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A wind turbine is pictured at Loftsome Bridge Treatment Works, in front of Drax Power Station near Selby, northern England, June 19, 2008. As many as a quarter of British homes could be fitted with solar heating systems and thousands of wind turbines erected across the country under government plans for a "green revolution" to be set out around June 28, 2008. Photo taken June 19, 2008. REUTERS/Nigel Roddis (BRITAIN) (© Nigel Roddis / Reuters/REUTERS)
A wind turbine is pictured at Loftsome Bridge Treatment Works, in front of Drax Power Station near Selby, northern England, June 19, 2008. As many as a quarter of British homes could be fitted with solar heating systems and thousands of wind turbines erected across the country under government plans for a "green revolution" to be set out around June 28, 2008. Photo taken June 19, 2008. REUTERS/Nigel Roddis (BRITAIN) (© Nigel Roddis / Reuters/REUTERS)

Value Propositions

Appeal of fixed prices starts to sink in Add to ...

As promises go, it seemed too good to be true.

Ecosystems Inc., an energy retrofit company, pitched administrators at Toronto’s St. Michael’s Hospital in 2005, with a plan to shave a guaranteed 30 per cent to 40 per cent from the institution’s energy bill, if it approved the freedom to make “radical” changes to the antiquated steam-heat and chiller systems.

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Other energy retrofit firms were offering more modest 10-per-cent to 15-per-cent reductions based on conventional fixes, such as low-energy lighting, but the hospital’s board decided to award the contract to Ecosystems based on the promise of higher savings over time.

After the Quebec City-based firm installed $7.5-million worth of state-of-the-art chillers and high-temperature boilers, St. Michael’s slashed $1.8 million from its annual energy bill, hospital vice-president of planning Rob Fox says. “The payback was quite strong.”

The Ecosystems value proposition focuses on guaranteed results for customers looking to reduce cost uncertainties associated with large capital projects. The company puts its own skin in the game, offering up-front project financing in exchange for a share of the downstream energy savings, says co-founder Andre Rochette. “We want people to say, `Wow, I didn’t think it was possible to reduce energy bills by 40 per cent.’”

If it doesn’t deliver results, Ecosystems makes up the difference.

Companies such as banks and natural-gas distributors have long understood the appeal of fixed prices, offering long-term rate guarantees as a hedge against inflation. The approach is starting to take hold in a range of other sectors, including infrastructure construction, energy retrofits and corporate legal work. Apple, for example, relies on a rigorous fixed-price strategy with its consumer electronics, and both Samsung and Sony this year adopted a similar approach with their HDTV lines.

For large public-sector procurements, the attraction of a fixed price is that “you only pay for what you ask for,” says Tim Murphy, a project finance partner with Toronto law firm McMillan LLP. In the public-private partnership field, governments are looking to transfer project risk to consortia that can design, build, operate and even maintain assets such as hospitals, schools and transit lines. The quid pro quo is that the consortia has to absorb any costs that exceed the agreed-upon price.

In Ontario, a provincial project management agency has completed dozens of such deals in recent years. Mr. Murphy, a former senior official in former prime minister Paul Martin’s government, adds that the firms bidding on such projects tend to do a lot more upfront due diligence on potential risks and look for innovative solutions, but they also submit somewhat higher bids than traditional contracts. “You want to give yourself leeway.”

The legal firms advising such consortia are expected to operate on the same principle. “The guaranteed price model is working its way into the legal profession,” Mr. Murphy says.

With the retrofit sector, energy services companies (ESCos) have been searching for years for a value proposition that convinces building owners to make up-front capital investments that will yield long-term financial and environmental benefits. Contracts that guarantee a certain energy reduction threshold “get people to the table,” says Keith Stewart, an energy analyst at Greenpeace Canada.

The U.S. energy retrofit market is worth about $5 billion (U.S.) a year, according to Mr. Rochette, and the Canadian sector generates $450 million (Canadian). The largest players include Honeywell, Siemens and Ainsworth, with the bulk of the business coming from the institutional sector and straight-forward savings, such as changes in lighting and more versatile temperature control systems.

With $70 million in annual revenues and 150 employees in Quebec, Ontario and New York, Ecosystems is one of Canada’s largest players. Mr. Rochette says the firm’s risk-based formula creates a financial incentive to maximize the client’s energy reduction. The company has completed more than 150 projects, most of them public-sector buildings, including the CBC headquarters in Toronto, Montreal’s BioDome and the Beth Israel Medical Center in New York City.

An engineer by training, Mr. Rochette founded a thermostat repair firm in the early 1990s when entry-level jobs were scarce. As Ecosystems grew in the early 2000s, Mr. Rochette and his partner, Richard Tremblay, decided to break away from other retrofit firms by financing the installation of high-tech heating and cooling systems, many of them developed in Europe where energy prices are higher.

“There’s no secret sauce,” he says, although he acknowledges that conservation retrofits are less sexy investments than solar panels, glazed windows or geothermal heating systems. “Our business is about going three floors down in the basement and replacing boilers and pipes.”

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