ENERGY FIRMS TAKE ADVANTAGE OF CUSTOMERS WHO DO NOT USE PRICE COMPARISON WEBSITES
Customers who do not use price comparison websites to compare energy suppliers are less likely to choose the best deal, allowing energy providers to charge higher prices. That is the one of findings of research by Monica Giuliettiand colleagues, presented at the Royal Economic Society’s 2011annual conference.
The research also shows that there is no single ‘best buy’: some people, given where they live, how much they consume and when they are searching, will find one supplier cheaper, some will find a different firm to be cheapest for them.
The research, which analyses household bills from all energy suppliers in the UK between 2002 and 2005, finds that firms manage to charge higher prices than they would do in a properly competitive market. One reason is that the cost of switching deters customers from changing provider.
But the main reason is because customers do not shop around for the best deal. Most customers who switched providers did not use the internet to choose a deal but instead signed up with sales people who called or visited them.
Since 2005, there are likely to be more customers using the internet, thus putting more pressure on suppliers to lower their prices. But the market has also become even more complicated. There is no one firm that offers better prices than any other to all of its customers and so making the right decision is not easy.
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British domestic energy prices present something of a conundrum. Each supplier’s electricity is the same, there are several suppliers, consumer switching between suppliers is extensive, yet prices remain significantly above costs and they can differ by an extraordinary amount between suppliers.
The explanation of these market features in this study is based on search costs being high and firms taking advantage of this. The researchers develop a model they put to data so as to generate estimates of switching costs, which cannot be observed directly, and then compare these estimates with actual numbers switching – they match well. If the researchers are right, prices will not fall to competitive levels in this market.
Why are firms’ offerings not more competitive? Each supplier, apart from British Gas, grew out of existing regional suppliers. Thus a supplier potentially receives profit from three possible sources: their existing customers in their ‘home’ area (for whom they are an ‘incumbent’), new customers in other areas coming from their incumbent, plus customers from other suppliers who search and find this firm cheapest among those they have searched.
In the stage when firms such as British Gas or an entrant had few electricity customers, they needed to offer cheap deals to persuade people to switch. When a supplier gains more customers, the downside of setting lower prices to capture new customers is that many consumers who are already supplied by it would have stayed at higher prices.
Therefore the incentive to reduce prices becomes muted. (In some industries, although not electricity in the period studied here, suppliers offer incentives only to new customers not old ones, so there is more incentive to cut prices to keen switchers, but not others.)
Why doesthe explanation lie in search costs and not switching costs? The cost of actually switching is no doubt important, at least in people’s minds, but if this was the whole explanation then the incumbent’s price would be high with all other firms’ prices lower.
Differential pricing between entrant firms can only be explained by differences in search costs, because if someone thinking of switching was able to find out all the prices easily, why should they not go for the cheapest, in a market like this where the products are so similar? In fact, at least over the period examined here, most consumers who switched did not carry out an internet-based search, instead making the decision based on the somewhat unreliable door or phone seller’s pitch.
The study is based on the period 2002-05. Since then substantial changes in the market have made it more difficult to model, but big price differentials between suppliers persist. Now more people switch using online methods, but the market, like the mortgage market, has become more complex, so that making the right decision for your particular case is not easy.
Notably, it remains true that there is no single ‘best buy’ – some people, given where they live, how much they consume and when they are searching, will find one supplier cheaper, some will find a different firm to be cheapest for them. If there was a single ‘best buy’, then this firm would tend to attract all the customers over time.
But the best buy differs, so consumers may move between suppliers but none gains the upper hand permanently. Coupled with this, the firm you switched to which was a best buy, is unlikely to remain a good deal once a year has passed.
ENDS
‘Estimation of Search Frictions in the British Electricity Market’ by Monica Giulietti, Michael Waterson and Matthijs Wildenbeest
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Michael Waterson
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Monica Giulietti
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