(John Kemp is a Reuters market analyst. The views expressed are
By John Kemp
LONDON, March 27 Britain's gas and electricity
markets are characterised by high entry barriers, weak
competition and possible tacit collusion among the six largest
energy suppliers which helps keep prices and profits high,
according to regulators.
"Suppliers are able to segment their customer base, and
charge different groups of customers different prices for what
is essentially the same product," the Office of Gas and
Electricity Markets (Ofgem) complained in a scathing report on
the state of competition in supplying residential and small
Ofgem found plenty of other things to be critical about in
its first annual competition assessment, including the sharp
rise in profits the Big Six are making from residential
customers and the impact of vertical integration in reducing
competition in the electricity market.
But the ability of the Big Six to charge different customers
different prices for the same service, exploiting customer
confusion and apathy to charge legacy customers higher prices
than new ones, lies at the heart of its concerns about the way
in which domestic gas and electricity markets are working.
THE DEVIL CUSTOMERS KNOW
More than 60 percent of customers cannot remember ever
having switched supplier, and another 14-16 percent switched
just once, according to Ofgem. The proportion switching in
search of a better deal, never very high, has actually been
falling since 2008.
As a result, more than a decade after switching was allowed,
most customers have stuck with their incumbent supplier. Over 40
percent of gas customers are still being supplied by Centrica
, the country's former gas monopoly, and 37 percent of
electricity customers are still being supplied by the former
monopoly electricity supplier in their region.
Customers who have stuck with their legacy supplier are
typically paying more than those who have switched to another of
the Big Six, and much more than if they had switched to one of
the smaller, newer companies that have entered the market.
Customers who manage their account online, pay by direct
debit, and fix the cost of their energy for 12-18 months at a
time get a much better deal, according to the regulator.
Ofgem estimates customers could make annual savings of
almost 100 pounds on average by switching from their incumbent
supplier to another one of the Big Six, and almost 250 pounds by
switching to the best online deal offered by one of the smaller
DELIBERATELY CONFUSING PRICES
Britain's retail gas and electricity prices are not directly
regulated. The market-based regime relies on customer switching
to constrain the pricing power of suppliers. But Ofgem now
doubts whether that constraint is effective.
Nearly all customers are aware of the possibility of
switching (84 percent) yet few do. "Some customers feel there is
no point ... either because there isn't any difference between
suppliers to make switching worthwhile or say they have checked
prices and believe they are on the best deal," Ofgem says.
"Many customers doubt that switching could lead to the kind
of benefit (financial savings and/or improved customer service)
that would justify their time and effort and the risk that
things could go wrong," according to the regulator.
In 2012, the Big Six offered a choice of no fewer than 161
different plans. Most were so complicated that were hard to
compare. The result was confusion rather than genuine choice.
"Consumers considered the (tariff) information available to
be unclear, complicated and deliberately confusing," Ofgem says.
Even after switching, only seven in 10 customers who
switched were fully confident they had made the right choice.
Ofgem found evidence some customers actually switched to plans
that were more expensive.
The number of tariffs has been radically simplified
following Ofgem's Retail Market Review. But by now most
customers have already given up.
The proportion of customers who do not trust their energy
suppliers to be open and honest with them hit a new high of 43
percent in 2013.
Britain's utilities are not the only businesses to practice
what is benignly called "market segmentation" or less benignly
"price discrimination" among their customers.
Banks, mobile phone operators, insurance companies and a
growing number of other businesses increasingly charge different
prices to different customers for an identical service.
The aim is to attract new customers with lower prices
without losing revenue by offering similar price reductions to
Price discrimination conflicts with most people's sense of
fairness. The concept that all customers should pay the same
standard "list price" for the same service is deeply ingrained.
But from a marketing perspective, each customer should be
charged a price that reflects their willingness to pay, subject
to the cost of supplying them.
It is no accident that many businesses offer cheaper prices
and better deals to new customers, while exploiting the inertia
of existing users.
Fairness implies the most loyal and longstanding customers
should get the best deals, but profit maximisation suggests
customers who have revealed their stickiness are the easiest to
Some analysts have suggested gas and electricity suppliers
should be required to offer a single price to all customers,
similar to the list price charged at a filling station for
The aim would be to promote transparent price competition
among suppliers and force prices to converge on the lowest cost,
eliminating excess profits.
But suppliers, and not just the Big Six, argue "petrol
station pricing" would restrict their opportunity to innovate by
offering new tariff plans - for example discounts for off-peak
Moreover, given how pervasive market segmentation is
becoming in the modern economy, it is hard to see how regulators
could justify banning it in gas and electricity while permitting
it in other areas like banking and insurance, which also have
EXCESS PROFITS QUESTION
Under market segmentation, sticky customers subsidise bills
for those who are more flighty. If switching actually became
much more widespread, or a uniform list price was strictly
enforced, savings for the average customer would prove to be far
less than the 100-250 pounds quoted by Ofgem, unless suppliers
really are making substantial excess profits.
Yet it is far from clear that Britain's energy suppliers are
making excess profits that could be squeezed. This is the part
of the report where Ofgem is most tentative.
"Based on the available data, there are indications that
suppliers may have had an opportunity to earn high profits,
although further work is required to establish this
conclusively," was as far as the regulator would go.
In fact, data on profitability paint a confusing picture.
Overall profits reported by the Big Six have risen moderately
from 3 billion pounds in 2009 to 3.7 billion pounds in 2012.
But while profits from supplying residential customers have
soared from 233 million pounds to almost 1.2 billion pounds, the
profitability of non-residential supply and generation has
Margins on the retail supply of electricity have fallen
while margins from supplying gas have surged over the same
Ofgem hints at evidence of cross-subsidisation between gas
and electricity, residential and non-residential customers, and
between generation and retail.
But identifying and quantifying, let alone unpicking, all
those subsidies will prove immensely hard.
One option would be to return to a strict separation of
retail from generation, forcing all generators to sell into an
open market, and all retailers to buy from it.
But with regulators still uncertain about whether the Big
Six are actually making any excess profits at all, the ultimate
reduction in customer bills could turn out to be very small.
Some customers (mostly the legacy non-switchers) might see a
small reduction in their bills, while others are likely to
experience a rise (the most avid users of price comparison sites
and internet billing).
Ofgem estimates suppliers made an average pre-tax margin of
just 7 percent in March 2014 on the residential supply part of
their business, the only one where profits have been
consistently growing since 2009.
So unless the regulator can identify a large amount of
excess profit in the generation business, something Ofgem has
struggled to pinpoint so far, the scope for squeezing the
average residential bill is not very big.
(Editing by Pravin Char)