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The Domestic Energy Market

Introduction

Achieving fair treatment for energy market consumers has long been a key goal for Which?. June 2016 saw the Competition and Markets Authority (CMA) publish its final recommendations after a two year investigation into the energy market. This article sets out some of the key elements of our research and analysis into energy tariffs and the attitudes and behaviours of consumers in relation to those tariffs.

Tariffs

Despite a recent rise in the market share of smaller independent suppliers, the energy market remains dominated by the six major suppliers (British Gas, e.on, npower, Scottish Power, EDF, SSE). These Big 6 companies together supplied approximately 24 million customers in December 2015, (88% of all residential customers in Great Britain(1).

This market dominance coincides with the fact that the vast majority of customers of the “Big 6“ are receiving their energy via standard tariffs (also referred to as ‘standard variable tariffs’, SVT) which are the default tariffs of the market. These tariffs are among the most expensive available, and an estimated 17.2 million (62%) energy customers are currently paying more than they need to be because they have not switched away from them(1).

There are currently some very competitive energy tariffs available, and the extent to which the typical “Big 6” standard tariff customer can save has been increasing over the course of the last two years. In May 2014 the average big 6 standard tariff was £1,127 per year for a typical dual fuel consumer (assuming “medium use”), and by comparison the cheapest tariff available at that time was £945 (First Utility iSave fixed 2015) – this was £182 or 16% cheaper than the average “Big 6“ standard(2).

By May 2016 the average big 6 tariff had reduced slightly to £1,063 (5.7% less than it was in May 2014), and by contrast the cheapest deal on the market dropped to £734 (IRESA Flexi1 12 month fixed) – 22% cheaper than the cheapest deal in May 2014(2).

This means that the gap between the average “Big 6” tariff and the cheapest available deal has significantly widened, such that the annual amount disengaged “Big 6” customers are losing out on has very nearly doubled from 16% (£182) to 31% (£329)(2).

Switching

The demand side of the market does not yet appear to have responded very strongly to the availability of these savings. In the year from April 2014 to March 2015 11.3% of customers switched electricity provider, and 10.9% switched gas provider. Between April 2015 to March 2016 this had increased to 12.9% for both respectively (3).

Which?’s view is that the persistent availability of significant savings (undoubtedly a good thing for the engaged and savvy consumer), has yet to work to significantly increase switching levels. This means that by far the majority of energy customers are still overpaying for their energy.

Customer Attitudes and Perceptions

A key question to answer then is why are energy consumers still detached from this market when such significant savings are on offer? Our March 2016 polling(4) told us nearly everyone knows that they can switch tariff with the same supplier (85%), or switch supplier altogether (91%), and on top of this nearly half (48%) of GB households think there is probably a better energy deal than the one they are currently on. However there is a misconception among energy customers about the amount that it is possible to save. Our polling in June 2016(5) found that the average amount ‘sticky’ consumers (“Big 6”, non-fixed, dual fuel) thought they could save was £133 per year. This is a long way from the actual average saving on offer of up to £329 per year according to our energy tariff analysis. Only 2% of these energy customers thought they would save more than £300 a year(2).

So it could be possible that increasing awareness of the level of savings available will incentivise more people to switch. In relation to this, the CMA has proposed that Ofgem take responsibility for tackling consumer inertia by asking them to compile a database of energy customers who have not switched supplier in the last 3 years. This database will then be shared with competitor suppliers who will be allowed to write to ‘sticky’ consumers in order to inform them of their tariff deals.

Our research from March 2016(4) finds that more than a third (35%) of those who have been with their energy supplier for more than 3 years would put such a letter straight in the bin or scan it quickly. But conversely there were also 35% of people who said they would “look further into the information they provide”, and 26% say they would consider switching.

Saving money is certainly one of the most significant reasons given by those who haven’t looked into switching (supplier or tariff) in the last 3 years. This took two forms in our June survey, either passively where 31% said price increases would make them switch, or more actively 35% said becoming aware of cheaper deals would be a prompt.(5)

Behavioural context

These findings from various surveys with energy customers all suggest that there should in theory be significant numbers of people switching provider or tariff, and yet our analysis of switching rates shows that this is simply not the case.

Perhaps this is a case of attitude and opinion not matching real life behaviour. Better understanding of real life consumer engagement with the energy market is urgently needed to shape policy and regulation that works for the demand side of this market.

Behavioural economics has shown that consumers may suffer from biases that impact ‘rational’ behaviour (6,7). These behavioural barriers might include:

Status-quo bias:

Status quo bias refers to the tendency of individuals to prefer the way things currently are, and only be motivated to change if there is a significant strong reason for doing so. Status quo bias is strongly linked with inertia and the lack of sufficient motivation to move individuals to action. In the energy market if you have been with a supplier a sufficient amount of time this could contribute to status quo bias

Hassle:

If an individual perceives an action to be a hassle they will be less likely to engage in that action. Whether the hassle is real or not is irrelevant if it is perceived. If a consumer therefore perceives switching energy suppliers as too much hassle, then they may be less likely to act.

Time Inconsistency or Present bias:

Individuals are more likely to think about immediate rewards than things that appear far in the future. In the case of switching consumers may feel the loss of time in the process is not worth the long term benefits, which they don’t accrue immediately.

Defaults:

Similar to status quo bias individuals are more likely to stick with default options, particularly if they’ve formed a habit around the default. There is significant evidence that defaults are effective at changing behaviour however if the default is to behave in the current way this may prove harder to. A rolling contract with an energy supplier could provide a significant default bias.

Complexity:

Complexity, e.g. having too much choice or too much information, has been shown to cause overload and stop individuals making a decision. In an experiment on the UK energy consumer market, Sitzia, Zheng, & Zizzo (2012) found that more complex contracts resulted in individuals ending up with more expensive contracts than necessary(8).

Framing:

The way information is presented can have an impact on consumer decision making. For instance, individuals are more sensitive to loss than they are to gain, therefore presenting switching in terms of savings might not prove enough motivation to action, whereas framing it as a loss might.

These factors should be taken into consideration in designing behavioural policy interventions. For example, making the switching process easier for consumers might encourage action, perhaps in conjunction with introducing reminders or prompts. Similarly, emphasising loss rather than gain, reducing complexity, and emphasising immediate rather than longer term benefits might encourage switching behaviour. The important thing however is to ensure that any interventions are tested with real consumers.

References

  1. Which? analysis of OFGEM Electricity supply market shares by company Q4 2015; DECC Quarterly domestic energy price statistics QEP 2.4.1
  2. Which? analysis of Energylinx tariff data.
  3. Which? analysis of DECC energy transfer statistics.
  4. Populus, on behalf of Which?, interviewed 2,002 Adults in Great Britain between 24th-28th March. 2016
  5. Populus, on behalf of Which?, interviewed 2,015 Adults in Great Britain between 3rd - 5th June 2016.
  6. Ofgem. (2011). What can behavioural economics say about GB energy consumers? Available at https://www.ofgem.gov.uk/sites/default/files/docs/2011/03/behavioural_economics_gbenergy.pdf
  7. Centre for Competition Policy. (2013). Behavioural Economics in Competition and Consumer Policy.
  8. Sitzia, S., Zheng, J., & Zizzo D. J. (2012). Complexity and Smart Nudges with Inattentive Consumers. Centre for Competition Policy Working Paper, Issue 12-13,
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