Pricing Strategy for a Deregulated Electric Utility
Client Problem
Our client was the deregulated subsidiary of a major US electric utility
- The client was facing full deregulation in their home service territory and would now be forced to identify, attract and retain customers in a competitive market
- How could the client price its services to maximize profits in the deregulated market?
- What is the appropriate trade-off between share and price?
- How should pricing differ by customer segment?
- How should we react to likely competitive strategies?
- How should the strategy be updated as the market evolves?
Project Objectives
- Develop optimal prices by customer segment given today's market conditions
- Develop an ongoing process and set of tools for the client to evaluate and respond to market changes as the deregulated utility industry matures
Approach
- We built a model that used customer survey data already compiled by the client to predict share at given price levels
- Derive customer elasticity by customer group from survey data
- Use elasticity and usage variation to construct customer segments with widely varying profitability and price trade-off characteristics
- Predict share change for both client and competitive price changes
- We built a model of our client's internal fixed and variable costs by customer segment and forecasted likely changes over time
- Sensitive to changes in share that altered our economies of scale
- Allowed for scenario gaming—alternate strategies, wholesale power prices, etc
- We then modeled the competition's fixed and variable costs in a similar manner
- We used a dynamic optimization model to determine the optimum price by customer segment over time
- Determine price by segment and target share
- Maximize profit, not price or share
- Ability to restate results should assumptions, competitors or customer behavior change
- We created a process for sales managers to use the model on a daily basis in making marketing program decisions and for the marketing strategy group to use the model on an ongoing basis to answer higher level questions (market entry, customer targeting, partnership deals, etc…)
Results
- Developed two versions of our models for use in ongoing pricing strategy
- One to evaluate individual pricing plans and deals that is used by sales people in the field (e.g. to evaluate a particular partnership deal with another company)
- A more versatile version to evaluate the appropriate strategy in new markets or the appropriate reaction to market changes such as wholesale power price changes -- this is used by the central strategy team to make decisions at the overall business level
- Developed optimal prices for current conditions which client has implemented
