How weak is customer response in the energy market, why, and what is the benchmark?

(by Catherine Waddams) In its provisional decision on remedies for the Energy Market, the Competition and Markets Authority measures weak customer response by the amount of money which is ‘left on the table’ by customers who do not switch to cheaper tariffs.  However, research at the Centre for Competition Policy shows that understanding such inertia is complex, and that consumers differ considerably in their propensity to change suppliers.  This variation is found even among comparatively well informed respondents who are aware of potential gains and the time it might take them to search for and switch to a better deal, and even after accounting for observable demographic and other factors, and for consumer expectations.  This matters both for designing an effective package of remedies and, in due course, for evaluating their success.  Why?

A paper co-authored with Minyan Zhu shows that while the length of time which needs to be devoted to switching may deter some consumers, longer searching time to find the right deal generally does not[1].  Perhaps (at least some) customers find the searching process fun, but the switching process is more stressful.   Joint work with Miguel Flores[2] focuses on how consumers differ when divided into three groups according to their general attitudes to shopping, e.g. whether or not they agree with statements like ‘Life is too short to keep worrying about whether you are getting the best deal around’.  Each group responds differently both in its general propensity to switch and in how likely members are to respond to various policy measures. For example, more frequent use of the internet, which is associated with more searching amongst both the group which is most active in searching and switching and the group who do not define themselves as bargain hunters, is unlikely to stimulate activity amongst the third group which define themselves as anticipating price differences in the market but being too time poor to take advantage of the offers. However, this latter group may be encouraged to switch by increasing their confidence in estimates of potential gains, a factor which has no significant association with activity for the other two groups.  So to stimulate consumer activity across the board, a variety of policies is likely to be needed.

One important variation between individuals is in their expectation of how much they could gain through switching, with older people expecting lower potential gains. Indeed these lower expectations explain the lower activity rates among older groups. It is the middle aged, rather than the older participants, who appear least active once expectations of gain are controlled for.  Some of the lower expectations among older people may reflect their smaller households (and so lower energy consumption) but the lower expected gains cannot be explained by size of bill alone.  The CMA’s focus on testing interventions, where appropriate through randomised controlled trials, is particularly welcome in light of these findings, and we urge them to include awareness of consumer differences when gathering the necessary data.

In assessing how effective its remedies have been ‘ex post’, the CMA will need to determine how much switching is ‘enough’. Customers incur real search and switching costs (if only in terms of opportunity costs and perhaps some anxiety about the process).  Some people will prefer to stay with their familiar provider, despite forgoing considerable savings.  Forcing everyone to switch would be both prohibitively expensive to implement and would ignore these costs.  Indeed, some friction in consumer switching may be an inherent part of a ‘well-functioning’ retail energy market.[3]  The roles of potential customer stickiness and of consumer switching sometimes conflict in terms of supporting an effective market.  This makes it difficult to know when the level of consumer response should be graded as ‘good’ rather than ‘inadequate’ or ‘requires improvement’.

 

[1] Empirical Evidence of Consumer Response in Regulated Markets by Catherine Waddams Price and Minyan Zhu, Journal of Competition Law and Economics 12(1), 113-149, 2016

[2] See Waddams Price and Zhu above, and Consumer behaviours in the British retail electricity market by Miguel Flores and Catherine Waddams Price, 2016, mimeo available from CCP.

[3] See Morten Hviid and Catherine Waddams ‘Well-Functioning Markets in Retail Energy’, European Competition Journal, 10:1, 167-179, 2014, http://www.tandfonline.com/doi/pdf/10.5235/17441056.10.1.167

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