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Utilities and Cloud-Based Software
What is cloud-based software?
Software that’s developed and hosted by a vendor
and which the end user accesses over the Internet.
It is also referred to as “Software as a Service” or
SaaS.
Unlike traditional packaged applications that users
install on their computers or servers, the SaaS
vendor owns the software and runs it on computers
in its data center.
The customer does not own the software but
effectively rents it, usually for a monthly fee.
We use cloud-based software every day
Software for regulated businesses is transitioning to the cloud
Why are consumers, businesses, and government all
embracing the cloud?
“SaaS applications establish a modern,
innovative IT environment with operational
agility and business advantage…and have a
lower total cost of ownership (TCO)”
Sound business is driving software to the cloud
1. Reduce spending on IT infrastructure
2. Keep pace with technology changes
3. Improve flexibilityUsing today
45%
97% of utilities are
using or plan to use the
Cloud
Utilities are moving to take advantage of the benefits of Cloud
They are focused on three benefits:
How do utility customers benefit from cloud-based software?
On-premise Customer Service
Representative (CSR) Software
• Quickly out of date, expensive to update
• Transactional systems offer information but
no insights
• Clunky, complicated interfaces make it hard
to answer calls quickly and effectively
IMPACT ON THE CUSTOMER: On-premise tools fall short
Traditional Customer Service Representative (CSR)
screen, showing limited information available via on-
premise solutions.
Cloud CSR Software
• Frequently and easily updated
• Personalized insights are automatically
calculated and prioritized for reps
• Utilities benefit from lower call volume,
faster handling, and fewer truck rolls
• Seamless customer experience across
channels
IMPACT ON THE CUSTOMER: Cloud-based tools deliver a superior experience
State-of-the-art Customer Service Representative (CSR)
screen, showing personalized information available via
cloud-based solutions.
How are utilities buying and using software today?
The regulatory system and software:Utilities tend to think of on-premise software as capital, since they buy it just like power plants
Years
Inve
stm
en
t
One big up-front
investment in the
system
Minimal maintenance
over the system’s life
Another big lump
investment when
the system is past
its useful life5-20 years
Utility Web Investment Model
Available
Already committed
Operating budgetCapital budget
Already committed
Utilities don’t have an incentive to underspend on capital budgets.
Capital budgets are typically bigger than operating budgets.
The utility gets to keep whatever they don’t spend from the operating budget, so the incentive is to not add any new operating expenses.
Operating budgets are typically smaller than capital budgets.
The regulatory system and software:Utilities prefer to use capital budget for software, which pushes them toward on-premise solutions
The regulatory system and software:Utilities earn a rate of return on capital expenses, which pushes them toward on-premise solutions
Revenue Requirement = Expenses + (Rate Base x Cost of Capital)
Software that’s treated as
an operating expense does
not earn a rate of return
Software that’s treated as a capital expense
goes into the rate base and earns a rate of
return (as part of the cost of capital)
Utility incentives will be aligned with the public interest if cloud-based software is treated as a
capital expense.
This issue is getting national attention
•US House of Representatives
– Energy bill would require states to consider allowing utilities to earn a rate of return on cloud-based software
• Illinois Commerce Commission
– Seeking feedback on the role of cloud-based software in utilities and regulatory barriers to adoption of the technology
•New York PSC
–May 19, 2016, order provides a way for utilities to earn a rate of return on SaaS
This is a Regulatory Accounting issueRegulatory Accounting rules are driven by the Uniform
System of Accounts (USOA), which is created by the
Federal Energy Regulatory Commission (FERC) and
implemented by state regulators
Regulatory Accounting answers 2 important questions
1. What can be part of the rate base and can earn a
rate of return?
2. What budget can be used to pay for something?
New York set precedent for earning a rate of return on SaaS
• A NY PSC order from May 19, 2016, explicitly says how utilities can earn a rate of return on SaaS
• Utilities simply need to pre-pay SaaS contracts
• The PSC’s goal is to make utilities indifferent between on-premise and cloud-based software
• Other states can follow NY’s lead since they use virtually identical regulatory accounting guidelines (FERC USOA)
New York Public Service Commission, REV Proceeding on May 19, 2016
“Rather than developing their own software, many businesses find it more efficient to enter contracts to
lease software services over extended periods, typically three to five years. To the extent that these leases
are prepaid, the unamortized balance of the prepayment can be included in rate base and earn a
return. As utilities evaluate whether to purchase or lease these applications, their ability to earn a return
on a portion of the lease investment should help to eliminate any capital bias that could affect that
decision.”
What did the NY PSC say?
Source: “Order Adopting a Ratemaking and Utility Revenue Model Policy Framework.” This is the final order on Track 2 of the REV proceeding, which is
Matter 14-00581. http://documents.dps.ny.gov/public/Common/ViewDoc.aspx?DocRefId=D6EC8F0B-6141-4A82-A857-B79CF0A71BF0
Example 1: Putting the NY approach to work
• There are no limits on the length or size of the contract, but it must be approved by the Commission (just like other expenses)
1. Prepay a multiple year term agreement using working capital.
2. Record that prepaid amount in USOA
Account 165, “Prepayments,” an
account used for prepaid contracts.
3. Draw down the prepaid amount as you use the software, with the part remaining in the account being included in rate base.
Illinois utilities recommended a second approach
• The Illinois Commerce Commission issued a notice of inquiry in February 2016 about utility adoption of cloud-based software
• Every utility recommended that the ICC allow them to categorize cloud-based software as “intangible property”
• This approach would solve the capital bias and works within existing regulatory rules
- North Shore Gas Company and The Peoples Gas Light and Coke Company, response to Illinois NOI
“NSG/PGL support treating investments in cloud computing solutions as “intangible plant”
(account 303). The benefit of this treatment is that it places identical investments (cloud and on premises
solutions) on equal footing. It removes the rate incentive for an on-premises solution and means that a
cost benefit analysis of different computing solutions would be indifferent to the rate implications.
Notably, this change would not create an incentive to choose a cloud solution; it would just eliminate the rate
bias in favor of an on-premises solution. Consequently, NSG/PGL did not identify any costs of this approach.
Like any investment, inclusion in rate base and recovery of a return on and of the investment would be
subject to review in rate cases. A Commission order would be sufficient to implement the policy.”
What did an Illinois utility say?
Source: https://www.icc.illinois.gov/downloads/public/NSG%20PGL%20Init%20Comments%2016-NOI-1%20%2004-28-16.pdf
Example 2: Treating SaaS as intangible property
• Accountants view this structure as similar to a capital lease, which should be included in the rate base, and recognize that Account 303 is the appropriate place to record it.
• In the proceeding in Illinois, 4 utilities recommended that the regulator adopt this method.
1. Sign a term agreement to cover the useful life of the software.
2. Record that contract amount in USOA
Account 303, “Miscellaneous intangible plant,” an account used for intangible property.
This treats the license as a traditional asset.
3. The depreciated asset value will be included in rate base and will earn a rate of return.
Takeaways: Regulators and cloud-based software
Regulators want utilities to buy the software that best
serves the public interest, so they’re motivated to
solve the capital bias
There are approaches in place that will work for gas
utilities in every state
Regulators are eager to see proposals from utilities in
their state
Summary: Cloud-based software compared to on-premise
On-premise software Cloud-based software
Complex to secure Security through simplicity
Requires significant hardware and
multiple independent deployments
Hardware and maintenance
costs spread across multiple
users
No updates until new software is
purchased
Updates happen in real time
SECURITY: Cloud-based software meets CIA’s security needs
Using today
45%
COST: Cloud-based software can be cheaper than on-premise over lifetime
Example from C3 IoT comments in response to Illinois Commerce Commission Notice of Inquiry. Note: This example excludes license fees for software.
$8M
$97M
$70M
$22M
Difference between cloud and on-
premise
Procurement expenses
Hardware and software
maintenance support
Hardware and software
infrastructure
Application and data integration
costsCloud-Based Platform On-Premise Solutions
cloud costs
$189M less
over lifetime
PACE OF INNOVATION: Cloud-based software keeps up with rapid technological improvements
Technology changes a lot in just
five years, but many utility
software tools are purchased
every 20 years.
“Full-scale system upgrades may
occur every 4 to 5 years for some
applications, or may happen only
every 15 to 20 years for energy
management systems.”
Source: Navigant Research, “Smart Grid IT Systems”
