Materiales de Bloqueo

Threats Due to Overcapacity

The profitability and long-term survival of companies in previously deregulated industries have been threatened by over-capacity. In the past, regulated monopolies created companies that exhibited higher than normal returns at a relatively low level of risk. This made the regulated industry appear very profitable, attracting the attention of potential competitors. When such industries underwent deregulation, new entrants arose to serve the market, armed with capital to invest in additional infrastructure. In both the telecommunications and airline industries, this has led to over-capacity. In the airline industry, over-capacity and price wars have led to periodic bankruptcies and corporate takeovers. In the telecommunications industry, extremely optimistic demand projections led to over-investment and multiplication of networks, resulting in a capacity glut. Profitability was threatened by the failure of expected revenues to materialize, and

increased costs associated with operations and debt servicing.

The current difficulties plaguing the airline industry are caused in part by excess capacity that was added to meet business travel demand generated by the “dotcom” bubble. This section of the market paid premium prices, supporting the capacity buildup. Collapse of this segment of the market left the industry with an excess of capacity and a collapse in prices. In the telecom

industry, the buildup of high-capacity networks to meet as-yet unrealized projections of demand growth for premium services based on new technology (e.g., internet, data streaming) has led to a massive excess of capacity and a collapse of demand.

Opportunities through Price Customization and Customer Segmentation

In order to respond to increased competitive and profit pressures, the companies in the two industries have sought to increase revenue by utilizing creative pricing strategies. They have utilized price differentiation in various ways. By better understanding the needs of the customers, they have sought to price to value (instead of pricing to cost) and thus increase revenue. Realizing that value is product-specific, idiosyncratic (varies from customer to

customer and from segment to segment), contextual and dynamic,10 both industries have utilized price customization in an attempt to capitalize on these features. They offer different prices based on:

• Customer segmentation – Different customer groups pay different prices for the same good or service.

• Product form pricing – Different versions of the same product are priced differently, but not in proportion to their respective costs.

• Image pricing – The same product is priced at more than one level based on differences in the image projected to different customer segments.

• Location pricing – The same product is priced differently at different locations even though the costs are the same.

• Time pricing – Prices are varied by season, day or hour.11

Based on the regulatory structure, the characteristics of demand and the kind of products and services that the firms could offer, the airline and the telecommunications industry have changed their pricing structures and service offerings in order to maximize revenue.

Stability Through Management of Revenue Volatility

Customer segmentation and price customization have given both the airline industry and the telecom industry the opportunity to maximize revenue, but have also increased revenue volatility. In a deregulated environment, reducing the quality of service has been one of the primary responses to revenue shortfalls. Airlines in particular have cut costs by accepting a lower level of reliability and a lower level of service. This issue is likely to be watched closely in the energy industry, with regulators particularly sensitive to reliability and quality declines. The successful companies have been able to minimize the impacts of revenue volatility. Currently, the successful telecom companies are the companies with a large regulated revenue

10 _{Homa, Kenneth. http://www.HomaHelp.com, Georgetown University.} 11 _{Kotler, Philip. A Framework for Marketing Management, © 2001, p 229.}

base from retail sales, primarily the RBOCs. Airline companies such as Southwest Airlines that have not traditionally offered premium services at premium prices have been able to maintain their customer base without reducing prices.

Issues for Natural Gas Industry LDCs

The airline industry has been able to leverage concepts related to customer segmentation and price discrimination in order to maximize the value gained from customers. Natural gas

marketers and utilities have already implemented forms of the customer segmentation and price discrimination pricing strategies widely used in the telecom and airline industries. For example, by differentiating between firm and interruptible services, natural gas providers are applying both customer segment and product form pricing. There are, however, certain restrictions that prevent natural gas providers from employing different forms of price discrimination. The following section discusses how the rate structure in use by utilities makes it hard for the players in the natural gas industry, particularly the regulated LDCs, to follow the airlines’ lead.

Utility Rate Structure

Natural gas transmission and distribution tariffs remain heavily regulated. Most utility regulators believe that customers in the same rate class should face similar pricing structures. This is particularly true with respect to residential and small commercial customers. In this case, the gas industry would be closer to the structure of the telecommunications industry. In the

telecommunications industry, states have jurisdiction over local telephony and intrastate toll services.

Most utility rates are made up of three different components: a fixed component, a semi-variable component and a variable component. The fixed component is the monthly customer charge that is typically regulated by state public utilities commissions. The customer fixed charge supports the investment and fixed costs associated with gas delivery, including construction and

maintenance of pipelines and systems. Customers in a given community and a given rate class typically will pay the same amount in fixed charges regardless of the size of their houses or the quantity of gas they consume. Therefore, the more a consumer uses, the lower the average price per unit consumed.

Using the airline industry pricing structure as a model, LDCs could segment customers based on levels of consumption and requirements, and set prices based on the value the customers assign to the service. Gas utilities would then be able to charge these customers different rates, depending upon the customer’s willingness and ability to pay, assuming state commissions approved the rate.

This is starting to occur in the telecom industry as telecommunications companies have begun to utilize customer segmentation and demand analysis to maximize the revenue that they generate from the non-regulated portion of the local bills. In voice telephony, the telecommunication companies have encouraged demand growth by offering both flat fee and usage fee structures. Higher-volume consumers can pay a higher monthly fixed charge with low usage fees. The

consumer thereby has the option to increase consumption without incurring a high charge. Lower-volume consumers pay a lower monthly fixed charge, but their usage fee is higher. So far, however, this has occurred only on a limited basis in the natural gas industry. While some gas utilities have special rates for residential uses such as natural gas fireplaces, few offer different rates for customers with both a hot water heater and a furnace relative to customers with just a furnace, even though the combination of the two appliances has a flatter overall load factor and hence a lower cost impact on the utility.

In the commercial and industrial sectors, LDCs occasionally offer special rates for natural gas cooling customers. Gas cooling demand occurs primarily during summer off-peak periods, which tend to be cheaper to service than winter load. However, LDCs could be much more aggressive about providing special rates for distributed generation customers and other high load factor natural gas uses.

2.5

CONCLUSIONS

Price volatility for natural gas and electricity is exhibit substantially greater than the other commodities examined in this report. That said, volatility is a natural feature of commodity markets and the mechanisms that result in volatility are fundamentally the same. In any efficient market, prices adjust to correct imbalances of supply and demand. The magnitude of the change in prices is determined by the size of the imbalance and the willingness and ability of producers and consumers to respond to relieve the imbalance. This is true for both the short term and the long-term.

The large capital requirements and significant lead times associated with energy production and delivery make energy markets more susceptible to the imbalances in supply capability and demand that result in price volatility. The lead times for large energy infrastructure projects do not allow for rapid increases in energy supply that could mitigate short-term imbalances. In addition, energy markets such as natural gas, electricity, and heating oil are particularly susceptible to market and price volatility because fluctuations in weather can change the underlying demand for the commodities significantly, and the increase or decrease in demand affects all of these commodities in the same direction.

Nature gas and electricity have exhibited a particularly large increase in volatility because the restructuring of these industries compounded the incentive for efficiency improvements and cost cutting that tend to reduce the amount of underutilized supply capability available to moderate volatility. Other deregulated industries, such as telecom and rail transportation provide only limited lessons regarding the management of volatility.