Constellation Energy: A Star Is Born

Can a company in an industry roiled by dramatic and unforeseen change achieve high performance? Can its leaders build a powerful performance anatomy and instill a winning mindset in an organization that was protected from competition for almost 200 years? Moreover, what can we learn about the nature of performance anatomy itself by comparing high-performing businesses in very different industries? These questions were foremost in our minds as we undertook a case study of Constellation Energy in the spring of 2005. But the same questions had much more urgency for Mayo A. Shattuck III when he took over as Constellation Energy's CEO more than three years earlier. The company's stock had fallen by 53 percent during 2001, and electricity prices had declined by 90 percent from the previous winter's high. Employees were demoralized, while analysts excoriated management. Shattuck arrived amid these difficulties with a bold new strategy in mind. But he knew that successful implementation was anything but guaranteed—unless he, with considerable help from others, could change the thinking about how the company operated and competed.

The company's stock had fallen by 53 percent during 2001, and electricity prices had declined by 90 percent from the previous winter's high. Employees were demoralized, while analysts excoriated management. Shattuck arrived amid these difficulties with a bold new strategy in mind. But he knew that successful implementation was anything but guaranteed—unless he, with considerable help from others, could change the thinking about how the company operated and competed.

 

The transformation at Constellation Energy would require not only strategic and operational change but also a fundamental change in the company's culture—something Shattuck knew could not be accomplished overnight. Nevertheless, he forged ahead with his plan to unite employees around a common vision by infusing the organization with a new performance anatomy that would support his strategic focus and enable the company to outexecute its peers.

This article chronicles how, in a few short years, Constellation Energy evolved from a $3 billion regional regulated utility into a nearly $13 billion national energy company and North America's leading supplier of energy to customers in competitive markets. By 2004, the company had strengthened its market share to 21 percent (more than 50 percent greater than its nearest competitor) and could boast 10,000 commercial and industrial customers, including two-thirds of the companies in the Fortune 100. Plus,its marks for customer loyalty and satisfaction were soaring. In 2005, it was awarded the electric power industry's highest honor, the Edison Award, for its financial performance and for its leadership in establishing a competitive marketplace. The story of Constellation's transformation also provides valuable insights into the challenges of building a robust performance anatomy, one of the three building blocks of high-performance business.

Prelude To A Crisis
Constellation's antecedent, the Gas Light Company of Baltimore, was founded in 1816 by artist Rembrandt Peale, who had illuminated an exhibit at his gallery with lamps powered by coal gas. The company grew and thrived for nearly two centuries, becoming Baltimore Gas & Electric in 1955. By the 1980s it was a stalwart producer in a heavily regulated, monopolistic industry.

For years, the industry's economic formula was simple: Prices were set by state regulators using a "cost-plus" formula, by which any "excess" profits were returned to investors through dividends. Management would explain to regulators what its costs were, and the state would allow the utility to set a price that would guarantee a specific return on investment. As BGE's management saw things, this formula rendered any efforts to improve operational effectiveness or make financial forecasts a waste of time. As for employees, a culture of entitlement permeated the company—pay grades were the benchmark for career advancement, and pensions the brass ring.

This cozy arrangement began to unravel in 1992, when the U.S. Congress passed the Energy Policy Act, which effectively gave states the option of deregulating their electricity supply markets. This landmark legislation broke the large utilities' monopoly by allowing independent power producers access to transmission lines; it also allowed states to adopt policies that would encourage competition between power suppliers and transmitters.

Maryland, however, BGE's home turf, resisted deregulation for more than seven years. But as the stock of business media darlings like Dynegy and Enron hurtled to stratospheric heights, the company was pressured by shareholders to get into the game. By early 1999, BGE's management had refashioned the company as Constellation Energy Group to take advantage of the newly deregulated market and ride the wave of investor euphoria over high-growth, high-risk energy-trading companies. The new company consisted of units whose products and services ranged from power generation and supply to energy consulting.

But the wave soon petered out. The US economy began to slide into recession, and the terrorist attacks of 9/11 accelerated the decline. Meanwhile, Enron and Dynegy collapsed, and their executives were disgraced. Energy trading suddenly became a symbol of the era's excesses. In November 2001, Mayo Shattuck, a Constellation board member and chairman of the board of Deutsche Bank Alex. Brown, was recruited to lead the embattled company.

Despite Constellation's condition, Shattuck had no doubt about the path forward: Even as companies that had been selling on the open market retreated to the safety of still-operating regulated markets, Constellation Energy would strive to become the leading competitive provider of energy to wholesale customer in North America. The need for swift action was paramount. "That was the holy grail", Shattuck recalls. "We had to build a strong position first and figure out fundamentals of how profitable this business would be later."

In fact, building a strong position effectively involved building a high-performance anatomy at the heart of which were those five critical skills that make up a winning mindset.

1. Shaping The Market, Executing With Discipline
Shattuck's contrarian philosophy left Constellation poised to shape the markets its competitors were abandoning. Under his direction, it bought up everything from trading books to nuclear power plants. The most important acquisition was a retail energy supplier, NewEnergy, which it acquired in 2002 from The AES Corporation, the global power company headquartered in Arlington, Virginia, for approximately $260 million.

Despite Shattuck's convictions, however, a "generation-centric" mindset permeated the venerable utility and nearly derailed the new strategy. The only thing that mattered to some of the old-guard management, Shattuck discovered, was "producing megawatts and pushing them into the grid." In a culture in which, for many, "winning seemed to be about keeping the lights on," Shattuck notes that one of his big concerns was "how to develop a sense of commercial behavior at all, given that we've almost never had to market or sell anything."

A new focus on the customer was one important change. In the past, customers had all too often been an afterthought. Now Constellation put a priority on both acquiring new customers and keeping existing ones happy. In 2004, for example, the company helped redesign the power delivery system in recently deregulated Ohio, and in the process acquired detailed knowledge of power and rate structures. This work helped Constellation win new business, says Thomas Brady, executive vice president of corporate strategy and retail competitive supply. "When the state finalized the deregulation in mid-December, our team came up with 30 customers before the end of the year and saved them money. The competition, quite honestly, was nowhere to be found."

Constellation also strengthened its relationships with existing customers.
Constellation NewEnergy led the charge, figuring out how to make the customer sticky. Price was no longer the driving factor, as customers became more integrated with Constellation and relied on it for the entire process of managing their energy costs.

Organizational Overhaul
But this ambitious focus on the merchant energy business would require superb execution in addition to clear vision. Better execution would first require an overhaul of Constellation's organizational structure, which consisted of carefully guarded silos.

Shattuck was convinced that a matrixed management structure could help Constellation, but he knew that implementation would be difficult. Change did not come easily in the IT function, for example. Recalls Follin Smith, executive vice president, CFO and chief administrative officer, "It took me three months to get everyone to agree that we were going to have one CIO over this company, as opposed to lots of people who run computer departments." But through persistent effort, the matrix was put in place throughout the company, and Constellation became more agile and better at effecting change more quickly.

Another key to improved execution was cultural change. Everything Shattuck did was aimed at reinforcing the message about competitiveness, from changes in pay scales to new incentive programs. At one point, he even flew to Las Vegas with Baltimore icon and baseball legend Cal Ripken Jr. (a man so competitive he played in more than 2,600 games without taking a night off) to do the Sunday night sales speech. This was something new for the once-staid BGE, and it caught people's attention.

At the same time, Shattuck balanced the emphasis on competitiveness with messages designed to instill a sense of teamwork and partnership at all levels. And, as he did with the Ripken appearance, he made use of potent symbols to get employees to think beyond the current tough times by reminding them of Constellation's proud heritage and innovations. Using an extensive array of artifacts from the company's past, Shattuck created a veritable museum on each floor of company headquarters that highlighted major transitions the company had initiated and successfully executed.

Restructuring the organization and creating a culture of competition were both necessary, but not sufficient, for superb execution. Constellation was also in serious need of capital. To recapitalize the company, Shattuck began to sell off noncore assets—including 1,300 acres of real estate, an oil tanker, a nursing home and several utility holdings outside the United States—soon after taking the helm.

The true benefits of the asset sale were not limited to an improved balance sheet and a more strategically aligned cost structure, however. Other companies, including industry heavyweights Dynegy, El Paso Corporation and The Williams Companies, took similar actions and subsequently saw their share prices plummet. But unlike those other companies, Constellation sold its assets not just to buy a bandage for a mortally wounded business; instead, the sale freed up capital and management's time—time it used well to execute the new strategy.

While Constellation's management was shoring up the balance sheet, federal authorities and Wall Street analysts, with the memory of Enron and other debacles still fresh in their minds, were busy scrutinizing the company. Constellation's trading operations were clean, however, largely because of practices the company had learned from its old investment-bank partner, Goldman Sachs. Notes Stu Rubenstein, hired from Goldman in 2001 to be COO of Constellation Energy Commodities: "In investment banking, we learned to respect the markets, and we had controls in place for our trading activities. We instituted the same tight controls here at Constellation Energy."

Despite Constellation's clean record, however, management still had to overcome investor cynicism about the industry. In January 2002, at the new management team's first meeting with analysts, senior executives showed up with a presentation that had projections showing where they were going to take the business and specifics about how they were going to make money—more detail than CFO Smith had ever seen at an investor presentation. "It was," she recalls, "the complete opening kimono." The analysts were impressed and signaled their approval. Corporate strategist and retail competitive supply chief Brady: A key change at Constellation was a new focus on the customer. Within two weeks of Ohio's deregulation of the power industry in 2004, the company had 30 new customers.

2. Using a Selective Scorecard The energy industry has historically been dominated by companies top-heavy with monetary and physical assets. Industry executives have not been accustomed to managing intangibles such as human capital or customer relationships. Deregulation changed this aspect of the game as well—something Constellation under Shattuck was quick to recognize. The company considers its most significant intangible asset to be its knowledge of the industry and its ability to understand—and manage—the various components of the energy value chain, chiefly through measuring and modeling activities. "That resource has enabled us to better manage our knowledge asset by ensuring that our bids for service offerings are not driven by gut instinct," says Andrew Good, chief financial officer of the company's commodities group. Using a data-driven approach to determine sales tactics is unusual in the capital-intensive energy industry, where measuring and modeling activities are often left in the hands of a sales force or traders.

Constellation has identified and seeks to manage many other intangible assets. For example, it maintains knowledge of regulatory environments in part by providing the sales force with incentives to keep current on rules at all levels of government. It also manages employee relationships thoughtfully. "Through our work environment, pay, open-door policy, we try very hard to manage the business in a way that treats employees fairly," explains Ken DeFontes, president of BGE. As a result, Constellation's workforce is only 7.3 percent unionized, a much lower rate than that of other energy companies. Another key intangible—the most valuable, in corporate strategy chief Brady's view—is the management team's credibility, which has been carefully cultivated over time to win the trust of all stakeholders. CFO Smith: Despite Constellation's clean record, the company had to overcome investor cynicism about the industry, which was reeling from the Enron debacle when new management took over in 2002. At their first meeting with analysts, senior executives arrived with more detailed information than one observer had ever seen at an investor presentation

3.Multiplying Talent Shattuck knew that a competitive top team would be central to Constellation's transformation. To build his team, he relied heavily on outside hiring, believing that fresh blood would drive change and implement the company's new strategy most quickly. He purposely recruited managers with functional rather than industry expertise. "We set up a system where, for a while, about half the management committee could not substantively engage in the strategic dialogue but could challenge the people who knew the industry with questions from right field," he says. The approach quickly proved successful as culturally entrenched assumptions were challenged and often dispelled. To change the culture at all levels, external hiring was widespread throughout Constellation early in the transformation. Aggressive performance management was the second key component of the human resources transformation. Management needed to get the organization thinking about how to assess, improve and differentiate performance. "We had the disease that the vast majority of companies have," says CFO Smith. We let everyone off at performance evaluation time with a nice word, and didn't make hard distinctions."

No longer: Employees now clearly hear how their performance measures up to the new standards. A general Constellation Energy framework for feedback, customized by each business unit, uses a performance rating system and an incentive plan, tied to overall company performance and specific business unit success, that links in individual contributions.

The next priority was to establish a relationship between performance and pay. Constellation sets base salaries that are often well below the median of the marketplace. But with variable pay, strong company and individual performance can take an employee's total compensation above the 90th percentile. By contrast, the old compensation system had set almost all employee salaries at the highest level for their pay grade. CIO Perlman: IT is regarded as a strategic weapon at Constellation, where the IT function is a full business partner in the organization and the CIO is a full-time member of the management committee.

4. Viewing IT As A Strategic Asset To build a strong performance anatomy, an organization's executives must see information technology as a strategic weapon. But at Constellation, IT's climb up the strategy table would not be an easy one. To begin with, the function had never been highly regarded in the regulated utility. For example, it was generally an afterthought for the company to tell IT about any acquisition activity. CIO Perlman and her team knew that if they wanted IT to be included in the company's strategic planning process, they would need to establish the function's credibility by delivering a stellar performance. "We can't just show up and say we want to be a business partner," says Wynne Hayes, manager of IT for Constellation Generation. "First, we must earn the trust, then we earn the respect, and only then can we become a business partner."

Constellation's IT department earned that trust through the successful implementation of initiatives such as the Common Enterprise Technology Program. The department faced significant resistance to the program, which aimed to standardize employees' computers. But as IT worked with one group at a time, doing small implementations, it gradually gained credibility.

Another key to changing minds was the role IT played in the acquisition of the Ontario, New York-based R.E. Ginna nuclear power plant, which was announced in November 2003. According to one senior IT manager involved in the acquisition, "We planned to close on Ginna in six months, which was unheard of in the industry. Just setting such a goal was a testimonial to the new strategic direction of the organization."

To respond to the challenge, Constellation assigned more than 100 IT professionals to the project. They operated in specialized groups to integrate all the seller's systems, from finance to HR to procurement. Recalls Constellation Generation's Hayes: "IT impacted that acquisition in many ways. It wouldn't have been successful if management hadn't supported the earlier standardization initiative. And if they hadn't engaged IT early in the acquisition process, it never would have closed in six months.

Less than two years after Perlman's hiring as CIO, constellation's IT function had become a full business partner in the organization, and Perlman is now a full-time member of Constellation's management committee.

5. Continuously Renewing The Business
Even a high performer needs to continually review its performance anatomy, or it can become complacent. Constellation's leaders understand this, as their approach to quality measurement demonstrates.

In 2002, Smith noticed diminishing returns from the company's Six Sigma quality improvement program. The organization had had two years of quick wins and relatively easily achieved improvements, and others might have been content to continue with the status quo. Smith was concerned, however, that as results became harder to achieve, employees might lose their faith in this and other management tools. To reinvigorate the company, she hired Roger Cockroft from IBM to serve as Constellation's vice president of Six Sigma programs.

Cockroft observed that the Six Sigma adoption was not aligned with strategic objectives and that consequently the program was viewed throughout the organization as merely "an extra thing to do." After observing the organization's operations for six months, he pointed out that Constellation was already practicing a host of process-improvement methodologies in addition to Six Sigma and recommended putting them all under one umbrella he dubbed SIRIUS. "Six Sigma and other programs like it can only improve the current process," he says. "In our case, that is not good enough. Old processes can be fixed easily, but if the process you need does not exist, you can create a Frankenstein monster by patching old processes together. The SIRIUS methodology enables us to both improve and create processes.

Constellation has used its culture of continuous renewal to help strengthen its performance anatomy in many ways. IT's strategic value was enhanced through performance-improvement practices and innovative applications of technological solutions. Talent multiplication was bolstered with a performance measurement and management system new to the industry. And management of intangible assets was honed not only through the innovative use of human capital resources but also through a better approach to solving forecasting problems.

By the end of 2004, Constellation's stock had rebounded nearly 100 percent from its low at the end of 2001, and revenues had more than tripled. A few months later, Constellation was named the most admired energy company in America by Fortune magazine; it also jumped from 203 to 167 on Fortune's annual rating of America's 500 leading companies.

But Shattuck was particularly proud of Constellation's 2005 receipt of the Edison Electric Institute's prestigious Edison Award. Accepting the industry accolade, he noted that Constellation had, in just three years, fundamentally changed its course: "We had the ability to transform. We made some big strategic moves and saved it from going under. That's the exciting story."

The Constellation story also yields significant insight into the nature of a high-performance anatomy. It reaffirms something we had learned from Harrah's Entertainment, the first case study in this series (see "Exploring the Mindset of the High Performer," Outlook, October 2005)—that a winning attitude is essential to sustained financial achievement. But it also brings to center stage two other facets of performance anatomy: leadership values and the strategic use of company history as a means of translating those values into action. Throughout the company's renaissance, Constellation's top management team voiced a core set of values regarding customers, competitiveness and integrity. It also reached into the company's long history for example after example of how those values, though newly voiced, were nevertheless central to its culture, even 200 years after its founding.

That litany, in turn, gave rise to a new, winning mindset at Constellation—and to the emergence of a high-performance business.

The Outlook Performance Anatomy Case Study Series Through a program of original research, Accenture has determined that high performance rests on three building blocks: the creation of distinctive capabilities; market focus and position; and performance anatomy. Because performance anatomy embodies a company's unique approach to managing the core elements common to every business—and therefore is crucial to long-term effectiveness, the quality and speed of decision making, and the mastery of change and innovation—we believe it deserves special attention. This article is the second in a series based on in-depth case studies undertaken by Accenture to gain a better understanding of how high-performance businesses build and sustain their performance anatomies.

A high-performance anatomy consists of a number of elements, but at its heart are five essential skills that determine how—and how well—an organization approaches tasks critical to the execution of its strategy: balancing market creation with disciplined execution; multiplying talent; using a selective scorecard to guide performance measurement; viewing information technology as a strategic asset; and renewing continuously. Organizations like Constellation Energy, which demonstrate those skills collectively, have what we term a "winning mindset."

Sidebar: Constellation Energy Business Units

• Baltimore Gas & Electric delivers electricity and natural gas to more than 1.1 million electric and 600,000 natural gas customers in central Maryland.

• The Constellation Generation Group owns or has an ownership position in 35 power plants in 11 states, and markets energy throughout North America. In 2003, it generated 51.6 million megawatt-hours of electricity from both renewable and alternative fuels.

• Constellation Energy Commodities Group manages the logistics of transporting, storing, receiving and delivering energy in deregulated markets for wholesale purchasers such as co-ops and municipalities.

• BGE HOME provides energy-focused products and services for residential and small commercial customers in Maryland, and sells and services heating and air-conditioning equipment and plumbing and electrical systems.

• Constellation Energy Projects & Services Group provides infrastructure services and maintains these services. For example, it builds, operates and maintains such projects as the central heating and cooling plant for the Pittsburgh Steelers' Heinz Field and the central chilled water and distribution system for the Las Vegas Fashion Show Mall.

• Constellation New Energy serves as an extension of large commercial and industrial customers' energy procurement functions, helping management control costs and usage based on their unique business requirements.

• Fellon-McCord & Associates provides energy consulting and management services—managing more than $2 billion in natural gas supply and more than $2 billion in electricity supply and transportation annually.

About The authors
Robert J. Thomas is the executive director of the Accenture Institute for High Performance Business in Wellesley, Massachusetts. Dr. Thomas is also a partner in the Accenture Human Performance service line and a leading authority on leadership and transformational change. He is a frequent contributor to Outlook, and his ideas on human capital development have also appeared in Harvard Business Review, Sloan Management Review and The Wall Street Journal. His book Geeks and Geezers, which he co-wrote with Warren Bennis, was one of the best-selling business books of 2002.

Walter E. Shill is the managing director of the Accenture Global Strategy service line. He has extensive experience advising Fortune 500 clients across a broad spectrum of strategy, organization and M&A issues. Mr. Shill is based in Washington, D.C.

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