EMU has arrived. For many Irish companies the focus has been largely on operational issues such as changing IT systems, deciding on euro/national currencies payment and transaction formats, and implementing a new treasury policy. These are significant issues in themselves but in terms of impact on shareholder value they represent the tip of the EMU iceberg. Companies which give insufficient attention to the key strategic issues do so at their peril. EMU creates a new business landscape - different to that which existed in the past. This will have major implications for many companies - creating valuable opportunities for some while threatening shareholder value for others.
Price transparency is one of the single biggest challenges facing businesses in Europe. The outcome is uncertain but already there are clear signs that the business stakes at play are large.
As all prices within the euro zone will eventually be converted to euros (by 2002 at the latest - but earlier in many cases), all prices across euro zone states will become transparent. There are currently wide variations in prices across Europe.
Price differentials also exist in other markets, notably the US. Importantly, however, the differentials in Europe are assessed as significantly higher than in the US.
Of course, there are various reasons why price differentials across Europe exist. Income levels, consumer taste, different product specification and relative brand positioning, the level of competition, and differing legislation will remain important determinants of the degree of price differential.
The 60 million euro question is whether existing price differentials are sustainable in the future. While in many cases differences in prices across markets will continue to exist, our experience suggests that there will be price convergence in a number of tradeable goods sectors, with convergence tending towards the lower range within the price corridor, resulting in a tightening of profit margins. The key issue for both companies and investors is determining which products are most exposed to price convergence over what time-scale.
In particular, the conclusions of Dresdner Kleinwort Benson in a recent research paper are worth considering. These include:
EMU will reveal wide price differentials in branded consumer goods prices across Europe. These vary to a greater extent than can be explained by costs alone;
the scale of difference between German and Spanish prices is surprisingly high - 37 per cent for an identical branded goods;
cultural differences in Europe's tradable goods sector will persist but markets will move closer together and differentials will narrow;
the variance in branded food prices between countries and within product categories appears "extreme and therefore unsustainable". VAT, distribution and labour costs could only account for a fraction of the wider price differentials observed in branded foods. Pan-European food manufacturers' pricing has been influenced according to what they believe the consumer can bear;
food retailer concentration across Europe has substantially shifted the balance of power towards retailers. Pan-European food manufacturers know they have a price differential problem; retailers are becoming increasingly aware of the opportunity;
price differentials of non-food tradable goods are probably just as wide but likely to converge less quickly
Many of the pan-European manufacturers are already actively trying to address this issue and minimise the risk of price convergence downwards. The euro is not the only factor creating pricing pressure - larger organisations created through mergers and acquisitions, greater centralisation of purchasing negotiations, driven by a need to maximise purchasing muscle and facilitated by technology, have increased the capacity of buyers to explore existing differentials. The euro, however, will add impetus to this both because of the immediate creation of a common currency and the very expectations created by EMU.
Also, there is evidence that investment advisers and institutions are already looking at corporate opportunities and exposures arising from price transparency. Dresdner Kleinwort Benson, for example, recently assessed the prospects for national retail markets, indicated buy/sell status for pan-European retailers and assessed the exposure of the main pan-European food producers to price transparency. This provides clear tangible evidence that EMU is a major strategic issue.
Investment analysts are starting to make stock market buy and sell recommendations based on company EMU exposure.
Essentials - basic necessities such as food, energy and telecom services - are acutely price-sensitive and are likely to become even more so given the enhanced transparency and choice following EMU. Consumers will increasingly shop around for the best value, and the combination of EMU and technology will give them the means to do so very effectively. Following the adoption of EMU, discretionary spending on consumer goods such as cars, household appliances, VCR's and even DIY homes will become increasingly commoditised, with cross-border price transparency allowing consumers to buy at the lowest price point.
Demand for price competitiveness will augment the pressure for convergence of indirect taxation levels across national boundaries.
There are two very effective price convergence transmission mechanisms that will act in conjunction with EMU and euro effects to produce a degree of price convergence in the longer term, where a price corridor is more likely to exist, rather than a single European price.
Firstly, distribution changes - the growth of direct marketing and electronic commerce.
These should increase the pressure for price convergence for some, but not all, tradeable products. E-commerce will assist in this by increasing the availability of information on price across Europe and providing the opportunity to order products and services over the internet without regard for national boundaries and the need for physical access to distribution outlets;
Secondly, as the pace of retailer concentration increases and pan-European buying and distribution centres are established it is evident that retailers will take advantage of differential pricing by manufacturers in markets defined by national boundaries.
For consumers the outlook after EMU is bright, with the promise of increased cross-border competition from both inside and outside Europe, greater access to products from across the EU, significantly lower prices, and as a consequence, heightened competition based on quality and other non-price factors.
For business, however, EMU brings threats and opportunities, with the prospect of increasingly fierce competition. Companies that proactively take to advantage of the opportunities and position themselves to minimise the risks leave themselves a far greater chance of success than those which simply react to the actions of customers or competitors.
The effect of EMU on corporate pricing strategy is one of the key strategic issues posed by the introduction of the euro.
Likely winners following EMU include efficient, low-cost producers formerly operating in small markets, who are looking to expand via technology to pan-European sales; losers will be high-cost producers whose formerly protected markets are set to be opened up to pan-European competition.
The authors are specialist EMU consultants with PricewaterhouseCoopers Ray Gray is EMU services practice leader in Ireland and Stephen Gill a senior manager.
