Energy-services companies have evolved into a major force shaping the energy-efficiency market.

Energy-services companies (ESCOs) ain't what they used to be, and neither is the niche in which they dwell.

ESCOs, which offer the most sophisticated package of design, technical assistance and often installation services in the energy-efficient market, have reshaped the energy business, and this market in turn is reshaping them, with help from external forces such as utility deregulation.

The prospect of deregulation has utility executives scrambling to put in place nonregulated operations that provide services that customers will demand in a competitive power market and contribute to the bottom line. Toward this end, most of the major investor-owned utilities (IOUs) have either acquired stand-alone ESCOs or started their own ESCO operations within the past two years.

The utilities' sudden affection for the ESCO business has produced a rash of consolidation among the independent, stand-alone ESCOs in the market. Many of the independents are being acquired by utilities or merging their operations to create larger companies capable of serving customers on a nationwide scale. At the same time, startup ESCOs are coming out of the woodwork, causing significant growth in the number of people employed in the energy-services business, says Bill Marshall, vice president of marketing at Leviton Manufacturing Co., Little Neck, N.Y. He believes within five years there will be more ESCO salespeople on the street nationwide than there are electrical distributor salespeople today.

This growth is one of the factors that makes people such as Jack Briody, president of Advance Transformer, Rosemont, Ill., think ESCOs are the industry's rising star. Having so many people on the street telling customers about the benefits of upgrades could lead to a boom in demand for electrical products, he says. "In the next five years, more people are going to replace outmoded, inefficient electrical products with state-of-the-art products that will allow them to maintain their level of light, heat and cooling at half the cost of energy."

ESCOs could also create a demand for electrical products strong enough to carry the industry through the next economic slump, says Briody. And this demand will not be limited to lighting and efficient motors; it will include the whole building infrastructure.

The ascendancy of the ESCOs should concern traditional marketers of energy products in the electrical industry, he adds. "As ESCOs grow, they grow in between distribution and the end user. In response to their time, effort, diagnoses and services, they're the ones who are going to be determining how these products are purchased and from whom, what brand and which of the available service providers in the areas of installation and maintenance are going to be selected for the job. Contractors, distributors, manufacturers and reps must consider the roles that the respective members of the existing food chain will play."

Some distributors see the growth of the ESCOs as a lucrative sales opportunity. WESCO Distribution, Inc., Pittsburgh, Pa., has two regional energy marketing managers focused on the ESCO market, but most of the servicing is done by WESCO's utility and commercial/industrial branches. The company wasdrawn to the ESCO market by its desire to serve utilities' total supply needs, says Don Thimjon, vice president in charge of WESCO's utility operations. "A lot of investor-owned utilities have expanded into that market, and we'll sell to that customer base as it expands," he says.

Until recently, most distributors took little notice of ESCOs, and ESCOs had little use for distributors. Most ESCOs subcontract the supply of electrical products along with the installation to an electrical contractor, and leave it to the contractor to find the best source for the product. Distributors in the commercial lighting market ran into ESCOs once in awhile as competitors, but otherwise the ESCO's role was often transparent to the distributor.

That is changing, says John Dilliplane, vice president of the Preferred Products Group (PPG), Trenton, N.J., a buying/marketing group that builds alliances between ESCOs and manufacturers and between ESCOs and service providers--a description that could be defined to include electrical distributors. Dilliplane has a career of experience in electrical distribution to draw on--he left a position as vice president and general manager of Rumsey Electric Supply Co., Conshohocken, Pa., to get involved in the fast-growing ESCO market.

"In the beginning, one of the problems manufacturers and distributors had was that ESCOs started out purchasing materials through subcontractors," Dilliplane says. "Manufacturers and distributors didn't know who the customer was because the traditional customer of the distributor was still purchasing the product. With a few exceptions, the distributors didn't know about the ESCO or who he was. ESCOs were the same way. They didn't understand the value of a distributor. Some are now starting to understand the benefits of distribution."

Indeed, ESCOs are forming partnerships with distributors to approach accounts together. The PPG, now offering ESCOs marketing incentives to source products through member suppliers, is also planning to expand its service offering to include alliances with one or more distributors. Dilliplane expects to announce such an alliance in the next 12 months.

These relationships with electrical distributors are just one example of the changes in the market for ESCOs. They are also expanding the scope of their services to include predictive and preventative maintenance of the systems replaced and, with the dawn of a deregulated energy market close at hand, the supply of the commodity energy as well-electricity, gas, etc. Some industry observers predict systems maintenance will become a core activity, with ESCOs being compensated based on the energy-efficiency of the building systems. This new range of activity requires expertise in more products and services, says Edward Liston, president of EUA Cogenex, a 14-year-old ESCO based in Lowell, Mass. "ESCOs usually only had to deal with a few technologies-lighting, controls, maybe a little insulation.

"We now have to deal with building-envelope issues, energy-supply issues, and operations and maintenance, because we are starting to have to guarantee certain operating costs per foot. That's a combination of energy efficiency, operations and maintenance, as well as supply-side savings."

Distributors can provide some of the expertise ESCOs need, and the expanded product and service scope makes ESCOs more valuable to distributors. Several ESCOs say they would welcome the opportunity to work with distributors to approach customers that need to lower their total energy costs.

"ESCOs offer services that increase sales for projects," says Frank Mazanec, senior vice president of Onsite Energy, an ESCO based in Carlsbad, Calif. "We provide financing or a guarantee, and assist in the deregulation arena. If more projects are installed, more widgets go in. If distributors were more in tune with ESCOs and opened up their customer bases, everybody would benefit."

Distributors possess one asset that is coveted above all others from the ESCO's point of view, says Dilliplane of PPG, and that's customer loyalty. By spending years building relationships with local contractors and facilities maintenance people, distributors know which customers would be most amenable to comprehensive energy-efficiency retrofit projects. In partnership with a local ESCO, a distributor could offer customers energy savings that go far beyond the electrical and lighting system--a true value-added service. Other services offered by some distributors, such as specifying and supplying premium efficiency motors, or at the far end, a premises-wiring upgrade, could conceivably be added to enhance the total value of the deal for distributor and ESCO alike.

To meet the increasing demands from customers, ESCOs are having to acquire expertise in unfamiliar areas, either by developing new in-house capabilities or building partnerships with new service providers outside.

ESCOs have always relied heavily on subcontractors. This is why they were able to operate in the lighting market for more than a decade before most distributors even knew they were there. They were buying from distributors' existing customers, electrical contractors, and their role in the sale was virtually invisible. That continues to be the preferred arrangement, but some ESCOs see more advantage in having some of the engineering, maintenance and monitoring capabilities in-house.

At Unicom Energy Services, Oak Brook, Ill., Robert MacDonald puts his confidence in the internal approach. One reason is the margins. "When you subcontract-out the work and you don't provide any value yourself, all the margin goes to the subcontractor," says MacDonald, director of government markets for Unicom's Energy Solutions group. "When you do engineering and design and things like that internally, you get to keep more of the margin."

Increasing demand for energy-services contracts that include management of the actual energy supply is forcing ESCOs to secure strategic alliances with one of the many electric utilities and power-marketing firms looking to expand their energy services capabilities. Either way, the goal of the ESCO is to be able to finance and provide anything and everything a customer might want from an ever-expanding menu of options.

"We are starting to provide energy commodities to customers, to deliver the BTUs and the kilowatt-hours. We have to do that through alliances or through consolidation," says Liston. "Customers are forcing ESCOs to deal with the energy-supply issue, and with capital improvements in their facilities that are not necessarily related to a simple payback of a certain amount. That's when you start to get into electrical distribution systems and upgrades in technology. That usually is in the electrical system, boiler systems, chillers and building controls."

The need for new expertise, new capital and new sources of power is one factor behind the consolidation of ESCOs. There have been some significant mergers among ESCOs, but the big consolidators in this market have turned out to be the utilities.

Many of the major ESCOs that were independent a year or two ago are now owned, wholly or in part, by a utility. Utilities are anticipating that the electricity itself will become so cheap in a deregulated market that their margins for selling it will be nearly zero, because they and power marketers will give it away to sell more profitable services such as energy-efficiency performance contracting or the repair of refrigeration systems along with it.

When utilities began to get into the ESCO business a few years ago, independent ESCOs were concerned that a utility-owned ESCO would have an unfair advantage in that utility's service area, because it would have access to billing and energy-usage data about every customer, an advantage independent ESCOs couldn't hope to fight. That issue has fallen by the wayside, say some ESCOs, as it has become clear that ESCOs will need at least an alliance with a utility in place to function in the future, and that one of the chief advantages of such an alliance is access to prospective customers.

The shift to utility ownership of ESCOs is changing the look of the business. ESCOs realize definite advantages and disadvantages from utility ownership. Access to commodity power is one major advantage. Since ESCOs don't produce electric power, they must get it from a utility or power-marketing company. In a deregulated market, anyone can contract to buy power. But because so many utilities have gotten into the energy-services business, the likelihood that a local power company has or will have a stake in a competing ESCO is fairly high, which can make it difficult to get a good deal.

This makes strategic alliances with utilities an important part of the business, says Mazanec of Onsite Energy. Onsite is owned about 29% by Western Resources, Inc., an electric power company based in Topeka, Kan. Having an established partnership with a utility opens up the power-marketing arm of the ESCO's capabilities.

Onsite Energy's venture with Western Resources brought some exceptional advantages, such as a chance to combine services with an ESCO that the utility already owned, focusing on the high-voltage market and building substations for customers, he says.

Other advantages to the partnership are true for virtually any utility ESCO. For instance, utilities already have meters in place at all their customers' sites, making the monitoring and data-gathering functions of a performance contract more efficient for a utility-owned ESCO and less redundant with utility systems, says Mazanec.

Disadvantages do exist for an ESCO being run by a utility, though, say executives at some of the ESCOs that have been acquired. Where utilities buy total control of ESCOs or start their own, their tendency is to move somebody from their regulated operations to oversee the ESCO market. These managers often don't have the mindset to lead a business in a competitive market.

Project financing and industry consolidation are two other major trends that affect all ESCOs. Getting financing for a job used to be a major barrier, but it has become so abundant it's a non-issue now, says Mazanec. Financing companies have grown comfortable working with ESCOs, and many financiers offer project financing programs specifically designed for them.

Many of these financing packages are used in the performance contracts that an ESCO develops for customers. These contracts guarantee a customer a certain level of energy savings over a period of time. The ESCOs' compensation over the term of the contract--usually five to 10 years--typically comes from shared savings-splitting the difference between what the customer's energy bill would have been and what it is after the installation of more-efficient systems. Consolidation is also a big factor in the market, and will soon force a major shakeout, Mazanec says.

"I see fewer national players and more regional players developing. A lot of companies have jumped into the energy services market over the past few years, especially the utilities, and over time there will be a shakeout, with a few very big players, a second tier of very small players, and some people who decide to get out of it altogether."

Advance Transformer's Briody believes ESCOs will become the key driver in the growth of the market for energy-efficient products, and that the U.S. economy as a whole will benefit.

"No matter who gets hurt or who gets helped (by this trend), we as a nation are going to pay a much lower cost for our energy, and therefore we'll be more competitive on a global basis."