Switching and the Smart Energy Market

Back in 1776 Adam Smith made the observation that England is a Nation of Shopkeepers (although Napoleon usually gets the credit for the phrase).  If either were alive today they’d probably reconsider and point out that we’re now a nation of Switchers.  Nowhere is that more true than our attitude towards energy suppliers.  According to OFGEM, over 76% of us have switched our energy supplier in the last ten years.  Around 26% of us do it every year.

For some reason, we love switching.  Our favourite TV adverts are for comparison sites.  One – the advert for Compare the Market uses a family of animated meerkats which have become so popular they’ve spawned a range of merchandise.  Whether it’s insurance, energy, mobile phone plans, broadband or saving plans, we’re addicted.  And nowhere more so than with switching energy provider.

It’s not just the websites urging us to do that.  Government ministers keep on telling us that to get the best energy price we should switch suppliers.  Their message is not to use less energy – just change supplier.  And part of their plan for smart metering is to make it even easier to switch – as often as once a day.  It’s creating a very interesting dynamic for the industry, but one that is about to change.

If you live outside the UK this may sound strange.  For large parts of the world, particularly for many households within the USA, energy companies have not been deregulated.  As far as the world’s greatest democracy is concerned, for most users energy supply still follows a Stalinist approach where you have no choice but to buy your energy from the local “benevolent” state monopoly. 

In the UK, the energy industry was deregulated in the late 1990s.  This split the network generators and retailers, allowing customers to buy gas and electricity from any of the energy companies.  The hope was that this would introduce competition which would benefit the customer.  Whether that has been achieved is debatable – initial choice was rapidly eroded though consolidation within the industry, limiting the scope for innovation.  Although deregulation gives customers choice, the problem is that there’s not a lot of ways to differentiate electricity or gas.  It’s like petrol or water – they’re petrol or water (unless you’re in the US, when they’re gas and water).  The only real differentiator is customer service, which is something for which utilities are not famous.

The EU and Australia have followed the same route.  The US started to follow, only to cut the experiment short, leaving enclaves of deregulation in a largely sceptical nation.  There’s a wonderfully rabid diatribe about the UK experience that the Consumer’s Union produced in 2003, claiming that the UK public was manipulated, misled, ignored and abused , which is still well worth reading.  But however persuasive or accurate it may or may not have been at the time, the Enron experience did a far better job of halting progress.

For UK consumers, deregulation has been a bitter-sweet experience.  The growth of Internet companies which help us switch, along with some questionable doorstep sales techniques have turned us into a nation of switchers.  Most householders would question the benefits they’ve attained by switching as bills still seem to go up.  To be fair, that’s not necessarily duplicity on the part of the utilities.   When basic prices continue to rise, then regardless of whether you switch, your bill is likely to increase.  As users have little feedback on what they actually consume (how many of us actually check the annual consumption on our energy bill?), the perception is that prices rise inexorably regardless of switching, hence it’s all a con.  Despite which we all keep on doing it.

This switching behaviour has become the focus for the way the industry works in deregulated markets, and imparts an important difference between the US and the rest of the world.  The concept of annual switching grew out of the mobile phone (cellular) industry, where the growth of personal handsets sent the network operators into a frenzy of customer acquisition.  UK mobile phone ownership hit 75% in 2003.  That marked the point where growth from first time customers started to come to an end.  For the next seven years, the only way UK networks perceived that they could grow was by persuading customers to switch, largely regardless of cost.  Eventually the mobile industry learnt and started to concentrate more on customer retention and growing ARPU through longer contracts and added services.

In the UK the utilities followed this same model.  They had a slightly different starting point as there was no real customer growth – everyone already had an electricity or gas supplier, and new build homes were a limited additional market.   So they embraced switching with enthusiasm.  Anyone offering analytics to a supplier would discover that the three drivers in utility marketing were acquisition, acquisition and acquisition, with a grudging bit of engagement and retention.  Because of this, energy conservation – a business model which has driven analytics companies like OPower in the US, has been largely absent in deregulated markets, unless backed by Government reimbursement programs such as the UK’s CERT scheme.  And even there, money has been channelled into more direct engagement solutions – typically energy monitors.  But in the single minded pursuit of customer acquisition, the industry has slid into some shady doorstep sales techniques.

The bubble burst just before Christmas 2008, when nPower were fined £1.8 million by OFGEM for misselling.  More prosecutions followed, and by the end of 2011, all but one of the major utilities announced that they would stop doorstep sales.  As a result, switching has slumped, falling from 26% to less than 14% over the year.  And recent Goverment figures for the last quarter of 2011 show it’s still falling along with the statement that “turst in energy firms has never been lower”.

Despite continuing Government calls to keep on doing it, switching is set to fall further.  Doorstep sales counted for a large percentage of acquisitions and that’s gone.  The next largest chunk was driven by discounts given to switching sites.  That’s disappearing too, as energy companies have decided to use that money to reduce tariffs.  It’s a move that will probably see another halving in switching, decreasing it to something between 5% and 8%.

It means a whole new marketing game plan for the UK energy industry.  The reduction in web discounts is a response to complaints from consumer groups about complex tariffs.  Unlike US energy companies, who generally only offer two or three different tariffs, UK companies have historically offered hundreds, and in some cases thousands, including some long standing Time of Use tariffs.  They’ve been stung by allegations from consumer groups that this makes it very difficult for customers to understand whether they are on the right one, and there is evidence that a lot of customers are not. 

Although the market is dominated by six large utilities, the past few years have seen the introduction of new entrants, encouraged by OFGEM’s policy of encouraging innovation in supply, who are concerned that competition is being stifled.  Faced with the possibility of more nimble competition, it makes total sense for the big six to stop buying customers (who are likely to keep on switching) with web discounts, but use this money to support a simplified tariff structure, which they can claim leads to lower prices for consumers.

And that’s what’s happening.  But it means a massive change in business model as they now need to concentrate of extracting value from long term customers.  Which means concentrating on customer engagement and selling new services.  That is a difficult challenge for any industry.  It’s a massive challenge for the utilities, where risk aversion and slow, careful deliberation is the order of the day.  To make it more difficult, this is happening at exactly the same time as the UK is starting its smart meter rollout – itself a major step change in technology and IT complexity for these companies.

The UK is taking a dramatic lead with its smart metering deployment, designing a system for the most complex energy market in the world.  The structural changes in the industry described above lay a further level of complexity which makes this even more challenging.  What is apparent is that utilities will need to rely on external expertise more than ever before to transform their industry through the next five years.  And rely on sectors with which they have previously had little engagement, for many of the skills they need lie outside the energy industry.

What does it mean for the switching public?  It looks as if they may change their switching behaviour, at least for energy suppliers, despite the best protestations of government ministers and consumer groups.  I don’t think they’ll stop switching; they’ll just turn to purchases other than energy.  That is, until the energy industry makes it interesting for them to start switching again.  My suspicion is that will not be because of price, but because of other services, which have yet to be defined. 

Which presents a challenge for the energy retailers.  For the foreseeable future, customers are likely to remain surprisingly loyal, even in the face of rising energy prices.  However, the first utility to offer compelling new services will have the opportunity to disrupt the market and move to the number one slot.  What makes this even more worrying for the competition is that they will probably achieve through acquisition of the most profitable segment of customers from their rivals.  So the race is on to find and provide that service and change the face of energy retailing.

And Government will need to change its advice.  As tariffs become simpler and more similar, and as web discounts disappear, an exhortation to switch has little value and soon becomes meaningless.  Instead, ministers need to think about the more difficult problem of how to persuade people to change their energy use, including what steps they need to take to promote that change of behaviour.  And switching government policy is likely to be the most difficult switch of all.