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The Utilities Industry Report Economics Essay

The utilities industry is made up of the electricity, gas and water markets. Electricity accounts for over half (52%) of the total revenues of the UK utilities industry in 2008; while gas and water share the rest of the total revenues (31.9% and 16.1%, respectively).

There are three leading companies in UK utilities industry: EDF Energy plc, Centrica plc and British Energy Group plc. The British Energy Group plc is now part of EDF Energy and the combination forms are one of the UK’s largest energy companies. EDF takes its advantage of vertically integrated structure and pays more attention to operating efficiently, and in contrast, Centrica highlights on reducing costs and improving capacity of profitability. Besides, both of the two companies stress on satisfying their customers.

The sum of these three groups’ revenue in 2008 took accounts of 43% of total value of United Kingdom’s utilities industry, which means this industry is an oligopoly market and the competition structure tends to be intensified in recent years.

Because of the inexistence of product differentiation, low switching costs and customers brand loyalty, the high growth and profitable market attracts more new companies. However, as sunk cost and environment protect cost are relatively high, potential entrants will hesitate while facing the pressure of incumbents’ price campaign.

While considering the financial ratios (2004-2008), the performance ratios are diverse in different companies since they have different business operations and scales. The gearing ratio which falls in the areas of 0.7 to 1.3 can be seen as an industry standard. Similarly, the current ratio also has an industry standard which is about 1. Finally the investment ratios(EPS) are different in each company and each financial year.

All in all, utility companies are facing significant price volatility and increasingly uncertainties of competitive customer markets. Companies can identify opportunities for improvement, encourage consistency and control enhancements by review the financial and risk reporting and orientate their financial systems and data within the finance functions.

Table of contents

Executive summary 2

Table of contents 3

1 Introduction 4

2 Discussion 4

2.1 Industry overview 4

2.2 Leading companies 4

2.3 Leading companies’ strategies 5

2.4 Industrial concentration (C3=43%) 5

2.5 Barriers to entry 5

2.6 Industry standards 6

3 Conclusion 7

References 8

Appendix 1 ROE 9

Appendix 2 Operating Profit Margin 10

1 Introduction

In this report, the utilities industry overview will be presented in the beginning. Then, the leading companies and their strategies will be introduced, and the concentration and barriers to entry in utilities industry will be discussed as well. Finally, the industry standard for some important ratios will be given and analysed.

2 Discussion

2.1 Industry overview

Taking a whole look at utilities industry, Electricity, gas and water consist of the major units of the whole industry. From latest available annual reports, it can be observed that electricity department generates over half of the revenues made by entire utilities industry in UK market. Follow up is gas department which processes around 30 percent of industry shares, and water department contributes least to the industry (16.1% of utilities industry sales revenue). Since the market is large and maturely grown by years, the supplier amount is relatively limited; the industry could be profitable and high tolerance of competition. In UK there are around twenty companies serving each department of the market and providing resources to both business and individual. Therefore, the utilities industry in UK is an oligopoly market and the competition structure tends to intensified in recent years.

2.2 Leading companies

There are around 25 companies in UK served as electricity providers, 20 of them provide gas as well. The major reason to that is electricity and gas share the similar energy resource and vertical diversification can effectively facilitate cost reduction burden of the companies. In UK people can change electricity and gas providers at any time, which makes the competition between companies more fierce than in the water department. On the other hand, water supply in UK has a local district tendency, and customer cannot switch among providers, therefore brand image here is less significant.

EDF Energy is one of the largest energy groups in both UK and rest of the Europe, which provides both electricity and gas. After the acquisition of Seeboard and London Electricity, it is now generating 1/5 of the electricity requirement and serves over a quarter of customers in UK.

Centrica is another leading company in utility industry, it owns utility provider such as British gas. British gas is one of the major supplier in UK provides electricity and gas to business and individuals. Centrica had already built up its brand image, and earned more than 520,000 customers by the end of 2008.

2.3 Leading companies’ strategies

EDF Energy’s mission is focus on “sustainable energy solutions”, and aims for “respect for individuals, respect for the environment, excellent performance, social responsibility and integrity”. The competitive advantage of EDF is probably derived from its vertically integrated structure which enables the company operating more efficiently. EDF’s strategy pays more attention to the external environment, such as maintain customers’ relationship, undertake social responsibility, etc. Grown as a global energy supplying company, EDP may have the ambition to explore the market through intensifying its brand image.

In terms of its strategies, there are 4 set of directions, which are: transform British Gas, sharpen the organization and reduce costs, reduce risk through integration, and build on our growth platforms. Compared to EDF’ strategy, Centrica emphasizes on maintaining its growth and profitability through cost reduction, which in terms of lower price, better service which are attractive to customers.

2.4 Industrial concentration (C3=43%)

According to the datamonitor, electricity sales dominated the utilities industry in the UK in 2008 by taking 52% of the total revenues. There are three leading companies in the utilities industry: EDF Energy plc, Centrica plc and British Energy Group plc (Now part of EDF). They are the generators of energy which focus on providing electricity. The sum of these three groups’ revenue in 2008 took account of 4.3% of total value of United Kingdom utilities industry. Thus it could be the oligopoly competition in utilities industry in the UK (Utilities in the United Kingdom: Industry Profile, 2009).

2.5 Barriers to entry

The barriers for new entrants are medium to high.

There are several ways to entry into the utilities industry: new companies, existing companies’ diversification and acquisition of a utilities company. The high market growth attracts more new companies, because the new entrants may find it profitable to enter into the utilities industry. Since there is no product differentiation existing in the industry, the switching cost and brand loyalty for customers is low. As a result, price strategies are often used as the entry-deterrence (Utilities in the United Kingdom: Industry Profile, 2009).

However, the regulation trends to be more stringent in current years, because of the environmental concerns, which may increase the cost for both incumbents and new entrants. Furthermore, the sunk cost is relatively high in this industry, since the high financial requirement for the set up facilities. Those may bring barriers for new entrants (Utilities in the United Kingdom: Industry Profile, 2009).

2.6 Industry standards

In order to find the industry standards for the utility sector, this report indicate several key financial ratios through the analysis of UK utility leading companies’ annual report. It compared the performance, gearing, liquidity and investment ratios from the latest 5 years data (See Appendix 1-6).

For the performance indicator, the return of equity, operating profit margin and the gross profit margin ratios are calculated. Except the abnormal value for particular years, the operating profit margin and the gross profit margin are range from 20% to 40%. The dispersive ratio of return on equity may results from the different growth and profitability of each corporate. The interest, accounting and foreign exchange risks all influence the ratio in some degrees.

For the gearing ratio, it seems to be normal distributed for each company during the year of 2004 to 2008. Most of the gearing ratio falls in the areas of 0.7 to 1.3 which indicates the long term borrowing conditions and the financial leverage power. It can be seen as the industry standards of UK utility industry.

The current ratio seems all around 1 which indicates the current assets equal to current liabilities in general. The liquidity of utility industry in UK represents their ability to meet its short term obligations.

The investment ratio earning per share measures the share performance and help assess the investment potential of a business’s shares. The data shows that there are no industry standards for EPS ratio which are different between each company and each financial year.

3 Conclusion

The utilities industry is consist of three major units, which are the electricity, gas and water. There are three leading companies in UK utilities industry: EDF Energy plc, Centrica plc and British Energy Group plc. The British Energy Group plc has recently is now part of EDF Energy and the combination forms one of the UK’s largest energy companies. EDF takes its advantage of vertically integrated structure and pays more attention on operating efficiently and Centrica, in contrast, highlights on reduce cost and improve capacity of profitability. Both the two companies stress on satisfying their customers. The sum of these three groups’ revenue in 2008 took account of 43% of total value of United Kingdom utilities industry, which means this industry is an oligopoly market and the competition structure tends to intensified in recent years. Besides, the barriers for new entrants are medium to high and there are several ways to entry into utilities industry. While consider the financial ratios (2004-2008), the performance ratios are diverse in different companies since they have different business operations and scales. The gearing ratio which falls in the areas of 0.7 to 1.3 can be seen as an industry standard. Similarly, the current ratio also has an industry standard which is about 1. Finally the investment ratio EPS are different between each company and each financial year.



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