Blockchain: The basis for disruptive innovation in the energy sector?

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Blockchain technology has passed its peak in the hype process – at least according to Gartner Consulting’s well-known hype cycles for emerging technologies. In the second quarter of 2017, blockchain technology has passed the peak of inflated expectations and is now on its way down towards the phase of disillusionment.

Figure 1: Hype cycle of emerging technologies (source: Gardner, 2017)

Regardless of the question whether the hype really has reached its peak, blockchain technology potentially changes how different business processes are executed, e.g. financial transactions or electricity trade. With today’s post we want to build on our previous introduction of the theory of disruptive innovation as it was defined by Clayton Christensen (1997) and apply this theory to try and answer the question whether blockchain technology is a disruptive innovation for the energy sector. If you are not familiar with the basic concept of blockchain technology we strongly recommend to first read this post here and then proceed with this post.

In our last post we have already introduced the theory of disruptive innovation as it was defined by Clayton Christensen in his book “The Innovators Dilemma” (1997). We will only sum up the key elements of the theoretical concept here and recommend this post for a more detailed introduction of the concept.

Disruptive innovations in a nutshell

In general, Christensen differentiates between two types of innovations: sustaining innovations that improve your product and disruptive innovations, that replace your product with a cheaper, more convenient or better product from the customers’ perspective. More recently, Christensen (2015) added efficiency innovations to this basic structure. Efficiency innovations aim at cost reductions (making more with less) and are actually quite important in the age of digitalization and automation.

Still, from Christensen’s perspective an innovation only then qualifies as disruptive if an innovation enters an existing market at the low-end side, meaning that it is less convenient to use,  is of poor quality compared to the premium products in the market and generates lower revenues than the premium products in the same market. For incumbents, these low-end products are less interesting, as they offer smaller rate-of-returns than their existing premium products. Therefore, they do not invest much (if any) capital into the low-end market product.

Alternatively, the innovation addresses similar consumer needs as do the incumbents’ products in the established market, but it can still open up a new market as it adds new features that go beyond the characteristics of the established products.

An innovation that started from the low-end or a new market then becomes a disruptive innovation if it conquers the mass-market and drives the incumbents’ customers to switch products. Then, the revenue of the incumbent shrinks quite dramatically, which in the end results in a disruption of the incumbents’ business model. 

Blockchain lays the foundation for disruptive innovation – but does not qualify as a disruptive innovation itself

Blockchain is a fundamental technology, just like the TCP/IP protocol was and still is. For those of you who are interested in the similarities of these technologies we recommend to take a look at this article by Iansiti & Lakhani (2017) who provide a nice comparison of blockchain and the TCP/IP protocol. While the TCP/IP protocol provided an open and shared public network to exchange information at very low costs, the blockchain now provides an open (in case of public blockchains that is) and shared public network to execute transactions at low costs (at least in the future).

For our analysis here it is important to note that not the TCP/IP protocol disrupted traditional business models, but the applications that made use of this infrastructure did. Amazon sold books via internet and with this concept challenged normal book-stores, Expedia offered travel services online etc. Similarly, blockchain itself will not disrupt business models, but the applications that make use of this new technology might. Even if applications make use of the blockchain, they might result in sustaining or efficiency innovations, e.g. by reducing the costs of transactions, increasing the speed of processes etc. So the fact that an application is based on the blockchain technology does not imply that the application is disruptive, nor is the blockchain technology itself a disruptive innovation.

Actually, what we can see in the financial sector is that most large financial institutions are currently investigating and testing first blockchain applications. If the incumbents apply blockchain technology to reduce costs, increase efficiency and improve customer services, then it is likely that these applications will result in sustaining or efficiency innovations - which is fine by the way. Not every innovation has to be disruptive, actually, very few are.

As we are already on the topic of finance: BitCoin is one of those applications that make use of the blockchain. Whether BitCoin will become a disruptive innovation for conventional currencies remains an open debate. So far, cryptocurrencies, most prominently BitCoin, are not yet accepted as currencies in the formal way (only in Japan BitCoin is an official currency). We will see in the coming years whether BitCoin has the potential to disrupt the currency market. Though this is an interesting topic, we won’t dive deeper into this here, as this is discussion only marginally effects the energy supply chain for now. If this changes, we will of course pick up the issue of cryptocurrencies in the energy sector on this blog.

For the ones being active in the energy sector the interesting question then is: Where can we expect that applications based on the blockchain technology disrupt the energy industry?

Blockchain applications in the energy sector - where disruption could happen

Due to the fact that disruptive innovations start at the low-end market and need some time to conquer the mass-market, it is not possible from today’s perspective to identify the future disruptive blockchain technologies, simply, because the technology is not ready yet and far away from entering the mass-market, at least in the energy sector.

Still, what we can do is to take a look at the energy supply chain and try to identify the areas where the risk of low-end market or new market entries is high. Recall, for an innovation to be disruptive the incumbent needs to have a premium product with high revenues on which he focuses its innovation process and thereby ignores the low-end or new market addressed by the innovation. So where in the energy supply chain can we find such incumbent products with high revenues that might be disrupted by blockchain applications?

Blockchain-enabled applications in the generation sector

Generation was fundamental for the utility business model in the last century. As we have discussed in a previous post this traditional business model is already challenged (and potentially disrupted, yes) by renewables. Still, generation companies like Uniper (the conventional business that evolved out of E.on in 2014) or RWE rely on generation assets for their revenues and remain to do so for the next years. Is generation a field where we could expect blockchain technology to facilitate new applications that might disrupt the utilities’ business model? Possibly! The key feature of all blockchain-based applications is the fast and direct execution of transactions without intermediaries. As a stand-alone solution, this feature is not yet challenging the generators’ business case. However, the blockchain technologies offer the potential to address one of the key challenges for renewables that hinder them from taking over further market shares from conventional generators: it is the access to markets. More specifically, most markets where flexibility from renewables or demand can generate sufficient revenues are not accessible for small-scale distributed resources. In most flexibility markets, in the US as well as in Europe, you can only participate with a capacity of 500 kW, 1 MW or even 5 MW. Most photovoltaic power plants are far smaller, in Germany a photovoltaic power plant has an average size of less than 50kW. Therefore, distributed renewables and especially photovoltaics cannot access the existing flexibility markets (leaving aside the question whether they have a financial incentive to do so).  

Now, blockchain applications, especially those that aim at P2P trading, decrease potential market entry barriers and open up new markets (e.g. selling electricity to neighbors) for distributed generators. The Brooklyn Microgrid in New York and PowerLedger in Australia are the most prominent examples for such P2P applications. Recently, Tennet has started a cooperation with Sonnen and together they aim at a blockchain-enabled aggregation of distributed battery storage for ancillary services (more details can be found here). These projects are developing the next level of virtual power plants that eventually will be able to adapt production and feed-in into the grid according to price signals or requirements by the network operators. Thereby, blockchain-based applications might unlock flexibility markets for distributed generators. If this application proves to be feasible, blockchain-based applications might offer the potential to disrupt the generators’ core business model. Whether this will actually be the case depends on two factors:

1. The potential applications that are based on blockchain technology need to develop into real business cases.
2. Utilities that still rely on the revenues from conventional generation must ignore these applications, even though they might have a positive business case. This will only be the case if the ROI for the new application will be significantly lower than is the ROI for conventional generation.

Blockchain applications in the network sector

Network ownership and operation are regulated tasks. Therefore, they are less exposed to disruptive innovations. Especially, as each innovation needs to be signed off by the regulator. Therefore, blockchain applications like any other innovation are not likely to disrupt the network operators’ business model. Still, blockchain-based applications for network operation might soon become relevant, especially in combination with IoT applications. It is very likely that IoT and blockchain applications will result in efficiency innovations for network operations, under an innovation friendly regulation this might even increase the revenue from the networks, but heavily depends on the regulatory scheme.

Blockchain applications in the retail business

Retail is the second pillar of the incumbent utilities market-based business model. Already today, retail business is under pressure from competition, at least in those markets that have introduced retail competition. For now, utilities remain big players in this business, but the retail sector is and will be the part of the energy supply chain that is targeted by most blockchain applications currently developed in the energy sector. Basically, P2P applications aim at eliminating the retailer and allow consumers to bilaterally trade electricity on a local level without any intermediary in-between. The approaches mentioned above, like the Brooklyn Micro Grid as well as PowerLedger have the primary aim to develop a blockchain application that eliminates retailers. Here, the potential for disruption from blockchain-based business models seems to be the largest for now and the concepts are the most advanced ones as well. However, we are still waiting for the large-scale proof-of-concept of these applications. If this is achieved by one of the concepts out there, pressure on the retailers’ business model will increase significantly and yes, might be disrupted as well.   

Blockchain applications might disrupt the energy sector, but not as a whole

What we can conclude from the scenario described above is that the blockchain technology itself cannot be considered to be a disruptive innovation. Rather, it seems likely that the blockchain technology will provide the basis for new applications that might have the potential to disrupt certain stages of the energy supply chain. Most prominently, generation and retail might rather soon face disruptive powers from blockchain-based applications. Now that the hype about blockchain has passed the peak we will see in the near future of 5 years in what direction the first blockchain-based applications with positive business cases will evolve. The question then is: Will utilities pick up these new applications and thereby turn them into sustaining or efficiency innovations, or will the utilities stick to their current core business models with (potentially) higher ROI and thereby increase the chance of disruption?

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