Comparing the costs of commercial and social enterprise

Comparing the costs of commercial and social enterprise: An empirical comparative analysis of the renewable energy sector

Reblogged from EMES Junior Experts' Blog

Introduction

In many countries there is growing debate over the merits and disadvantages of widespread civic engagement with energy generation and the role of different ownership models in the renewable energy transition. For social enterprises to be seen as legitimate actors in the energy sector and justify policy reform, there is an urgent need for evidence of both the costs and benefits of local ownership models relative to conventional models, as well as for a better understanding of the broader meso- and macro-level implications of distributed- versus centralised energy generation.

In a study commissioned by the Climatexchange, Scotlands centre for expertise on climate change, we explored the comparative costs of commercial and community-owned renewable energy projects over time. Both the conceptualization and empirical results will be of interest to anyone interested in the cost-efficiency and the dynamic evolution of social enterprise sectors more generally. We argue that local (‘community’) organisations across different geographies and sectors face certain common challenges that are likely to influence project costs negatively, in particular at early stages of development. Some of these challenges have been implied in previous work on management challenges (Borzaga and Solari, 2001). The results are instructive for the Social Enterprise and Innovation research community in that they serve as a reminder that the social enterprise sector, in as far as it involves skills, expertise and political obstacles that differ from conventional business models, is likely to experience cost savings over time as a result of positive externalities and learning-by-doing as the sector expands and matures.

Methodology

We compared the costs and cost factors for three different ownership models in the renewable energy sector: (i) commercial; (ii) commercial-community partnerships; and (iii) community. We define commercial projects as owned and managed by professional private entities, and community projects as owned and managed by constituted non-profit – distribution organisations established and operating across a geographically defined community. Research is based on the application of a number of methods, including a literature review, descriptive statistical analysis of cost data over a cross-section of community energy projects in the UK, and paired case studies. In addition, we develop an economic valuation model to explore how risk and timescales of project development can affect the expected net present value of a project under each form of ownership.

A summary of findings

Very little academic work has explicitly addressed cost differences across different ownership models within the renewable energy industry, either in Scotland, the wider UK or elsewhere. Wiser (1997) compares wind project costs of (vertically integrated) utility ownership with non-utility private ownership, and shows that the nature and terms of finance and tax incentives associated with different ownership models can have a substantial influence on project cost. There is scant literature on community energy cost or cost determining factors. An exploratory survey of Scottish community energy projects conducted in 2011-2 demonstrated that early stage project costs comprised a higher proportion of total costs than in commercial projects (Harnmeijer et al., 2012). This is surprising given that community projects at early stages in particular are often run by volunteers, with low or zero labour costs. A diversity of studies have looked at costs that are specific to the community sector in other industries, including community forestry (Ezzine de Blas et al., 2009; Teitelbaum, 2014; Vega & Keenan, 2014; Chand et al. 2015; Chhetri et al., 2012; Adhikari & Lovett, 2006; Meshack et al., 2006), water (Aggarwal, 2000) and urban sanitation projects (Bremer & Bhuiyan, 2014; Ibem, 2009; Hasan, 2008). The literature broadly suggests that the community sector faces certain common challenges that occur across different geographies and sectors and that influence project costs. These challenges can be categorised as 1) ‘Internal Process Costs’, 2) ‘Legitimacy Costs’, 3) ‘Transaction Costs’, and 4) ‘Internal Diseconomies of Scale’.

1. Internal process costs – Due to their ‘bottom-up’ organisational structure, community projects are generally responsive to the diverse perspectives of their constituents. This can result in slower decision making, meaning community projects are less responsive to windows of opportunity and exposed to greater development times and costs.
2. Transaction costs – Communities commonly lack in-house skills and knowledge and therefore have to engage with the private sector for project development services. This exposes community projects to market costs, which can be exacerbated by a lack of bargaining power and market knowledge.
3. Legitimacy costs – As new entrants to markets in which commercial counterparts are already established, community projects can face greater challenges in accessing finance and investment.
4. Internal diseconomies of scale – Community organisations are typically significantly smaller than commercial renewable energy organisations. They therefore do not benefit from the same economies of scale in terms of bargaining power, finance and the ability to manage risks.

Based on average cost data, paired case study data and a net valuation model, we find the following. In comparison to the commercial sector, development costs in the community sector:

(1) Are more variable. Community energy project costs are more variable, but have become less variable over time.

(2) Have higher pre-planning costs. These ranged from 25% to 275% higher than commercial analogues in the paired case studies examined.

(3) Show a downward trend over time, converging over time with commercial cost levels.

(4) Community-commercial partnership projects show a cost advantage on a ‘community £ invested / community MW’ basis. In other words, engaging in partnerships with commercial developers enables community organizations to acquire greater degrees of project ownership for every pound they invest.

(5) Projects in the community sector take longer to complete than those in other sectors, largely because they take much longer to get to planning. Getting from inception to planning submission took 50% to 1100% longer for community projects in the paired case studies we examined.

(6) Community projects can be strongly disadvantaged through the higher risks of project failure, particularly at the feasibility stage.

It is likely that the costs patterns and determinants identified in this study apply to social enterprises beyond the energy sector, in particular where local ownership models are a novel phenomenon and developed by citizen non-professionals.

The report on which this blog is based will be available for viewing on the Scottish ClimatexChange Publications site in August 2015.

References

Adhikari, B. & Lovett, J.C. (2006). Transaction costs and community-based natural resource management in Nepal. Journal of Environmental Management, 78, pp.5–15

Aggarwal, R.M. (2000). Possibilities and limitations to cooperation in small groups: The case of group-owned wells in Southern India. World Development, 28(8), pp.1481–1497

Borzaga and Solari (2001). Management Challenges, Chapter 19 In: The Emergence of Social Enterprise, Routledge Publishing.

Bremer, J. & Bhuiyan, S.H. (2014). Community-led infrastructure development in informal areas in urban Egypt : A case study. Habitat International, 44, pp.258–267. Available at: http://dx.doi.org/10.1016/j.habitatint.2014.07.004

Chand, N., Kerr, G.N. & Bigsby, H. (2015). Forest Policy and Economics Production efficiency of community forest management in Nepal. Forest Policy and Economics, 50, pp.172–179. Available at: http://dx.doi.org/10.1016/j.forpol.2014.09.001

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Harnmeijer, A., Harnmeijer, J., McEwen, N., and Bhopal, V. (2012). A Report on Community Renewable Energy in Scotland. Scene Consulting, Edinburgh.

Hasan, A. (2008). Financing the sanitation programme of the Orangi Pilot Project–Research and Training Institute in Pakistan. Environment and Urbanization, 20(1), pp.109–119

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Meshack, C.K. et al. (2006). Transaction costs of community-based forest management: empirical evidence from Tanzania. Methods, pp.468–477.

Teitelbaum, S. (2014). Criteria and indicators for the assessment of community forestry outcomes: A comparative analysis from Canada. Journal of Environmental Management, 132, pp. 257–267. Available at: http://dx.doi.org/10.1016/j.jenvman.2013.11.013.

Vega, D.C., Keenan, R.J. (2014). Transaction cost theory of the firm and community forestry enterprises. Forest Policy and Economics, 42, pp.1–7. Available at: http://dx.doi.org/10.1016/j.forpol.2014.01.006

Wiser R. (1997). Renewable energy finance and project ownership: The impact of alternative development structures on the cost of wind power, Energy Policy, Volume 25, Issue 1, January 1997, Pages 15–27.