How To Affect Innovation in Energy
A playbook for navigating incumbent thinking and driving meaningful, scalable change in the energy sector.
As Clay Christensen detailed in “Innovator’s Dilemma”, driving meaningful innovation in large incumbent corporations is hard and plagued by misaligned incentives. Innovating in the electricity industry with its layers of regulations on earnings and operations, commodity markets, and 150 years of risk-averse command-and-control culture is perhaps the greatest manifestation of this dilemma. Yet, that is what needs to happen to combat climate change.
The large investor-owned utilities and oil & gas supermajors must find ways to transition their business models, not just to avoid being displaced by a young disruptive startup, but to avoid a breakdown of our most basic critical infrastructure. As much as energy innovators like to rhapsodize about their plans to replace utilities and oil companies, the reality is that modern society is too dependent on them for disruptive innovation to safely or reliably work. In the U.S., energy expenditures may only account for about 6% of GDP, but they are the first 6% of GDP. All other commerce, activity, and wealth creation of a modern economy is built from a reliable, available, and relatively low cost energy system.
I have spent five years helping a large utility holding company rethink how it incorporates new technologies and business models into its long term strategy. In doing so, I have seen first-hand what helps realize innovation and what hinders it in the ecosystem of corporations, universities, government labs, startups, philanthropists, and venture capitalists trying to accelerate the energy transition. Below is a list of best practices in innovation for incumbent energy companies that also highlights what the other key players (startups, universities, government, venture capital) must consider to be effective partners:
Build a Network of Innovators
Invest the time and effort to build an ecosystem of early, middle, and late stage innovators in your geographic regions of operation and in your existing and adjacent technological fields.
Early stage innovators include universities, national labs, the Department of Energy (particularly ARPA-e), and private labs (e.g. Otherlab, PARC, etc.); they include anyone who is developing wholly new technologies from basic science. Early-stage innovators are critical to expose your company to the most creative thinkers, latest economic and policy ideas, and the most disruptive technologies (it is like an early-warning system for strategic threats and opportunities). Many early-stage innovators have the added benefit of carrying a lot of credibility with policymakers (it’s hard to argue with scientists and inventors).
Middle stage innovators include startups (from founding to about Series B), incubators (e.g. Powerhouse, Greentown Labs, etc.), and venture capital firms. Middle-stage innovators help bring new products and business models to market that do not have an obvious path to market through an existing established player (GE, Westinghouse, ABB, Schneider, etc.). They refine new innovations through rapid, iterative, and small-scale business model tests to find product-market fit and a promising go-to-market strategy. As concepts mature and gain traction, venture capitalists help filter and accelerate the most promising opportunities. Building an effective middle-stage innovator ecosystem is by far the hardest exercise compared to early or late-stage innovators. This is where the rubber-meets-the-road for new innovations; where you either need to bridge the valleys of death or acknowledge that the innovation wasn’t as good of an idea as everyone thought. The middle-stage ecosystem has also been subject to the most active experimentation and debate in the last 10 years. After claims that traditional venture capital failed clean tech, new institutions such as Cyclotron Road, Breakthrough Energy Ventures, The Engine, Energy Impact Partners, Volta Energy Technologies, and Chain Reaction Innovations have been stood up. The effectiveness of each of these organizations is still playing out but they are definitely filling many of the gaps that existed a decade prior.
Late stage innovators include the established manufacturers, vendors, and suppliers for hardware and software solutions in the industry. Examples include GE, Westinghouse, ABB, Schneider Electric, and many more. Incumbent energy companies likely already have fairly robust buyer-supplier relationships with these players, but they may not always expand those relationships into the domain of new product co-development. This could mean collaborating on developing a new product in return for revenue-sharing and most-favored nation pricing or it could mean collaborating on research and development with a 3rd party university or startup to expedite its path to commercialization through IP licensing. Late stage innovator ecosystems are all about expanding the nature of existing relationships to better align incentives around innovation.
Embrace Open Innovation by biasing your organization towards engaging external parties rather than relying on internal resources. Utilities occasionally have a bad habit of trying to maintain a proprietary mindset around innovation when it provides marginal commercial value (given that they are already state-protected monopolies). Utilities have far more to gain from curating and catalyzing innovations amongst external parties than trying to build new products themselves. Utilities are the inherent gatekeepers to energy innovation, all of the other players in the energy innovation ecosystem must strive to develop fluid partnerships with utilities that promote openness and experimentation.
Formalize Partnerships
As a company builds a broad network of innovators, it must also look to formalize partnerships with key players in its jurisdictions and business lines. Formal partnerships strengthen relationships and provide access to the most meaningful and novel innovations. They also help expedite follow-on engagement.
Universities
Universities like MIT, Stanford, UC Berkley, and many others are excellent at nucleating commercially relevant ideas due to the entrepreneurially-oriented researchers and students they attract, but they are plagued by rigid and sometimes draconian IP policies that date back to Cold-war era funding and innovation paradigms.
Typical University IP policy:
Everything invented by university personnel during a company-sponsored R&D project (R&D paid for by the company) is solely owned by the university unless a company employee was heavily involved in the R&D project directly (in which case it is jointly owned). Since most energy companies (particularly utilities) don’t have R&D personnel to spare on a full-time basis, most IP ends up as the property of the university
In order to receive an exclusive commercial license to the IP, the company must negotiate a license issuing fee, annual fee, and royalty sharing agreement with the university as well as agree to pay all of the patent filing costs (this is after it has paid for ~3 years of R&D at the university). The company must trust that the university will be reasonable in this negotiation before it engages in the R&D in the first place (and despite the university’s lack of knowledge on energy markets).
This policy is painful enough for large corporations but it is particularly painful for startups that do not have the cash to pay all of the associated fees
For this reason, many startups try to circumvent any claims a university administration might have to their core IP, and many corporations limit their involvement in university R&D (given the uncertainties associated with getting a return on investment). Despite all of this, universities still tend to be one of the best sources of new ideas and startups.
Recommendations to maximize university energy innovation:
When negotiating master research agreements with universities, focus all effort on the IP rights section (all other terms such as confidentiality and publishing rights should be easily amenable to both parties). It is easy to burn time and social capital on non-contentious terms when the only contentious term should be IP.
Universities should consider granting joint IP ownership to all research sponsored by companies (particularly anything related to climate change). The primary role of a university as a tax-free educational institution should be to see innovations commercialized. Joint ownership gives a company the confidence and freedom it needs to commercialize (and justify the expense of R&D in the first place) as well as the freedom the university needs to find other commercialization paths if the original company sits on the innovation. Universities should share in the upside of a great innovation (such as when a company negotiates an exclusive license on the university’s ownership stake) but not at the expense of adding further fees and uncertainty to the already expensive and uncertain process of bring energy innovations to market. Universities need to be as accommodating as possible to the startups and corporations trying to defy odds in realizing clean energy innovation; joint IP ownership policies would be a big step in the right direction.
Universities should allow companies to choose the counsel used to file and defend IP derived from their sponsored research. Unfortunately, this is rarely the norm today since universities generally consider most generated IP to be their sole property. Allowing the companies to choose counsel would help align incentives and result in stronger patents (no one wants a stronger patent more than the company trying to use that patent to make money). It is not uncommon for university counsel to rush through a filing with a professor to accomodate an academic publication or even convince themselves that a patent is not worthwhile because the professor does not consider it sufficiently novel. The best patents come from those who are motivated to build a business around the innovation rather than those who are just looking for another publication on their CV. For this reason alone, it is in a university’s best interest to allow the company sponsor to be more involved in the selection of counsel.
Universities and large companies should consider licensing research-derived IP to startups in exchange for equity in those startups. For many early-stage breakthroughs deriving from university research, startups present the best vehicle for discovering a new market and business model. Graduating PhDs also make for great technical founders who want to see their inventions prosper. Rather than demanding a fee or future revenue stream that would encumber a startup’s ability to manage or raise capital, universities and corporate research sponsors should capture their return on investment through equity. Further, universities should not block the original research sponsor from capturing a return on investment for their research funding (a risk that currently exists with today’s university IP policies). If companies cannot capture a return on investment, they will be discouraged from sponsoring future university research.
National Labs
National labs are undergoing a culture shift to produce research that is more commercially relevant. Historically, they tend to focus on research initiatives defined by government goals or academic interest. This can make them a treasure trove for some of the most “outside-the-box” ideas or breakthroughs but it requires a great deal more “hand-holding” to identify commercially-relevant opportunities. With the proper engagement structure that conveys business constraints and spurs entrepreneurial thinking, national labs can be powerful partners for innovation.
Given the DOE’s involvement and the tendency for politics to get in the way, try to be opportunistic and need-driven about which labs to partner with. Many labs have unique research facilities and core competencies that can be more easily accessed once a specific technical need is defined.
For broader partnership, establish blanket Collaborative Research and Development Agreements (CRADAs) that pre-define IP and confidentiality terms. While these take a long time to negotiate (again largely due to the DOE), they lay the groundwork for closer interaction and collaboration.
National Labs are particularly valuable for conducting research targeted at setting energy policy
Venture Capital
Possibly one of the most critical partnerships that needs to improve is between the venture community and large electric utilities:
Venture capitalists often cannot diligence or justify their investments without utility industry buy-in
Utilities struggle to procure from new startups unless they are resourced well-enough, and utilities (at least in the U.S.) are limited in their ability to provide venture funding directly without triggering affiliate transaction restrictions
Utilities and venture firms should strive to formalize partnerships that enable utilities to pilot and diligence new startups’ technologies, helping venture capitalists make informed investment decisions, in exchange for some option of commercial upside down-the-road (e.g. co-investment rights, warrants, pre-emptive investment rights in later rounds, etc.)
Startups
Sometimes a startup has a very strategically interesting technology but is still too early-stage for a utility to procure from (because the product is not ready) or directly invest in (because utilities have limited risk capacity). In those instances, utilities and other large energy companies should consider funding pilots and prototypes with convertible notes that are specifically tied to a scope of work the utility would like to see. These convertible notes should have reasonable but fairly light-weight terms to ensure the startup has sufficient flexibility to pivot and raise capital, but they should task the startup with building-out a specific capability the utility needs and would procure. This gives the startup important commercial direction, helps them raise funding from other sources, and allows the utility to participate in future upside.
Carrying out R&D via startups and convertible notes can also result in more useful deliverables and prototypes than the same research tasked to a university or national lab. Companies interested in pursuing R&D should consider whether the questions they are posing are better addressed by a public lab or a private team of entrepreneurially minded engineers.
Other Corporations
Startups and public labs do not have a monopoly on innovation. Many energy products require the involvement of well established manufacturers like GE, ABB, Schneider Electric, etc. While special supplier partnerships between manufacturers and utilities are nothing new, both parties will need to explore more creative structures such as revenue sharing and royalty agreements to better incentivize deployment of larger-scale innovations
Participate in Every Stage of Innovation
Innovation does not follow a linear path from lab to startup to corporation. The most impactful ideas can emerge from any stage of the ecosystem after rattling between labs, startups, and established corporations for years. To capitalize on the most critical innovations, energy companies need to be engaged (to some extent) at every stage of the ecosystem. Further, engaging at each stage will provide organizational learnings (e.g. how incentives differ between inventors and entrepreneurs, IP strategy, investor criteria, etc.) that accelerate and lubricate the transition and evolution of ideas between stages. Engaging in just R&D, just venture capital, or just M&A will limit your organization’s innovation efficiency and likely cause one to miss the most critical opportunities (either because they emerged from a different part of the ecosystem or worse, because your organization doesn’t know what good looks like).
R&D
Learn what it takes for fundamental discoveries and inventions to form
Converse with the types of people, teams, and environments that spur creative invention and understand the factors that motivate them
Explore the competencies and cultures of different universities, national labs, and private labs
Negotiate through the legal processes of protecting IP
Venture Capital
Understand what “good” looks like for a business plan, team, market size, and go-to-market strategy
Know what different types of venture investors are looking for
Negotiate through terms sheets and the various economic and governance items that affect incentives in the near and long term
Product and Customer-centric Thinking
Learn what it takes to achieve product-market fit before scaling production or sales
Build a culture of product managers who are able to translate between customers, engineers, designers, and executives
Most importantly, learn how to study your customer and infer what their true demands are
A company that knows how to build products will have a much easier time identifying meaningful innovations at the venture and R&D stages
Design your Organization around Product Champions and a Culture of Cooperation
The skillset to produce a great invention is very different than the one needed to commercialize a product successfully, and they are rarely found in the same person. For this reason, product champions are crucial to shepherding new ideas through organizations and accumulating the buy-in necessary for commercial success. Product champions (or “Product Managers” as they are referred to in the Tech industry) are able to speak the language of inventors, engineers, designers, sales teams, operations team, executives, and lawyers. They coordinate the expertise and resources needed to develop truly innovative new products, and they are unfortunately very rare in the utility industry. Utilities are organized around operational efficiency and hierarchical authority. In order to innovate, utilities need to learn how to empower lower ranked employees who can serve as champions for major initiatives.
Product champions should be given some urgency in their roles. They should not be allowed to linger, hunting for new ideas amongst the year’s favorite buzzwords. Product champions must identify their set of products and focus on seeing them through to fruition (likely creating a new role for themselves in the process). If the same person is constantly chasing the latest ideas and technologies, they will lose the credibility needed within the organization to help meaningful innovations get realized.
Another pitfall of utilities’ operations-focused organizational designs is their tendency to create silos that develop unhealthy competition culture, in which separate teams or entire departments inefficiently fight for attention and credit. Cooperation and a shared identity during “wins” is crucial in an industry where customer expectations, politics, and commodity pricing are hard enough adversaries on their own.
Incentivize your Innovators
Innovation is always an uphill battle against the status quo. It always takes longer than the project champions expect and it is often an unrewarding process unless one actually succeeds. For these reasons, the employees responsible for persevering through an organization and industry of naysayers need to have a stake in the idea’s success. Often this comes in the form of equity, but whether it is cash, stock, or some alternative mechanism, what is important is that the reward be proportional to the risk and the magnitude of the real outcome. The most innovative companies in the world today (e.g. SpaceX, Amazon, Alphabet, etc.) compensate all of their engineers and product developers with stock options (no matter how low their rank). This is not the norm in the utility industry. Stock options are rare and essentially non-existent below the rank of Vice President. There is a general cultural sense that anyone who is not an officer of the company does not move the needle on overall company performance. There is some truth to this because utility stock prices are, by design, relatively predictable and non-volatile. However, to form a culture that creates meaningful innovations, the utility industry must find ways of enabling employees to participate in their successes.
Much of the incentivization structure at the employee level within a utility stems from how utilities are regulated at the state-level. Utility commissions should explore regulatory models that encourage utilities to pursue new technologies and business innovations that improve long-term performance and costs for the societies they serve. Examples of such constructs could include creating designated R&D or piloting budgets, adjusting affiliate definitions and transaction rules so that publicly traded utilities can pursue more corporate venture capital, or designing revenue models that allow utilities to share in cost savings. There are many ways to approach such incentive structures that have various pros and cons, but regulators need to find ways of encouraging a more innovative culture within their utilities.
Listen to Clay Christensen: Relinquish Full Control
The central thesis behind Clay Christensen’s “The Innovator’s Dilemma” is that the incentive stack behind incumbent corporations inhibit them from pursuing disruptive innovation organically. Even if a corporation has all the IP, know-how, and resources to build the new business before anyone else, investors and boards won’t let the innovation proceed if it poses too much of a threat to the existing revenue model. Creative destruction has a habit of cannibalizing the old. Christensen’s proposed solution is to separate the new innovative business from the old core business as much as possible (e.g. the way GM separated Saturn). Given that investment decisions within utilities are heavily swayed by preserving relations with politicians and a conservative investor base, this separation is even more crucial. Even with the full backing of the CEO, innovative initiatives within utilities will be killed if they are too much at odds with existing investors expectations of low risk and a reliable dividend (exemplified when NRG’s board ousted David Crane as CEO in 2015). If a new business is attempting to innovate on the utility regulatory model itself, insert itself between utilities and their customers, or wrest any further control of the grid away from utilities (which includes most new energy startups), it is probably a good idea to keep its governance separated from the governance of an existing utility.
Experiment with New Models
As I have emphasized throughout this article, more experimentation in corporate innovation models within the utility sector is key to seeing the broader energy innovation society needs. Utility cultures have begun to evolve but a great deal more evolution is necessary if we are to advance the energy system without sacrificing affordability. Below is a list of some specific experimental innovation models that utilities and others in the energy innovation ecosystem may find impactful:
Joint Development Agreements (between utilities and startups): establishes a framework for co-development of new products and services that are more ambitious and disruptive than what a utility would pursue by itself. Utilities benefit from preferred pricing, revenue sharing, political equity with local stakeholders (demonstrating a willingness to innovate quicker), and a “seat at the table” for defining new products. Startups gain from reduced barriers to market entry, expert input, faster product-market fit, and reduced development costs
Super Pro Rata Rights: A strategic investor term that would allow an incumbent energy company to ratchet-up its equity stake in a startup over-time in exchange for helping the startup pilot and grow their product. This term helps alleviate an incumbent’s aversion to investing in the most disruptive innovations.
Warrants: A strategic investor term that incentivizes and incumbent to help a portfolio startup sell to other large energy companies. While regulators may place restrictions on a utility procuring directly from a startup it is invested in, they should be open to a utility helping that startup sell to other utilities.
New Regulatory Frameworks: Utilities need to be rewarded for making the most prudent investment choices for the grid. Today, their incentives can have a tendency to point them towards the most capital intensive investments. Regulators need to allow utilities to realize “outsized” returns for demonstrating meaningful savings in their infrastructure investment strategies. This is a difficult balance to strike but is necessary to build a clean grid swiftly at a reasonable cost to society.