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The Changing Marketplace

Home Energy Magazine Online May/June 1996

The Changing Marketplace: Recovering the Costs for Efficiency Services

by Paul I. Berkowitz and Sabrina L. Karl

Paul I. Berkowitz is the director of Community Energy Efficiency Projects and Sabrina L. Karl is the Energy Smart project manager at Wisconsin Energy Conservation Corporation.

"Customer pay" financing programs are being tested to replace traditional subsidized energy efficiency services in a deregulated marketplace.

Historically, residential energy efficiency services have been subsidized by utility ratepayers and by taxpayers through federal and state government programs. Over the last 10 years, customers have received free home energy audits, large rebates for efficiency products and services, and in some instances, free efficiency measures.

Now, with deregulation of the utility industry on the horizon, along with cutbacks in federal and state spending, money is becoming less available for these programs. As a result, providers of residential energy services are beginning to look for ways to generate income that can cover all or most of the costs of providing these services.

The major challenge ahead is determining how to design programs in which customers value the services enough to pay for them. Through a series of four community efficiency projects, Wisconsin Energy Conservation Corporation (WECC) is striving to determine if residential efficiency services can indeed be self-sustaining, or if they will perpetually require some level of subsidy to exist.

Finding Out What Customers Want

WECC asked small samples of customers (focus groups) in several communities about proposed project characteristics. The results showed that most customers believe energy efficiency is very important, but many lack the money for retrofits of their homes. Focus group participants liked the idea of an energy specialist providing a home energy assessment, installing low-cost efficiency products, and suggesting major energy efficiency retrofits. These customers also generally agreed that $35-$50 was a reasonable fee for these services.

The participants also liked benefits such as contractor coordinating, financing, and quality control of contractor work. Contractor coordinating involves helping the customer both solicit and evaluate bids for performing recommended work. Many participants also felt financing through loans was an attractive option as long as interest rates were kept below 10%. "Positive cash flow" financing plans, in which the savings from the installed measures pay for all or some of the monthly loan payment for improvements, were especially appealing to the focus group participants. They also responded favorably to quality control inspections of the contractor work, since it helps assure customers the contractors are both competent and reputable.

Pricing Project Services

It can be difficult to price project services in a way that maximizes participation, while also providing ample profits for the energy service providers. Customer value, benefits, ease of participation, and positive cash flow financing all need emphasis to effectively promote market-driven efficiency services. Residential efficiency services that have historically been heavily subsidized or free for customers can alter a customer's purchasing perceptions. For example, promoting compact fluorescent lamps (CFLs) with $5 to $10 rebates off the wholesale prices may create a perception that CFLs are only worth the amount paid. WECC has found that customers are willing to pay a fee for a home energy assessment as long as they receive something for their assessment fee, such as low-cost measures (showerheads and faucet aerators), especially if major energy efficiency potential is not identified in the home. Major measures include high-efficiency furnaces, boilers, water heaters, and air conditioners; wall and attic insulation; and air sealing.

WECC's residential program model includes a paid home energy assessment, during which homeowners can learn, among other things, about potential efficiency upgrades for equipment replacement.

Components of an Assessment

WECC has designed four community efficiency projects based on feedback from focus groups. Typically, WECC has used a "whole house approach," meaning a home assessment addresses all areas of potential energy efficiency improvements, including a home's heating and cooling system, water heater, insulation, air leakage, lighting, and major appliances (such as refrigerators and dryers).

The size of the assessment fee can be an important barrier for project participation. From the focus groups, WECC found that few people were willing to pay more than $50. One approach is to charge a set fee for an energy assessment and more for an energy assessment plus other WECC services such as contractor arranging, efficiency measure financing, and quality control. In other words, home assessment pricing may be based on a "full menu" or an "a la carte" basis depending upon the needs of the customer.

To receive a home assessment, participants in WECC's projects pay an initial fee of $35. For this fee, they receive:

A walk-through assessment to determine potential efficiency upgrades for insulation and equipment replacement.
A blower door diagnostic test.
Installation of low-cost hot water saving devices, such as a low-flow showerhead and a water heater wrap.
An assessment of water heating and dryer fuel switching opportunities (electric to gas).
Demonstration of CFLs.
Investigation of potential energy savings from installing a programmable thermostat.

Customers have the option to purchase CFLs or a programmable thermostat through the project. The cost includes the wholesale price plus a 25% mark-up.

Tapping Trade Allies

While it is not possible to provide the full menu of project services beyond the home assessment for $35, other potential areas of fee collection can help offset the cost. These include trade ally contributions and margins of profit for products sold to customers. Trade allies, such as HVAC contractors, plumbers, and insulation contractors, can greatly benefit from a market-based energy efficiency project that refers customers to a pool of qualified contractors. Trade allies who meet proper insurance requirements and field installation protocols can become major contributors both in marketing project services to customers and in providing installation services for the efficiency measures that customers elect to install.

Utility energy efficiency projects can help trade allies increase their customer base and the amount of work conducted by their firm. Since contractors receive project referrals without investing much of their own time, a contractor fee for referrals can be justified. A fee could be a percentage of the total dollar amount of a project. Contractors may pay 2% of the total project cost in a new community energy efficiency project being initiated by WECC. The higher the installation cost, the larger the fee captured for project expenses.

A yearly contractor participation fee was also considered by WECC in lieu of, or in combination with, the per job fee. However, some contractors will probably be unwilling to pay a yearly participation fee until they receive a sufficient volume of work from the project. Also, it would be necessary to trace the projects' trade ally work trends before determining a participation fee.

Since participation and per job fees can be justified as a cost of the contractor's doing business, they will probably be embedded in the price of the goods and services to customers. Customers would be less likely to object to embedded costs than to an additional customer fee.

Customer Mark-Up

Another way to capture project delivery costs is to mark up the wholesale price of low-cost efficiency products that customers purchase during the home assessment. For example, CFLs and programmable thermostats can be sold at a "cost plus" basis, where the customer pays a price that consists of the wholesale price plus 25%. These prices should be comparable to local retail prices in order to have a consistent pricing message in the marketplace. Hopefully, retailers will meet any future demand for these products after the project is over.

Financing

As utility companies have shifted their focus away from demand-side management to industry restructuring and competition, financing has attained new importance. Utilities often view financing projects more favorably than traditional rebates because loans offer several benefits. For example, loans help customers overcome "first-cost" barriers, such as lack of access to capital or limited disposable income. In addition, loans do not raise the rates paid by all utility customers as do subsidized efficiency projects. The availability of loans that are easy to access and reasonably priced may contribute to a long-term demand for energy-efficiency products and services that does not depend on utility resources.

Customer financing programs can provide a sustainable way to develop energy efficiency markets. Since a customer pays the full cost of energy efficiency improvements and loans are available for any energy-related measures, the market is not limited to products and services that receive a utility subsidy or rebate.

Customers will typically respond favorably to financing that has:

An interest rate below 10%.
A loan term that allows for all or a portion of the monthly debt to be paid by energy savings-typically 5 to 7 years.
Options for early loan repayment without penalty.
An easy and quick one-stop financing approval process through utility bill payment history and/or credit check.
No minimum amount to be financed, since many residential efficiency purchases fall below $1,500. Installment-type loans could be offered for transactions below a set dollar amount (e.g. $1,000). For example, a $500 purchase could be financed at roughly $20/month for 2 years.

Since loans can cause utility risk due to potential customer default, utility risk needs to be balanced with loan underwriting criteria. But it is important to note that the customers with the most to gain from the project may have less disposable income and may be a higher credit risk. Utility bill payment history can be tied to conventional creditworthiness as the basis of approving a loan. Most past and current utility loan programs have incurred modest loan default rates of 1.0% or less.

A loan default pool that is used to cover customer nonpayment of loans can be embedded in the cost of loans to all customers. For example, a loan rate of 7.0% can be increased to 7.5%. The funds collected by the 0.5% can be used to cover default payments by customers.

Though financing can become a tool to provide more sustainable energy efficiency activity in the marketplace, financing by itself cannot accomplish this end. Programs must address the many barriers to energy efficiency transactions in the residential sector. Barriers such as the hassle of selecting technologies or contractors, timing of work to be performed, complicated paperwork, limited customer time to secure a loan, and risk aversion to new technology, can discourage customers from purchasing energy-efficient products and services. In addition, many trade allies require training on diagnostic procedures and field installation protocols for the myriad efficiency products and services (see "Contractor Training Key to PG&E Loan Program"). Training will improve the quality of work performed and help ensure that savings persist for customers.

CFL Leasing

In one of WECC's community efficiency projects, a leasing option was available for CFLs. Since CFLs have a high initial cost in relation to their savings, a seven-year leasing program, at 6% per year, was designed to produce more positive cash flow for customers. Customers had the option to buy the bulbs at any time during the leasing period, or at the end of the lease. Also, customers had the option to terminate the lease without any obligation by returning the undamaged bulbs to the utility within 90 days of the lease. Customers receiving an energy assessment were receptive to the CFL leasing program. Almost one-half (42%) of these customers leased CFLs, at an average of five bulbs each.

While leasing provides an easy and minimal-risk opportunity for customers to obtain CFLs, WECC found that transaction costs (paperwork, billing, etc.) are prohibitive when customers purchase only CFLs for a seven-year term. If a program wishes to finance CFLs without other measures, a two-year installment payment scheme is more practical and less costly to operate. Charging customers for these purchases on their existing utility bill will also minimize administrative costs.

Insights from WECC's Projects

All four of WECC's community energy efficiency projects, including Park Falls' Energy Smart (see "The Energy Smart Project"), have provided lessons for designing and implementing future programs. Here are some of WECC's conclusions and suggestions:

"Customer pay" designs can work. When attractive financing is available, customers' first-cost barriers can be effectively addressed without resorting to rebates or heavy subsidies. Customer value, benefits, ease of participation, and positive cash flow financing are all important in effectively promoting unsubsidized projects.
To recoup project delivery costs, all sources of potential project revenue need to be tapped, including customers and participating contractors.
Financing appears to be most attractive for major efficiency purchases. For lower-cost items, many customers will pay cash, especially when a prompt payment discount is offered. However, more customers are apt to participate in the project if they have the option to finance.
An attractive financing package cannot, however, substitute for an easy and customer-friendly project design. Customer convenience and mitigation of the "hassle factor" increase customer participation. Attractive financing options may fail if participation in the project is not convenient.
Utility risk due to potential customer loan default needs to be balanced with loan underwriting criteria. A default pool can be embedded in the cost of loans to all customers.
WECC's initial involvement in the contractor bidding process was both time-consuming and expensive. WECC created customized savings estimates and collected bids, and then hand-delivered these to customers. A more efficient and less expensive method-using simplified savings calculations and mailing bids to customers-is favored by WECC in its current projects.
Bundling efficiency services to include electric, natural gas, and/or water is essential to keeping project costs low and customer benefits high. WECC tries to get as many partners as possible involved in the projects. For instance, in a current project WECC is working with a municipal electric utility and an investor-owned gas utility. The partnership distributes program development and administration costs. Futhermore, bundling efficiency services between an energy services company (ESCO) and a utility can offer unique customer benefits (see "A Unique Fee-Based Approach to Solar Hot Water Programs").
Customers with more potential for energy savings should receive more services, but a minimum level of efficiency services should be established for all customers.
Customers need a flexible and broad menu of services (some may be non-energy such as fiber optics and telecommunications). More customers will perceive value from the project services if they can be tailored to an individual customer's need.

The Energy Smart Project

A two-year energy efficiency project is underway in Park Falls, Wisconsin, a small town of 3,100 people. Sponsored by Northern States Power Company-Wisconsin (NSPW) and designed and delivered by WECC, the Energy Smart project is testing the potential for offering market-based services to various communities throughout NSPW's service territory. The project targets both the residential and commercial sectors with electricity and natural gas efficiency measures and includes community components such as local retail promotions of products, community events, school energy education activities, and a community advisory committee assembled to guide the project's delivery in the community.

What's Special About Energy Smart?

Four characteristics make Energy Smart different from efficiency projects NSPW has offered in the past.

Energy Smart participants are offered positive cash flow financing plans for efficiency improvements. No rebates whatsoever are offered through the project.
Customers pay a participation fee for the home and business assessments and customer services they receive from Energy Smart.
A retail mark-up of 20%-30% is applied to all products customers purchase through Energy Smart, such as CFLs and programmable thermostats.
A complete package of services is offered to participants, from the identification of efficiency potential to contractor arranging to quality control of technologies installed.

The "Customer Pay" Approach WECC offers two different home assessment packages to Park Falls residents. A Complete Assessment costs $35. The fee can be financed, or a customer can pay immediately and receive a $5 prompt-payment discount. The Complete Assessment includes:

A full walk-through assessment of potential efficiency upgrades, such as insulation and equipment replacement.
A blower door diagnostic test.
Installation of low-cost hot water saving devices, such as faucet aerators, low-flow showerheads, and water heater tank insulation.
Demonstration of CFLs in the customer's lamps and fixtures.
Investigation of potential energy savings by installing a programmable thermostat and insulation.

Customers can select various contractor services (such as contractor selection, bid review, and quality control of contractor work) and Energy Smart financing to install recommended measures. Customers are not required to use contractor and financing services to receive a home assessment.

For customers who do not have potential for major efficiency improvements, or who are not interested in a Complete Assessment, a Minor Assessment is offered for $18 with a prompt payment discount of $3. The Minor Assessment includes installation of hot-water-saving measures, a CFL demonstration, and an evaluation of the potential to install a programmable thermostat. The price of CFLs and a programmable thermostat are not included in the Minor Assessment fee.

When a customer signs up with Energy Smart, an energy specialist screens the customer for efficiency potential in the home. The energy specialist addresses the age of equipment, comfort, and efficiency improvements already completed on the home to determine whether to recommend a Complete or Minor Assessment. However, customers always have the option to choose which service they desire. The telephone screening minimizes the number of Complete Assessments that result in little or no savings potential, which controls the overall costs of providing in-home services.

Since the customer fees do not entirely pay for the project's cost, the project also includes a retail mark-up for purchased CFLs, programmable thermostats, and additional showerheads and aerators (beyond those provided through the assessment). This mark-up results in products being sold at retail cost. For instance, the CFLs sold through Energy Smart range from $12 to $19. Not only are there no subsidies or rebates for these products, but NSPW actually generates some project income from the mark-ups. In addition, by paying retail cost for CFLs, the customer is sold on product value, which may lead to additional purchases in the retail marketplace.

Energy Smart Financing

NSPW commonly offers financing to its customers for energy efficiency improvements. However, with Energy Smart the utility has modified its financing strategy. Customers now pay the full cost for efficiency improvements to their homes. Also, the project's financing plan allows home energy assessment fees and costs for minor measures such as CFLs and programmable thermostats to be financed with major energy efficiency improvements.

The loan interest rate is about 7% and the maximum loan period is seven years. At these low terms, customers can in many cases achieve positive cash flow, meaning the monthly loan repayment amount is less than the energy savings that are generated from the installed measures.

Some design elements of the financing plan have been included for cost efficiency and ease of management by NSPW. For example, a minimum monthly payment of $5 is imposed on all residential Energy Smart loans to prevent small monthly payments which would result in unacceptably high transaction costs for NSPW.

A WECC auditor evaluates his home energy assessment, while discussing financing programs with the residents. Participants have the option of financing efficiency measures through low-interest, long-term loans.

What Does the Future Hold?

With the current shift from a subsidized energy efficiency structure to a competitive environment, the next generation of residential projects needs to be innovative and sustainable in the new marketplace. It is important for service providers to address the home energy and comfort needs of customers, with affordable pricing for their services and products. A pay-per-service approach allows customers to select the products and services they want without paying for a complete package that includes some unwanted or unnecessary services for their home. This type of approach will hopefully prompt customers to drive the marketplace based on perceived value, available resources, and required expertise.

Using trade allies and bundling energy efficiency products and services with water conservation, telecommunications, energy brokering, and other similar services will increase project demand, participation, and revenues. An increased demand will produce a more sustainable and profitable venture for an energy service provider such as WECC. Energy providers who can develop financing programs that meet the needs of customers, while making a profit, will become the successful players in this changing marketplace. Ultimately, however, their success depends upon customer demand. The more that customers demand the different products and services that energy service providers offer in the marketplace, the more self-sustaining these products and services will become.

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