Knowledge Problem

Lynne Kiesling

The cost saving-focused mindset has prevailed in regulated industries for over a century, slowing innovation in the process. In electricity, regulation that bases firms’ profits on cost recovery erects market barriers by recognizing only a business model that involves providing a specified product (110v power to the home) transported over a monopoly network. Even in 2011, well into the third decade of the digital revolution, this narrow focus and cost-saving mindset persists, and it fetters smart grid-enabled economic growth by emphasizing cost recovery and ignoring value creation.

In fact, one of the main reasons why smart grid investments face regulatory and political opposition is that focus on cost recovery (among others). I think this Greentech Media article gets the story right: the ways that smart grid investments can lead to cost savings are limited. We’ve discussed this idea here at KP quite a bit — a limitation on the benefits of transactive technologies and dynamic pricing is the fact that for most people, electricity bills are not a large share of their annual expenses, so even saving 15% on the electricity bill may not be a salient enough benefit to induce a lot of people to make technology investments. In other words, smart grid may or may not lead to cost savings for a lot of residential customers.

But is that the right metric by which to evaluate smart grid investments? Of course not. The Greentech Media article linked above starts with a telecom metaphor that I use frequently. In nominal terms, most of us pay much more for our communication services today than we did when all we had was a single land line (and leased Western Electric phone!) back in the 1980s, and even in real terms we probably still pay more than we did then. But look at how much more value we get — mobility, Internet, automation, all of the services that have been created at the edge of the network. We are much richer and better off because of the change in communication technologies and services since the 1980s, even taking into account that we pay more for them. Apply this metaphor to the regulatory calculus today, and the mismatch of its cost recovery focus and the benefits arising from new value creation is apparent. Innovation in telecommunications didn’t occur and thrive and expand because of cost savings and cost recovery, but instead because of new value creation.

Those who argue that the business model for customer-facing smart grid investments has to be grounded only in cost savings are incorrect, and are looking too narrowly at consumer value propositions. This debate came up in the post I wrote in October about the new Nest thermostat, a gorgeous and beautifully designed piece of consumer-focused in-home technology from a group of former Apple engineers, and in other articles about Nest around the same time. Observers from this traditional cost savings mindset dismissed the Nest thermostat because of its $250 price tag, saying that consumers would not save enough money to make the payback period on it make sense, even with dynamic pricing. This criticism overlooks the additional features and capabilities of such a device — motion sensing, serving as a hub to integrate and manage and automate in-home digital devices, learning algorithms, extensibility to be able to bundle with other digital services in the home, and so on. It also overlooks the persistent pattern in the history of new technology adoption, from the Roman baths onward; there will always be consumers with strong “first adopter” preferences, who are willing to pay more to be the first ones to have the novelty, and in the case of digital devices, incur that cost fully aware that prices will fall in the future as the technology matures. They guinea pig new technologies for the rest of us.

Those two aspects — additional features and first adopter preferences — mean that a lot of the value proposition in consumer-facing smart grid technologies is new value creation, not cost savings. This means that the regulatory calculus and the traditional electricity cost-focused mindset misses the real action, the real opportunity, the real potential that the investments could unleash.

One data point supporting my claim is that, only one week after its commercial release, the Nest thermostat was sold out and is now only available on backorder. Such innovation is about value creation more than cost savings, and ignoring and stifling that process holds back the contribution of the electricity industry to economic growth and well-being.

Lynne Kiesling

Appliance and consumer electronics manufacturers are starting to incorporate digital technology with energy-related applications into their products … but as with most new technologies, the first commercial stage of the innovation cycle takes the form of “because we can” product differentiation rather than use-specific innovation. Take the example that Technology Review highlighted this week: Samsung’s new refrigerator with an Android LCD display panel on the door. This high-end, gorgeous, stainless-steel refrigerator has an Android touch screen, which I think is pretty neat even if it does not read from the scripture of “the Internet of Things” that Christopher Mims wants it to — if I store my recipes in Evernote or in an Epicurious app, I can pull up a recipe on the door as I’m cooking, or make a shopping list as I’m looking in the fridge to see what I need. Mims’ tone is almost condescending when he observes that

A really smart fridge, part of the Internet of Things, would know when you put that lettuce in the crisper, so it could alert you when it was about to become inedible. It would tweet its current temperature so you know when your kid failed to close the door all the way. A really smart fridge probably doesn’t even have a display — far better to control it from any other internet-connected device.

The cynical view of Samsung’s move to embed a tiny tablet in its fridge is that these devices have become so cheap that sticking one in a fridge hardly makes any difference to their margins. It’s just one of those features — like a pop-up spoiler on the back of a luxury sports car — that makes a buyer feel like they got their splurge’s worth. If that’s the case, we can all look forward to Android-powered microwave ovens and clothes washers.

No. First of all, while I agree that automated monitoring features like produce spoilage detection and door ajar detection are desirable and user-friendly, Mims’ hyperbole about “Oh noes! We’re doomed to useless technology kitchen candy because of this!” shows a strong misunderstanding of the economics of consumer product innovation life cycles. The “version 1.0 mass-market user friendly right out of the gates model” is an outlier, a great exception to the typical evolution of technology; in fact, I’m having trouble thinking of a consumer technology product other than the iPod that comes close to that description. The “because we can” product differentiation puts the technology in the hands of early adopters, who are eager to kick the tires and are willing to spend their income to do so. These customers guinea-pig the technology for the rest of us, and provide companies like Samsung with feedback, which I’m sure will include comments like “it would be great if this technology enabled me to detect produce spoilage” and “this screen is pretty useless if all I can do is get to the Internet and not monitor my food”. Those experiences get incorporated into the evolution of the technology. Starting with the “because we can” technology is not necessarily going to lead to missed opportunities, as Mims argues, as long as companies like Samsung combine their engineering and business knowledge of what’s possible with the feedback they receive throughout the new technology adoption process.

Second, I think his definition of a “really smart fridge” is too limited. A really smart fridge would be transactive. A really smart fridge would enable its owner to program in price triggers to change settings on the chiller during expensive hours, saving the owner (an admittedly fairly small amount of) money and reducing energy use (good if the owner cares about conservation) and reducing peak demand on the distribution infrastructure (good for the wires company) — all without changing the quality of the refrigeration that the owner experiences, thanks to the beauty that is thermal mass. A transactive fridge would enable its owner to choose to cycle the chiller down if there isn’t much green power available, up to the point where the temperature change impairs the refrigeration, if the owner has a preference for green power. A transactive fridge is empowering for consumers.

A better article on the same topic comes from Greentech Media from earlier this summer (and has been sitting open in my browser to be blogged for too long!). In it Katherine Tweed argues that the current, first generation of smart appliances are oversold relative to their features. Without saying it explicitly, she makes the point that these first-generation smart appliances are expensive and likely to appear to early adopters — buyers more at the Viking end of the product line than the bottom of the Whirlpool line. She also, correctly, points out that if the value proposition to the consumer is saving money by reducing energy savings, the smart appliance features do not contribute much at the margin beyond the EnergyStar appliance standard; so if you are buying to save money by saving energy, you aren’t going to get much bang for the buck at the margin by choosing a smart fridge over an EnergyStar fridge. But as I remarked earlier, that’s not the only value proposition, because consumers care about other features.

It’s going to take some time to get the technology integration across the value chain to create all of these features, from spoilage detection to transactive automated response to dynamic pricing to preferentially choosing green power to sending the beer order to the store when my supply is low. It’s also going to take some choice in terms of electricity pricing for residential customers, and (surprise surprise) monopoly utilities and regulators are dragging their feet on that front. But don’t dismiss smart appliances today simply because V1.0 isn’t perfect. V1.0 never is.

ETA: I also recommend reading the comment thread on the Greentech Media article; it has a good back-and-forth about dynamic pricing.