Written by Evan Byrne, Senior Account Executive in Energy
The belief that the energy market is broken is now an orthodoxy that few would dare challenge. The Energy Regulator Ofgem has announced that they seek to go much further than ever before in tackling issues in the market particularly in light of the Government’s announcement on a future price cap.
Ofgem wants customers to be automatically switched to better tariffs, without any involvement from them. However, this proposal demonstrates just why the market is broken: “inertia” or non-engagement by consumers.
The basic model for competition in a market goes as follows: Two vendors are both trying to sell a product to a customer. Vendors can try to entice the customer to buy from them by beating the other on price or by providing a superior service or product.
Some customers will be won over by price; others will plump for a better service. The more vendors in a market, the more options a customer has to buy according to their own preferences.
However, this model fails if the customer only ever buys from one vendor and never another. The only motivating factor to amend your offering is the knowledge that doing so could entice customers you do not currently have into your tent.
If one knows that this will not happen, there is little motivation to do so. Likewise, if you have a large customer base, which is guaranteed to stay in your tent no matter what, then there is little motivation to offer either a cheap or good service, as you don’t run the risk of losing customers to competitors.
The energy market is in fact highly competitive, for the people who switch each year. Most fixed term contracts, reserved for new customers, are loss making. These are sustained by the majority of customers on termless Standard Variable Tariffs (SVTs) who will never leave a supplier, no matter how expensive those tariffs get.
Therefore, the reason why most customers get a bad deal on energy is because not enough of them engage in the market, in order to drive down prices and foster competition. Thus, in order to fix the broken energy market, more customers need to engage with the market.
If the Government must intervene (and there is an argument that it should not), then they need to take steps to engage more customers with the market.
Ofgem’s plans for collective switching, fundamentally misses the issue, because it fails to engage customers with the market (it spectacularly does the opposite). In all likelihood, automatic switching will lead to a race to the bottom, as suppliers seek to undercut one another on price, in order to acquire new customers.
This would most likely benefit the largest companies as they are best able to absorb losses.
A sensible intervention is one in which SVTs (or any termless contract) are prohibited. Many suppliers already support this. By forcing consumers to engage in the market, there is a greater chance of more of them will be willing to shop around, which gives suppliers the motivation needed to compete with one another. This will result in a better or cheaper service.
It is not the Government’s duty to ensure everyone receives cheap energy, and certainly not while consumers have access to a free market. The energy market will remain broken until there is buy in from consumers, so we must seek to affect change first on the consumer side.