Enron Corp. - University of California | Office of The President

equipment, a significant portion of which costs Enron knew it was likely never to recover and
certainly never to make a profit on. Enron executives knew that Enron would lose money on the
EES deals, but had to make them more and more attractive to generate new clients, while the
Company utilized unrealistic projections and mark-to-market accounting to mislead investors into
believing that the EES contracts were making money. For instance:
(i) EES had originally targeted residential retail customers, but this failed
due to insurmountable hurdles, including the fact that Enron did not have sufficient infrastructure
to bill residential customers monthly. In 97, Enron transformed EES into a commercial-industrial
business and then purportedly signed up several major customers, including Starwood Properties,
Chase Bank, Eli Lilly, Owens-Corning, Simon Properties, the Archdiocese of Chicago, and others.
However, EES still faced insurmountable hurdles: One, because each customer's contract was
individualized, there were no economies-of-scale savings and the cost of performance precluded
making a profit. Two, Enron still did not have sufficient infrastructure to do the monthly billing.
Three, a prerequisite for each contract was for Enron to upgrade the customer's facilities with huge
current capital expenditures, which was uneconomical and guaranteed losses on most contracts;
(ii) EES entered into DSM contracts, which bundled energy-related
products and services for its customers, including providing power and equipment as commodities
to companies like J.C. Penney, Quaker Oats, IBM, Starwood Properties, Albertsons, Safeway, and
others, along with long-term management and consulting services on the customers' usage of the
power over the life of the contract. Enron booked 100% of the commodity portion of the contract
up front, and 70% (on average) of the estimated long-term services revenue. Because the revenues
from each contract were pulled into the single quarter when the contract was signed using mark-to-
market accounting, EES had to close increasingly higher revenue-producing DSM transactions to
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