Situation

When executives in a state-owned company face the liberalization of its industry, they may well encounter a trade-off long familiar to managers reared on competition: to what extent should they lower prices to gain market share or maintain those prices to protect their margins? That was the problem facing an incumbent European postal service eyeing the rapid growth of private delivery services in response to an EU directive calling for postal deregulation by 2009. The incumbent found that competitors were cherry-picking its most profitable segments: business customers and deliveries in densely populated regions. In response, it considered cutting its prices and relying on its superior economies of scale to muscle out the new players.

Complication

A simulation of the competitors' economics and of the likely effects of changing products and prices showed the incumbent that it couldn't undercut its rivals without incurring an unacceptable decline in profitability. One reason was the labor cost advantage the attackers enjoyed (exhibit). Moreover, the incumbent found that charging different prices for its urban and rural deliveries (a possibility given the regulatory environment) would also be counterproductive: increasing the price of mail in rural areas would simply make them more attractive to competitors, and...