Creating a Process Oriented Enterprise at Pinnacle West

T. S. RaghuW. P. Carey School of Business

Arizona State UniversityTempe, AZ 85287Version: 6-8-2009

1. Introduction

As the 2008 holiday season approached, Denny Brown, Vice President and CIO of Pinnacle West, wondered how he would navigate his organization through a tumultuous economy in the coming year. The year had begun very well for Pinnacle West Capital Corporation (PNW), a company that provides energy and energy- related products throughout Arizona. One of the largest affiliates of Pinnacle West, Arizona Public Service (APS) was named the top energy utility for Information Technology (IT) innovation by Information Week. They were also listed among the top 10 U. S. companies in the InformationWeek 500. APS also received the prestigious Edison Award by the Edison Electric Institute for developing the Transformer Oil Analysis and Notification (TOAN) System. TOAN monitors transformers on a near real-time basis for anomalies in power transmission. Denny firmly believes a CIO’s mission is to transform the business. Thus, he began to accelerate the transformation processes set in motion over three years ago. Clearly, the coming decade would be pivotal to the energy industry.

During the 1990s, Denny left APS to pursue a career at IBM for nearly a decade. When he returned to APS in 2000, he reacted to pressure from his customers to produce more services and products at a lower delivery cost. However, when he pushed for “more” from his own Information Services organization, he quickly realized that his organization lacked formal processes and was highly dependent on people knowing who to contact to get work done. Denny began to institute a process discipline within the IT organization.

Soon after, Denny began to realize if the Information Services organization could embrace a process oriented approach, other business units in APS should be able to do so as well. To help achieve this, he created a Center for Process Excellence (CPE) within his unit which would act as an internal consulting organization to other business units in their process improvement efforts. One of the most successful engagements of this team was its work with the sub-station maintenance group that eventually culminated in the TOAN project and the Edison Award.

2. Company Background

Pinnacle West is based in Phoenix, Arizona and provides energy and energy related services and products to residential and business consumers in Arizona. PNW has been in business for more than 120 years. The company’s largest subsidiary, APS, serves more than a million customers across Arizona. APS also co-owns and operates the Palo Verde Nuclear Power Generating Station. Palo Verde is the largest power generation facility in the U.S. and is a primary source of power for the Southwest United States. Arizona’s utility industry is highly regulated with two power utilities serving most of Arizona

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utility customers. Apart from nuclear power (24% of total power supplied), the generation portfolio for the company includes coal (37%), natural gas (18%) and solar (less than 1%) – about 20% of the power is purchased from outside sources. In the early part of the 21 st century, Arizona was one of the fastest growing states in the nation. In 2008 it was the second fastest-growing state with a population of about 6.5 million. During 2008 APS served more than a million customers in Arizona. In addition to APS, Pinnacle West also owns a real-estate subsidiary, SunCor, which accounted for 4% of operating revenues in 2008. The electricity generation, transmission and distribution activities contributed to 93% of the operating revenues in 2008. Pinnacle West employs approximately 7,500 people, of those approximately 6,900 are APS employees.

The utilities industry is a highly regulated industry in the United States. In Arizona, the Arizona Corporation Commission (ACC) regulates electricity rates. Although, there have been sporadic attempts at deregulation, competition in retail electricity markets seem to be unlikely in the near future based on the disastrous deregulation experience in California during 2000 and 2001. In 2006, the ACC approved a renewable energy standard increasing the renewable energy generation percentage from 1.5% in 2007 to 15% in 2025. A significant percentage of renewable energy has to be generated from distributed sources (i.e., small-scale generating equipments at customer locations). In order to meet the projected 60% increase in customer peak demand by 2025, APS identified several key initiatives including – increasing energy efficiency, doubling renewable energy production, and adding additional nuclear power capacity. Operating revenue for 2008 was over $3.1 billion with a net income of $262 million. Consolidated financial information for Pinnacle West from 2003 to 2007 is provided in Exhibit 1.

Arizona’s projected growth poses unique challenges for APS. Given the environmental concerns, APS must continuously improve the reliability of its power generation and distribution capabilities. The capital investment requirements for energy production are quite substantial – APS expects to spend around $1 billion per year for energy infrastructure. Major utilities in the United States, including APS, face the challenge of replacing aging distribution infrastructure. Major initiatives are underway to upgrade the power grid and install “smart” meters. In a regulated price market, APS found it challenging to keep up with the commodity price and increasing fuel cost. Investment per new customer had risen from under $10,000 in 1987 to over $25,000 in 2007. These challenges call for efficiency improvements throughout the organization to achieve savings in operations costs. The collapse of the housing market and the general economy in the recessionary environment that began in 2008, called for even more concentrated efforts to improve process efficiencies and innovation.

3. Process Improvements Efforts in the Information Services organization

The transformation process began with identifying a clear vision for Information Services – “One team working with our customers to advance and transform the business.” To achieve this, the team developed an implementation strategy with three key areas (see Exhibit 2).

At the top of the implementation agenda was Business Process Transformation – which focused on building process change skills, methodologies and tools. Initial process transformation efforts started in 2001 and culminated in the identification and monitoring of 36 separate processes. These processes

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were divided into four broad areas – Strategic Processes (I/S Portfolio Optimization, Business and Technology Planning, and Financial Planning), Development Processes (Project Planning, Requirements, Design, Development and Maintenance), Operations Processes (Incident and Problem Management, Capacity Management and Disaster Recovery), and a number of Support Processes.

The Information Services initiatives are designed to support the Business Process Transformation efforts and ultimately transform the business. The initiatives cover Professional Development and Key Projects. The Professional Development initiative is geared toward acquiring the skills and training necessary to embark on business process optimization. The strategy is to continuously shift IT personnel to identify and act on strategic initiatives. The Key Projects initiatives supports the shift to strategic work by setting in motion a series of projects geared toward integrating service oriented architecture into the design of IT projects. The service oriented concept was identified as a key enabler for achieving business process transformation.

Supporting the transformation and innovation aspects of the strategy are the foundational areas. This includes specific strategies for achieving Service Performance, Security and Budget Management. The goal is to achieve high availability and high service levels. The motto “Technology drives business. Business is a moving target” drives this strategy.

Denny’s emphasis on process orientation is driven out of his conviction the functional model has run its course in Corporate America –“The only reasonable approach to business transformation is process alignment and service orientation. I am pushing for a change from functional to a process model. One of the first steps we took is to transform IT and it has been very difficult. We have 50 years of IT experience run on the functional model. It served us well – people are comfortable with it, but it is costly and not as responsive to change.”

A Process Engineering Services (PES) group was created to provide support for information services processes and continuous improvement. At the end of 2008, the team consisted of four individuals to support the 600+ employees in the Information Services organization.

4. The Center for Process Excellence (CPE)

The successful process oriented transformation in the Information Services organization encouraged the creation of a Center for Process Excellence (CPE) within the Information Services organization in 2004.

Denny described the genesis for this idea as follows – “To push for process orientation, you create a burning platform from the top down. I looked around in our industry, and found there were two companies following the top down approach – Pacific Gas & Electric (PG&E), and Southern California Edison (SCE). For these companies, the burning platform was their financial collapse caused by the energy debacle. They were able to push for process orientation throughout the enterprise from the top down. However, they did it out of necessity; they needed to cut costs and survive. Our industry does well under crisis – but it is not sustainable. Creating a false sense of a burning platform is not sustainable either. It will work for a while until the first budget cuts come, so I didn’t want to do that.”

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The goal of CPE is to institutionalize the process transformation knowledge gained within the Information Services organization to provide facilitation and redesign services throughout the Enterprise. Since its inception, CPE has engaged business units opportunistically in IT-centric projects. CPE personnel engage the clients from the early stages of the projects. The engagement continues even after a project is completed, so that continuous improvement opportunities are periodically reviewed and implemented.

At the start of 2009, the CPE group included eight individuals from a variety of backgrounds and skills. Randy Sorensen, Director of the CPE group, has extensive experience in Nuclear power plants. Prior to joining the CPE group, Randy was the Station Chemistry manager at the Palo Verde Nuclear Generating Station for a number of years. Other members of the team and their backgrounds include – Christine Dicken (Project Management), Kirk Gould (Mechanical Engineering), Kathy Perry (Training), Steve Freeman (Inter-governmental relations), Scott Archibald (Entrepreneurship), Carla Howard (Lean / Six Sigma Practitioner), and Guled Yousuf (Intern – Electrical Engineering). Overall, the group was designed to have a very business focused orientation. Each member of the group is trained in the basic skill sets of facilitation, process discovery, modeling, and problem resolution.

Randy Sorensen had this to say about his organization: “I came to this group in 2005. I believed Business Process Management is something most businesses know little about; for a lot of reasons it is overlooked. Given the perception that IT was becoming a commodity, Denny felt the real value is for IT to have business acumen and help the enterprise get more out of technology…It makes a lot of sense to first understand business and then get technology involved. The promise of a group like CPE was great in this context. Given my business focus, I thought I could help IT deliver on this.” When asked about his vision for the CPE unit, Randy commented that “…our vision is to be a competency center for the organization. We want to create franchises, help the line of business set them up and think about their own organization. We should be the people that businesses approach to understand how to do that.”

A typical engagement for the CPE group involves setting up an “engagement review” session with a client that has requested help. The objective of the session is to gather a charter for the engagement. If the group decides the project is outside its scope, it can turn down the engagement due to a lack of fit. If the project moves forward, the client and the CPE personnel go through a “process discovery phase.” Initially, the groups discuss the process at a high level and identify all the relevant stakeholders (covering the SIPOC chain supplier->input->process->output->customer). Further refinements to the initial models gather the events, results, roles and responsibilities, business rules, issues, opportunities and risks. The group consciously keeps the process discovery sessions short and gathers most of the required information in a few sessions (usually not more than three) of less than two hours each. In most cases, once the process transformation solution is identified, the CPE group guides and monitors the implementation process as well.

As the process oriented approach matured within the Information Services organization, the group procured an Enterprise level modeling tool in 2004. A large number of processes created during client engagements are modeled and maintained in this repository (see Exhibit 3 for a sample process model from the repository). To create consistency in the process oriented approach, CPE developed a Process

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Facilitator Certification program that includes classroom lectures and practical exercises. In 2009, the group is focusing on the integration of Lean principles into the Business Process Management initiatives.

CPE has been involved in a number of initiatives over the years, but two specific process change initiatives served as exemplars on the value of the CPE expertise. The two initiatives are described in the following sections.

5. A Burning Platform

On July 4, 2004, a fire broke out at the APS Westwing substation in Phoenix destroying several transformers and impacting numerous customers (see Exhibit 4 for before and after pictures of the substation). Eventually the entire substation was rebuilt.

A thorough investigation determined the event was not attributed to maintenance failure. APS was required to present a corrective action plan to Arizona Corporation Commission (ACC). As part of the plan, APS agreed to incorporate leading practices into maintenance processes.

Ironically, the first set of cascading events that eventually led to the fire happened at the time when the maintenance group was in a workshop reviewing maintenance processes. Mark Ostendorp (who started on this project as a consultant from EPRISolutions Inc. and continued to work on the project as an employee of op X consulting, LLC) can still recall the day – “We were in a self-assessment workshop with the maintenance group . We were about 15 minutes into the workshop and there was a flicker of the lights – the guys in room were joking about it, and about 10 minutes later almost everyone’s beepers went off. We stopped the workshop while the workshop attendees answered the calls. After a while, they said we will need to postpone the workshop. Essentially, one of the transmission lines tripped (later identified as a “grid disturbance”) and had to be attended to immediately. So, we packed up and left with the intent to reschedule the workshop for a later date.”

After the Westwing fire, Pete Atwell, Director, Operations and Maintenance, called Mark and asked his group to come in and perform a detailed assessment, substation audit and do a failure root cause analysis. Mark’s group assessed the maintenance practices based on interviews of several maintenance staff, engineers and company leadership. The assessments also focused on evaluating maintenance practices and processes and benchmarking against other utilities. EPRISolutions also conducted detailed audits of 12 APS substations to check if there were any hidden surprises.

Pete Atwell had always been a proponent of process orientation within the maintenance group. He asked for an assessment of the maintenance practices in 2000 after the Commonwealth Edison fire in Chicago. At the time, EPRISolutions made several recommendations. Pete viewed the Westwing fire as a critical turning point for his maintenance organization – “In the past, maintenance was controlling us!. Most of the time we were in a fire-fighting mode… West Wing facilitated us to accelerate the process changes. It gave us momentum and made it easier to implement the necessary changes.”

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After the Westwing fire APS hired an independent consultant to evaluate the organization. The assessments resulted in a set of recommendations. A summary of these recommendations is provided in Exhibit 5.

Interestingly, Pete Atwell’s direct report, John Lucas, had just joined the APS maintenance department as a manager prior to the Westwing fire. In a way, John’s entry into the maintenance organization had been a trial by fire and John views it as a life-changing experience.

5.1.Process Changes

Both Pete and John felt the urgency to change the maintenance organization based on the recommendations. John enlisted EPRISolutions as the domain experts and the CPE group as the process facilitator throughout the process. John viewed CPE as pivotal to the process change effort – “We were trying to change…the CPE facilitator’s job was to help us not forget that we were trying to change while we were still doing our daily work…Their [CPE] role was to guide us to write down our process; ensure that we document reality and list the discrepancies/gaps. They challenged us on our process and helped us identify / list the gaps or issues.”

With facilitation help from EPRISolutions Inc. and experts from the CPE group, the process change initiatives initially focused on two of the recommendations – work prioritization and backlog management, and productivity planning & scheduling metrics. The management team felt some of the other recommendations would fall in place naturally as the team addressed these two high priority items.

Mark Ostendorp summarized the overarching goals for the process change initiative as follows – “We set clear goals at the outset – any equipment failure is a failure of maintenance. We coined the phrase ‘there are no unexpected failures.’ Second, we will not permit anything to be scheduled and assigned to crew unless it is fully planned. Third, we will not close out a work order until it has been identified that all of the things have been done – materials have been reconciled, testing records are entered and all those other things.” The goals coincided with the major milestones of the maintenance process. Based on the above overarching goals, the team identified a high level process model as shown in Exhibit 6.

5.2.Developing a Predictive Maintenance Culture

One of the ways to implement predictive maintenance is to place diagnostic tools at various points in the substations. However, the dilemma with diagnostic tools is that they generate large amounts of data and place a huge resource burden on an organization that tries to analyze the generated data. The maintenance organization at the time of the change initiative had one individual with expertise in handling diagnostic tools and data. The team quickly realized the need to prioritize the equipment based on criticality. A master list of equipment was drawn up and criticality of the equipment with respect to the organizational goals was determined. This allowed the process change team to determine the

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frequency of diagnostic information that would need to be collected for equipment on the master list. For example, equipment at the highest priority would be monitored on a daily basis; equipment on the next level of criticality would be monitored on a weekly basis and so on. Based on this approach, the resource requirements for proactive maintenance was determined. The leadership planned to staff the required resource levels in a two-three year time period.

5.3.Planning and Execution

At the beginning of the initiative, the maintenance organization did not have dedicated planners and schedulers. As part of the reorganization associated with the process change initiative, the team identified process owners for each milestone of the process (Exhibit 6) and assigned team members to each of the groups. The planners’ responsibility was to create a fully comprehensive work package before execution could begin. Since, standard procedures were not in place for work orders this started out to be a tedious process. Initially the planners could at most complete five to eight work packages in a month. Over time, with the help of continuous crew feedback the planners created standards for work orders. Eventually, the work order generation process was completely automated through a custom-built work management system. A planner can enter the work order and identify the work order type, and the entire work package is printed for crews to take to the site. To facilitate continuous improvement, a simple survey at the end of the work package allowed crew members to provide feedback on what worked and what did not work during work execution. Crew members were initially hesitant to fill these out; however, after repeated assurances of the intent of the feedback surveys, the response rate reached close to 100%. Within a few months, productivity improvements in planning were perceptible - planners could easily create up to 100 work packages a month.

Each work order is assigned a dedicated case worker who retains ownership for the order from beginning to end. The initial goal of the organization was to schedule work orders out to five weeks. After initial hiccups resulted in another review of the process, the team was able to schedule work orders out to 15 weeks.

Leaders of each group within maintenance meet on a regular basis to review work orders and completion rates. The culture within the organization has shifted to a collaborative orientation where it is entirely acceptable for leader of one group to interact directly with team members in other groups.

5.4. Process Metrics

Both Mark Ostendorp and Christine Dicken emphasized the need to keep the process metrics simple. Christine’s commented on her approach to metrics is as follows: “An ideal metric is automated, timely, available, somewhat anonymous, and allows people to answer a lot of “why” questions.” In addition to costs of direct labor and materials, the team collectively identified the key performance indicators for the process as: Proportion of predictive work orders, Average time of completion per work order, Work completion to close out time, and number of work orders open/planned/scheduled/executed.

Within the first two years of the process change initiative, there were considerable improvements in the maintenance process. Before the process change effort, over 80% of the work orders were reactive; this

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has been brought down to 20%. While more than 80% of the organizational reliability metrics set for the substations had not been consistently met before; by 2007, APS met or exceeded all of the reliability metrics. In 2008, outages per customer were reduced 34%; and the average outage duration per customer decreased 14%.

When recalling the improvements made thus far, Christine highlighted some key indicators: “In 2005, we had over a thousand open work orders at any given point in time. By 2007, the maintenance organization brought this down to below 200. The average age of work order in 2005, when we could track them, was about 450 days. By 2007, the average age of a work order was about 100 days.”

While there was a clear improvement in the key performance indicators, John and Pete focused on qualitative improvements to maintenance processes. Both viewed overtime and night-time calls as being big impediments to an effective maintenance organization. The best indicator for them was to make sure their leaders and crews had less calls to handle – which implied a better overall condition of equipment in the distribution system. After the process changes, Pete viewed his role as a facilitator who manages the budget and resources for the maintenance organization.

5.5.Innovation and Recognition

As the maintenance organization met or exceeded the operational goals of the process change initiative, innovative ideas began to emerge throughout the organization. A highlight of the process innovations was the Transformer Oil Analysis and Notification (TOAN) System. TOAN was born out of the need to monitor transformer data on a continuous basis to prevent catastrophic failures. A major problem with the diagnostic data collected from transformers was the difficulty of manually analyzing the data. One of the ways to detect potential failures is to detect the gas-in-oil through data mining and pattern recognition. The engineers within the maintenance organization designed and built a sophisticated neural network based approach to analyze the continuous feeds of data from transformers. The system identified abnormalities in near-real time and turned large quantities of data into actionable maintenance tasks.

The TOAN system earned APS the 2008 Electrical Engineering Institute’s (EEI) Edison Award, the electric utility industry’s highest honor. Thomas Kuhn, President of the EEI, commented on the TOAN system as follows: "APS' new system for monitoring transformer performance is a remarkable achievement and could potentially benefit electric utilities everywhere. Electric transformers are a key component in the transmission and delivery of electricity, and by providing real-time monitoring of their performance the TOAN system greatly increases system reliability and saves money in replacement and repair costs. This system represents a significant step forward in managing and monitoring the electric grid."

The process change initiatives in the Information Services organization and the TOAN system also contributed to other recognitions. APS was named the No. 1 energy utility for IT innovation in the 2008 edition of Information Week 500 magazine. APS was also recognized by Information Week as being among the top 10 U. S. companies for IT innovation.

6. Process Change Initiatives at Palo Verde Nuclear Plant

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After two years of declining performance, the Nuclear Regulatory Commission (NRC) placed the Palo Verde Nuclear Generating Station in Category 4 (second to the highest level of NRC oversight) in 2006. In communicating the decision, the NRC commented that Palo Verde plant would fix the symptoms when problems arose and not adequately get to the root causes of the problem. Given the high standards of safety, the Palo Verde plant was placed under a high degree of scrutiny by the commission.

Under the direct leadership of Executive Vice President and Chief Nuclear Officer, Randy Edington, a fundamental culture change to the organization was initiated in 2007. A key part of this effort was an in-house process improvement organization, named “Site Programs.” While Palo Verde Site Programs has a similar orientation to that of CPE, its role was more central to the operation of the Palo Verde nuclear plant.

The Director of Site Programs, Gary Shanker, has worked at the Palo Verde power plant for a number of years. Gary also worked as a key member of Denny’s team which implemented the process orientation strategy in the Information Services organization. In 2007, Gary came back to the power plant to lead the process improvement efforts. On the state-of-affairs in the power plant, Gary made the following observation: “In 2007, we were being run safely but not reliably. We had a lot of cut back in resources over the years…when you reduce resources, organizations have a tendency to suck themselves into silos to focus on their own goals. As a result, we were operating to a large extent based on informal processes. In the long term, this cannot be a successful strategy, especially with an aging workforce and increased turnover.”

Gary put together a plan and recommendation for the VPs at Palo Verde to bring together the elements necessary to guide the process approach. While Gary has a technology background as well, he firmly believes technology is the last piece of the process puzzle. A critical part of Gary’s approach was to create a steering committee for overseeing the process changes. The steering committee included the leaders of major groups at the Palo Verde plant. The Site Programs group reported to the committee on a monthly basis to get their feedback and buy-in. Many felt the leaders would bring in the needed organizational perspective and knowledge to identify the critical aspects in process change initiatives. It also helped the site programs group to effectively communicate its initiatives to the Enterprise.

Jim Glass, the process improvement leader in Site Programs, also observed the need to manage demand for process changes: “One of the big reasons why we have a steering committee is to control the demand for process improvements. We recognize that multiple groups feel the need to be engaged in strategic initiatives. There are a lot of ‘type A’ people here who, once they see an issue, will want it to be fixed immediately. So we are trying to manage the demand for process improvement…If you have too many projects going on at the same time, you tend to lose focus.”

Site Programs used a number of ways to communicate its efforts. They maintain an internal website for listing major initiatives and materials on process improvement techniques (such as lean, six sigma, facilitation, and problem resolution skills). Site Programs worked with the web council to create links from other key Intranet sites to its website. They also arranged a number of brownbag sessions and invited key functional leaders to participate and share their experiences with others in the organization.

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In 2008, Site Programs identified sixteen employees to be trained in the tenets of Lean improvement techniques at Arizona State University over an extended period of time.

By the end of 2008, Site Programs began to track its own performance. Palo Verde did an assessment of the “corrective actions program” (the program cited by the NRC as being deficient in 2006). As a result of the process change efforts as well as leadership focus, the internal assessments revealed the corrective actions program had considerably improved. An NRC inspection completed in early 2009, cited similar improvements in a number of areas including problem resolution, change management and backlog tracking systems. The Site Programs group also initiated a plan to assess the process maturity of the Palo Verde plant and identify areas for improvement.

While the initial approach to process change involved a focus on critical processes related to safety and effectiveness, the Site Programs team also recognized the need to manage processes from the top-down. To accomplish this, the team began an ambitious process infrastructure plan that would enable top management to directly monitor the most critical processes. In a sense, the goal of this strategy is to integrate the bottom-up process improvements with a top-down management strategy for processes. A process infrastructure map created by Site Programs is shown in Exhibit 7.

Gary described why the process infrastructure was important to institutionalize process orientation – “With processes, it is pretty hard to find what you need to work on. The steering committee is one way of doing it in a qualitative way. But, over time, with the infrastructure development we will start to use performance indicators to assess what processes to improve upon.”

Jim contrasted the Site Programs initiative to the more grass roots based efforts of CPE – “The way CPE is functioning is more grass roots. Out here it is more centrally established. The scope is bigger. We had a significant burning platform –we got into Category 4 of NRC. If we continued to do what we were doing we would be shut down…part of the problem was the complexity of our processes. As a result, the site as a whole got behind the process improvement efforts. It helped us to drive process change from the top down. The Senior VPs fully support our efforts. We review the progress with them every month. They are endorsing the improvements we are implementing. This is a key to our success.”

On March 24, 2009, the Nuclear Regulatory Commission (NRC) upgraded the status of the plant to the least regulated “Column 1.” The NRC said that the plant's upgrading from the most-regulated "Column 4" category, which is one step away from a forced shutdown, in a little more than two years is among the fastest recoveries on record.

Both Gary and Jim acknowledged CPE’s help in their efforts. CPE helped the process infrastructure strategy by championing the use of an Enterprise Modeling tool and training site programs in mapping and facilitation techniques. CPE training materials were adapted to Palo Verde context. Palo Verde was also able to benchmark their processes against another nuclear power plant through the help of CPE.

7. Going Forward

Denny’s next step in building a process -oriented organization is shaping up. In describing his plans for the next steps he observed a common interaction between IT and business: “IT and business customers

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often get into a deadly embrace defining requirements. The IT folks tend to wait for the business to define the requirements. The business people cannot define the IT requirements because they don’t fully understand what the technology is capable of doing. The IT people don’t know what the business is, so they don’t typically suggest innovative business changes…Process orientation puts the creativity and innovation on the table and it is really easy for the business to define the process. Clearly, business leaders need to think in a process mode…. Now the challenge is how we move forward!”

Because of the Westwing project, TOAN and the Edison award, Denny feels the process orientation strategy has arrived at a crossroad. The CPE group achieved a level of recognition. He believes the Information Services organization should increase the ante, especially since major parts of the organization like Palo Verde are taking the lead around methodology and technology in process improvement and assessment.

On the other hand, there was a resurgence of commitment on TOAN like projects in the distribution organization. This type of commitment was bound to stretch APS on resources in terms of facilitators, process mappers, and change agents. Therefore, Denny know they will have to be careful in how they expand this approach. Denny’s following comments best summarize the opportunities and challenges facing the Information Services organization: “For 120 years, our business model has not been challenged all that much. For the most part, we pretty much boil water, create steam, turn the turbine and put the electrons on the wire and send it home….with the notion of SmartGrid, automatic meter reading, and the consumer product information we are going to have…we become the Google of energy. The business model is therefore going to change. Distributed generation and renewable generation are coming to the fore front…all of these are colliding like a perfect storm. That begs a different view from the IT standpoint. We have an early start – but the key is going to be integrating the backend into the normal day-to-day operations. My view is you get only one opportunity to win this market; one bullet to shoot. So, when you flip the switch to top down, you have to have it fairly well couched and have your ducks in a row– if you launch it too early you go by the wayside, because there is not enough commitment. If you launch it too late, you have missed the boat.”

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EXHIBIT 1CONSOLIDATED FINANCIAL STATEMENTS

(All numbers in Millions)

2003 2004 2005 2006 2007Sales 2,817.85 2,899.73 2,987.96 3,401.75 3,523.62 Cost of Sales 1,897.66 1,992.36 1,986.45 2,424.23 2,530.93 Gross Profit 920.20 907.36 1,001.50 977.51 992.69 Gross Profit Margin 32.66 31.29 33.52 28.74 28.17 Interest Expense 204.59 195.86 185.09 196.83 212.62 Nonop Income/Expense 58.67 18.68 19.85 51.52 43.07 Net Income 240.58 243.20 176.27 327.26 307.14 EPS from Operations 2.53 2.34 3.18 3.33 2.98

Total Current Assets 969.05 1,137.13 1,891.39 1,474.66 947.45 Total Assets 9,536.38 9,896.75 11,322.65 11,455.94 11,243.71 Total Current Liabilities 1,150.97 1,625.90 2,272.07 1,458.56 1,384.97 Total Long Term Debt 2,897.73 2,584.99 2,608.46 3,232.63 3,127.13 Total Liabilities 6,706.60 6,946.55 7,897.68 8,009.83 7,712.10 Total Stockholders' Equity 2,829.78 2,950.20 3,424.96 3,446.12 3,531.61

Oper Activity - Net Cash Flow 901.83 842.08 730.30 393.50 657.94 Invst Activity - Net Cash Flow (716.77) (531.95) (585.09) (568.73) (873.35)Financing Activ - Net Cash Flow (33.85) (277.82) (154.57) 108.44 184.53 Dividends Paid - Cash 157.42 166.77 186.68 201.22 210.47 Capital Expenditure 722.92 554.54 645.55 758.77 941.64 Cash Flow 12mm 660.94 638.19 570.82 675.79 673.41 Change in Cash & Equiv 151.21 32.30 (9.36) (66.79) (30.89)

Source: Research Insight

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EXHIBIT 2. IT STRATEGY FRAMEWORK IN APS

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ProfessionalDevelopment Key Projects

Security Budget Mgt Service Performance

Foundation

Core

InnovationBusinessProcess

Transformation

EXHIBIT 3. AN EXAMPLE PROCESS MODEL FROM THE ENTERPRISE PROCESS REPOSITORY

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Last Updated: 9/23/08By: Christine DickenED.100 Substation Maintenance

Core

Identify T&D

Work

Manage T&D

Work

C lose Out T&D

Work

T &D MaintenanceB asis Required

T &D New EquipmentE ntry Received

T &D WorkIdentificationRequired

Execute T&D

Work

T&D Results &Lessons LearnedCommunicated

Support

Handle Hauling

Needs

R eclaim Oil Filled

Equipment

Continous Improvement

Perform T&D

C ontinuous

I mprovement

T &D ContinuousImprovement WOReview Required

T &D Work OrderCompleted

T&D Results &Lessons LearnedCommunicated

Handle Spare

Substation

Transformers

EXHIBIT 4: The Transmission substation fire – before and after

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EXHIBIT 5: KEY RECOMMENDATIONS FROM THE WESTWING FIRE ASSESSMENT STUDY

Recommendation Area (Priority, Value)

Recommendation

Communication (High Priority, High Value)

It is recommended that APS either develop, review and/or modify its current communication protocols as it relates to communication from the field to the operation’s Center or vice versa. Formal, clear and precise communication protocols as well as associated verification routines and backup measures need to be defined and communicated to all stakeholders to eliminate ambiguity, uncertainty and human error in all communications.

Maintenance Basis & Discipline (Medium Priority, High Value)

APS started the process of defining the maintenance basis for transmission and substation systems and components in 2000. While a maintenance basis (maintenance templates) exists for a significant number of substation systems and components the assessment indicates that the existing templates are not currently executed with the appropriate level of discipline and that the development of maintenance basis templates for the remaining systems and components has stalled. APS should continue the development of a comprehensive maintenance basis for all non-trivial transmission and substation systems and components. The maintenance basis should be

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documented and integrated into the Computer Maintenance Management System (CMMS), effectively communicated to all stakeholders and executed by operations.

Work Prioritization & Backlog Management (High Priority, High Value)

APS’s maintenance organization should define system and equipment prioritization criteria in accordance with the corporate strategic objectives and values. The current prioritization of all non-trivial transmission and substation systems and equipment should be reviewed, documented, and integrated in APS’s Maximo work management system (CMMS) and effectively communicated to all stakeholders. APS should also develop an effective process for the analysis, forecasting and management of the maintenance backlog.

Equipment Maintenance Procedures (Low Priority, Medium Value)

A significant number of APS’s current maintenance procedures for transmission and substation systems and equipment are manually developed for each work order and these procedures are not readily available to all stakeholders. APS should develop standard maintenance procedures in electronic format for all non-trivial transmission and substation systems and equipment. This work will facilitate the creation of a library of standard procedures to be issued with each work order, ensure the availability of these procedures to all stakeholders, the integration of standard procedures in the CMMS for the automated creation of effective work packages, and the capture of the maintenance staff’s current knowledge and expertise to develop new employees and address future training needs.

Data Automation & Maintenance Intelligence (Medium Priority, Medium Value)

It is recommended that APS develop the appropriate processes and tools to acquire and integrate all transmission and substation condition data to facilitate the effective analysis, forecasting and management of corrective, preventive and predictive maintenance tasks and processes. Processes and/or tools should be integrated with the CMMS to provide the organization with high level, near-time intelligence and condition status.

Planning, Scheduling & Outage Coordination (High Priority, High Value)

APS should develop a planning and scheduling organization as well as the appropriate processes and tools to increase the effectiveness of the planning and scheduling processes. The implementation of improved planning and scheduling processes and tools will maximize the effective use of the current work force and minimize outage requirements as well as the number of outage requests.

Productivity Planning & Scheduling Metrics (High Priority, High Value)

APS’s leadership should develop the appropriate process metrics to evaluate and track the transmission and substation maintenance organization’s effectiveness in the areas of planning, schedule adherence, productivity, and the management of the maintenance backlog. The development of these metrics shall not distract from the organization’s strong focus and performance in the area of reliability metrics but rather serve to extend the organization’s focus.

Periodic & online monitoring (Low Priority, High Value)

APS should increase its investment in on-line monitoring technologies in out years to maximize its maintenance intelligence while maintaining an economic labor cost structure. On-line monitoring technologies should be leveraged wherever the risk or impact associated with a failure or loss of a particular system or component is significant and poses a threat to the organization. On-

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line monitoring technologies should also be used where the technologies significantly reduce craft wind shield time. APS should review and modify current periodic monitoring tasks to increase the type and frequency of diagnostic and inspection tasks to a level comparable to industry Standard Practices.

Source: Adapted from the Final Assessment Report submitted by APS to Arizona Corporation Commission

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EXHIBIT 6. REDESIGNED MAINTENANCE PROCESS AT APS

19

EXHIBIT 7: PROCESS INFRASTRUCTURE MAP FOR PALO VERDE NUCLEAR PLANT

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People/Business

Processes

Business PlanningFinancial ServicesLong Range PlanningHuman ResourcesCommunications Svcs

Operate, Test, and Monitor

Plant Systems

Monitor and

Control Plant

Chemistry

Monitor and

Control Effluents

Conduct Emergen

cy Operation

sStartup Plant

Systems

Shutdown Plant

Systems

Perform CM/EM

Maintenance

Procure and

DeliverFuel

Provide Material

and Services

Provide Contract

and Procurem

ent Services

Provide Inventory Managem

ent

Perform Preventiv

e Maintena

nce

Manage Design

Requirements

ScheduleActivities

Monitor and

Control Contamin

ation

Monitor and

Control Rad

Exposure

Perform Planning

Provide Fuel

Management

Services

Modify the Plant

Provide Design

Services

Manage Plant

Configuration

Perform Compone

nt Monitorin

gPerform System

Monitoring

Perform Continuous

Equip Reliability

Perform Life Cycle Managem

ent

Operatethe Plant

Processes

ManageConfiguration

Processes

Provide Material And Services

Processes

Maintain the Plant ProcessesOptimize Equipment Reliability Processes

Performance Improvement

Processes

Perf MonitoringCAPOp ExperienceSelf AssessmentProcess Improvement

TrainingProcesses

Training AnalysisTraining DesignTraining DevelopmentTraining ImplementationTraining Evaluation

Licenses/Permits and Oversight Processes

LicensingComplianceNuclear AssuranceIndependent Oversight

Information Management

Processes

Admin Controls ProcDocument ControlRecords ManagementInformation Technology

Loss Prevention Processes

Risk ManagementManage SecurityFire ProtectionEmergency PlanningIndustrial SafetyFitness for Duty

Support Services

Processes

Manage FacilitiesManage VehiclesManage Grounds

SAFELY and efficiently generate

electricity for the long term

ENABLING PROGRAM AREASCORE PROGRAM AREAS

PALO VERDE PROCESS INFRASTRUCTURE