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PDPaperNovember2000GoforaHigherPrice–
Incumbents'RaceforCompetitionBernhardSchmidt,BEAndreasFlorissen,DUBorisMaurer,BEAxelFlasbarth,BEAchimHausen,CGThomasVahlenkamp,DU0
Source: McKinseyINDUSTRIESWHERE"GOFORAHIGHERPRICE"
CANBEAPPLIEDOligopolisticmarketswithnewentrantsand/orstrongcompetition:Retailing,Banking,Insurance,AirlinesFast-growingindustriesfightingformarketshare:Mobileoperators,Internetserviceproviders,
E-commerceNewlyderegulatedindustries:Telecommunication,
Utility,TransportationCompetitionperceivedashighNewentrantswithnewtechnologies,especiallyinbanking(e.g.,onlinebrokerage)Traditionallylow/negativemarginsinretailingFlawedbusinessmodelsthatleadtocustomerswithnegativevalueNewtechnologiestendtoleadtolowerprices(pricetransparency,auctions,etc.)Noskimmingfornewtechnologies(e.g.,DSLflatratebyDTAG)MainissuesDestructivepricewarsProactivepricecutsFocusof
presentation1HOWINCUMBENTSAREBOUNDTOFEEL2"AOLTOUNVEILFLATRATESINGERMANY,UK"TheWallStreet
JournalEurope,06/20/2000"Competitionhashitushard"(…)Electricitypricesforindustrialcustomers(inGermany)havefallenby30to50percent,privatecustomersarepleasedwithbills15to20percentlowerFAZ,11/01/2000PRICEWARLOWERSTURN-OVERATNECKARWERKESTUTTGARTAGSüddeutscheZeitung,05/08/2000THENETWARINEUROPEBusinessWeek,06/19/2000PRICEWARONGERMANFOODRETAILMARKETBECOMESFIERCERThepricewaronGermany'sfoodretailmarkethasintensifiedsincetheentryofWalMartStoresInc.,theU.S.retailgiant,ontothemarket(…)
DieWelt,04/28/2000AT
thecane.g.RWE:ElectricityPricesHaveHitRockBottom(…)operatingprofitsfellby15percent(…)Thiswasduetothefallinthepriceofelectricity,causedbythederegulationofthesector.DieWelt,07/04/2000ReweSeesNoEndtoPriceWar(…)theso-calledretailpricewarinGermany,inwhichRewehasundeniablybeenoneofthekeyplayers,severelydentedgroupoperatingprofits,whichdeclinedbyDM100mtoDM500m(…)Eurofood,03/30/2000DeutscheTelekomhardlyearnsmoneyinitsoperationalbusiness(…)Shrinkingprofits(…)aredueto
highmarketingcostforacquiringnewcustomers(…)andthepricewarinthe
conventionaltelephonenetwork.FTD,11/01/2000PricingturnsintoascienceHowacompanypricesproductsandservicesisincreasinglyacknowledgedasanimportantstrategictoolaffectingprofit,growthandshareholdervalue(…)FT,10/31/2000INCUMBENTSHITINPRICEWARS
Source: Miscellaneousnewspapers,McKinsey3CHALLENGESFORINCUMBENTSINDEREGULATEDMARKETS
Source:McKinseyIncumbentPricingAvoidpricewarsGoforahigherpriceOrganizationBuildupnewskillsCreateaflexible,adaptiveorganizationCostsCutcostsIncreaseyourefficiencyRegulationFightforregulatoryfreedomTrytoraiseentrybarriersGrowthBuildupnewbusinessesPrepareforM&APricingAvoidpricewarsGoforahigherprice4PRICEWARINTELECOMMUNICATIONS–FINLANDTimeNewentrantSonera(incumbent)PriceDay1Day2Day3-50to-70%pricedeclinewithinseveraldaysMarketshareSonera
(?LANDIsland)Percent405060100ProactivepricecuttingCompetitorundercutsincum-bent'spriceNextpanicreaction * Population=20,000 Source:McKinseyResearch60%loss
inmarketshare5PRICECUTSAFTERDEREGULATION–POWERSUPPLY
SWEDEN
Source:McKinseyAverageprices
SEK/kWhLargecustomersPrivatecustomersSpotmarketpriceapprox.
14SEK/kWhSME199819991998199919981999-6%-19%-35%Largepricedeclinedespitesmallactualswitchingrates156MISINTERPRETATIONOFKEYINFLUENCINGFACTORS
Source:McKinseyHypothesisPricecutsaretooaggressivemostofthetimeWhy?Competitors'pricereactionsarenottakenintoconsideration;aninitialpricereductiontriggersanavalancheofself-destructivepricecutsCompetitors'price1OverestimationofcustomerswitchingratesSwitchingrate2Fearoflosingevenasinglecustomerduetoun-differentiatedoverestimationofcustomervalueVolume-oriented,notvalue-orientedCustomervalue3Noideahowcosttoserve(own,competitors')effectpricingschemesCosttoserve47WHATISTHERIGHTPRICE? Source:McKinseyHowhigh?
Even
higher!Theprice
ishigherthanyouthink!8?WHATISTHERIGHTPRICE?EXAMPLESGERMANY:
PRIVATECUSTOMERInyouropinion,
howhighshould...…anincumbent
telecommunicationsprovider(peaktime,
long-distancecalls)…anincumbentpostalcompany(localmail)and…anincumbentutility Source:McKinseyAttacker'sprice9€cent/min0.40€/letter9€cent/kWh**Actualpricesetbyincumbentafterfirstpricedecrease12-18€cent/min0.55€/letter11€cent/kWhOptimalmodelprice16€cent/min*0.75-0.90€/letter*16€cent/kWh*
Estimatesforvariablecost,customervalue**Netprice,belowvariablecostsetitspriceatthebeginningofderegulation?9PRICINGASKEYFORSHAREHOLDER-VALUECREATION Source:McKinseyStrategic
dilemmaTwoleversforshareholder-valueTobesolvedwitha"profitablegrowth"pricingstrategy:conscioustrade-offbetweenmarketshareandprofitStrategic
dilemmaProfitabilitySalesCostGrowthGain/keepmarketshareGrowththroughinnovation/newbusinessesGrowththroughM&A10Marginal
contributionAssumptionsNomarketparticipantwillsetpricesbelowcosttoserveequilibriumwithequilibriumpricesfornewentrantandincumbentIfincumbentsetshispriceabovecompetitor'sprice,customerswillswitchThelossofsalesdependsonswitchingratesThemarginalcontributionequalspriceperunitlesscosttoserveCompetitorentersthemarketandsetspriceUseoptimizationmodeltocalculateoptimalpriceforincumbentOPTIMALBEHAVIORFORINCUMBENTS Source:McKinseySalesCONCEPTUALCompetitor'spriceSwitchingratesCustomervalueCosttoserveTheincumbent'soptimalpricemaximizeshismarginalcontributionTheincumbent'spriceisabovecompetitors'pricesOptimalpriceforincumbentTotalmarginalcontributionMarginalcontributionCosttoservePriceofnewentrantCompetitor'spriceSwitchingratesCosttoserveCustomervalueThecustomervalueconsistsoffuturepricepremiums,cross-sellingpotentialandthecostsforreaquiringlostcustomers11PRICECOMPARISONPRIVATECUSTOMERS–
UTILITYGERMANY
Source: Capital3/2000,McKinsey1RelevanttariffHowtoselecttherelevantcompetitor'spriceOnlyconsiderpriceofcompetitorwhoismostrelevanttocustomers,i.e.,WhoiswellknownWhoattractsmostoftheswitchersTherelevantpriceisnotnecessarilythelowestFamilyTariffs(4000kWh)Utility1.2000,Minden2.AbasEnergie,Hamburg3.Vossnet,Bremen4.FHE(ZeusAG),Hamburg5.überlandwerke
Gro?-Gerau6.Energieversorgung
OffenbachAG7.YelloStromGmbH8.EnergieAGIserlohn828920923948967
984
988996AnnualPriceDM12DEVELOPMENTOFSWITCHINGRATESHealthinsurerTelecommunications
(totalmarketbyminutes)Preselection:telecommunicationsBuildinginsuranceUKgasmarket1.780.920.270.340,250.3350.741.711.900.0830.0870.890.26Switchingratesareneverhigherthan2%per5%pricepremiumSwitchingratesriseinthefirstyearafterliberali-zationandfallinthefollowingyearsSwitchingrate
Percentper5%pricedifferenceTimeafter
liberalization41year2years3years231
Source:McKinsey: McKinseyresearch213CUSTOMERVALUECustomerportfolioasapercentageofactualnumber(Today)100Time
Years12345NPVofcustomerrelationshipPricedifferencetocompetitors
Incumbent'spriceOptimal
price
differenceAttacker'spricePremiumofincumbentvs.attackerValuecontributionfromcustomerrelationshipTime
Years12345Dis-
countTrenddepends
onswitching
rate3
Source:McKinseyCONCEPTUALSeriesofvalue
contributionincludescross-sellingpotentialsandavoi-danceofacquisitioncosts14Competitors'costtoserveareespeciallyimportantaslongastheincumbentcannotobservecompetitors'offersinayoungmarket4COSTTOSERVEFROMSALESPERSPECTIVE
Source:McKinseyInfluenceonpricingofincumbentDirectOwncosttoserveareoflittlerelevanceforoptimalpricing,sinceprice>cost
toserveIndirectCompetitors'pricesareofmajorimportanceforownoptimalpricing;theycanbederivedandanticipatedfromtheircosttoserve1
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