Should we Regulate the Structure of Consumer Tariffs to Make Competition Work Better? Two Cheers for Ofgem

(by Catherine Waddams) The UK energy regulator today published its heavily trailed and significant proposals to constrain the regular tariffs which energy companies can offer to residential consumers. Ofgem’s proposals to simplify energy tariffs are an excellent start, but will they be enough to get consumers active in the market?  Just as important, will they motivate companies to offer better deals to the majority of consumers and not just for those who shop around regularly?

 This intervention is a major step away from deregulation, in which Britain has often claimed leadership.  It is designed to make it easier for consumers to compare prices between suppliers – these will differ only in the charge ‘per unit used’. Is such strong regulation, at least compared with the recent past, justified by its likely stimulus to consumer activity? Research at the Centre for Competition Policy based on consumer questionnaires over the past decade show that the main driver for consumer activity in the market is the expectation of financial gains, and these can only be identified if the charges by the various companies are known. Moreover, around a fifth of consumers who switch to save money end up on a more expensive deal (Do Consumers Switch to the Best Supplier? by Chris M. Wilson and Catherine Waddams,  Oxford Economic Papers, 62: 647-668, 2010).  Simpler tariffs should help them avoid this pitfall.

Some active consumers have been able to use price comparison websites which cut through the detail of tariffs to compare the total bills.  However, some consumers distrust these sites, apparently justified by recent statements by some companies that they have in the past offered cheap deals which are not widely available in order to get to the ‘top of the list’. The number of special time limited offers has also burgeoned in the last few years, following the introduction of non-discrimination clauses.  Ofgem is concerned that companies have used these special offers to lure customers to switch to them, later transferring them to a more expensive deal. The regulator’s new price comparison tool should make the benefits and limits of such offers much clearer. Added to Ofgem’s takeover of the confidence code for switching sites, this should remove another important barrier to switching. CCP’s research shows that low confidence in whether the decision is the right one often deters activity. All these initiatives should improve decision making, encourage those who are currently interested but do not make the move to do so, and put more pressure on the companies to offer better deals to their consumers.

But it may not be enough to make a big difference to the market. CCP’s surveys consistently show that some households are just not ‘the switching type’. Some people are inactive across most markets where they need to take the initiative to switch, such as telecoms, bank accounts, mortgages and insurance. Such inactivity seems to depend on their more general attitudes to savings as well as the particular confidence in the market discussed above.  Their expected time it would take to search and switch has little effect on whether households are active in looking for and taking up better deals. So while Ofgem’s drastic interventions in the market may well improve the situation, it may not make as much difference as the regulator hopes.

The impact also depends on the companies’ responses.  In the past, companies seem to have used even basic tariff structures to appeal to different groups of consumers (Nonlinear Pricing and Tariff Differentiation by Stephen Davies, Catherine Waddams Price and Chris M. Wilson, available from the authors on request). This will be more difficult under Ofgem’s new proposals.  When the non-discrimination clauses were introduced in 2009, companies argued for an exception to make special offers and predictably circumvented some of the spirit of the clauses by expanding the number and complexity of  time limited deals (Non-discrimination clauses in the retail energy sector by Morten Hviid and Catherine Waddams, forthcoming Economic Journal). The consultation period will prove a valuable time to assess and explore the implications of any counter proposals to avoid a similar effect in response to these new tariff constraints.

For the regulator to set one element of the tariff and dictate the format of that tariff is a momentous intervention in a market which is supposedly competitive.  It should help active consumers to identify their best deal and may encourage more to become active. Whether it will activate enough consumers who are currently passive or find themselves on a disadvantageous deal to make a real difference to the prices offered by companies remains to be seen. If, as many suspect, the companies are not competing vigorously with each other, these changes alone are unlikely to affect their prices and profits except through new entry to undercut the current ‘big six’.  Ofgem’s continuing vigilance to assess the effect of this bold step will be crucial, and its role in taking over the confidence code and other monitoring arrangements is particularly welcome.  So is its associated work in ensuring that companies are not able to make misleading claims about their prices. Making comparisons easier for consumers is a necessary step to increase rivalry for residential energy consumers, but it may not be sufficient to affect the market fundamentally.

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