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Betting on Retail Risk Management: Flat Prices for Peak Hedging

Why a risk-hedging product for small customers isn't the gamble you may think.

Fortnightly Magazine - November 1 2002

assess risks and returns and make small adjustments to the pricing model, as well as to the program's terms and conditions.

The second method is to manage risk through a risk adder (). The risk adder is the premium charged to compensate the company for the additional risk it assumes. In any given year, the program could take in more or less money than what customers would have paid under the tariff-based, volumetric-pricing plan. Increasing the amount of the risk adder increases the likelihood that in any given year, the revenue outcome for the company will be a gain. Of course, the larger the risk adder, the smaller the participation rate.

In an industry built on the bricks and mortar of unit price efficiency, some will continue to scoff at this pricing innovation, dismissing flat pricing due to its perceived inefficiency. We suggest those skeptics carefully examine the many industries offering flat bills. Consider the Internet service providers offering unlimited use for $19.95 per month; the mobile phone firms hawking unlimited use at $50 a month; and auto rental companies with unlimited miles for $40 per day.

There is a market niche yearning for such a product, and it can be constructed safely and profitably. It simply requires that you clearly define the norm and logically address it. If you don't, someone else will.


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