"Some of the social costs we’re seeing are causing a significant break to growth. It is a huge overhead"

Small suppliers have had a tough time of it lately and, despite its experience in the market, Flow Energy is no exception. At a time when even the big six are feeling the pressure to merge, increasing competition in the energy market and the burden of government costs are creating a difficult environment for a small energy supplier to grow.

Flow Group was originally founded as an engineering company in 2013, and now has three strands – home services, domestic energy retail, and research and development. The group announced in February last year that it would sell off its domestic retail business Flow Energy – which reported a turnover of £98.4 million but made an overall loss of nearly £9.2 million for 2016 – due to pressure on margins and a desire to pursue growth in its smart boiler business. However, it halted the sale after a US investment firm offered to provide funding to help turn the business into a “viable challenger” to the major retailers, and decided, instead, to step back from its boiler business.

Flow Energy managing director Andrew Beasley meets Utility Week in London to talk through some of the reasons behind the company’s recent decisions, the issues facing smaller suppliers, and where he sees the energy market heading.

Many small suppliers have struggled over the past few years because they have not been able to afford to hedge against wholesale prices, which have risen sharply and have offered loss-leading tariffs. A case in point was GB Energy Supply, which ceased trading in November 2016 as rising wholesale prices made its business “untenable”. Brighter World Energy then closed at the end of 2017, saying its business model was unsustainable because of market conditions. More recently, Future Energy shut up shop saying the marketplace is “difficult for challenger energy suppliers, which lack the financial advantages of larger, national energy firms”.

We could see a consolidating giant market at one end and an increasingly straggling market at the other

Even the big six are feeling the squeeze: SSE and Npower announced the merger of their retail businesses to create the second-largest supplier in the market and, last week, RWE and Eon announced a deal in which Eon would take on Innogy’s retail business.

Beasley warns that the market could suffer: “We could see a consolidating giant market at one end and an increasingly straggling market at the other and a challenging position for those in the middle.”

Flow, unlike many small suppliers, hedges against wholesale prices – as it is required to as part of its deal with Shell – which supplies the company gas and electricity at wholesale rates. “We’re possibly quite unusual,” he says.

Hedging can often reduce your margin, and it does in Flow’s case. “I speak to my shareholders and the rest of the board, they say: why is it that some small suppliers came out of last year with a higher gross profit? “The answer is if you buy month-ahead or week-ahead on a falling market, you generally do better than if you hedge two years out like we do. The kicker comes when it goes the other way, and that was the GB Energy scenario.”

When the US investment was first announced, the idea was that the group would raise up to £29 million through loans and share sales to allow it to quadruple the number of gas and electricity customers it supplies to more than one million. However, the company struggled to get past the 250,000-customer barrier – the point at which payments into government social schemes such as the Warm Home Discount (WHD) and Energy Company Obligation (Eco) kick in.

In a trading update at the end of last year, Flow made a strategic decision to drop back below the 250,000-customer level. “We actually churned a lot of customers last year. We brought in a lot of higher value customers through a variety of different channels and we dropped some of the more acquisitive customers who, when they were faced with the price rises we were putting through, were going out and finding that there were significant savings to be made, including from a number of products put out by the big six.” In August last year, Flow put its prices up by an average of 10 per cent.

Competition in the energy market has risen at an unprecedented rate over the past few years. More than 660,000 customers switched supplier in February, which Energy UK claims is the “highest number ever recorded”, meaning the energy market has “never been so competitive”. While this is good for customers, Beasley warns that many smaller suppliers will “rush up to the 250,000-customer-barrier and will be unable to move sustainably past it” because of the huge costs they are hit with.

Beasley says this was less of a problem four or five years ago, when there were only 20 suppliers in the market, but now there are more than 60, with more joining every month. With this extra competition comes extra difficulties.

Two hundred and fifty thousand cliff-edge trigger for inclusion in WHD and Eco is a massive growth constraint in the current market

“Let’s say for rounded numbers that we have £100 million turnover and 250,000 customers. Then you trip over the trigger and it adds about £4 million to your cost base – not a trivial amount of money. You effectively take 4 percentage points off your gross profit. You need to accelerate very fast through there – you need to be at about 400,000 customers just to get back to where you started,” he explains.

And it is very hard to hit this sort of number with “60 or 70 competitors behind you who are not paying it and they all drag you back”. Beasley says the company could have cut its margins and spent more on acquisition to retain its customer number levels, “but it wasn’t worth it considering the extra costs that would have brought from Eco and WHD”. “Two hundred and fifty thousand cliff-edge trigger for inclusion in WHD and Eco is in fact a massive growth constraint in the current market,” he says.

Beasley says when new entrants such as Ovo and First Utility went through the 250,000-customer barrier four or five years ago it was easier, so they got through the growth period with a significant capability of making that margin.

“Some of the social costs we’re seeing are causing a significant break to growth. It is a huge overhead. We end up almost having to pay out a WHD to people by (in the non-core group) guessing who they are and then being marked afterwards by the Department of Work and Pensions (DWP) saying: no, you got that one wrong.”

So how do you correct this issue? Beasley says: “My personal view would be: if you need the WHD, it should be at a lower value of customer numbers and it should be managed centrally by the people who are best positioned to managed it, which would be the DWP fundamentally.”

Beasley believes WHD payments are something that should be placed in general taxation to avoid the costs “hitting poorer people harder”. “We get a situation where there is somebody living in one house next door to somebody who is claiming the WHD. This house might only be slightly better off, but their electricity bill gets hit by the costs.”

Another concern Beasley has with the WHD is to do with the levelisation costs smaller suppliers have to pay to larger suppliers. “Because of the nature of small suppliers, they have a lower proportion of WHD customers than others. Because proportionally, larger suppliers have the biggest group because they’ve been around longer, we have to make a levelisation payment to them.”

This, he says, is an “unintended consequence of what looks like a sensible plan”. “We’re all low-margin businesses, and for us these things become very important. Like a lot of small businesses, we make most of our money from investors and we pay investment-grade rates for the money we have. Certain costs we pay into the industry go to asset-based companies that are better placed to be able to borrow than we are and can borrow at much lower rates than we can.”

The reason why manufacturers are generally very large organisations is that they need to be

Both the WHD and Eco are up for consultation this year and Beasley hopes the way they work will change, but Beasley says that if “there is a way to grow profitably, we will” regardless of whether they are reformed. “The challenge is trying to create a business that can maintain itself through thick and thin and grow safely,” he says.

Flow Energy’s parent company, Flow Group, had big plans for its boiler business but, sadly, its vision was never realised. Beasley explains that the business struggled with the technology and had insufficient working capital to realise its ambitions. “As we made public last year, we stopped manufacture of the boilers in the UK and instead shifted commercialisation focus to the European market.” Since then, Beasley says hopefully, Flow has been looking at “other options” for the boiler.

“The reason why manufacturers are generally very large organisations is that they need to be,” he says. “It takes an enormous amount of working capital to build and maintain a mass market product, and we as a small Aim-listed company, struggled to do that.”

The company tried to raise money for the boiler business – which in 2016 generated revenue of £349,000, against development costs of £690,000 in the same year – but found a lack of appetite. There was, however, interest from some investors who wanted to “flip the thing on its head” and invest in, rather than sell, the retail energy part. Beasley admits the company did “a bit of a U-turn”, and has “shifted focus” away from the micro-CHP business since the US investment came in.

There are places for organisations looking to bring together technologies that can be greater than the sum of their parts

He is sad to have lost the company’s unique selling point and maintains that it was a “good concept”. He says “bringing together various technologies in a localised prosumer environment is certainly something which needs to happen” but concedes that market rules need to change to facilitate it properly. Many codes still relate to the days of giant coal-fired power stations, and Beasley insists the entire structure of the energy market “needs to be looked at in the context of a more modern distributed network with increased renewables”.

“There are places for organisations looking to bring together technologies that can be greater than the sum of their parts by using storage and generation technologies within communities. Perhaps even more than in single homes, you could start to see the growth of localised balancing markets.

“We had hopes through micro-CHP to play in that space and we conceptually would have generated at peak times of stress on the grid. It was a natural peak-lopping mechanism to be able to do that. Sadly, it didn’t work out, but the concept of having that sort of technology, whatever it may be, working correctly with the effect it has on the grid is something that will come. I think now maybe more related to battery storage than internal generation mechanisms.

“We’ve got a long way still to go on solar, but maybe one day we’ll see all houses pre-tiled with solar panels. There’s a huge amount of stuff still to develop in that space and there is a possibility that some small suppliers will still have a role to play in that if they’re more technological suppliers. There have been a good few attempts at different business models – it’s a question of eventually getting it to a point of cheap rollout of technology at scale, which works within people’s life cycles. There are people who will engage fully, but there are people – just like myself – who will say: I will engage if the equipment I buy deals with it all for me.”

Beasley hopes Flow will “still be part of this market” in the future.

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