY: It really is. So, they’re on the ground floor because all of a sudden now electronic vehicles are going to be much more popular and become affordable by more people. So they could really be at the beginning of a whole movement and be at the ground floor.
MARK KRAMER: That’s absolutely right and they are creating an electro mobility division that will focus on leasing and improving technology for electric cars. And they’re doing it in partnership with Tesla, and partnership with Google. And again, what’s so amazing is here’s this a hundred and some year old state-owned monopoly now a public company, but being at the forefront of innovation in this renewables technology and electric cars.
BRIAN KENNY: I’m sure they’ve thought about this, but as they think about the future at some point, do they divest of all those capital intensive assets that they used to do traditional power generation?
MARK KRAMER: At this point, they still have a significant amount of their power generation that comes from traditional thermal sources, including coal. They are closing down those plants, but they’re not yet at the point that they can eliminate them. They have made a commitment going forward that they will only invest in new renewables. They will not invest in any more thermal power plants. And part of the reason for that is not just environmental, but is that the power industry is changing so rapidly now, the idea of building a power plant and recouping the cost over decades, no longer makes sense. Things are changing every year, every six months. And so they have to look at much shorter term investments, which renewables are.
BRIAN KENNY: Yeah. And do they have to shape shift depending on where they are in the world, because the case talks about some of the challenges they face in Latin America versus in Europe versus another part of the world?
MARK KRAMER: They do. Absolutely. I mean, one of the interesting things about the power market is that in mature developed countries like Europe and the US, power consumption is actually declining. For decades, there was a direct relationship between increasing GDP and increasing use of electricity. But as people have focused more and more on conservation and efficiency and reducing the costs of power, they actually are finding that there is less and less need for power to produce the same GDP. So the growth is going to happen in emerging markets. And those are a very different kind of market to work in than Europe and the US and other developed countries.
BRIAN KENNY: Yeah, and different regulatory bodies that you’ve got to contend with and…
MARK KRAMER: Different regulatory bodies, and of course, much, much less infrastructure. And so the idea of using renewables in Latin America, in Asia and other emerging markets makes tremendous sense because the investment cost, the infrastructure, the distribution system is so much lower.
BRIAN KENNY: Yeah, that makes perfect sense. So, have you discussed this in class?
MARK KRAMER: I have. We had great fun teaching this with the MBAs.
BRIAN KENNY: Yeah. So, I’m curious as to, and this is a generation of MBA students who are in the millennial classification. They’re very concerned about the environment. How did they think about what Enel was doing?
MARK KRAMER: Well, I think they were very excited by it. I think all of the cases we studied in this course on creating shared value are really examples of companies that are seizing new opportunities to have a positive social impact that can drive the success of their business. A lot of them are interested in social enterprise and impact investment, but most of those deal with very small companies. And one of the things that’s exciting about Enel is this is a $90 billion company. This is not small. And the fact that they can already be more than 50% renewables and have a commitment of going toward a hundred percent renewables is really dramatic.
BRIAN KENNY: Yeah, and it sort of gives hope for a brighter future on this front.
MARK KRAMER: It does. Absolutely.
BRIAN KENNY: Mark, thank you for joining us today.
MARK KRAMER: Thank you, indeed. Pleasure to be here.
HANNAH BATES: That was former Harvard Business School’s senior lecturer Mark Kramer in conversation with Brian Kenny on Cold Call. Kramer’s Research focuses on strategies for social impact, and he co-founded FSG, a social impact consulting firm. We’ll be back next Wednesday with another hand-picked conversation about business strategy from the Harvard Business Review. If you found this episode helpful, share it with your friends and colleagues and follow our show on Apple Podcasts, Spotify or wherever you get your podcasts. While you’re there, be sure to leave us a review.
And when you’re ready for more podcasts, articles, case studies, books and videos with the world’s top business and management experts, find it all at HBR.org. This episode was produced by Ann Saini and me, Hannah Bates. Ian Fox is our editor. Special thanks to Maureen Hoch, Adi Ignatius, Erica Truxler, Ramsey Khabbaz, Nicole Smith, Anne Bartholomew, and you, our listener. See you next week.
