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