Consumer Choice and Industrial Policy Catherine Waddams Centre for Competition Policy University of East Anglia with Monica Giulietti, Michael Waterson, Christopher Wilson ACCC 2005 regulatory conference, Queensland, July 2005
“ The (UK) Office of Fair Trading's goal is to make markets work well for consumers.” “The objective of the Trade Practices Act is to enhance the welfare of Australians through the promotion of competition and fair trading and provision for consumer protection.” “Key areas of focus for [the ACCC] include : • deal with the regulatory consequences of changing market structures • support and protect competition in recently deregulated markets” 2
Role of consumers in making markets work well: Energy markets (UK) as examples of recently deregulated markets � Relation between supply side concerns (concentration, co-ordinated effects) and consumer action � Relevance to other energy markets being reformed across the world � Application to consumer choice in other ‘relationship’ markets e.g. financial, telecoms � Homogeneity enables search/switching cost identification � Recent and novel experience Model early choices, check the model 3 given consumer choices and market developments
Consumer response → incumbent power → assessment of opening markets → policy lessons � Background to UK energy markets Investment model of consumer choice in gas Consumers’ tolerance and expectations provide market power for incumbent Cost benefit analysis of opening market Consumer choice and market development Verdict 4
Until 1998, electricity distribution & retail organised as 14 regional monopolies Gas a single national market 5
Key dates in UK Retail Energy Market Reform Gas Electricity Privatisation/ regulation 1986 1990/91 Separate generation from transmission traditional 1990/91* Separate distribution from retail 1997 2001 First consumers can choose May 1996 Sept 1998 All consumers can choose May 1998 May 1999 Generation reform (NETA) 2001 Last price caps removed from incumbents Apr 2002 April 2002 Number of suppliers July 2005 6 5 Approx incumbent market shares 05 57% 47%-85% * England and Wales only 6
Restructuring Electricity England and Wales Production National Local retail transmission distribution 91 3 genrs National Grid 12 regional Entry 01 many National Grid 12 distcos Sep licence 04 ~ 6 NGridTransco 1/2 distcos 5 + Centrica co-owned 7
Restructuring Gas Production National Local Retail transmission distribution 86 N Sea British Gas 90s N Sea Transco Centrica 05 N Sea NGridTransco 4 distcos Centrica imports + 5 El cos 8
Background to UK energy markets � Investment model of consumer choice in gas Consumers’ tolerance and expectations provide market power for incumbent Cost benefit analysis of opening market Consumer choice and market development Verdict 9
2 stage: switching contingent on awareness Survey of 692 consumers, 1999, 6-30 months after choice Asked about whether could switch (awareness) switched/considering switching Awareness: intrinsic consumer/demographic factors, firm’s marketing (potential profitability), time market open Switching: whether expected benefits > anticipated costs Expected benefits: perceptions of savings available, viz bill savings, length of gains (would incumbent match?) Consumer’s intrinsic valuation: importance of savings, supplier reputation, ease of switching Search costs: experience from switching other products Switching costs: expected time to switch (no financial costs) 10
Sample was broadly representative, slightly higher awareness because of survey method Variable name Mean Std Dev Min Max 0.86 0.34 0 1 Awareness 0.23 0.40 0 1 Switched gas supplier Consider switching 0.32 0.45 0 1 OAP household 0.09 0.29 0 1 Market open (months) 10.3 6.51 6 32 Prepayment meter customer 0.09 0.28 0 1 4.01 3.171 0 22.8 Bill savings available (£s/month) 0.12 0.33 0 1 Missing bill value Expected time to switch < 1 hour 0.19 0.393 0 1 Income (£0000) 1.4 1.42 0 15 Non-BT customer 0.26 0.44 0 1 Changed car insurance 0.18 0.38 0 1 Changed house insurance 0.12 0.32 0 1 11
After an average of 10 months, 86% knew that they could choose their gas supplier Awareness increases If switched telecoms (intrinsic) with time market open (at decreasing rate, maximum 22 mg5191 months, confirmed by later market experience) Decreases If household consists only of pensioners (intrinsic) Prepayment consumer (profitability and marketing) modelled (considering) switching contingent on awareness 12
Slide 12 mg5191 pick this up later Catherine Waddams, 8/07/2005
If aware, 21% had switched, 32% considering (Considering) Switching increased with Importance of savings, income (at a decreasing rate), switching other products, reluctance of incumbent to match Decreased with Expectation that incumbent would match the entrants lower prices, not knowing gas expenditure, supplier reputation important, expected time to switch, importance of ease of switching Confirmed investment model appropriate, identified factors for search/switching costs Explore implications for incumbent behaviour 13
Background to UK energy markets Investment model of consumer choice in gas � Consumers’ tolerance and expectations provide market power for incumbent Cost benefit analysis of opening market Consumer choice and market development Verdict 14
Minimum savings required to switch, proxy for search/switching costs, gives incumbent market power (published price charged to all) If entrants offer prices at competitive level, incumbent has choice of keeping price high, losing consumers but making high profits on remainder Or lowering price and keeping more consumers, with lower profits for each From the answers, incumbent’s most profitable strategy would be to maintain prices around £8/month (33%) above entrants, retaining around 55% of consumers How long savings expected to last mattered too 15
Switching probability under different assumptions 0.8 0.7 switching probability 0.6 0.5 none believe 0.4 BG will 0.3 match half 0.2 believe 0.1 0 0 5 10 15 20 monthly savings So changing expectations affect incumbent power 16
Background to UK energy markets Investment model of consumer choice in gas Consumers’ tolerance and expectations provide market power for incumbent � Cost benefit analysis of opening market Consumer choice and market development Verdict 17
Verdict on deregulation depends on assumptions about what happened next At survey time 23% had switched, made gains for themselves relative to incumbent, price caps in force Each consumer cost £50-£60 to recruit, say £12.50/year Optimistic scenario: incumbent lowers price to competitive level with no more switching (11/12 thinks incumbent will match) Pessimistic: incumbent follows profitable outcome, keeps price above entrants (after deregulation) and loses 45% of market Distribution of benefits: not progressive Comparing the 2 scenarios with market today 18
Net losses in equilibrium (£million per annum) Scenario 1999 Opt =m Pess =m % switched 20 20 45 % paying comp price 20 100 45 Costs incurred by producers Entrants cost -48 -48 -107 switchers gain -182 -182 -410 Non switch gain -730 523 Consumer benefits Incumbent to switchers 182 182 410 Incum to non switchers 730 -523 Gain: switchers 4 4 10 Gain: non switchers 17 -12 Total cons gain (TCG) 186 933 -114 Welfare ch =TPB+TCG -44 -27 -110 19
Updating, and allowing for oligopoly Scenario 2003 opt 2003pess 2005 act % switched 39 39 43% % paying comp price 39 0 markup Costs incurred by producers £57 Entrants cost -94 -94 15% switchers gain -229 -229 Non switch gain -197 Incum to entrants -126 Oligopoly rent to entrants +126 Producer benefit (TPB) -520 -323 Consumer benefits Incumbent to switchers 229 229 Incum to non switchs 197 Gain: switchers 8 4 Gain: non switchers 4 Total cons gain (TCG) 438 234 20 Welfare ch =TPB+TCG -82 -89
Background to UK energy markets Investment model of consumer choice in gas Consumers’ tolerance and expectations provide market power for incumbent Cost benefit analysis of opening market � Consumer choice and market development Verdict 21
Benefits based on consumers making ‘best decisions’ Switching to best deal for their payment method and consumption level Contrary evidence from another survey soon after (2000) Related actual gains to the maximum available in their region Based on low income consumers, analyse electricity: 14 regional markets, different numbers of retailers We know not all consumers who can gain make the switch But among those who do, don’t all choose the cheapest and a third switched to a supplier more expensive than incumbent Early days of electricity market (new survey checking) 22
Consumer inaccuracy and overswitching 300 250 45° Gains made (annual £) 200 150 100 50 0 0 50 100 150 200 250 300 -50 -100 Maximum gains available (annual £) Evidence that this is due to ‘information overload’ 23
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