Consumer Choice and Industrial Policy Catherine Waddams Centre for - - PowerPoint PPT Presentation

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

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“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”

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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 given consumer choices and market developments

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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

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Until 1998, electricity distribution & retail

• rganised as 14

regional monopolies Gas a single national market

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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 Approx incumbent market shares 05 6 57% 5 47%-85%

* England and Wales only

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Restructuring Electricity England and Wales

Production National transmission Local distribution retail 91 3 genrs Entry National Grid 12 regional 01 many National Grid 12 distcos Sep licence 04 ~ 6 NGridTransco 1/2 distcos co-owned 5 + Centrica

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Restructuring Gas

Production National transmission Local distribution Retail 86 N Sea British Gas 90s N Sea Transco Centrica 05 N Sea imports NGridTransco 4 distcos Centrica + 5 El cos

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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

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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)

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Sample was broadly representative, slightly higher awareness because of survey method

Variable name

Mean Std Dev Min Max

Awareness

0.86 0.34 1

Switched gas supplier

0.23 0.40 1

Consider switching

0.32 0.45 1

OAP household

0.09 0.29 1

Market open (months)

10.3 6.51 6 32

Prepayment meter customer

0.09 0.28 1

Bill savings available (£s/month)

4.01 3.171 22.8

Missing bill value

0.12 0.33 1

Expected time to switch < 1 hour

0.19 0.393 1

Income (£0000)

1.4 1.42 15

Non-BT customer

0.26 0.44 1

Changed car insurance

0.18 0.38 1

Changed house insurance

0.12 0.32 1

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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 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

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Catherine Waddams, 8/07/2005

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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

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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

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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

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Switching probability under different assumptions

0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 5 10 15 20

monthly savings switching probability

none believe BG will match half believe

So changing expectations affect incumbent power

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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

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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

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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

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Updating, and allowing for oligopoly

Scenario 2003 opt 2003pess 2005 act % switched 39 39 43% % paying comp price 39 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 Welfare ch =TPB+TCG

• 82
• 89

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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

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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)

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Consumer inaccuracy and overswitching

• 100
• 50

50 100 150 200 250 300 50 100 150 200 250 300

Maximum gains available (annual £) Gains made (annual £)

45°

Evidence that this is due to ‘information overload’

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Extends, confirms awareness/switching model

Awareness increases with high social grade, age (up to 45), switched gas, number of firms; falls with prepayment, single, no gas If aware, switching more likely if switched gas, children; less likely if prepay If switched, gains increase with max available, prepay; decrease with number of firms, household size, disabled Note: prepay less likely to be aware and switch, but if they do so, more likely to make an ‘efficient’ change Consistent with ‘information overload hypothesis’ cf mutual funds findings of Hortacsu and Syverson (2004) Optimum firms around 15, implications for competition policy; but we may not need to worry……………….

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Electricity supplier nos. substantially reduced

Regional incumbents Entrants Total Feb 99 12 2 14 May 99 Choice of supplier for all Oct 99 12 3 15 Jun 00 11 4 15 Dec 00 9 4 13 Dec 01 7 4 11 Apr 02 price caps removed Jun 03 5 3 8 Dec 04 5 2 7

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No information overload, co-ordinated effects?

5 electricity incumbents and 1 gas incumbent repeatedly interact in 14 regional electricity and 1 national gas market Homogeneous product Transparency through published prices, evidence of signalling Regulatory reviews increase transparency Some maverick firms? Concerns about structure Verdict on deregulation and consumer role?

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Seven years on, the jury is still out…

Market hasn’t yet delivered net benefits sunk costs mean wouldn’t reverse them…yet But might not start if hadn't already done so Consumer awareness declines, needs to be reinforced Help consumers realise how easy switching can be Target particular groups less aware, likely to switch (efficiently) Distributional issues, special services Experiences in other markets suggest cross sector policy Market structure/behaviour: continued regulatory vigilance Supply side and demand side policies both needed

Deregulation more ‘interesting’ than (some) anticipated

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Consumer Choice and Industrial Policy

Centre for Competition Policy University of East Anglia www.ccp.uea.ac.uk

ACCC 2005 regulatory conference, Queensland, July 2005