Most companies know that the introduction of the euro in January 1999 will increase competition and level prices significantly across Europe. Yet few have changed their marketing and pricing strategies in response.

The opportunity forgone is huge. Over the next few years, it will be possible to create considerable value by carefully managing and delaying price reductions in higher-price countries and by acting to limit the fall in the average price levels of industries and companies alike.

Even before the euro’s introduction, prices across Europe had been converging slowly but constantly as a result of deregulation, the removal of formal trade barriers, the harmonization of regulatory ones, and the reduced ability of manufacturers to influence retailers’ prices. The euro’s introduction will probably accelerate this trend. Customers will be in a better position to exploit relatively small differences in price, as well as more inclined to establish long-term sourcing agreements with foreign suppliers. Some suppliers will harmonize prices in an attempt to gain market share, and many national companies will enter foreign markets as the costs and perceived risks of cross-border trade fall.

Nonetheless, prices still have a long way to move. In the automobile market, for example, variations in market structure and competitive conduct, to say nothing of historically large currency fluctuations, have created 40 to 50 percent price differences from one country to another. The situation is similar for many consumer goods (Exhibit 1) and industrial goods (Exhibit 2). In some industries we studied, such as automotive spare parts, construction materials, and large industrial equipment, price differences often exceed 40 percent. In pharmaceuticals, country-to-country price differences are often 50 percent—and more than 100 percent for some products. Even prices for commodities like steel and paper vary by country, although the differences are much smaller and largely reflect transportation costs.¹

The rate at which prices converge will vary by industry, depending on the size of the price difference for a product, the price sensitivity of its customers, their buying power, its appropriateness for electronic commerce, and the degree of international presence in the market. In all likelihood, the pace will be faster in pharmaceuticals, where price differences are large and government regulations increasingly direct hospitals to choose the cheapest alternative, than in automotive spare parts, a market in which volumes per item are smaller and availability is no less important than price.

Many companies in industries ranging from trucks and construction materials to hygiene products indicate that their price levels could quickly fall by 2 to 3 percent. In different industries, such a decline would translate into a corresponding decline in operating income of 15 to 50 percent (Exhibit 3). The slippage could be considerably greater over the long term if prices fell to North American levels, which in many cases are substantially lower than their European counterparts—by as much as 15 to 25 percent for some products.

As a result, companies must immediately review their pricing strategy by product and market. To prevent arbitrage, they must even try to raise prices in lower-price markets. Without doubt, they cannot stand idly by, watching prices fall and margins erode. In the coming months, companies can move to influence the speed and effect of the decline by refining their pricing and marketing strategies, managing their international accounts in a more sophisticated way, managing price transparency, making it more expensive for customers to switch to other suppliers, and improving the coordination and control of their pricing.

Refined pricing and marketing strategies

Some companies are rapidly harmonizing prices across Europe. They argue that prices will converge anyway and that harmonization is required to avoid arbitrage among countries and to gain market share by being the first to cut prices in higher-price countries. This approach may needlessly destroy value for two reasons: competitors will match these price reductions, and customers will prove to be less sensitive to prices than expected.

In fact, companies should aim to reduce prices as slowly as possible in higher-price countries, especially for less price-sensitive customers. Instead of carrying out across-the-board price reductions, suppliers should consider developing selective offers to price-sensitive customers using discounts or long-term contracts—measures that put less downward pressure on prices across the customer base.

Moreover, enhancing the perceived benefits a supplier confers on its customers—by meeting their needs on products and services more fully, for example, or by communicating the value of offerings more persuasively—can increase the supplier’s penetration of certain market segments and delay price erosion in less price-sensitive ones. A steel manufacturer that provides a distinctive product and service, for instance, has achieved higher average prices across Europe than its competitors and has also been less affected by price competition. This company has succeeded in maintaining country-to-country price differences of more than 25 percent, compared with just 10 percent for its rivals.

Managing price differences across Europe will be a delicate balancing act: too rapid harmonization and excessively large price differences will both destroy value. So for each individual product, it will be critical to review, continually fine-tune, and coordinate price bands: the maximum and minimum accepted price levels in each country and the relative price difference between countries. These price bands should reflect a thorough understanding of the price sensitivity of different customer segments and of the ability of customers to exploit price differences across countries.

Of course, one of the biggest risks companies face in maintaining large country-to-country price differences is arbitrage by the independent players, called parallel traders, who exploit price differences by shipping goods from one country to another and selling them. For arbitrage to be worthwhile for parallel traders in pharmaceuticals, say, the price difference between countries must exceed 30 percent, since the trader must cover repackaging and transport, discounts to pharmacies, and the desired operating profit. In other industries, the arbitrage costs for many products are smaller, often around 10 percent.

Companies can limit the hazard of parallel traders by understanding the prices they require and their strategies in selecting products. Delaying the launch of new products in the lowest-price markets to avoid arbitrage, for example, has helped reduce the price erosion of innovative products, such as pharmaceuticals, that competitors have difficulty matching in the near term. This approach is particularly useful when lower-price countries represent only a small share of the total European market.

International accounts

Mistakes in handling international accounts can put pressure on overall European price levels. International customers, for example, may exploit their knowledge of component prices in different countries to cherry-pick the best deals. To fight this tendency, one electronics company established a customer-specific, volume-dependent discount structure that reduced price differences among countries. Pricing was then closely controlled to ensure compliance with the volume discount structure. As a result, the prices offered to a single customer in a variety of countries could be better coordinated, and price differences could be justified as a function of volume. The company successfully avoided the convergence of prices to the levels of the lowest-price countries—which would have involved a decline of more than 10 percent.

Suppliers can often be much tougher than they are now in responding to requests for one price level across Europe. Many industrial customers, for instance, try to coordinate European purchasing by empowering a European purchasing manager or department. At the same time, however, some of these customers still have the traditional national structure, with subsidiaries in each country retaining considerable decision-making power. In many cases, the central purchasing function cannot enforce Europe-wide agreements without the explicit consent of local subsidiaries. Suppliers can take advantage of this divergence.

The following story shows how. One industrial supplier serving four of a customer’s nine business units across Europe received a request for a uniform European price list, which would have cut its average price level by 5 percent. The supplier then assessed the ability of the customer’s European purchasing function to enforce an agreement with the customer’s local business units. True decision-making power, the analysis showed, remained in local hands. So the industrial supplier agreed to a Europe-wide arrangement but also demanded the same payment terms throughout Europe and a single shipping address for the products. In the end, the customer’s centralized purchasing function failed to obtain authorization for this approach from the local units, and it eventually had to drop the request for a uniform price.

Managing price transparency and switching costs

Suppliers can also create considerable value by managing price transparency and switching costs to their own advantage. To do so, they should develop an understanding of which products and prices customers actually compare—list prices, for example, or invoice prices—so that price differences for these products can be reduced across countries.

Making it harder to compare prices can further reduce the risk of arbitrage. Suppliers should use discounts extensively, for instance, and in most cases avoid publishing European price lists denominated in euros. Varying terms and conditions from country to country and using pricing models based on loyalty or other drivers of profitability can reduce price transparency as well. Differentiating product features, packaging, and service levels has the same effect. In industries with complex offerings, such as construction equipment or industrial systems, bundling products and services and introducing service contracts also impedes price comparisons.

Another lever for reducing the risk of arbitrage involves raising the cost of switching for customers in higher-price countries—by introducing loyalty bonuses or long-term contracts, for example. Raising the amount of local service in product offerings may serve the same end.

Pricing coordination and control

To avoid pricing mistakes in one market that could adversely influence prices throughout Europe, successful suppliers are moving toward central coordination and control of pricing. These companies systematically track the prices they achieve in the marketplace and compare those prices with their own price bands and their competitors’ price levels.

An industrial equipment manufacturer managed to raise its average European price level by 2 percent in 12 months through such steps as removing any customer that paid prices outside the determined price band for a given country. To coordinate and control prices across Europe, the manufacturer appointed a European-level pricing controller who monitored the performance of affiliates in individual countries in achieving the targeted average price.

In addition, within each country the manufacturer set a price floor that local sales managers could not undercut without their country managers’ authorization. Information technology systems were established to track and evaluate list, invoice, and other prices by product and by country. These systems should help sales and country managers to detect pricing discrepancies rapidly.

Price differences across Europe are now very large, but the euro’s introduction will probably serve as a strong catalyst for accelerated price equalization. On balance, average price levels will fall. If not managed correctly, the financial implications of this development could be disastrous. Companies can pull a number of levers to manage the transition toward more uniform prices and to limit the decline in average price levels. The stakes are huge, and tomorrow’s winners must move quickly.