Benefits and costs of introducing tariff choice in uncontested markets – A Report for Ofwat

1. Theoretical models indicate that allowing a regulated company to introduce optional (or self selecting) tariffs can make individual consumers (and consumers on average) better off and be profitable for the company, as long as the original (regulated) tariff remains available to all consumers. 2. The models contain some restrictive assumptions and limitations and may be difficult to apply in practice. 3. One particular assumption crucial to the benefits is that consumers choose the best tariff for themselves. More recent research on consumer behaviour in general and in utilities in particular show that this may not be the case. Much of the market literature has been concerned with the telecoms and energy markets. 4. There may be distributional concerns if some consumer groups are less likely to choose well, particularly if there are likely to be long term effects on the ‘base’ tariff. Such concerns are reflected in the current British energy regulator’s consultation on reducing tariff choice for both suppliers and consumers as a response to perceived failure of competition. This experience raises questions about the intrinsic value of choice for consumers. 5. Experience of optional metering in England and Wales provides some evidence of how residential water consumers have responded to that particular tariff choice. Other evidence on water consumer perceptions indicates that the assumptions made in theoretical models of tariff choice may not be applicable to this market. This may affect the applicability of welfare assessments made in the models. 6. We conclude by identifying some questions about the circumstances in which allowing optional tariffs (alongside a regulated base) is likely to be beneficial

Distributional effects of liberalising UK residential utility markets

Competition is being extended into residential utility markets world-wide; the European directives on telecoms, electricity and gas will extend choice throughout the European Union by the turn of the century. In the UK, the Privatisation Acts not only changed the ownership of utilities, but imposed a duty on the regulators to encourage competition. It is the introduction of competition,actual and potential, that has been the main force behind changing the relative prices charged to different consumers, particularly in the residential market. We use household-level data to identify the distributional impact, particularly on vulnerable households and those for whom regulators have special responsibilities. We find a mixed outcome, with some vulnerable households, especially pensioners, adversely affected; we suggest potential compensation mechanisms that could improve welfare by enabling the benefits of competition in these industries supplying essential services to be gained without harming the most vulnerable households.

Charges, Costs and Market Power: the Deregulated UK Electricity Retail Market

The residential UK electricity market was opened for the first time in 1999, introducing choice of supplier, and about 40% of households changed supplier in the first four years. After three years price caps were removed. We review this process and assess the competitiveness of the market by examining how the charges levied by suppliers depend on cost and demand factors for three different payment methods and consumption levels. We also identify signs of additional market power of incumbency and the effect of levying a tariff with no fixed charge. We find that both cost and demand factors affect charges, and the relationship varies for different payment methods and consumption levels; and that tariffs with no fixed element have different effects for different payment methods. We also conclude that considerable market power seems to remain with potentially adverse distributional effects.Energy retail, Pricing, Seemingly Unrelated Regression Equations

Exercising consumer choice : switching gas suppliers in the residential market

In 1996 the UK government introduced competition into the UK residential gas market, the first such nation-wide experiment, and the forerunner of similar choice in the electricity market, both in the UK and later elsewhere. We report consumers’ attitudes to and behaviour in switching suppliers based on a representative nation-wide survey at an intermediate stage, when some consumers had a choice of suppliers, and other markets were yet to be opened. We explore their attitudes and choices using an investment model of costs and benefits

Liberalisation and divestiture in the UK energy sector

Over the past 10 years, the government has privatised two energy industries — gas and electricity — and is presently selling British Coal. Vickers and Yarrow (1988) point out that the privatisation of utilities has two components, for the sale of assets to the private sector may be accompanied by changes in industrial structure. It is possible to sell assets without liberalisation, just as it would be possible to liberalise a market without asset transfers.2 The three energy industries were privatised with very different structures and competitive environments. This paper examines the structures chosen in the light of the benefits to government, private producers and consumers, focusing on whether restructuring and liberalisation should occur before or after privatisation. A similar choice exists after flotation between divestiture and restructuring of the industry itself and changing the external competitive or regulatory environment. Within energy, we show that the structure chosen for one industry affects the options available for another, because of the complex interactions within the sector.

Competition in the British domestic gas market: efficiency and equity

The British domestic gas market is to be opened to competition from April 1996; within 24 hours of enabling legislation being confirmed (Queen’s Speech, 1994),British Gas (BG) announced the first significant change in gas tariff structure since it had been privatised nine years earlier. The changes introduced cheaper tariffs for some of those who paid promptly and so were cheaper for BG to supply. These are likely to be the first of many such changes, as the threat of competition leads BG to abandon its previous policy of charging similar tariffs to a wide range of consumers even when they incur different costs of supply. It is clear that competition will have a much more dramatic effect on domestic tariffs than did the flotation of the industry. While it retained its monopoly in the domestic market, even the privatised BG continued its policy of crosssubsidisation between consumers, using a single charging structure despite cost differences. (One reason for this may have been to avoid signalling cost

Gain or Pain: Does Consumer Activity Reflect Utility Maximisation?

Competition Authorities are introducing new informational remedies to help consumers search and switch more actively. Using a specially commissioned data set, and unique direct estimates of the gains, search and switching time which consumers anticipate, we examine the determinants of consumer activity in eight markets. We find that expected costs (and to some extent gains) do influence consumers as a utility maximising model would predict; but that their role is small, and other factors, particularly experience of switching in other markets, are also influential. We conclude that consumers’ confidence in their own estimates is crucial in encouraging market activity

Charges, Costs and Market Power: the Deregulated UK Electricity Retail Market.

The residential UK electricity market was opened for the first time in 1999, introducing choice of supplier, and about 40% of households changed supplier in the first four years. After three years price caps were removed. We review this process and assess the competitiveness of the market by examining how the charges levied by suppliers depend on cost and demand factors for three different payment methods and consumption levels. We also identify signs of additional market power of incumbency and the effect of levying a tariff with no fixed charge. We find that both cost and demand factors affect charges, and the relationship varies for different payment methods and consumption levels; and that tariffs with no fixed element have different effects for different payment methods. We also conclude that considerable market power seems to remain with potentially adverse distributional effects.Energy retail;Pricing;Seemingly Unrelated Regression Equations;

Redundant regulation? : competition and consumer choice in the residential energy markets

The UK energy regulator has recently removed price controls from about 40% of residential energy users, and plans total deregulation of the gas and electricity markets by 2002, relying instead on general competition policy to protect consumers. We examine responses to a specially commissioned survey of over one thousand consumers, to identify determinants of consumer choice between suppliers. We conclude that there are substantial switching costs which seem higher for more vulnerable groups. By assessing the savings which consumers require to switch supplier, we deduce that the incumbent retains considerable market power, suggesting that some continued regulation may be necessary

Irrationality in Consumers’ Switching Decisions: When More Firms May Mean Less Benefit

We report evidence of three types of consumer switching decision errors within the UK electricity market. We identify consumers who do not switch despite substantial available savings, consumers who switch from a cheaper to a more expensive supplier and consumers who switch to a cheaper, but not the cheapest available supplier. Moreover, we find that consumers make more efficient decisions in markets with fewer competitors. This finding is consistent with theories of consumer confusion and “information-overload” rather than other “rational” explanations of consumer mistakes such as perceived differences in firm quality or uncertainty over consumers’ own demand.Consumer choice, Switching costs, Behavioural IO