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AES Report


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AES Report

  1. 1. Page |1 AES - THE POWER OF BEING GLOBALCompanyAES Corporation has emerged as the leading private power company in the world since itsestablishment in 1981 with a capital of $60,000.Its founders Dennis Bakke and Roger Sant came from a government and academia background.After doing some research together on energy conservation techniques, they came up with abusiness model recognizing an opportunity for independent generators to produce power at muchlower costs than the established utilities.17 years later, in 1998, AES assets have reached almost $8 billion (SEC 10-K). Its phenomenalsuccess was attributed to a spate of mergers and acquisitions in an era of deregulation in theLatin American region. Another factor was its driving principle of stewarding the worldsresources, which is firmly rooted in Dennis Bakkes Christian upbringing. To keep up withcompetition, AES was engaged in a decentralized team approach to problem solving.Today AES is a case study in how to bring discipline to a large company without killing itsessential spirit. The companys phenomenal growth is due to having been in the right place at theright time - namely, Latin America during the unprecedented deregulation and opening to foreigninvestment that has occurred since 1990. Meanwhile AES built power plants as fast as it could,borrowing whatever money it needed. The payroll grew from 1,400 people to 50,000. Theytested the limits of how fast a company can grow before things start to fray around the edges.Certainly unusual, the decentralized AES corporate structure included no human resourcesoffice, no public relations unit, no safety or engineering departments. And in theory, at least,AES executives exist largely to guide and provide counsel, while decisions on everything frommaintenance to financing are not made by leaders, but by individuals and team members.Responsibility and creative thinking are demanded of employees, who are expected to learn fromexperience. For AES, changing its "thinking" is an issue that goes to the very heart of thecompanys existence. Thats because the entire AES enterprise has been constructed upon whatbegan as its founders unique notions about competitive power generation and the potential forproviding more reliable energy to consumers in a socially and environmentally responsiblemanner.Clearly, AES has a unique ability to get people to sit up and take notice when it talks of higherideals - ironically, such talk raised sufficient alarm at the US Securities and ExchangeCommission when AES first went public that regulators made AES list its pledge to placeprinciples above profits as a potential risk for investors. One might think the AES corporatemission bizarre enough to scare the wits out of normally cautious investors and analysts. Theyset out to do a corporate experiment, to see if you could create a company that would empowerthe people in the field to take responsibility, to take culpability, to take entrepreneurial roles indeveloping their own businesses...and its worked.
  2. 2. Page |2In this paper we are going to examine if it is possible to sustain this competitive advantage insituations outside of the scope of regular business operations, for example in a crisis. We willalso look at how a company of this organization needs to change to adapt to the growing needs ofinternalization.Culture and ValuesAES’s unique organization and management systems are the direct result of the values uponwhich the company was established and continue to define every aspect of its management.These values reflect the personal beliefs of the two founders. Bakke’s attitude to enterprise andmaterial possessions was strongly influenced by ideas of Christian stewardship, whichemphasized responsibility, building for the future, and sharing good fortune with others. Santbecame less committed to the church and increasingly active in the environmental movement.From the outset, both men viewed AES as an opportunity for them to pursue their values andeffect a fundamental change in business practices. In a section of its 10K report entitled―Principles, Values and Practices,‖ AES states:A core part of AES’s corporate culture is a commitment to ―shared principles or values.‖ Theseprinciples describe how AES people endeavor to commit themselves to the Company’s missionof serving the world by providing safe, clean, reliable and low-cost electricity. The principlesare:• Integrity – AES strives to act with integrity, or ―wholeness.‖ AES people seek to keep the samemoral code at work as at home.• Fairness – AES wants to treat fairly its people, its customers, its suppliers, its stockholders,governments and the communities in which it operates.• Fun – AES desires that people employed by the Company and those people with whom theCompany interacts have fun in their work. The Company believes that making decisions andbeing accountable is fun and has structured its organization to maximize the opportunity for funfor as many people as possible.• Social Responsibility – Primarily, the Company believes that doing a good job at fulfilling itsmission is socially responsible. But the Company also believes that it has a responsibility to beinvolved in projects that provide other social benefits, and consequently has instituted programssuch as corporate matching of individual charitable gifts in addition to various local programsconducted by AES businesses.AES recognizes that most companies have standards and ethics by which they operate and thatbusiness decisions are based, at least in part, on such principles. The Company believes that anexplicit commitment to a particular set of standards is a useful way to encourage ownership ofthose values among its people. While the people at AES acknowledge that they won’t alwayslive up to these standards, they believe that being held accountable to these shared values willhelp them behave more consistently with such principles.AES makes an effort to support these principles in ways that acknowledge a strong corporatecommitment and encourage people to act accordingly. For example, AES conducts annualsurveys, both company-wide and at each business location, designed to measure how well itspeople are doing in supporting these principles through interactions within the Company and
  3. 3. Page |3with people outside the Company. These surveys are perhaps most useful in revealing failures,and helping to deal with those failures. AES’s principles are relevant because they help explainhow AES people approach the Company’s business. The Company seeks to adhere to theseprinciples, not as a means to achieve economic success but because adherence is a worthwhilegoal in and of itself.Sant and Bakke recognize that these values cannot easily be reconciled with the concept of ashareholder-focused, profit-maximizing corporation, and both leaders have made it very clearwhere their priorities lie:―Where do profits fit? Profits...are not any corporation’s main goal. Profits are to a corporationmuch like breathing is to life. Breathing is not the goal, but without breath, life ends. Similarly,without turning a profit, a corporation too, will cease to exist...At AES we strive not to makeprofits the ultimate driver of the corporation. My desire is that the principles to which we strivewould take preeminence.‖ (The Marketplace)AES’s commitment to its values, at the expense of shareholder gain where necessary, is indicatedby the provision which AES inserts in all of its prospectuses for new security offers whichidentifies AES’s values as a source of investor risk:―The Company seeks to adhere to these principles, not as a means to achieve economic success,but because adherence is a worthwhile goal in and of itself. However, if the Company perceivesa conflict between these principles and profits, the Company will try to adhere to its principles –even though doing so might result in dominated or forgone opportunities or financial benefits‖.9The AES principles and the way they are implemented reflect a set of assumptions about humannature. Sant and Bakke believe in the ultimate goodness of people – ―Man is made in the imageof God,‖ declared Bakke. (Personal meeting) Douglas McGregor provides a theory ―The Human Side of Enterprise‖ in which he suggests thatif the company encourages the positive sides of human relationship to work, the results can beoutstanding.
  4. 4. Page |4Hence, within organizations, people can and should be trusted to exercise responsibility, and atthe same time should be held accountable. Critical to the ability to motivate people is the innatedesire of people to make a contribution to society. This implies that, for an organization to beeffective and to harness human effort and ingenuity, the organization must be committed to awider social purpose. These views are at variance with many of the assumptions upon whichmany traditional management systems and techniques are based and imply a different approach:―[t]he people in AES are not principally economic resources. We are not tools of the corporation.Rather we hope the corporation is structured to help individuals make a difference in the worldthat they could not otherwise make.‖ (AES Corporation Annual Report.) AES’s annual employee surveys are an indicator of the importance which is accorded to thecompany’s principles and values. Dennis Bakke has commented that he devotes more attentionto studying the annual employee surveys than the annual financial statements. Emphasis onresponsibility to the environment and to local communities is viewed as integralto the efficient running of power plants.Organizational structureAES’s organizational structure and management systems manifest the company’s values and
  5. 5. Page |5principles. AES describes the key features of its organization in its statement of values: integrity,fairness, social responsibility and fun. In general, AES teams work extremely well in bothachieving a common goal and having fun while doing so. The following ideas provide insight onwhat makes teams work well and what can stimulate true and productive teamwork.―Teams imply friendship; not only the ability but the desire to work together. Starting with thewonderful example set by the original AES team, Roger and Dennis, working together in smallgroups has been a natural way to get big things done while preserving the dignity of eachperson.‖ Tom Tribone (Senior executive at AES)In order to create a fun working environment for its people and implement its strategy ofoperational excellence, AES has adopted decentralized organizational principles and practices.The project subsidiaries are responsible for all major facility-specific business functions,including financing and capital expenditures as can be seen from the following example.―His hands still blackened from coal he has just unloaded from a barge, Jeff Hatch picks up thephone and calls his favorite broker. ―What kind of rate can you give me for $10 million at 30days?‖ he asks the agent, who handles Treasury bills. ―Only 6.09? But I just got a 6.13 quotefrom Chase.‖In another room, Joe Oddo is working on J.P. Morgan & Co. ―6.15 at 30 days?‖ confirms Oddo,a maintenance technician at AES Corp.’s power plant here. ―I’ll get right back to you.‖Members of an ad hoc team that manage a $33 million plant investment fund, Messrs. Oddo andHatch quickly confer with their associates, then close the deal. ―It’s like playing Monopoly,‖ Mr.Oddo says as he heads off to fix a leaky valve in the boiler room, ―Only the money’s real.‖ (WallStreet Journal)There is no one person in charge of teams and there is no Human Resources department. Teamsare the basis of structure, and they encompass the four values of the company. They are fluid;many people are members of more than one team at one time. A team is somewhat autonomous;all decisions about a project are made within that team, with final say granted to that team.Decisions are made not from the top-down, but from the bottom-up. Furthermore, responsibilityis pushed to the lowest level possible, encouraging everyone to be part of a decision. As a result,each team member views the project in terms of a whole. Colleagues and team members musttrust each other to follow through to the best of their ability. Consider this example:―The development of the $404 million Warrior Run power plant in Cumberland, Maryland wasundertaken by an AES team of ten people who handled all the work necessary leading up to theplant’s groundbreaking in October 1995. They secured 36 different permit approvals involvingabout 24 regulatory agencies and arranged financing that involved tax-exempt bonds and tenlenders. Within the industry, such a project would typically involve well over a hundredemployees‖. (Wall Street Journal)―There are two reasons why teams are successful at AES: the type of people we have here andthe environment in which they work. People at AES tend to be independent and thrive in a looseenvironment where roles and responsibilities are not always clearly defined. The environment at
  6. 6. Page |6AES is one where responsibility is pushed down to the lowest level possible, encouragingeveryone to take ownership for not only their piece of the project, but for the project in itsentirety.‖ (Michael Cranna, Investor Relations)For plant financing, for example, CFO Barry Sharp raised less than 10 percent of the estimated$3.5 billion needed for AESs first ten power plants; most of the necessary financing was raisedby each plants own multi-disciplinary project team, composed of a broad cross-section of AESemployees. By all accounts, this management system worked spectacularly well for AES. Bygiving workers a greater sense of involvement in, and responsibility for their own professionaldestiny, employee morale was boosted.This is not to say that AES lacks formal structure altogether. The most striking feature of itsorganization is the few layers of hierarchy: until recently there were only three organizationallayers between the front-line employees and the CEO. AES is divided into regional organizationsor ―groups.‖ These groups comprise the different plants, each of which is headed by a plantmanager. Within each plant there are typically seven areas or ―families,‖ each of which is headedby a superintendent.AES refers to its organizational structure as a ―honeycomb.‖ The idea is that each plantcomprises a number of small, flexible, self-managed teams who are able to operate cooperativelyand efficiently without any centralized direction. At the basis of this structure is the belief thatorganizations do not need to be managed. Thinking, motivated people can manage themselvesand undertake the communication and mutual adjustment needed to coordinate complex tasks.According to Dennis Bakke, the key to effective decentralization is keeping the basic units oforganization small:―I think of AES as a conglomeration of small communities. And I don’t think there’s anycompany in the world that’s so big that you can’t organize this way. Even a plant with 400people can be broken down into smaller groups. It’s a small enough community that there is theability to have an accountability structure within it, you know, a social structure as opposed to amilitary structure. We will break down the Kazakhstan plant into four units. How can we staysmall and be big? By breaking the organization into groups with chief operating officers.17The principle of self-organization imposes a very different role on managers from theconventional management model. Indeed, the term ―manager‖ is seldom heard within AES; it isat odds with the principle of letting people decide for themselves. The example comes from thetop. ―The most difficult thing for me as CEO,‖ confided Bakke, ―is not to make decisions.‖ Ifindividuals are to develop, they must be given responsibility and allowed to learn: [T]he modernmanager is supposed to ask his people for advice and then make a decision. But at AES, eachdecision is made by a person and a team. Their job is to get advice from me and from anybodyelse they think it’s necessary to get advice from. And then they make the decision. We do thateven with the budget. We make very few decisions here [indicating the headquarters office]. Weaffirm decisions.‖ (Wall Street Journal)Sant has made similar observations:―If Dennis and I had to lead everything, we couldn’t have grown as much as we have. Peoplewould bring deals for us to approve, and we would have a huge bottleneck. We’ve shifted to
  7. 7. Page |7giving advice rather than giving approval. And we’ve moved ahead much faster than we wouldhave otherwise.‖ (Markels)One consequence of this approach is the small size of AES’s corporate headquarters. At anypoint in time there may be between 40 and 70 AES employees at the Arlington office, but interms of actual corporate staff, these number only about 35.In terms of performance, one of the most important advantages of the AES system is that itpermits speed in decision making, preparing bids, and completing projects. AES abounds with afolk history of teams and individuals given huge responsibilities or thrust into unique andunexpected situations. Consider the following:‖Paul Burdick, a mechanical engineer, had only been at AES briefly when he was asked topurchase $1 billion in coal. ―I’d never negotiated anything before, save for a used car,‖ he said.Burdick spent three weeks asking questions of people both within and outside of the company onhow to accomplish the task. At AES, he says, ―You’re given a lot of leeway and a lot of rope.You can use it to climb or you can hang yourself.‖ (Wall Street Journal)Instead of trying to work backwards like many companies do by hiring different people and thentrying to incorporate the firm culture into them, AES has a more natural approach of hiringpeople that already live by the same principles and values as AES. That way they don’t have toconstantly monitor people and make decisions for them.Criteria for hiring new AES people include a person’s willingness to accept responsibility andAES’s principles as well as a person’s experience and expertise. Every AES person has beenencouraged to participate in strategic planning and new plant design for the Company. TheCompany has generally organized itself into multi-skilled teams to develop projects, rather thanforming ―staff‖ groups (such as a human resources department or an engineering staff) to carryout specialized functions.Issues such as hiring practices, leave periods, and promotion criteria, which in more conventionalcompanies would be spelled out in a ―Policies and Procedures‖ handbook, are left at theemployees’ discretion. When trying to find out how much time she could take off after the birthof her daughter, a Project Director for AES Puerto Rico discovered that the company did nothave a policy about maternity leave. After investigating what other ―AES people‖ had done, shedecided to do what made sense for both herself and the business requirements of the project. Inthe end she decided to take three months, but she made herself available at critical points in theproject’s execution. (Jeffrey Pfeffer)The owners focus on characteristics that help determine how the candidate will fit with thecompany’s culture and values. There is little importance given to the candidates’ educationalbackground or experience, as greater emphasis is placed on the candidates’ desire to learn,contribute, and grow, as well as their personal values and self-motivation.―As soon as you have a specialist who’s very good, then everyone else quits thinking,‖ Bakkesays. ―The better that person is, the worse it is for the organization. The information goes
  8. 8. Page |8through the specialist, so all the education is to the person who knows the most.‖ (Wall StreetJournal.)Because people are what make up AES, they have an organizational model. management is not really about managing knowledge, but rather managing andcreating a corporate culture that facilitates and encourages the sharing, appropriate utilization,and creation of knowledge that enables a corporate strategic competitive advantage.Employees among different continentsThe AES principles and its concept of the honeycomb organization imply a different type ofrelationship between those employed and the corporation than that which characterizes mostcompanies. To begin with, the absence of functional specialists and the ideas about self-organization require a tremendous amount of information-sharing. According to the company,employees are given full access to the company’s operating and financial information. Becauseof the extent of employee access to information that would normally be confidential at othercompanies, AES lists all its employees as ―insiders‖ in its submissions to the SEC.Nevertheless, AES remains committed to its principles not just for its US, but for its worldwideoperations. Bakke firmly believes that the AES principles are universal and are not culturally
  9. 9. Page |9specific either to the US or to the West in general. AES’s experience so far is that its owncorporate culture can be transplanted in many different national cultures.Bakke firmly believes that the AES principles are universal and are not culturally specific eitherto the US or to the West in general. AES’s experience so far is that its own corporate culture canbe transplanted in many different national cultures. The challenges presented in running one ofthe world’s biggest (and once one of the most dilapidated) coal-fired power stations inKazakhstan, and turning around heavily bureaucratized, former state-owned utilities in SouthAmerica have provided remarkable test-cases in AES’s ability to export its company culture. Theresults have often been amazing. Even though AES has been unable to eliminate the distinctionbetween salaried and hourly paid employees within the US, in England, Argentina, and Pakistanit has moved to an all-salary workforce.International ExpansionBecause of the rapid growth in electricity demand in many emerging markets, inadequategenerating capacity, and the trend towards privatization, Sant estimated that over 70percent of AES’s opportunities lay outside the US. The fast-growing Asian markets forelectricity, especially the huge potential markets of India and China, were especially attractive.In the early 1990s AES inaugurated its international strategy by acquiring two plants inNorthern Ireland and one in Argentina. International expansion involved participating in theauctioning of state-owned electricity companies by governments, and bidding for long-termpower supply contracts from governments which were opening the generating end of theirelectricity industries to competition.Overseas expansion was primarily through the acquisition of existing power-generating facilitiesrather than building new plants. A similar transition was occurring in the US. Changes in utilityregulations at the state level resulted in some utilities selling off their generating facilities – AESwas among the most prominent bidders for these facilities.In Latin America alone, AES distributes electricity to nearly nine million customers, itsgenerators are capable of churning out more than 5,300 megawatts (MW) of power per hour, andanother 1,314 MW of capacity are now under construction. (See Chart on Latin Americanpresence)Fueled by its growth in Latin America, AES has seen its total assets mushroom more thanfivefold from $1.44 billion when it first went public in 1991 to nearly $8 billion today. It is nowone of the largest and most important foreign players in Latin American power. Thanks to itsaggressive growth in Latin America since then, nearly 40% of AESs cash flow today comesfrom Latin American projects it either owns or operates outright or in consortium withinternational and domestic partnersAESs original investment in Latin America was a paltry $50 million, a figure which pales besidethe estimated $5.16 billion AES has invested to date in the region. The company has pursued inrecent years what bankers say is a fairly textbook sandwiching of debt-equity-conversiontransactions. AES chief financial officer Barry Sharp thinks of it in terms of "a stairstepapproach" that allows AES to maintain an attractive securities rating (Standard & Poor’s gives
  10. 10. P a g e | 10AES corporate credit a "BB," with "B+" on both subordinated debt and preferred stock), whilegrowing via the issue of low-cost capital.OperationsThe company owns a portfolio of electricity generation and distribution businesses on fivecontinents and in 29 countries, with generation capacity totaling approximately 43,000Megawatts and distribution networks serving approximately 11 million people, as of December31, 2008. In addition, the company has approximately 3,000 MW under construction in 10countries. Its workforce provides electricity to people in various markets ranging from urbancenters in the United States to remote villages in India. It is headquartered in Arlington, Virginiaand employs about 25,000 people.AES operates a generation portfolio which is diversified in terms of fuel source, market, andgeography. Its portfolio of power generation facilities employs a broad range of technologies andfuel sources, including coal, gas, fuel oil, and renewable sources such as hydroelectric power,wind, and biomass. In 2008, AES generated 41% of its power from coal, 33% from gas, 21%from renewables, 2.5% from oil, 1% each from diesel and pet coke, and 0.5% from biomass.In addition to being diversified in terms of fuel sources, the company’s generation operations arealso geographically dispersed. In 2008, it generated 34% of power in North America, 27% inEurope, CIS, and Africa, 26% in Latin America, and 13% in Asia and Middle East.Diversified and balanced generation portfolio reduces its exposure to the risks arising due to thefluctuations in commodity prices, as well as changes in weather conditions and regulations.BusinessThe company operates two primary types of businesses: Generation business, where it ownsand/or operates power plants to generate and sell power to wholesale customers, such as utilitiesand other intermediaries; and Utilities business, where the company owns and/or operatesutilities to distribute, transmit and sell electricity to end-user customers in the residential,commercial, industrial and governmental sectors in a defined service area. The company’sportfolio employs a range of fuels, including coal, gas, fuel oil, biomass and renewable sourcessuch as hydroelectric power, wind and solar.GenerationThe company owns or operates a portfolio of approximately 38,000 MW, consisting of 93Generation facilities in 26 countries on 5 continents at its generation businesses. It also hasapproximately 2,900 MW of capacity under construction in six countries. Its Generation businessuses a range of technologies and fuel types including coal, combined-cycle gas turbines,hydroelectric power and biomass.UtilitiesAES utility businesses distribute power to approximately 11 million people in 7 countries on 5continents and consists primarily of 14 companies owned or operated under managementagreements, each of which operate in defined service areas. These businesses have various
  11. 11. P a g e | 11structures ranging from distribution businesses to integrated utilities, which generate, transmitand distribute power.SegmentsThe company had seven segments of business: Latin America Generation; Latin AmericaUtilities; North America Generation; North America Utilities; Europe & Africa Generation;Europe & Africa Utilities; and Asia Generation. Three regions, North America, Latin Americaand Europe & Africa, engaged in both Generation and Utility businesses. Its Asia region onlyhad Generation.Now the new organizational structure has three geographical areas each with two business lines:1) North America, 2) Latin America and Africa, 3) Europe, Middle East and Asia.Latin AmericaLatin America Generation: The company’s generation business in Latin America, AES Tiet(Tiet), located in Brazil. AES holds a 24% interest in Tiet. The company has seven newgeneration plants under construction—five coal plants and one diesel plant in Chile and onehydro plant in Panama.Latin America Utilities: Each of the company’s Utilities businesses in Latin America sellselectricity under regulated tariff agreements. Utilities businesses provide electricity servingapproximately 1 million customers.North AmericaNorth American Generation: The company’s North America Generation businesses consist ofseven gas-fired plants, ten coal-fired plants, and three petroleum coke-fired plants in the UnitedStates, Puerto Rico and Mexico.North American Utilities: AES has one integrated utility in North America, IPL, which it ownsthrough IPALCO Enterprises, Inc. (IPALCO), the parent holding company of IPL. IPL isengaged in generating, transmitting, distributing and selling electric energy to approximately470,000 customers in the city of Indianapolis and neighboring areas within the state of Indiana.Europe & AfricaEurope and Africa Generation: In 2006, the company began commercial operation of AESCartagena (Cartagena), its power plant in Spain, with 1,199 MW capacity. AES operates fivepower plants in Kazakhstan. In 2008, the company completed the sale of a generation plant and acoal mine in Kazakhstan.Europe and Africa Utilities: AES has a 56% interest in an integrated utility AES SONEL(SONEL). SONEL generates, transmits and distributes electricity to approximately half a millionpeople and is the source of electricity in Cameroon. Its distribution businesses in Cameroon, theUkraine and Kazakhstan together serve approximately 2.4 million customers.
  12. 12. P a g e | 12AsiaAsia Generation: The company’s half of the facilities and generation capacity in Asia are locatedin China. It also has a combined power and desalination water facility in Oman. In April 2008,the company purchased a 92% interest in a 660 MW coal-fired thermal power generation facilityin Masinloc, Philippines (Masinloc). AES Amman East (Amman East) is a 380 MW combined-cycle gas power plant under construction in Jordan.Significant Events and Alternative EnergyThe company owns and operates 1,060 MW of wind generation capacity and operates anadditional 215 MW capacity through operating and management agreements. Its wind business islocated primarily in North America.AES has taken up several new international projects in recent years. The company’s projectbacklog (projects under construction) as on December 2008, totaled 14 core power projectstotaling 2,993 MW (equal to supplying power for a year to a range of 1,197,200 to 2,693,700homes) and 11 wind power projects totaling 410 MW (164,000 to 369,000 homes).StrategyThe Company also strives for operating excellence as a key element of its strategy, which itbelieves it accomplishes by minimizing organizational layers and maximizing company-wideparticipation in decision making. AES has attempted to create an operating environment thatresults in safe, clean and reliable electricity generation, distribution and supply. Because of thisemphasis, the Company prefers to operate all facilities and businesses which it develops oracquires; however, there can be no assurance that the Company will have operating control of allof its facilities.The Company attempts to finance each domestic and foreign project primarily under loanagreements and related documents which, except as noted below, require the loans to be repaidsolely from the project’s revenues and provide that the repayment of the loans (and interestthereon) is secured solely by the capital stock, physical assets, contracts and cash flow of thatproject subsidiary or affiliate. This type of financing is usually referred to as non-recourse debtor project financing.In the debt market AES has traditionally secured financing with the help of strong interest frominstitutional investors, which is attributed to the combination of interest in the power sectorsmature-investment profile, plus the fact that AES is a growth company. Until recently, thecompany tended to rely for project debt on syndicated loans, finding easy bridge capital via itssyndicated $600 million line of credit. A solid debt rating and the companys growth andpredictability have allowed AES to issue common stock at an attractive level, which permitsthem to finance their expansion.AES is determined to stick to its strategy of being the first into a country in order to get the bestopportunities. AES is absolutely resolute in its strategy to continue acquiring distributors in orderto conquer the Latin American power market. A power generator here, an electricity distributor
  13. 13. P a g e | 13there may seem like piece work to some. But there is method to AESs apparent madness of adecentralized approach to growth. Their strategy is that they’ll take all these pieces together andin 10 years put together a regional energy company.Nevertheless, they dont do any strategic planning, no five-year plans. What does exist is theAES mission: Its not profits and growth, the mission is to serve the world. AES owners hope tokeep its principles in focus as it seeks to remain a premier, global power company dedicated toone thing: providing clean, safe, reliable power.The company operated without rules, regulations, or even a well-defined hierarchy. They donthave procedures, just using common sense. Setting itself apart from the stodgy world ofregulated electric utilities--or any conventional company - AES trusts people to do good andencourages them to step a little bit outside the norm.The company’s global presence insulates it from region specific problems. Increasing geographicreach helps improve the market share and secures revenue growth. The company’s revenues andoperating profits have increased over the years. Higher revenues are attributed to highergeneration rates in Latin America, favorable foreign currency translation of approximately $350million, and better utility tariffs and volume. AES described itself as: ―a global power companycommitted to serving the world’s needs forelectricity in a socially responsible way.‖ (SEC 10-K).It describes its strategy as:• Supplying energy to customers at the lowest cost possible, taking into account factors such asreliability and environmental performance;• Constructing, acquiring, and operating projects of a relatively large size in geographicallydispersed markets;• To the extent available, maximizing the amount of non-recourse financing;• When available, entering into longer-term power sales contracts or other arrangements withelectric utilities or other customers with significant credit strength;• Where possible, participating in distribution markets that grant concessions with long-termpricing arrangements; and• When available, entering into hedging, indexing, or other arrangements to protect againstfluctuations in currency, fuel costs and electricity prices. Value Chain
  14. 14. P a g e | 14Supporting activities are what makes a company stand out from all the other energy giants.Because if you think about it, electricity is just a bunch of electrons, one suppliers productindistinguishable from anothers. The one exception is the fledgling attempt to sell "green"electricity, electrons generated by renewable sources.Infrastructure: As can be seen from the parts of the paper on organizational structure, the lackof hierarchy, central planning or corporate strategy (which often pulls a company into a web ofbureaucracy), permits speed in decision making, preparing bids, and completing projects. Thenon-recourse debt strategy requires the loans to be repaid solely from the project’s revenuesand provides that the repayment of the loans (and interest thereon) is secured solely by thecapital stock, physical assets, contracts and cash flow of that project subsidiary or affiliate. Thisputs more pressure on the project managers, as they can’t rely on the headquarters to come andsave them. However, the return is a higher project completion rate as the people take moreresponsibility over their decisions on a plant level.Human resource management: As can be seen from the part on Corporate Culture, AEShuman resources is the asset that is most valuable and hard to replicate.Barney (1991) developed a model that demonstrates that, for a resource to be the source ofsustained competitive advantage, it must create value (V) for the firm; it must be rare (R); itmust be inimitable (I); and it must be non-substitutable (S).Applying Barneys VRIS framework of sustained competitive advantage, Wright, McMahan,and McWilliams (1994) demonstrate that human resources (defined as the total pool of humancapital under the control of the firm) have the highest probability (among all resources) ofbeing the source of sustained competitive advantage for the firm. This is because humanresources are more likely than other resources to be inimitable and non-substitutable, as well asbeing valuable and rare (Wright, McMahan & McWilliams, 1994). Letting the employees have access to all the information allows for an ―open source‖ sharing.Assuming that they hire motivated and responsible individuals, it is likely to expect from theemployees to come up with new ideas on how to save money or make a project more efficient.This proof can be found in the examples provided earlier how efficient the teams were whenleft to themselves. The ability of employees to take part in such important decision making asbudget planning really takes the burden of the CEO’s who don’t mind the honest sharing of the
  15. 15. P a g e | 15profits.Technology: As with any decision, even in technology, AES is not focused on the highestefficiencies, but on doing the right thing. An example from the Harvard Business School Casesupports this idea:―Members of the development team for the AES Corp.s power plant project in India mustdecide what plant technology to specify in their application for techno-economic clearancefrom the government of Indias Central Electric Authority. Their choice is between moreexpensive technology that would enable the plant to meet more demanding U.S. environmentalstandards or less costly technology that would meet local environmental standards and free upfunds for contributions to other needs of communities surrounding the projected plant. At thesame time, executives at AES headquarters in Arlington, VA, are considering whether thecompanys traditional focus on meeting its social responsibility through CO2-offset programs isthe best approach to social responsibility as the company expands worldwide.‖ (AES GlobalValues, 1998)As can be seen from this example, their choice is not between cost-cutting or meetingenvironmental standards; their choice is about what they want to support more – a sustainableenvironment or the development of a local community. The picture below summarizes AESCorporation’s attempt to provide energy while sustaining the communities and offsetting itsemissions by planting more trees.Procurement: Is decentralized according to the company’s strategy.
  16. 16. P a g e | 16The LDCs (local distribution companies) have largely been insulated from competition. Thatschanging, and as a result of a decade or more of R&D, the gas industry has new commercialproducts based on gas ready for the customer base. Many compete with products driven byelectricity.In the new energy value chain, the consumption of electricity deserves special attention.Because of competition and deregulation, a whole new area of energy services has sprung uparound electricity consumption. And many enthusiasts look to a new concept, a distributedpower network, to revolutionize how electricity is produced, bought, sold, and used.At the same time, anyone connected with this industry will tell you that gross inefficiencies andimbalances do exist throughout the value chain. Better application of information technologies,telecommunications capabilities, and customer relationship management, can play a vital rolein optimizing the physical assets. Automation software, optimization routines encoded intotodays software, and better measurement and control devices extract more value fromrefineries and power stations. Dispersed, modular resources can be regulated and controlled,with respect to the distribution grid, as easily as one large plants supply. New technology getsthe credit for the higher productivity we enjoy from our natural gas wells and the fact that we
  17. 17. P a g e | 17keep finding new reserves that can be tapped for future needs.The R&D in electricity is expected to be especially intensive over the next twenty yearsbecause there are greater inefficiencies to be worked out.Electricity is known to be among the most volatile commodities ever traded. Electricity isdifferent. First, electricity demand is largely dependent on the weather. Second, and this issomething that can be fixed, electricity cant be stored. You can store oil in barrels and tanks;you can store natural gas in large tanks within the city gate or distribution system or in hugeunderground caverns. You cant store electricity, but you can store the energy in anotherform—mechanically as water pumped up to a higher reservoir or compressed air sitting in acavern overnight, or chemically in a battery or a fuel cell.Today’s energy companies have answers. Part of that answer is building new transmissionlines, which have been almost impossible to permit over the last decade. But part of the answeris technology which can increase the amount of power transmitted on a given line, allow theremote monitoring of transmission lines and substations, and make the entire grid far moreflexible than it is today. The grid was built for limited amounts of power transfers betweenregions of the country; it needs to be renovated and expanded for the flexibility demanded by acompetitive market.If transmission is the neglected dimension, energy storage is the sixth dimension, the missingdimension, at least with respect to electricity markets. Only one commercial bulk energystorage technique is prevalent today. It’s called pumped storage hydroelectric. Water is pumpedup a hill to a reservoir using low-cost electricity at night time. During day-time peak periods,that water flows downhill to drive huge turbine/generators. That same concept, storingelectrical energy as mechanical energy of a flowing fluid, can be applied by compressing air,storing in it huge underground caverns, and then releasing it to drive gas turbine/ generators.Other energy storage devices, batteries and certain fuel cell designs, are being developed forthe distributed power markets and can potentially be scaled up to serve for bulk energy storage.Electricity Value Chain with Energy Storage as the "Sixth Dimension"
  18. 18. P a g e | 18 primary activities in the value chain for an energy generating business are fuel/energysource, power generating station, transmission, distribution, and consumption. The electricityindustry value chain consists of four elements.1. Energy generation, requiring both a fuel source (e.g., coal, nuclear, natural gas, wind energy) and a power plant to convert that fuel source into electricity. Generation business is largely tied to securing new power purchase agreements (PPA’s), expanding capacity in existing facilities and building new power plants.2. Electricity transmission involves both transforming generated electricity into electricity that can be transmitted over power lines and matching end user requirements (demand) with energy availability (supply).3. After transmission, electricity must be distributed to individual end users via a vast network of power lines and substations. Electric utilities often own miles of power and transmission lines.4. Lastly, there is delivery, where electricity is transformed again and delivered directly to an end user. Delivery also involves metering and billing. Relevant competitive factors for the power distribution businesses include financial resources, governmental assistance, regulatory restrictions and access to non-recourse financing. In certain locations, distribution businesses face increased competition as a result of changes in laws and regulations which allow wholesale and retail services to be provided on a competitive basis.In general, distribution companies sell electricity directly to end users, such as homes andbusinesses and bill customers directly. The amount distribution companies can chargecustomers for electricity is governed by a regulated tariff. The tariff, in turn, is generally based
  19. 19. P a g e | 19upon a certain usage level that includes a pass through of costs to the customer that are notcontrolled by the distribution company, including the costs of fuel (in the case of integratedutilities) and/or the costs of purchased energy, plus a margin for the value added by thedistributor, usually calculated as a fair return on the fair value of the companys assets. Thisregulated tariff is periodically reviewed and reset by the regulatory agency of the government.Components of the tariff that are directly passed through to the customer are usually adjustedthrough an automated process.Unlike gasoline or heating oil, both of which are liquid fuels and have similar networks,electricity cannot be stored. Natural gas is transported through interstate pipelines to localdistribution companies (LDCs). The gas business has been "deregulated" for fifteen years butmost of that applied to sourcing and transport. A wave of energy deregulation swept electricitymarkets in the 1990s.Competitive forcesElectricity is a natural monopoly--there is typically only one power line connected to a house.While one company may own that power line, they do not have a lot of say in the prices theycharge due to government regulations. If prices went up, it would be difficult to impossible tochange companies for people. However, due to the recent deregulation in the industry in theattempt of the governments to lower prices by promoting competition among companies, someof the subsidiaries face a lot of competition.Most of AES utilities though operate as monopolies within exclusive geographic areas set bythe regulatory agency and face very limited competition from other distributors.Power production is facing strong and growing competition, highly efficient gas-power plantsare causing pressure on the prices. Demand for electricity is driven by industrial andcommercial activity and by population growth. The profitability of individual companiesdepends on the efficiency of their operations. Large companies have economies of scale inpurchasing power; small companies can compete effectively by specializing in geographicregions.AES faces most of the competition in contracted generation businesses prior to the execution ofa power sales agreement during the development phase of a project and as contracts nearexpiration and they seek to extend contracts or seek new contracts with other customers. Due tothe long-term nature of sales contracts, they generally face very limited competition during theoperational phase. Trying to conduct business under long-term contracts, AES relies on power sales contractswith one or a limited number of customers for the majority of relevant plant’s output andrevenues over the term of the power sales contract. Power sales contracts range from 1 to 25years. AES hedges the exposure with forward fixed price power sales. If the counterpartiesbreach, they may not be able to enter in contracts of similar favorable terms.On the supply side, AES relies on a single supplier or several few for provision and
  20. 20. P a g e | 20transportation of fuel. If suppliers fail, AES faces the risk of buying fuel at market pricesexposing the company to market volatility. To limit the exposure to fluctuations in fuel prices,the company signs long-term contracts for fuel with a limited number of suppliers.Consequently, the cash flows and results of operations are dependent on the continued abilityof customers and suppliers to meet their obligations under the relevant power sales contract orfuel supply contract. Any loss of significant power sales contracts or fuel supply contracts, orthe failure of any party to fulfill the obligations there under, may have an adverse impact on thebusiness and financial condition of the company, eventually hampering the growth plans.Utilities face relatively little direct competition due to significant barriers to entry which arepresent in these markets. In this arena, they compete against a number of other marketparticipants, some of which have greater financial resources, have been engaged in distributionrelated businesses for longer periods of time and/or have accumulated more significantportfolios.To keep up with the competition, the company is developing an alternative energy business asthese alternatives to the traditional fossil fuels are economically competitive. AES expanded itswind and solar portfolio by 332 MW in 2008. At the end of 2008, renewables accounted for21% of the company’s total operating fuel portfolio. AES also expects tremendous growthopportunities for wind generation in China. AES also entered new markets for its wind businessin Bulgaria, France and Scotland.Furthermore, AES developed utility-scale solar photovoltaic projects through a joint venturewith Riverstone Holdings. As of December 2008, the joint venture was operating projectsthroughout Spain with advanced development activities throughout France, Greece, Italy, andSpain. The company has also continued construction of a hydropower facility in Panama andsmall hydropower facilities in Turkey, all of which will begin operations in 2010.These investments will help the company capitalize on the growing demand for non-conventional sources of energy, as well as cushion against the risks associated with its limitedpresence in the utilities value chain.
  21. 21. P a g e | 21 Bibliography AES Corporation, 10K submission to the Securities and Exchange Commission for 2008. ―A power producer is intent on giving power to its people,‖ Wall Street Journal, July 3, 1995, p.A1. An account of this period is found in ―AES Honeycomb A‖ (HBS Case 9-395-132) and ―AESHoneycomb B‖ (HBS Case 9-395-122). Dennis W. Bakke, ―Erecting a grid for ethical power,‖ The Marketplace, May/June 1996, p. 5.Dennis Bakke and Roger Sant, Annual Letter to Shareholders, 1997 AES Corporation AnnualReport.Alex Markels, ―Power to people,‖ Fast Company, 13 (March 1998), p. 155. ―A power producer is intent on giving power to its people,‖ Wall Street Journal, July 3, 1995, p.A1. Jeffrey Pfeffer, ―Human resources at the AES Corporation: the case of the missing department,‖Graduate School of Business, Stanford University, 1997, p. 14. ―A power producer is intent on giving power to its people,‖ Wall Street Journal, July 3, 1995, p.A1. ―Power plant builder tries to reenergize environmental image,‖ The Washington Post, July 6,1992, p.The power and the glory. (AES Corp.)(includes related article on AESs first Latin Americanpower distributor)(Cover Story)(Company Profile) Michael Tangeman. LatinFinance, April1998 n96 p19(6)