October 14, 2013 
By Viktor
One of the most helpful models for me in thinking about companies operating in the alternative energy space is Clayton Christensen’s disruptive innovation framework. This is a foundation of the BSSE Building and Sustaining Successful Enterprise class at HBS.
In this model, companies operating in the traditional energy space have been operating on the Sustaining Strategy line for over a century.Petroleum based fuels and coal have been primary energy sources in transportation and heavy machinery industries. Oil companies have been focusing on improving the quality of the end products, ranging from diesel to fuels with high octane numbers, to satisfy performance demand from their customers: car manufacturers and us, drivers. Those companies’ business models were tuned to capture decent profit margins. This development can be represented by the Traditional Energy line, “green” plane, by moving toward upper right corner in the diagram below. This natural progression is arguably driving traditional energy companies away from the performance that an average customer can utilize.
In his original work, Christensen showed how mini-mills disrupted big steel plants by producing low quality steel at a significantly lower margin and slowly improvingthe quality ofthe end product and thus commandinga higher profit margin. The early difference in profit margin didn’t make US Steel Corporation and others feel threatened. Moreover, big corporations didn’t have any desire to switch from high margin businesses to low margin ones.
Similarly, in the mid 70s, new technology was developed that allowedfor converting solar energy to electricity. The companies that focused on alternative energy technology were operating at a significant loss and would not have been able to survive without government support. Indeed, the cost of electricity generated from first solar panels was as much as 70 times higher than wholesale price of coal electricity. However,as time passed, the technology was improved and margins were improved as well. Private sources noticed potential for return on investment and the role of government subsidies was reduced. Exh.3 from “1366 Technologies: Scaling the Venture” case suggests the current prices of $0.25/kWh. Although this is still somewhat higher than prices commanded by natural gas fueled electricity, many consumers, both industrial and residential, became advocates for new technology and put additional pressure on the electricity providers. This entire development could be represented by low-end disruption line,the “alternative energy“ line in the “Green” plane. As one can notice, we are approaching “Performance that customer can utilize” from below. Keeping in mind a range of performance expectations, we are currently serving the least demanding customers, those who either don’t mind additional risks or get extra incentive to use disruption technology.
Christensen suggested two types of disruptions. The second one can be represented as the different “Orange” plane and can be characterized as either new customers or new content for consumption. For this particular example, I believe customers from emerging economies are the best examples of a new-market. Indeed, people in remote locations in Central Africa and India, who need to choose between no electricity at all and solar-based electricity for 4-5 hours day, will most probably choose the latter. I recently had a discussion with one of my sectionmates (whohad spent his summer internship advising influential people from semiconductor industry in India to consider building the first semiconductor plant in the country), and learnt that lack of energy sources were the primary reasons forthe non-existence of such a traditional energy plant. As technology itself and its peripherals, such as batteries, improve one can hope for a trend towards an upper right corner to occur. And maybe one day the projects that we currently can only dream about may become true.
Sources:
1) “1366 Technologies: Scaling the Venture”, Lassiter, Nanda, Richardson, Wagonfeld, HBS case 9-812-133, 2012
2) The Innovation Solution, Christensen and Raynor, Harvard Business Review Press, 2003
Innovation in Business, Energy, and Environment 
By John Macomber
I always appreciate it when students use frameworks from other classes in this course. With respect to the Disruptive Innovation model, there are some interesting aspects to energy that might be investigated.
One angle is to consider the assertion that customers are not being well served by traditional energy companies. If one uses Clay’s milkshake metaphor and the job to be done is to get me car from A to B, absent costing of externalities like C02, petroleum does a darn good job of storing accessible and transportable energy and powering my automobile. Cars work basically like they did 100 years ago. The disruption happened to manufacturers of carburetors, distributors, timing belts, AM/FM radios, window cranks, drum brakes, leaded gas, rear wheel drive power trains – even all-steel bodies – and those disruptions made the petroleum fuel perform better. In the electricity space the disruption arguably is LED lighting, combined cycle heat and power, other downstream equipment. This is without even discussing hydro-fracturing as one of the all time game changer inventions (although it is probably not on the same BSSE inventions path as steel mini-mills or floppy drives going from 8″ to 5″ to 3″ to gone).
The parallel plane of users with different needs might be more applicable, perhaps? Those users might not have access to the traditional grid (electric or in distribution of petroleum), or they might be particularly interested in the externalities. Do you think that’s a disruption? Or a niche market segment? Maybe the disruption question is around what would cause that market to really grow – buyer preferences or other regulations?
Another meaningful disruption could be urbanization and densification. You don’t really need a car in New York, Hong Kong, Tokyo, Singapore due to density of development and quality of public transportation. Is that another parallel plane that can grow beyond a handful of rich mega-cities and disrupt traditional energy companies?
Viktor, I love that you are applying the BSSE framework to energy disruption; that will actually be the focus of my BSSE paper! I would take your analysis further and look at the impact of distributed energy on the business model of the century-old utility company model.
Could what started as a “not good enough” low-end disruption rapidly threaten to disrupt even high-end customers?
Just a few years ago, it would have been unlikely for even the most bullish forecasts to predict that solar panel prices would fall below $1 per Watt by 2013 and that a shale gas revolution would so radically transform the US energy landscape. In the face of such game-changing events, regulators and utility companies are now finding themselves at risk of unprecedented disruptions to their century-old business model. According to a recent report from the Solar Energy Industries Association (SEIA), the installed cost of residential solar is falling by more than 10% per year. Currently, a residential solar generation system is being installed every four minutes in the US. Furthermore, the low price of natural gas suggests that technologies such as combined heat and power (CHP) could add significantly to the distributed energy supply.
I agree with you that emerging countries are a key “non-consumption” market that will enable distributed energy resources to gain a rapid scale advantage. The disruption may be happening faster than expected, however, which will require utility companies to adapt rapidly. Already, the Net Metering debate is symptomatic of bigger disruptions ahead.
Bolstered by the rapidly falling cost of distributed generation, customer installations of net metering systems have grown rapidly in the US from near zero in 2003 to over 200,000 customers in 2011. The rapid growth of distributed generation has been alarming for utility companies, who are increasingly worried about the potential disruption of their business model. In its “Disruptive Challenges” report, the Edison Electric Institute (EEI), which represents the interests of electric utilities, declares transformative changes such as demand response and the falling cost of distributed generation as “game changers” that will create adverse impacts on revenues. Are more customers reduce their consumption or choose to go “off-grid”, the (decoupled) price paid by other customers would rise, thus further tilting the economics in favor of distributed generation. This could create a “death spiral” that would disrupt the current utility paradigm, perhaps to the point of extinction.
In order to make distributed energy resources sustainable at high levels of grid penetration, policymakers, utilities and customers should find ways to fairly allocate the cost and value of grid modernization. The overall objective is to develop an electricity rate structure that reflects the value and cost of distributed energy as accurately, reliably and cost-efficiently as possible. In addition to decoupling revenues, state regulators could unbundle distribution tariffs to allow customers to choose grid services with respect to location (geographic pricing), time (time-of-use pricing), power quality (premium pricing based on power quality standards) and reliability (interruptible or curtailable pricing, standby charges). Such increased options would provide customers with more informed decisions on what services to obtain from the distribution utility versus investing in on-site distributed resources. This would also bring greater clarity in setting the buyback prices for distributed energy resources.
Ultimately, utility (and transportation) companies have a gargantuan opportunity to capitalize on the changes that are occurring by adapting their business models, collaborating with the shift and standardizing its implementation. If you ask me, however, I think that they will fail to adapt and face extinction much like what happened to US Steel.