Vertical Integration of Electric Utility

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To make, or vertically integrate, would mean performing the services in-house with their own employees. Where benefits are concerned, administering programs internally requires HR employees to have an extensive knowledge of every medical product or service HR personnel deem essential. This specialization requires training HR members and employing enough workers to carry out all the functions necessary to adequately forecast and care for employees. A company could rely solely on its HR department to make decisions, or could train HR members to build a rapport with the employees to better understand their specific needs. If neither option proves satisfactory, the company could also explore the possibility of outsourcing their benefits programs.

Contracting with a benefits vendor allows for further expertise pertaining to various benefits functions. A company may find outsourcing to be more cost-efficient as well. However, employees may be less satisfied using an external vendor as it potentially eliminates the personal element provided by an HR department (Miller-Merrell 2013). Also, if a company does not supply their own benefits services, employees may have to pick and choose from separate vendors.

As an employer of several thousand workers, LG&E KU has been faced with this make/buy decision of how to best serve their employees. Currently, LG&E KU outsources their retirement benefits services to two vendors—Mercer and Fidelity. Mercer administrates their retiree medical and life insurance plans, while Fidelity manages their 401k and pension plans. Despite their decision to outsource, the Benefits Department within LG&E KU remains responsible for guaranteeing that their benefits are administered in accordance with LG&E KU’s specifications.There were several reasons they chose to outsource this.

Around 2005, when LG&E KU was owned by the German energy company E.ON, the possibility for acquisition of other american companies to join LG&E KU under the E.ON banner was real. Under those circumstances, outsourcing would provide the recordkeeping platform, additional labor, and expertise needed for such acquisitions in an uncertain and fluctuating environment. This development is what led LG&E KU to begin outsourcing all retiree administration to Mercer in 2006. In 2016, the company “unbundled” and moved their 401k and pension plans to Fidelity, leaving their welfare plans to Mercer.

In comparison to other utilities companies, LG&E KU is similar in their decision to outsource benefits administration. As is typical of many industries in the U.S., the utilities industry is dealing with an aging workforce (Thompson 2014). This aging generation of workers presents the increased need of specialized retirement services, giving companies further incentive to outsource to vendors. Aside from retirement benefits, utility companies also utilize external vendors for health and wellness services. According to a December 2015 report by the International Foundation of Employee Benefit Plans, one-third of the companies surveyed across 20 industries outsourced benefits (Miller 2015). The most significant reasons included the specialization of vendors and lowering costs. Overall, the decision to use external vendors for benefits services is a common make/buy choice across industries.

Supply

LG&E KU’s profits, like any other large industrial company, rely heavily on how cheaply and reliably they can source inputs into their production process. For a company like LG&E KU, the single largest recurring cost is the fuel necessary to feed the insatiable needs of a thermal energy plant. To understand the colossal fuel needs of a thermal generation plant, all one has to do is drive by a coal plant and see the mountain of coal stored on site. Often the footprint of a typical 60-90 day fuel reserve at a coal power plant is equal to or greater than that of generation equipment (Image 1 in Appendix). To fulfill their demand for fuel, LG&E KU can choose to own fuel production facilities, participate in long term purchasing agreements, mix long term agreements with spot purchases, or only purchase fuel as needed on a short term

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LG&E KU currently fulfils their demand for power by mixing long term contracts with fuel producers and opportunistic spot buys. The company has adopted a strategy of mixing short and long term purchasing agreements in order to take advantage of fluctuating market conditions. Coal alone has seen vast price fluctuations in the past decade (Investment Mine 2016). By utilizing both long term contracts and spot buying the company is able to mitigate the effect of spikes in fuel prices by relying on fixed long term contracts and dips in fuel prices by purchasing excess fuel immediately from the market. The company also buys and stores massive amounts of natural gas underground throughout six counties across the state (LG&E GAS). With these storage facilities, LG&E KU takes advantage of cheaper gas prices in the summer to meet customer demand in the winter.

Although Duke Energy recently joined LG&E KU in a mixed purchasing strategy, this model represents a somewhat atypical relationship for an electric utilities (Larsen 2017). Most large electric utilities rely on fixed long term commitments to outside firms for fuel supply/shipping services and work closely with mines (Larsen 2017). These long term contracts help to provide stable fuel prices and allow a utility to more appropriately forecast variable costs in the long term for generation facilities, and financial consequences when contracts are broken (Litvak 2017).

Some firms go even farther than long term contracts by directly partnering with mining facilities. These utilities source coal from on-site mining facilities in what is known as “mine to mouth” production where a coal plant is built directly beside an active mine. By locating next to a fuel source, a generating station can completely eliminates the transportation costs associated with shipping coal by truck rail or barge. These shipping costs can represent up to half of total final fuel costs (Dixon 2014). The Navajo generating station located within the Navajo nation is an example of one such plant (Beeler 2017). The generation facility and nearby Kayenta mine are essentially linked, If one were to close the other would cease to operate.

Mine to mouth operation however is uncommon and only feasible where technology and infrastructure permits (Dixon 2014). Coal fired power plants require massive amounts of water to produce steam and are usually located next to lakes or rivers. It is difficult to find a single suitable location to satisfy