Gas Retail Case
Case:your client is the major operator, a monopolist, in one of the largest European gas market. his business includes two major activities:
1. gas sales to households and firms. gas bought from large producers in Russia, Norway, Algeria etc.
2. gas transportation from the national border, where it is delivered by the producer, to the end consumers. this implies the existence of a large ensemble of infrastructures: transportation network, distribution network, storage equipment, methane terminals...
let's look at the challenges on the natural gas market after market liberalization in europe.
concretely, the market's deregulation means:
1. the end of the monoploy for the gas sales. the arrival of new competitors.
2. the preservation of the monopoly on transportation, but under the surveillance of an independent authority that gurantees equal access to all competitors.
your client is the head of the purchases and sales department. he is in the following situation:
today, company market share at 100%
at a certain point in the next years the market will at once be opened to competition. (a simplification)
The client wants to know what will be the level of competitive intensity at opening? What actors are likely to become my competition?
case obtained from INSEAD
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Framework:
Market/Customers: assess the market attractiveness. look at the market size, its growth rates and trends, its customers, the costs and revenue structure, profit margins. of course, pay attention to segmentation of the markets.
Competitors: look at who are likely to be the competitors. pay special attention to synergies that they could possibly leverage on.
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I: let's focus on the gas retail sale activity's attractiveness. start with the market growth potential. what are the market's growth levers?
me: I would differentiate between households and corporate customers. however, before diving into there, i need some data on the overall market conditions, and data on these two segments.
I: The household market is not growing, pretty much stagnant. the firm sector is shrinking, as the price of the gas continue to surge and the risk factors associated with some of the largest firms have to do with the situation.
me: so i would imagine that new entrants should have to take clients from the major player, which is our client. now lets look at the market, its revenue and costs structures.
I: Can you imagine what the cost strucutre is?
me: i would imagine the costs include FIX COST and VARIABLE COSTS. fix costs include the INFRASTRUCTURE. variable costs include SALES AND MARKETING COSTS(commercial costs), GAS PER UNIT PURCHASING costs and labor costs.
I: here is a simple structure:
commercial 7%infrastructure 40%
margin 3%
what cost advantage can i new entrant expect to build for each one of these costs?
me: a new entrant will have to purchase gas, and its volume is unlikely to be more than us, so should not be able to obtain significant cost benefit over there. it will have to invest in infrastructure or use our existing infrastructure, which is unlikely to be lower than ours. it will also have to invest in sales and marketing, as they are less recognized in this market, unless they are an established firm in this country selling stuff like electricity.
commercialization synergies may be a way for the new entrants to obtain cost advantages. of course i would have to check these assumptions.
I: let's put ourselves in the shoes of a household client whose yearly gas invoice amounts to 500 dollars, what is the price reduction potential for a new entrant? can you give rough estimates?
me: let's suppose a 30% reduction in commercialization and a 50% reduction in margin. that would be 7% x 30% + 3% x 50% = 3.6% reduction in price. that is $18 reduction in price. the room for reduction is very low. this might allow it to compete with the established client. marketing sales costs could be reduced if they entrant is established in other sectors such as oil or electricity.
I: what can we conclude on the new entrant's margin level?
me: the margin would be very low.
I: let us consider the risks. during a warm year, the heating volume reduce by 10%, and costs of gas are totally variable, commercial costs totally fixed, 30% of the infrastructure costs are variable. how would you predict the margin.
me:
cold year warm year
gas 50% 50% x 90% = 45%
infrastructure 40% 40%-(40% x 30% x 10%) =38.8%
commercial 7% 7%
total costs 97% 90.8%
sales/revenue 100% 90%
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margin 3% -0.8%
in a warm year, the business has a negative profit margin. this is a low margin high risk business. not very attractive to new entrants.
I: your client meeting is tomorrow. what can you tell your client based on the analyses so far?
me: well, the market is not very attractive, it looks like the client does not need to worry about new entrants.
I: but why would it be a big mistake to tell our client not to worry.
me: we are looking at this segment in a stand alone basis. we need to look at the big picture and realize it is a strategic part of the energy sector. first, there is some interconnection between oil, gas and electricity, that changes in one sector might affect another. second, new entrant might enter the market offering gas, oil and electricity in combinations to win over the market. they might even be able to justify the risks with margins and sales in other segment.
I: are there any levers that would enable a player to enter the gas market in a profitable way?
me: yes. if an established oil company enter the market to sell gas, it could use its synergies in distribution channels to lower the infrasturcutre costs. it could also use the brand name to achieve a lower commercial costs. if an established electricity firm enters as a new entrant, it could also leverage on the brand name and its channels to penetrate the market, to lower the commercialization costs.
like i said, offering gas may be a strategic part of their business. it may not be very profitable but it could serve to bring up sales in their other segments, or to strengthen their brand name or market leadership positions.
I: what do you want to say to your client?
me: i would tell the client that the threat is real. we should worry about the oil and electricity companies that have established businesses here at the market where our client operates. other established firms may also be potential threats.
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