When we think about how we can make the retail energy market more competitive, we often fall into the trap of thinking we are “unique” and so forget to learn lessons from other markets.
It’s why I often point to supermarkets. While different in obvious ways, the outcomes for customers of transparent pricing leading to absolutely cut-throat price wars are exactly what we should expect of any consumer market.
On the flip side, we can learn from bad markets too. For example, printer ink is one of the most expensive liquids in the world – almost twice as expensive per ml as human blood. That’s because printer manufacturers compete like crazy on the price of the printer, knowing that they can tie customers in to higher prices on the ink by making that information really hard to see up front.
Energy pricing is remarkably similar. Consumers, shopping on a comparison site or responding to an ad, see Year 1 prices, with no indication of what will happen in Year 2. In the post-SVT world, it’s even harder to work out what a consumer will end up paying, and obfuscation, product proliferation, complex naming and intractable pricing – like you see with printer cartridges – abound. At Octopus we often describe this dynamic as “tease and squeeze” – and the outcome is a “loyalty penalty”.
New entrants will do better by aping incumbents than trying to correct the broken market
Classical economics often struggles with these scenarios. The traditional assumption is that some companies, seeing consumers being gouged, will spot the opportunity to undercut the gougers and offer more transparent pricing.
However, work by Harvard economists Xavier Gabaix and David Laibson shows that in these scenarios, there is no incentive for companies to fix the issue. New entrants will do better by aping incumbents than trying to correct the broken market. Not only that, but information remedies will usually fail because companies are so incentivised to maintain this model, they’ll innovate new ways to carry it out.
Happily, energy supply differs from printers in a very important way: in energy the Year 1 product is essentially the same as the ongoing product. This means that transparency could easily be delivered by tying the Year 1 price companies advertise to the ongoing prices they charge.
I’d like to see the government’s proposed price cap bill strengthened to address this loyalty penalty. This would ensure that as well as a “social safety net”, we’d see a dramatically more transparent energy market – leading to those price wars that supermarkets deliver for their customers so well.
Of course, this would also allow us to address some of the other inequalities in energy. For example, currently customers who receive benefits like the Warm Home Discount don’t feel they can switch to sustainable, good value energy providers because they can only get these benefits from the large incumbent suppliers. A market that had been transformed to deliver real competition would necessarily have to make sure that all suppliers were competing on a level playing field – and so the small supplier exemption from those benefits that companies like Octopus currently receive would have to go.
The fundamental requirement for good outcomes for customers in any consumer market is price transparency – and in energy, that means we have to end the loyalty penalty.
Greg Jackson will be speaking at Utility Week Energy Summit in Westminster in June