Characteristics of Infrastructure Sectors and
Implications for Innovation Processes
Jochen MARKARD
Cirus – Innovation Research in Utility Sectors Eawag, Überlandstrasse 133, 8600 Dübendorf, Switzerland Phone: +41 44 823 5671, email: [email protected]
www.cirus.ch
Abstract
Infrastructure sectors such as energy, gas or water supply, waste water treatment or telecommunication provide us with services that are essential for modern life and for industrialized societies. In order to better understand the preconditions, opportunities and limits of transformation processes in infrastructures, we will explore the particularities of infrastructure sectors in this article. We introduce and discuss seven dimensions, which help to identify key characteristics and also major differences of the various sectors and which can also be used to analyze and explain processes of change. These include i) capital intensity, ii) asset durability, iii) public organizations, iv) regulation intensity, v) systemic character, vi) environmental impacts and vii) competition and unbundling. We compare selected infrastructure sectors along these dimensions and finally, we discuss the implications of infrastructure characteristics for innovation and transformation processes in these sectors.
1 Introduction
Infrastructure based services such as water supply, electricity supply, sanitation, waste disposal, telecommunication, public transport or road infrastructure are of crucial importance for almost any economic and social activity. In most industrialized countries, it is a matter of course that the provision of these services is reliable and affordable, at almost any place. Despite the key role they play, infrastructure based services are under pressure for several reasons (cf. Gil and Beckman, 2009). Environmental impacts, massive (re-)investment needs or market liberalization are some of the key challenges ahead that have driven the emergence of new technologies (e.g. renewable energies) or triggered organizational reforms (e.g. privatization, public private partnerships).
In order to understand the preconditions, opportunities and limits of transformation processes in these sectors, we have to take into account the particularities of infrastructure based services. Stations and physical networks, for example, are often capital intensive and have a long life-time. This leads to a considerable degree of inertia and poses barriers for technological change. Infrastructure sectors are also characterized by a high level of public involvement, i.e. services are often provided by public organizations and regulation is intense. As a consequence, management and decision making may be subject to a variety of different objectives and regulatory frame conditions. In this article, we want to explore the particularities of infrastructure sectors in detail and discuss how these can be linked to the transformation and innovation dynamics infrastructure services may exhibit. But is such a task feasible when we think of how heterogeneous different services are (compare e.g. telecommunication, water supply and public transport) and how even national situations may differ within one sector? Obviously, it will not be possible to come up with some general characteristics that apply for most sectors. Still, we can identify some key dimensions against which infrastructure sectors can be classified and we can discuss the implications these dimensions or traits have on sector dynamics.
The text is structured as follows. In section 2 we will turn to the question of what constitutes an infrastructure sector or how it can be delineated from other sectors. Section 3 introduces a set of key dimensions along which infrastructure sectors can be classified and analyzed. Section 4 provides some first comparisons of different sectors along some of the dimensions introduced. The further parts of the paper still have to be written ☺...
2 What are infrastructure sectors?
According to Wikipedia, “infrastructure can be defined as the basic physical and organizational structures needed for the operation of a society or enterprise, or the
services and facilities necessary for an economy to function”.1 Particular reference is made to technical structures and physical networks as key constituents of infrastructure. Kaijser (2004) and Jonsson (2000, 2005) introduce the notion ‘infrasystems’ as they refer to large technical systems that “facilitate movements of different kinds; of people, goods and information” (cf. Kaijser, 2004, 153). From an abstract, technical point of view, Jonsson (2000) conceptualizes an infrasystem as “a network of links and nodes housing a certain flow that moves through the network links and is processed in the network nodes” (p. 84). However, it is also emphasized that infrasystems should be treated as socio-technical systems as they include socio-technical components as well as people, organizations and economic and legal conditions (Jonsson, 2005; Kaijser, 2004). The fact that attention is also directed to the non-technical, i.e. organizational and institutional components of infrastructure sectors is important in our view.
Table 1: Examples of infrastructure sectors
General function / service provided Examples
Transportation Air transport, railway transport, public transport (buses, streetcars, subways), road transport, sea transport
Energy supply Power supply, gas supply, petroleum supply, district heating
Water management Water supply, sanitation, drainage and flood control, irrigation
Communication Landline / mobile telephony, mail service, radio, TV, internet service
Waste management Waste disposal (household, industrial, hazardous waste)
Other Monitoring (meteorological, seismographic...), Remote sensing (by sattelite), GPS
Table 2: Examples of public sectors not included before
General function / service provided Examples
Security / protection Fire brigade, police, military services
Care Health care, public housing, elderly care, child care, other social services
Education Schools, universities, kindergarten, ibraries
Other Urban planning
Infrastructures have been divided into several categories, e.g. according to the kind of general service they provide: Transportation, energy supply, water management, communication, waste management and others, cf. Table. In addition to that, there is a related set of services typically referred to as public services because they are provided or mandated by public authorities (e.g. municipalities, the state). Public sectors provide merit
1
goods, i.e. commodities that fulfill basic needs of individuals or a society. Public services include education, health care, fire and police services, the military, social services, urban planning and again, electricity, gas and water supply, waste disposal, sewerage, public transport etc. (cf. Table 2).
So, drawing a line here between infrastructure sectors and public sectors is not always straightforward. The term infrastructure emphasizes the physical structures (especially networks) needed for service provision instead of the organizational aspect, i.e. whether public authorities are responsible or not. In the following, we concentrate on those sectors and services that are based on physical networks2 and we will refer to them as network or infrastructure sectors.
Network or infrastructure sectors are those sectors of economic activity that provide services of general interest by means of physical networks (interconnections). An infrastructure sector encompasses technologies, physical elements such as pipelines and plants, organizations such as utility companies and institutions such as regulations for grid access or quality norms.
This definition highlights two aspects, i) the fundamental importance of the services provided and ii) that physical networks are needed. Both aspect will be elaborated further below. It has to be noted that the notion of general interest may be difficult to interpret in some cases. We would exclude cable TV, district heating or irrigation, for example, but this is of course debatable. Our definition also excludes postal services, air transport or waste disposal as they are not based on physical interconnections. The same applies for radio or TV broadcasting services, which have been labeled as surface-shaped networks elsewhere (Kaijser, 2004). The reason to concentrate on physical networks is the assumption they are typically capital intensive, which has particular implications for the dynamics of infrastructure sectors (see below). As aforementioned, such distinctions are debatable, especially when sectors or technologies are very similar like mobile telephony (excluded) and landline telecommunication (included). We will therefore also refer to some of the other sectors below to maintain transparency.
2.1 Services of general interest or fundamental importance
Infrastructure sectors provide services that are of fundamental importance for our daily life and a precondition for the functioning of other industrial sectors or services.3 Infrastructure based services are typically difficult to substitute as today’s routines, life styles, technologies, products etc. are closely adapted to them. Electricity supply is an example
2
In general, networks include both interconnections and nodes. Here, we will use the term network to refer to a transmission and distribution grid. This includes all kinds of switching or converter stations but excludes treatment plants or power plants as specific nodes (end or starting points).
3
See also the concept of critical infrastructures defined as assets that are essential for the functioning of a society and economy (e.g. http://en.wikipedia.org/wiki/Critical_infrastructure, last access Aug-3, 2009).
of such a service so many other things depend on. While electricity can in principle be substituted (e.g. by gas light) or supplied in a different way (e.g. decentralized generation by solar panels), these alternatives have essential shortcomings as they are less convenient, less reliable or more costly.
Infrastructure based services, in many cases, are not just convenient, reliable and cheap
(cf. Jonsson, 2005) but also available at any time and almost any place - at least in industrialized countries. Moreover, they are universal in a sense that they can be used for many different purposes. Take road infrastructure, for example, which is a key element in the provision of many other, secondary services. The above mentioned characteristics have developed over time and are the reason for their fundamental importance of infrastructure services and why it is so difficult to substitute them.
The relationship between infrastructure sectors and other sectors is often asymmetric, which means that the input a sector receives from an infrastructure sector is - in qualitative terms - more important than the service or products it provides the infrastructure sector with. Take for example electricity supply and the music or entertainment industry. Such asymmetries in input-output relations, however, are not always straightforward (e.g. power supply and steel production) and, of course, modern industries and infrastructure sectors have mutually shaped each other in their (technological) development over time.
Figure 1: Relationships between infrastructure sectors and other sectors
The inter-sectoral relationship is also characterized by the fact that many infrastructure based services represent input factors for almost all other sectors, i.e. the number of output-linkages they have is typically higher than for other sectors. On the basis of these considerations, we can imagine a hierarchy of industry sectors with those at the bottom, which provide the most fundamental and widespread services, cf. figure (arrows represent input-output relationships). In such a hierarchy, infrastructure sectors can be rather found at the bottom than at the top.4
4
However, such kind of hierarchy seems to be somehow stylized as most sectors of industrial activity are closely intertwined today and their interrelations represent rather a network topology.
infrastructure sector other economic sector(s)
2.2 Different types of physical networks
According to our definition, physical networks for the transmission and distribution of matter, energy or information represent the backbone of infrastructure based services. Networks or infrastructure systems as a whole can exhibit three basic kinds of architecture (cf. Jonsson, 2005). Distributive systems distribute, for example, water or energy from central nodes via the grid to every single end-user, while accumulative systems work the other way round, i.e. they collect flows such as waste water and direct them to a central plant for further treatment. Both distributive and accumulative systems represent a centralized structure with large plants at one end of the flow. Supply services are typically organized on the basis of distributive systems, while disposal services are often based on accumulative systems. A third type of architecture is represented by point-to-point
systems, which have the task to allow for a connection of any two or more end-points that
are part of the system (communicative structure, cf. Jonsson, 2005). Typical examples are telecommunication as well as railway and road transport. Point-to-point systems may have centralized elements as well (e.g. highways or high-speed railways that bundle a larger amount of traffic) although their overall structure is decentralized. A further differentiation can be made with regard to the possibility of access (cf. Kaijser, 2004). Point-shaped networks can only be accessed at nodes (e.g. railway stations, airports), while line-shaped networks are more easily accessible along their interconnections (e.g. electricity, water, waste water).
3 Key dimensions for analyzing infrastructure sectors
In the following we will explore some key dimensions, which in our view help to grasp the particularities of infrastructure sectors. These include capital intensity, asset durability, public organizations, regulation intensity, and systemic character together with a particular resistance to change. Doing this we focus on the sectors’ commonalities and the major characteristics they share to some extent. This does not imply that differences are small or do not matter. On the contrary, many differences exist between sectors and countries. We also discuss two further dimensions, environmental impacts and competition, which rather highlight these diffferences as they are important just in some sectors.
Note that we describe infrastructure sectors in industrialized countries, thereby concentrating on the current situation or on very recent developments. The current situation though has developed over long time spans (often many decades or even a hundred years), in which technologies in infrastructure sectors and other sectors, products, routines, practices and thus the characteristics of demand have changed or rather mutually shaped each other. So the characteristics we will identify are not necessarily inherent or predetermined and may also change in the future.
3.1 Capital
intensity
The provision of infrastructure based services is often capital intensive. The main reason for this is that the often huge and regionally widespread physical network as well as plants or stations have to be built, and maintained later on. If the infrastructure is used intensively and over a long period of time, the investment costs can be recovered. However, they are fixed costs that occur mostly independently of the actual use of the network. In some sectors, they determine a large part or even the major share of the overall costs for service provision. This situation of capital intensity and fixed costs can even be pronounced due to the economies of scale for the erection of large, centralized plants (e.g. power supply, waste water treatment).
In economic terms, capital intensive infrastructures result in natural monopolies, i.e. the first supplier has an overwhelming cost advantage over potential competitors because his marginal costs are far below the average costs his competitors have to take into account. Natural monopolies imply the risk that the monopolistic supplier realizes rents much above what can normally be expected in a sector. This is the reason why many infrastructure based services are strictly regulated and / or provided by public utility companies (see below).
3.2 Asset
durability
A second key dimension in network sectors is the durability or useful life of the physical assets. In electricity supply, for example, nuclear power plants have a useful life of around 30 years, while hydropower stations can often be operated for almost 80 years without major re-investments. Power lines last about 40-60 years and sewers can again reach a useful life of 80 years before they have to be replaced. While highly durable assets are basically favorable because investments can be depreciated over longer periods, they also come along with high uncertainties because the frame conditions, under which the infrastructure was built, can change during such long timespans. Moreover, durable and capital intensive assets lead to a considerable degree of inertia, e.g. in technological terms. Investors want to avoid sunk costs by any means and thus try to operate their assets as long as possible. Technological improvements or innovations therefore can only diffuse gradually and it usually takes decades (if at all) until former technologies are fully replaced.
3.3 Public
organizations
In many cases, infrastructure sectors are dominated by public organizations. These may be corporations with public shareholders but also organizations that are directly controlled by a municipality, for example. While the former may exhibit management structures comparable to private firms (but are still controlled by the shareholders), the latter may be operated like public administration departments and policy makers may be directly
involved at the organizational level in decisions about investments or pricing. These latter organizations typically operate at the local, regional or national level on the basis of regulated monopolies. Examples for infrastructure sectors dominated by public organizations are water supply, sanitation, road infrastructure or railway transport - at least in many European countries. Also in the electricity sector, many firms are still publicly owned although strategic decision making is rather comparable to private business, especially in markets that have been opened to competition lately.
Political influence on service provision via public organizations is a result of the fundamental importance infrastructure based services have for society. A consequence is that multiple objectives have to be taken into account at the management level. These include, for example, prices that are low and equal among customer groups5, environmental objectives that exceed legal obligations, local autonomy and independence, a particular quality of supply etc.
3.4 Regulation
intensity
Regulation intensity is another key dimension for infrastructures. Many network sectors are characterized by a high degree of regulation including price regulation, service quality norms, rules for network access in the case of competitive markets, environmental regulations etc.6 Regulation intensity is driven i) by the fundamental importance of infrastructure services and ii) by the capital intensity and resulting natural monopolies. With regard to the former aspect, public authorities have to make sure that service provision is in line with pre-defined objectives such as affordable price, sufficient quality, high security of supply, non-discriminatory supply for customers in remote areas etc. These objectives are pursued by means of regulation and / or direct involvement via public utility companies (see above). With regard to the second aspect, abuse of the monopolistic system structures has to be prevented and price regulation thus plays a key role here. In some cases, the overall price for a specific infrastructure service is regulated, while in liberalized markets mainly the focus is on network regulation (price, grid access rules). In addition to that, there is a third driver for regulation intensity in those infrastructure sectors that cause environmental impacts (see below) and regulation than is applied in order to reduce these impacts or keep them within certain limits.
3.5 Systemic character and resistance to change
Many infrastructure sectors, finally, are characterized by a high degree of interdependencies between their various components in technical, organizational and
5
In many sectors, prices for customers in rural areas are the same as for customers in cities although specific service costs for the former are much higher.
6
See for example also Walz (2007) on the role of regulation for wind energy innovation in the electricity supply sector (Walz, 2007).
institutional terms. They are large technical systems that have gradually developed over long periods of time (cf. Hughes, 1987). The systemic character demands that if one element is changed, other elements have to adapt and change as well. A novel product, for instance, must not only meet prevailing consumer needs but it must also be compatible with the existing infrastructure and with technical norms. An innovative technology may be an improvement in one part of the system but may have a negative impact on other parts, which also have to be taken into account.
As a result of the systemic character, capital intensity and longevity of many assets, infrastructure sectors are characterized by a high degree of inertia and resistance to change. Innovations tend to be incremental and existing products and technologies undergo rather processes of slight, continuous improvement than radical change (Markard and Truffer, 2006).
3.6 Environmental impacts as a potential characteristic
Infrastructure sectors can be both, the cause or the remedy of environmental impacts. In the case of electricity or gas supply, depletion of fossil fuel resources, air pollution or nuclear waste are examples of negative impacts associated with energy consumption. In the case of waste water treatment, reduction of phosphate and nitrate burdens on surface waters is one of the essential services of the infrastructure system. Where infrastructure based services are coupled with environmental impacts, they may come under pressure because some stakeholders or even the wider public ask for a reduction of these impacts. In some cases, the impacts can be reduced by additional technologies that leave the core of the corresponding system unchanged. Typical examples are end-of-pipe technologies such as the de-sulfurization of coal fired power plants by advanced filter technologies in the 80s and 90s. However, there are environmental impacts that relate to the very core of supply services as it is the case for CO2 emissions associated with fossil fuel based
energy supply. Strict regulations in this case may lead to a substitution of established technology paths and a more fundamental transformation of the power supply sector, for example.
One of the general challenges with environmental impacts of infrastructure systems is the fact that the conventional cost structure of service provision with high fixed and low variable costs stimulates high levels of consumption and thus set adverse incentives in relation to environmental impacts. So, a typical conflict line is that utility companies make better profits with larger amounts of consumption, while this increases the environmental burden at the same time. Consequently, service providers often have little interest to internalize the environmental costs.
3.7 Competition
and
unbundling as potential characteristics
In some infrastructure sectors, it is technically possible to unbundle the value chain of service provision and to operate the network as the most capital intensive part of the
infrastructure separately from other elements (e.g. sales & customer care, trading, power generation). While network operation remains a (natural) monopoly business, other parts of the value chain can be opened up for competition. Since the 1990s, especially telecommunication and electricity supply have been re-organized in that way in many countries (e.g. Sioshansi, 2006). The key driver behind this market liberalization was an increasing influence of a neoliberal policy agenda that made economic efficiency (to be achieved by competition) the top goal for organizing all sectors of economic activity - including infrastructure sectors. This was in sharp contrast to the earlier, dominant conviction that services of general interest were organized at best with the direct involvement of public bodies. In the course of market liberalization, many public utilities were also privatized although this is no precondition for competition. It is a precondition though, to establish non-discriminatory access to the network for all market players by means of regulation and to also establish rules for an effective unbundling of former vertically integrated organizations, again in order to avoid distorted competition.7
3.8 Interdependencies between the different characteristics
White boxes contain external influences or factors that account for the differences among sectors / services.
Figure 2: Interdependencies between major infrastructure sector characteristics
7
In fact, these two issues have turned out to be major challenges in many cases because incumbent (and often highly influential) utility companies, of course, did everything to obtain an advantage over potential market entrants and competitors (REF).
Physical network Fundamental
importance Regulation intensity Capital intensity, natural monopoly Environmental impacts Innovation / Sector transformation barrier for change important factors driver for change Asset durability Prevailing technol. paradigm(s) definitory elements Nature of the service Public organizations Systemic character, inertia Competition Political decision(s)
It has been discussed before that a particular sector characteristic may trigger another characteristic, e.g. the monopolistic character calls for specific regulations and thus contributes to regulation intensity. The different characteristics and the underlying key dimensions, in other words, are not fully independent. The figure above provides an overview of how the key characteristics of network sectors may influence each other and how they finally contribute to a sector’s innovation and transformation characteristics.
4 Comparison of infrastructure sectors along some of the key
dimensions
In this section, we provide an overview of how different infrastructure sectors compare with regard to some of the dimensions introduced above. We also include public sectors or other service sectors that do not qualify under our narrow definition of network sectors.
mainly stations / buildings physical networks & stations / plants
key physical elements
military services bus transport education postal services health care police fire brigade streetcar transport road infrastructure internet services telecommunication district heating electricity
water supply gas supply sanitation waste disposal radio / TV air transport railway transport network sectors other (public) service sectors
private mainly stations / buildings physical networks & stations / plants
key physical elements
military services bus transport education postal services health care police fire brigade streetcar transport road infrastructure internet services telecommunication district heating electricity supply water supply gas supply sanitation waste disposal radio / TV air transport radio / TV bus transport railway transport public ownership of organizations
Figure 4: Sector landscape with a distinction between sectors dominated by public and private organizations public private mainly stations / buildings physical networks & stations / plants
key physical elements
ownership of organizations military services bus transport education postal services health care police fire brigade streetcar transport road infrastructure internet services telecommunication district heating electricity supply water supply gas supply sanitation waste disposal radio / TV air transport radio / TV bus transport railway transport no capital intensity little capital intensity some capital intensity high capital intensity
public private mainly stations / buildings physical networks & stations / plants
key physical elements
ownership of organizations military services bus transport education postal services health care police fire brigade streetcar transport road infrastructure internet services telecommunication district heating electricity supply water supply gas supply sanitation waste disposal radio / TV air transport radio / TV bus transport railway transport no competition little competition some competition intense competition
Figure 6: Additional differentiation in terms of competition intensity
5 References
Gil, N., Beckman, S., 2009. Infrastructure meets business: building new bridges, mending old ones. California Management Review, 51 (2), 6-29.
Hughes, T.P., 1987. The Evolution of Large Technological Systems, in: Bijker, W., Hughes, T.P. and Pinch, T. (Eds.), The Social Construction of Technological Systems. Cambridge/MA, pp. 51-82.
Jonsson, D.K., 2005. The Nature of Infrasystem Services. Journal of Infrastructure Systems, 11 (1), 2-8.
Kaijser, A., 2004. The dynamics of infrasystems. Lessons from history. Presentation hold at the 6th. International Summer Academy on Technology Studies “Urban Infrastructure in Transition: What can we learn from history?”, July 11 – 17, 2004, Deutschlandsberg, Austria.
Markard, J., Truffer, B., 2006. Innovation processes in large technical systems: Market liberalization as a driver for radical change? Research Policy, 35 (5), 609-625.
Sioshansi, F.P., 2006. Electricity Market Reform: What Have We Learned? What Have We Gained? The Electricity Journal, 19 (9), 70-83.
Walz, R., 2007. The role of regulation fur sustainable infrastructure innovations: the case of wind energy. International Journal of Public Policy, 2 (1/2), 57-88.
