2004 International Conference of the
System Dynamics Society
Oxford – England
25-29 July 2004
A System Dynamics Model for Scenario Planning and Evaluation of Princing Strategies in Bulk LPG Market
Financials - Average unit margin
Bulk LPG Business in Portugal
Portugal has the largest LPG (Liquefied Petroleum Gas) share of primary
energy demand in the EU (about 5%).
The bulk LPG market in Portugal is mainly about small and medium
business clients and household consumers, in the regions where natural
gas is not available.
+
99
00
01
02
03
98
Financials - NOPLAT and EVA
Fraction of new clients choosing LPG
per year
99
00
01
02
03
B1
Actual clie nts lost
LPG cost
Financials - ROCE and WACC
Pricing
Strategy
80
LPG price
60
Noplat
R oce
Eva
W acc
Substitute price
40
+
Clients
switching to
substitute
R1
-
0
98
99
00
01
02
98
03
99
00
01
02
99
00
01
02
03
98
99
00
01
02
+
-
Because of the high price sensitivity of the consumers, the preference of
new consumers for equipment using substitute energy has been
increasing.
Clients lost and won per year
98
Market Dynamics, Pricing Strategies and Value Creation
Agents perception
about fraction of
clients prefering
LPG
+
03
Clients
Due to the increasing of LPG international cost in the last 4 years, the
distance between LPG bulk price and price of substitute energy has raised
to expressive values.
R3
Clients won
99
00
01
02
03
Unit cost
R2
03
Excluding cooking and special appliances, the alternative energy with the
most competitive price is heating diesel. This substitute energy has had a
very low price, with small variations, because it has been subsidized by
government.
Clie nts lost
+
+
20
98
Clie nts won
Agents
recommendig
LPG equipment
Price
+
%
100
Actual clie nts won
+
Average prices
Resource flows - Clients lost and won per month. Actual vs simulated data.
Financials
objectives
Financial
Gap
-
Financials
results
98
Historical vs Simulated Data
Causal Loop Diagram
Financials - Net capital employed
-
Scenario Planning and Strategies Evaluation
Using that simulation model in combination with scenario planning method, we can
develop and evaluate alternative futures in uncertain environment, and test
alternative strategies as well.
R4
For example, considering a scenario with a cyclical variation of LPG international
cost, we might be interesting in testing two alternative pricing policies: fix price and
fix margin.
Some strategic questions about pricing arise from recent evolution in bulk
LPG market.
Policy 1 – Fix margin. Price is driven by margin.
Pricing strategies have to take into consideration some market dynamic
effects. Such effects are derived from consumer behaviour regarding his
willingness to switch to substitute energy and from the interest of
equipment sellers to promote LPG.
Policy 2 – Fix price. Margin will vary to absorb LPG cost variations.
Clients
Susbtitute clie nts won
Given that scenario for the future international cost, the following graphics show the
simulated impacts for those two pricing policies.
Susbtitute clie nts
close d
Substitute clie nts
Policy 1- Prices and unit margin
What are the best pricing strategies in terms of value creation, considering
different scenarios for the future evolution of LPG international cost. For
example, in a scenario of cyclic variation, fix price strategy would
deteriorate financial results, otherwise a fix margin would cause client
resource depletion.
Policy 2- Prices and unit margin
Mark e t
Fraction of clie nts
switching to substitute
C losing rate
Ne w consum e rs
C lie nts switching to
substitute
C lie nts re ne wing
contract
Price
Price
S price
S price
Margin
Margin
R e lative price
Actual clients won
Actual clients lost
C lie nts e nding contract
Mark e t growth rate
Simulation Model
C lie nts won
98
99
00
01
02
As we can see in the graphic above, existing LPG consumers have
switched as well to substitute energy.
The main driver for the consumer preference is the relative price between
bulk LPG and substitute energy. Due to LPG greater quality, consumers are
willing to pay a premium against substitute energy price. Then, until
certain price gap, consumers prefer LPG instead substitute energy.
That model provide that policymakers visualize the impacts over time of
certain strategies, and with that they have a dynamical understanding of
the pricing policies that create more value for the organization.
To build this simulation model, we have used historical data (1998-2003) of
LPG business.
%
100
To keep the model as simple as possible, we use relative variables and
non-linear graphical functions to describe the pricing effect in consumer
behaviour.
C lie nts close d
Fraction of age nts
re com m e nding LPG
e quipm e nt
Fraction of ne w clie nts
choosing LPG
C hange in age nts
re com m e ndation
Volum e
C ontract te rm
Agent
recomendation
80
60
40
0
98
99
00
01
02
03
To select the source of energy, some consumers estimate and compare the
total costs (equipment, energy price, energy consumption and
maintenance) while others follow agents (equipment sellers)
recommendation.
Tim e to adjust age nts
re com m e ndation
C lie nts switching to
substitute
Agents prefer to sell the kind of equipment that will meet consumer
requirements. So, agents are attentive to consumer options and opinions
in order to change their own perceptions and recommendations about the
most advantageous source of energy.
To minimize the market effect of high LPG cost, the margin was reduced.
As we can see in the following graphics such policy has deteriorated the
financial performance.
Lost
Lost
Price
Substitute price
98 990001020304050607080910 111213
98 990001020304050607080910 111213
C ontract bonus
Policy 1- Fraction of new clients choosing LPG
Financials
Product cost
Consum ption pe r
clie nt
Variable cost
Price
W acc
%
100
80
80
60
60
40
40
20
20
98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13
Policy 1 - NOPLAT and EVA
Noplat
Total cost
Eva
Policy 2- Fraction of new clients choosing LPG
%
100
0
Fix cost
It is assumed that agents influence the option in about 60% of new
consumers. The medium time to adjust agents perception about LPG
competitiveness and consumer preference is two years.
0
98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13
Policy 2 - NOPLAT and EVA
Pre fe rre d EVA
Pre fe rre d EVA
Tax rate
R oce
Change of
de pre ciation
Non-linear graphical function
used for describing new
consumer behaviour. For a
given price ratio, the function
gives the fraction of new
consumers preferring
substitute fuel instead LPG.
W on
R e lative price
Susbtitute clie nts won
The acquisition rate of new consumers is also dependent upon the relative
price, and that function was calibrated against historical data as well.
20
W on
Unit cost
Volum e
In the case of LPG consumers changing to substitute energy, the switching
rate is dependent upon the relative price between LPG and its substitute
energy. That function was calibrated against historical data, assuming one
year delay between consumer perception and action.
Policy 2 - Clients lost and won per month
C lie nts
The LPG international cost is an exogenous variable, and is used to define
the different future scenarios.
Resource stock - Fraction of agents promoting and recommending LPG
equipment. Agents alter the equipment recommendation when they percept
some change in clients preference.
98990001020304050607080910111213
Policy 1 - Clients lost and won per month
A simple system dynamics model was built, combined with Economic
Value Added framework, to evaluate some pricing strategies under
different scenarios of LPG international cost.
03
98990001020304050607080910111213
C ontract te rm
Noplat
Noplat
Eva
Eva
Change of capital
98990001020304050607080910111213
De pre ciation
98990001020304050607080910111213
Ne t capital
Policy 1 - ROCE and WACC
Policy 2 - ROCE and WACC
De pre ciation rate
Pre fe rre d R O C E
Contract bonus
Inve stm e nt
Inve stm e nt pe r clie nt
Clie nts re ne wing
contract
Pre fe rre d R O C E
R oce
R oce
W acc
W acc
Clie nts won
98990001020304050607080910111213
98990001020304050607080910111213