It may have taken six years, but Yello has just crept back into the black and recorded a small profit for Q2 2004. The energy retailer took on the German market with a striking price message and managed to acquire 1 million customers in six years. However, they came at a high price and as Datamonitor's Daniel Legg explains, there are better ways to make money in energy retail...
In 1999, competition was just taking off in Germany and no one knew how it would unfold. EnBW, one of the seven pre-liberalization Verbund, wanted a national retail presence, and so formed Yello. In this guise, it embarked on a customer acquisition trail across Germany, spearheaded by a simple price message: everyone in Germany could pay one, low price. This was supplemented by a national advertising campaign that garnered Yello 90% brand recognition. The admirable result was that, at one point, Yello was responsible for 70% of all switching in Germany, and it acquired 1 million customers in six years.
However, this success came at a cost: in six years Yello ran up losses of E700 million. This is because in the early days competitors reacted by lowering their prices, making Yello's strategy less effective. Furthermore, network access charges were very expensive, reducing Yello's scope to cut prices.
Yello has now raised its prices and differentiated them to allow for regional variations in network access charges. Price rises have been accompanied by cost reductions and, in short, Yello has started performing more like an incumbent utility retailer, and has just made a small profit. But E700 million is a high price to pay for 1 million customers and it will be a long time before Yello earns E700 profit on each customer. This recent, small profit comes after intense pressure to stem the financial losses and the turnaround is not necessarily the beginning of long-term profitability for the company.
The trouble with organic growth
The energy market is cursed by its products: both electricity and gas are commodities where the key customer proposition is price and this makes organic growth difficult. The problem is compounded by low customer interest, which means that retailers have to take their product to the customer, at a cost.
The cost to acquire a customer is higher than the cost to retain one. For example, DEW Dortmund was able to reduce its prices in response to Yello's challenge, although it did not try to match Yello. It implemented an effective winback strategy and curbed almost all of its residential customer churn, getting it down to 1% compared to a German average of closer to 3%.
Economically successful organic growth relies on a falling wholesale market and incumbents that want to keep their margins high. If prices are falling, the new entrant can drop its prices and still retain a margin. If the incumbent suppliers want to maintain their margins (or even increase them), they will not drop their prices in response to the new entrant. In this scenario, the new entrant would be sufficiently cheaper than its rivals to poach some of their customers. Unfortunately, wholesale prices also rise, and incumbent suppliers sometimes respond to successful new entrants.
There are better ways to grow an energy retail business
The most obvious alternative to organic growth is M&A, although this also has its drawbacks. A major one is the risk of integration problems, especially when trying to merge two large customer databases stored on incompatible systems. Churn is another risk; customers confused by the change of supplier are vulnerable to the scare tactics of rival sales agents. Also, if several bidders are interested in the acquisition target the price is forced up, creating a risk of overpaying.
So buyers have to assess the true value of the customers and avoid overpaying for them. Scottish and Southern Energy recently bought Atlantic customers at approximately E60 each - far less than Yello lost acquiring each of its 1 million customers (although admittedly in the past, some UK utilities have paid as much as E450). One important advantage of M&A growth is that this is the only way to acquire non-switchers, generally regarded as more valuable than switchers.
Another growth alternative is to adopt a multi-utility strategy. Utilities that already have their own customer bases and do not want to expand into other regions can increase their customer accounts by selling more services to each customer. Revenues per customer increase while costs per customer increase much more gently, hence raising profit per customer.
When spread over all but the smallest customer bases (e.g. 100,000 customers), it should not cost a utility much to add an extra service to its portfolio. The energy retail model is built upon customer billing and an effective sales channel, so utilities should easily be able to sell any service that can be sold and billed through existing systems, and which doesn't rely on ownership of distribution or production assets.
Reaping the rewards
The rewards can be remarkable. Between 2001 and 2004, Telecom Plus increased its profit per customer by GBP30 (E45), from GBP28 (E42) to GBP58 (E87). Increased services per customer resulted in an extra GBP14 (E21) and GBP16 (E24) was from increased gross profit per service. This was possible because over the three years Telecom Plus increased its customer base from 88,000 to 178,000, and its service accounts from 140,000 to 312,00 - an increase in services per customer from 1.59 to 1.75.
Multi-utility strategies have been tried before, often unsuccessfully. In the UK alone, examples include Scottish Power, Powergen and npower. The multi-utility strategy relies on the possession of integrated customer service systems, both for billing and in the call center. Traditional utilities with legacy systems were not able to integrate their services, and therefore could not offer the price savings and customer service levels needed to be successful. On top of this, the traditional utilities often did not have the sales ability to convince consumers to buy into the multi-utility proposition. However, neither of these obstacles are insurmountable, and new entrants especially should have the wherewithal to make it work.
Organic growth seemed a good idea when competition began, and Yello succeeded by every measure but one: the exorbitant price it paid for each of its customers.