Customer Switching
Fund Research Report
Report to the Electricity Authority
November
2010
Copyright Castalia Limited. All rights reserved. Castalia is not liable for any loss caused by reliance on this
document. Castalia is a part of the worldwide Castalia Advisory Group.
Table of Contents
Executive Summary
iii 1 Introduction
1 2 Potential Benefits of Customer Switching
3 2.1 Analysis of Competition in the Retail Market
3 2.2 Defining the Role of the Switching Fund
3 4 5 6 12 Barriers to Switching
17 3.1 Financial and Transaction Costs
17 3.2 Other Non-financial Costs
19 3.3 Reducing the Barriers to Enable Efficient Switching
21 Customer Switching in Other Industries
24 4.1 Telecommunications
24 4.2 Banking
28 Measures to Address Barriers to Switching
32 5.1 Measures to Reduce Financial and Transaction Costs
32 5.2 Measures to Address Other Non-financial Costs
38 Monitoring and Evaluating Performance
39 References
44 Appendix A Savings from Switching
45 Appendix B Analysis of Unique Retail Price Trends
47 Tables
Table 4.1: Estimated Annual Cost of Mobile Telecommunications
Services
24 Table 4.2: Likelihood of Switching Supplier
25 Table 4.3: Barriers to Switching Mobile Supplier (United
Kingdom)
26 Table 4.4: New Zealand Monthly Bank Fees (excluding
transaction fees)
29 Table A.1: Average Annual Savings from Switching per Customer
(2009 data)
45 i
Figures
Figure 2.1: Market Share of Incumbent Suppliers (2008 and 2010)
5 Figure 2.2: Potential Gains from Switching in Kapiti Coast
(Electra Network)
7 Figure 2.3: Potential Gains from Switching in Northland
(Northpower Network)
8 Figure 2.4: Average Savings from Switching by Island (per
customer)
10 Figure 2.5: Ten Areas with Highest Potential Gains from
Switching (per customer)
11 Figure 2.6: Customer Switching Rates in New Zealand
12 Figure 2.7: Churn in Australia’s Household and SME Electricity
Market (2009-2010)
17 Figure 3.1: Reasons for Not Switching Electricity Retailer
(Australia)
19 Figure 3.2: Average Household Electricity Bill (Auckland and
Dunedin)
20 Figure 3.3: Areas to Lower Barriers Assuming an Efficient
Switching Cost of $100
22 Figure 3.4: Consumer Attitudes to Switching Electricity Retailer
23 Figure 4.1: Annual Cost of Fixed Line Services (Residential Users)
25 Figure 4.2: Mobile Number Porting in New Zealand (2007-2010)
27 Figure 5.1: Average Business Days for Consumers to Switch
Retailers
36 Figure 5.2: “Highly Useful” Electricity Prices Comparisons
37 Figure 6.1: Potential Gains from Switching in Auckland (Vector
Network)
41 Figure 6.2: Reasons for Switching Electricity Retailer (Australia)
42 Figure B.1: Estimated Gains from Switching in Hamilton (WEL
Network)
47 Figure B.2: Estimated Gains from Switching in Dunedin (Delta
Network)
48 Figure B.3: Estimated Gains from Switching in Tauranga
(Powerco Network)
49 Boxes
Box 1.1: Main Themes from Stakeholder Interviews
2 Box 2.1: Complementary Measures to Increase Retail Competition
14 Box 5.1: Stakeholder Responses on Powerswitch
34 ii
Executive Summary
This report presents
research for a newly
established fund to
promote to consumers
the benefits of
comparing and
switching electricity
retailers
The Ministerial Review into the Performance of the Electricity Market in 2009
recommended that a fund be established to promote the benefits of comparing and
switching electricity retailer. The government has decided to establish such a fund
(the “Switching Fund”), and the Electricity Authority will administer the Switching
Fund.
The purpose of the
Switching Fund is to
promote competitive
outcomes in the retail
electricity market
The Switching Fund has been established to address the perception that customer
switching in electricity markets places insufficient discipline on supplier behaviour.
New Zealand is not the only electricity market where concerns about customer
switching have been raised.
Castalia has been engaged to provide the Electricity Authority and Ministry of
Consumer Affairs with research that underpins the Switching Fund. This research
is directed towards ensuring that the Switching Fund achieves its objectives and
provides value for money.
A high level of customer stickiness prevents the full impact of competitive forces
from being realised. If suppliers know that a proportion of their customer base will
not switch, then their response to cheaper offers from their competitors will be
less immediate and not as significant. In contrast, suppliers with highly mobile
customers need to respond to competitive threats to maintain market share and
profitability.
The objective of the Switching Fund is to promote retail electricity market
competition in New Zealand by ensuring that consumers are aware of their ability
to switch retailer, and the savings that they could access by switching. This should
put real pressure on retailers to improve their offerings, and place greater
competitive pressure on prices.
The Switching Fund will support initiatives that target residential and commercial
consumers.
Customer stickiness in
the New Zealand
electricity market
means that incumbents
generally charge prices
that are above the most
competitive offer
To estimate the possible benefits of the Switching Fund, we consider how the
stickiness of a customer base leads to deviation from the competitive market
standard of prices that are set by the cheapest (most efficient) competitor.
Although there are other factors that are relevant to retail electricity competition,
focusing on different price offerings sheds light on the role that customer
stickiness plays in producing the outcomes observed in the New Zealand retail
electricity market.
We suggest that customers fall into three broad groups:
ƒ Active switchers—those who will switch from the incumbent for a
modest financial gain, and who are likely to initiate the switching
process
ƒ Passive switchers—those who will switch if presented with an offer
that represents a reasonable financial gain. Generally these customers
need to be approached or have a particularly negative experience with
their current retailer
ƒ Non switchers—sticky customers that will never switch and will
remain loyal to the incumbent despite direct approaches.
In the New Zealand retail electricity market, we observe that the incumbent retailer
consistently prices above new entrants in more than 60 percent of retail pricing
areas, and these incumbents serve more than 40 percent of residential customers.
This strategy is commercially sound because where incumbents offer a single price
iii
to their cusstomers in a region, it will not
n be profit maximising (aat least in the near
term) to reaact too vigoro
ously to the lo
oss of market share to new entrants. If a new
entrant offe
fers a lower price
p
in an incumbent’s area, the incum
mbent should only
respond byy lowering its prices
p
for all of its customeers when the revenue lost from
the overall price reductio
on is less than
n the margin lo
ost on custom
mers that switcch to
the new enttrant.
In simple teerms, the high
h proportion of
o non switch
hers and passivve switchers in
n the
customer base means thaat incumbents have limited incentive to match
m
the cheaapest
competitor..
Premium prricing
(primarily by
incumbents)
s) means
that there arre financial
benefits to customers
c
that are nott being
accessed
Incumbent prices that are
a above new
w entrant pricces mean thatt customers could
c
save moneyy by switchin
ng away from the incumbeent. Some new
w entrant retaailers
also price ab
bove the cheaapest offer, altthough this prremium is gen
nerally smaller than
the incumb
bent retailer. The
T graph bellow shows th
he average savving that coulld be
realised by customers in different pricing areas acro
oss New Zealaand, assumingg that
ot with the cheeapest retailerr switch to thee cheapest rettailer.
all customeers that are no
These resullts are shown
n against a ben
nchmark of saving $100 peer year, and range
r
from less th
han $50 per yyear in the Bayy of Plenty (th
he Horizon Energy
E
networrk) to
more than $400
$
in Duneddin (the Deltaa network).
These savin
ngs are not trransitory. Sincce 2002, the average
a
consuumer in the North
N
Island couldd have saved around $150 per
p year by sw
witching to thee cheapest rettailer.
Over the same time perriod, average savings in th
he South Islan
nd have increeased
from aroun
nd $150 to mo
ore than $250 last
l year.
Price differentials may
arise for different
reasons, and barriers to
switching are likely to
play a role
In principle, the outcomes observed could arise from wholesale market
imperfections, particular retailer strategies, barriers to switching, or a combination
of these factors.
In the absence of a liquid contracts market, including transmission hedges,
vertically integrated generator-retailers will seek to balance their load and
generation in each area. This explains why retailers without adequate generation
cover in an area might post prices that are below an incumbent’s price without
marketing their services aggressively beyond their generation balance. Different
retailers will also have different information and views on the cost of supply and
the margin that can be earned, and will make different judgements on when to
respond to entry by lowering price.
The analysis presented in this report indicates that these other market factors do
not provide a complete explanation of the geographic differences in savings from
switching. Some of the regions with the highest savings from switching are
relatively remote, while others are located close to major generation sources owned
by different players. Some of the regions have state-owned incumbents, while
others are privately-owned. This suggests that barriers to switching are playing
some role in driving divergent retail prices.
The Switching Fund
should focus on
increasing the
propensity of customers
to switch electricity
retailers
Despite the concerns with retail market competition, recent trends in retail
electricity competition in New Zealand are positive. The number of retailers
operating in different parts of the country has increased, new retail offerings have
emerged (including an increase in the use of smart metering technologies), and
there are signs of greater brand differentiation between electricity retailers. One
way that this competition is currently playing out is through rates of customer
switching.
While the increase in customer switching from incumbent suppliers is encouraging,
focusing on the switching rate provides an incomplete analysis of competition. In
fact, relatively low rates of switching may be observed in highly competitive
markets because retailers are matching competitor prices or otherwise keeping
customers happy.
In our view, the Switching Fund should aim to increase competitive activity by
retailers by increasing the propensity of customers to switch. This will help to
create sustained competitive pressure on retail electricity prices by ensuring that
suppliers have limited ability to increase prices above competitive levels, and that
suppliers search out the lowest cost ways to provide the services that customers
demand.
There are financial and
behavioural barriers to
achieving an efficient
level of switching
What factors are currently preventing an efficient level of propensity to switch
from being achieved? We consider that the barriers to switching can be usefully
analysed in two categories—financial and behavioural barriers.
Financial barriers are relatively intuitive, and include the time taken to search for
the best deal, the transaction costs borne in transitioning to a new supplier, and the
costs of any new equipment that needs to be installed. These barriers all represent a
cost to consumers, and if the costs exceed the benefits that could be obtained it
would be perfectly rational not to switch (even though another retailer has a lower
price).
Behavioural barriers are more complex. These barriers relate to perceptions and
customer world views, rather than to the underlying economics of switching. For
example, psychological factors and peer effects may prevent consumers from
switching, even when it appears rational to do so.
At least some of the price difference between electricity retailers is also associated
v
with product differentiation. Although electricity is considered a homogenous
product, retailers differentiate themselves through green products, ‘dual fuel’
contracts (gas and electricity), customer loyalty bonuses, discounts that vary with
the length of a contract, and service features like regular metering reading and local
customer support.
The evidence from
Evidence from other industries suggests that switching barriers are not unique to
other markets suggests electricity, but that customer stickiness is stronger.
that these barriers are
In the telecommunications sector, both industry and government initiatives have
not unique to electricity
sought to increase customer switching. Despite these measures, some barriers to
switching remain and some customers could lower their bills by taking advantage
of more competitive offers.
In the banking sector, although the charges imposed by banks differ significantly,
New Zealand consumers switch banks relatively infrequently. This is due to the
hassle and uncertainty involved, which remains despite industry efforts to promote
switching.
To address these
barriers, the Switching
Fund could support a
range of measures,
primarily focusing on
providing good
information to
customers on the
available choices
The Switching Fund could support a range of effective measures to increase the
propensity of customers to switch and thereby unlock competitive forces. This
report does not seek to catalogue an exhaustive list of measures that could be
supported—one of the benefits of a contestable fund is to tap into market
innovation.
We see the main areas of activity relating to:
ƒ Providing information that consumers value, including more visibility
on the ability to switch, the gains from switching, and the relative ease
of the switching process
ƒ Taking advantage of media channels that might not be commercially
viable to retailers, but would improve the overall level of information
available to consumers
ƒ Upgrading and promoting the Powerswitch website (a specific
appropriation has been made for this purpose)
ƒ Supporting other price comparison websites
ƒ Using intermediaries to reduce switching costs, including advisors on
energy efficiency, budgeting advice, business activities, and billing
services.
Non-financial barriers
will be more difficult to
address, and will be a
good area for testing
innovative ideas
In our view, addressing the non-financial barriers to switching will be challenging.
Psychological factors and product differentiation are not based on price as they
respond to consumer attitudes, and therefore these barriers cannot be lowered by
focusing on switching costs. This area will be appropriate for players that
understand the non-price aspects of electricity competition to propose ways to use
these factors to improve consumer outcomes.
The success of the
Switching Fund should
be evaluated on the
basis of trends towards
price convergence,
supported by evidence
from other market
indicators and a regular
customer survey
Monitoring and evaluating the impact of the Fund will require measures of success
at both the Fund level and for individual projects.
At the level of the overall Fund, other market developments will make it difficult
to isolate the impact of the Fund. Rising electricity prices are driving greater
interest in switching to lower cost suppliers. The emergence of smart meters may
also make electricity customers into more active consumers. Changes in the
wholesale electricity market, including improved hedging, should promote greater
retail competition. For this reason, we recommend against a mechanistic approach
vi
to monitoring and evaluating the Fund performance.
An analysis of price convergence (as presented in this report) should be the
primary measure of the performance of the Switching Fund. If the Fund is having
the desired effect, retailers will need to respond to competitor offers or lose
customers. The analysis presented above should be updated across all pricing areas,
and aggregated up to an island-wide and nationwide level to evaluate whether the
Fund’s activities have stimulated retail market activity.
In addition, other indicators for monitoring and evaluating the impact of the
Switching Fund should include switching rates, incumbent market shares, and an
analysis of significant events in the retail market. We also recommend completing
an annual survey that captures information on customer attitudes towards
switching.
Individual projects
should be additional to
natural occurring
market activity (such as
retailer promotions),
and should be subject
to project-specific
performance targets
At the project level, specific performance measures should be proposed by parties
seeking funding. These measures should align with the objectives of the Switching
Fund and should be clear and measurable.
To ensure value for money, projects will also need to be additional to naturally
occurring market activities. We recommend that the Authority take a practical
approach to additionality:
ƒ If the activity is not currently occurring in its proposed form, or the
proponent can show that a service that is currently provided will be
discontinued, then the project should be considered additional to
naturally occurring market activity
ƒ If the service is currently being provided, or is likely to be commercially
viable without support, then the project should be considered to be
part of naturally occurring market activity that does not require levypayer support.
vii
1
Introduction
The New Zealand Government has decided to establish a fund to promote to consumers
the benefits of comparing and switching electricity retailers (the “Switching Fund”). The
Switching Fund will be administered by the Electricity Authority and Ministry of
Consumer Affairs, and will be funded through a levy charged to electricity retailers.
Castalia has been engaged by the Electricity Authority to research the basis for the
Switching Fund to achieve the outcomes sought by the Government, and ensures value
for money for levy-payers. The work on this report began in advance of the
establishment of the Electricity Authority on 1 November 2010 to enable the Switching
Fund to move quickly to programme implementation.
The creation of the Switching Fund was recommended in the Ministerial Review of
Electricity Market Performance completed in 2009 (the “Ministerial Review”).1 The
Ministerial Review recommended (Recommendation 25) that $5 million per year be
allocated to the Switching Fund for a period of three years. While most of the details of
the Switching Fund remain at the discretion of the Electricity Authority, the Government
has specified the following two features:
ƒ Contestability. The Government has decided that the Switching Fund will be
contestable, noting that a request for proposals could generate a wide array of
innovative ideas on how the switching fund could be best deployed
ƒ Funding for Powerswitch. The Government has decided that $1.5 million
per year will be set aside to promote and upgrade the Powerswitch website.2
This funding will be administered by the Ministry of Consumer Affairs (which
currently contracts Consumer NZ to operate and maintain the Powerswitch
website).
The Switching Fund is referenced in the Electricity Industry Act 2010, which states (at
section 128(3)(d)) that the electricity levy will recover the costs incurred by the Crown in
promoting to customers the benefits of comparing and switching retailers, subject to a
limit of $5 million per year and an overall limit of $15 million through to 30 April 2014.
Under the Act the Electricity Authority has the mandate to promote to consumers the
benefits of comparing and switching retailers (section 16(1)(i)).
We have used three research methods to complete this research. First, we analyse data
from the New Zealand retail electricity market to understand the role that customer
switching plays in promoting competitive outcomes in this market. Second, we use
comparative case studies to evaluate how other markets promote switching to improve
competition. We specifically consider Nordic and Australian experience with retail
electricity switching and we present brief case studies of switching in the
telecommunications and banking sectors. Finally, we have interviewed electricity sector
stakeholders in New Zealand that have a particular interest in customer switching. These
interviews gave interested parties the opportunity to contribute towards the approach to
implementing the Switching Fund, and generated useful ideas on how to ensure that the
money is spent to best effect. A summary of stakeholder comments arising from these
interviews is provided in Box 1.1.
1
Ministry of Economic Development (2009). “Improving Electricity Market Performance, Volume One: Discussion
Paper. Available online: http://www.med.govt.nz/templates/MultipageDocumentTOC____41697.aspx
2
See www.powerswitch.co.nz, or www.powerswitch.org.nz
1
Box 1.1: Main Themes from Stakeholder Interviews
Several stakeholders expressed reservations about the conceptual foundation for the
concept of a switching fund. The sceptics fall into two camps.
ƒ Those that don’t support the overall competitive market framework for retailing
electricity. Several stakeholders expressed the view that competition between retailers is
an illusory goal, and that encouraging switching to enhance competition will not
produce any benefits
ƒ Those that see limited value in levy-funded promotion of switching. Some stakeholders
that support a competitive market framework expressed doubt as to whether the Fund
could help achieve this outcome.
Other stakeholders believed that the Switching Fund could make a positive contribution to
retail market outcomes for consumers. Major areas where the Fund is generally perceived
as being able to add value are:
ƒ Information provision, and to simplify information that is available
ƒ Exploiting channels other than the internet to encourage switching
ƒ Through initiatives targeted towards specific customer groups that are generally
unaware of the benefits of switching, including:
– Small businesses (due to a lack of easily accessible ways to compare offerings)
– Poorer households (due to costs associated with switching and the high potential for
delivering very real benefits)
– Elderly consumers (due to strong peer influences and a conservatism bias)
– Renters (due to the lack of control this group has over other property-related costs)
– Certain geographic areas where the competitive process is not leading to consumer
benefits.
ƒ Several stakeholders also consider that the Switching Fund should be able to leverage
other funds or initiatives, such as energy efficiency
Some areas where the Fund needs to be carefully managed were highlighted by
stakeholders
ƒ Not to crowd out existing retailer activities to encourage switching between them, or to
lessen the accountability on retailers to promote the benefits of switching
ƒ Not to crowd out other private sector initiatives that help electricity consumers find the
best deal (such as SwitchMe, One Bill, and Save a Watt)
ƒ Not to prevent broader initiatives not purely focussed on switching. Stakeholders that
advise on switching as part of a broader package of customer interactions (for example
including advice on energy efficiency) believe that their activities should be eligible for
support from the Fund.
In preparing this report, we have also drawn on the experience gained by the forerunner
to the Electricity Authority (the Electricity Commission) in administering a dedicated
levy-payer fund for electricity efficiency initiatives. The Switching Fund shares a number
of common features with the Electricity Commission’s electricity efficiency funding—
both ultimately aim to achieve outcomes that have not resulted from normal market
interactions.
The Commission developed a three-step approach to administering the electricity
efficiency fund:
ƒ Identify the sectors, technologies, and practices across New Zealand where
significant potential exists for economic investments in electricity efficiency
ƒ Examine and understand the barriers to investment that are preventing
economic investments in electricity efficiency from taking place
2
ƒ Develop cost effective programmes that address the barriers identified and
therefore unlock the potential for economic investments in electricity
efficiency.
To gain funding, proponents of an electricity efficiency investment needed to show that
the investment would deliver cost savings at a lower cost than the long run marginal cost
of supply. While acknowledging that long-run marginal cost is not a single number, the
Commission considered that 8.5 c/kWh would be an appropriate benchmark.
This research broadly applies the approach used to prioritise electricity efficiency
funding:
ƒ We analyse retail market data on pricing and market shares to estimate the
potential for switching to drive better economic outcomes. This allows us to
identify the outcomes that the Switching Fund should seek to achieve (Section
2)
ƒ We analyse the barriers that prevent an efficient level of switching from taking
place, and consider what level of cost should remain (Section 3)
ƒ We describe some of the measures that the Switching Fund could support to
promote the benefits of comparing and switching retailers. We review how
other industries (telecommunications and banking) have dealt with customer
switching (Section 4), and we consider some specific workstreams that could
be targeted to address the barriers identified (Section 5).
We conclude by describing ways to evaluate proposals for funding and monitor the
performance of the Switching Fund (Section 6).
2
Potential Benefits of Customer Switching
The New Zealand electricity industry is governed by the principle that competition
between suppliers should lead to efficient outcomes, and that intervention in the market
should be limited to situations where competition fails to deliver desired outcomes.
Customer switching plays an important role in competitive markets. It allows consumers
to express their preference for (or against) a particular supplier, which disciplines supplier
pricing and behaviour due to concerns about maintaining market share and profitability.
In this section we analyse data on electricity prices and retailer market shares to evaluate
whether customer switching provides an effective discipline on behaviour in the New
Zealand retail electricity market. We also consider the possible savings that the Switching
Fund might unlock by promoting the benefits of comparing and switching retailers.
2.1
Analysis of Competition in the Retail Market
New Zealand introduced competition into retail electricity supply in 1998 with the
passage of the Electricity Industry Reform Act. The objective of retail competition has
been to increase consumer choice, encourage innovation, and ultimately result in lower
prices than would otherwise be charged.
Establishing a benchmark for successful retail electricity market competition
In a hypothetical competitive market with differentiated products, prices can be expected
to cluster around the level of the cheapest competitor, with small price differences
reflecting brand value and service factors. In such a market, the profit-maximizing
response for an incumbent faced with a low price new entrant would be to meet the new
entrant’s price in order to stem the loss of market share.
3
Customer stickiness changes the incentives for both the new entrant and the incumbent.
The new entrant has a higher market entry hurdle to overcome, as it needs to spend
more to acquire customers. The new entrant also faces adverse selection—the customers
it is likely to win will be the most mobile customer group—leading to a more volatile and
less profitable customer base than the incumbent retailer.
In contrast, the behaviour of an incumbent in such a market will be guided by its sticky
base. If the incumbent can price discriminate then it will reduce prices for the potential
switchers (for example, by offering to match any offer made by new entrants), while
keeping the prices for sticky customers unchanged. Where price discrimination is not
possible (or is limited), the profit-maximizing strategy for the incumbent may be to
maintain higher prices and accept some loss of market share in order not to reduce
revenue from the customers that will not switch.
In the New Zealand retail electricity market, incumbent retailers were allocated all
customers within a particular geographic area at the time the market was opened up to
competition. For example, Mercury Energy was allocated all of the customers in central
Auckland, and Meridian Energy was allocated all of the customers in Northland.
Because these incumbent retailers generally offer a single price to their customers within
a region, it may not be profit maximising (at least in the near term) for incumbents to
react too vigorously to the loss of market share to new entrants. If a new entrant offers a
lower price in an incumbent’s area, the incumbent may only respond by lowering its
prices for all customers when the estimated loss of revenue from the overall price
reduction is offset by the estimated loss of margin on customers that switch to the new
entrant.
A relationship clearly exists between the higher margins that the incumbent may be able
to obtain as a result of their incumbency and both the propensity for new entrants to
enter and the savings new entrants can offer. Therefore, an area with high incumbent
market share and high margins is more attractive to new entrants—it is easy to offer
savings and new entrants can quickly gain significant market share. However, even in
these circumstances it may not be profit maximising for an incumbent to respond until it
loses a large proportion of market share (because revenues are a function of both prices
and the number of customers). In some circumstances however, an incumbent might
take a long term view and lower margins earlier to deter new entrants.
The benchmark for successful retail electricity market competition therefore requires that
price differences between retailers reflect brand value and service factors (which are likely
to be small for electricity retailing). This is known as the “law of one price”. The
potential gains from having more informed and active electricity consumers can be
measured by the degree to which the law of one price prevails within distinct customer
classes or geographic areas (geographic areas are important because nodal pricing in the
wholesale market, and differences in distribution and transmission costs make it likely
that retail prices across geographic areas will differ.
This benchmark provides a maximum estimate of the benefits of increased switching by
assuming that suppliers respond immediately to competitor pricing that undercuts their
current offer.
Retail electricity market competition in New Zealand has not met this benchmark
The law of one price clearly does not prevail in the New Zealand retail electricity market.
The Ministerial Review found that residential customers could benefit by an average of
$150 per year by switching electricity supplier. This suggests that the full benefits of retail
competition have not yet been realised. Indeed, the Ministerial Review analysed retail
4
costs,, margins, an
nd competitivve activity, aand concludeed that “therre appears to
o be room
for substantial im
mprovement in the leveel of compeetition at thee retail leveel”.3 Other
indep
pendent sourrces have alsso found siggnificant pricce differentials between electricity
4
retaileers in New Zealand.
Z
In adddition to th
he persistent price differeences that exist between
n retailers in
n the same
geogrraphic area, two other observations
o
s are consisttent with th
he view that workable
comp
petition in eleectricity retaill can be imprroved:
ƒ High incumbent market shaares persistt in some parts
p
of thee country.
Despite consumerss being able tto switch rettailer, in som
me parts of th
he country
the incumbent electricity retailer has maintaiined a markeet share of grreater than
he market sh
hares held by incumbent retailers
r
in
70 perccent. Figure 2.1 shows th
2008 (lighter
(
shad
ding) and in 2010 (darkker shading). Although incumbent
i
markett shares havve fallen in every netwo
ork area, new
w entrants have only
manageed to attractt more than half of custo
omers away from incum
mbents in a
handfuul of networkk areas.
Figurre 2.1: Markeet Share of Incumbent
I
Suppliers (22008 and 20110)
ƒ A lack
k of intense marketing by cheaper suppliers to
o gain mark
ket share.
Custom
mers need to
t know th
hat better allternatives eexist to theeir current
electriccity supplier to take advvantage of retail
r
compettition. The Ministerial
M
Review
w posed the question:
q
Wh
hy are non-in
ncumbents n
not putting more
m
effort
into maarketing wheere there are llarge price diifferences?
In priinciple, at leaast two explaanations are possible for the observeed features of the retail
electrricity market:
hese featuress derive from
m imperfecttions in the wholesale
ƒ The firrst is that th
markett. In the abssence of a liiquid contraccts market, iincluding traansmission
3
Miniisterial Review off the Electricity Market
M
page 42, and
a Appendix 144
4
Consumer NZ http:///www.consumeer.org.nz/reports/electricity-pricees/price-trend-graaphs, 2 June 2010
constraint hedges, we would expect vertically integrated generators-retailers to
seek a close balance between their retail load and generation in each nodal
area. Since generation capacity is not equally distributed around the country, it
would be reasonable to expect high market shares for retailers with significant
generation in that area (who would have been most motivated to purchase the
incumbent retail base at the time of the reforms). It would also be reasonable
that retailers without adequate generation cover in an area may post prices in
that area, but would not market their services aggressively beyond their
generation balance
ƒ The second is that these features derive from the stickiness of the customer
base, which incumbent retailers have strong incentives to maintain.
The Switching Fund will be able to address the second of these factors, but not the first.
In the sections which follow, we explore which factors provide the most likely
explanations for the observed market outcomes as a precursor to advising on how to
target the Switching Fund.
Testing retail electricity market competition against the law of one price
To obtain a first-order estimate of the possible benefits of the Switching Fund, we start
by assuming that the deviation from the law of one price—i.e. the deviation from the
competitive market standard—is caused by the stickiness of the customer base. This
allows us to test the effect of improving the propensity to switch by considering what
would happen if the law of one price prevailed in the New Zealand retail electricity
market. We do this by quantifying the financial savings that would be realised if all
consumers switched to the cheapest retailer in their area—which is equivalent to testing
the financial impact of all suppliers matching the lowest price offered in each area.
While this analysis provides a useful estimate of possible benefits, there are a number of
factors other than price that will influence retail electricity competition. Retailers will
consider a multitude of other factors when deciding whether to enter an area and how to
compete, including the type of customers in each region and their consumption profile,
the costs of dealing with the local network company, and the availability of metering
contractors. Focusing on price does not directly address these factors, although to some
extent these considerations will be reflected in prices. However, the price analysis
presented in this report sheds light on whether customer stickiness might be responsible
for the outcomes observed in the retail market.
We have used two data sources to complete this analysis. The first is the Ministry of
Economic Development (MED) Quarterly Survey of Domestic Electricity Prices.5 This
publication provides data on the prices offered by each retailer across 42 “pricing
areas”—where the price offered by at least one retailer differs from the price offered in
an adjoining area. For many areas, retail offerings are determined by network boundaries.
However, some network areas contain multiple prices—for example, the western
PowerCo network contains six pricing areas: Hawera, Manawatu, New Plymouth,
Stratford, Wanganui, and Wairarapa. The price data comes in the form of a “levelised
tariff”—that is, one that combines both fixed and variable charges and divides them by
an average level of consumption (MED uses 8,000 kWh per year).
The second data source used in this analysis is the Electricity Registry.6 The registry
contains information on the number of Installation Control Points (ICPs) held by each
5
Ministry of Economic Development http://www.med.govt.nz/templates/ContentTopicSummary____21313.aspx
6
Electricity Authority http://www.ea.govt.nz/industry/market/registry-icps/
6
retaileer at each no
ode. We havee aggregated this data to match
m
the prricing areas used
u
in the
MED
D Quarterly Survey—givi
S
ing a consisttent dataset of prices an
nd market sh
hares from
Januaary 2000 to May
M 2010.
Figurre 2.2 illustraates the analyysis completted across reetail pricing aareas, using the Kapiti
Coastt as an exam
mple. The coloured
c
linees running across
a
the ggraph show the prices
offereed by compeeting retailerss, and the inccumbent supp
plier is show
wn by a thickeer line (the
incum
mbent in the Kapiti Coastt area is Con
ntact Energy). Prices are eexpressed as a levelised
tariff (incorporatin
ng both fixed
d and variablle price comp
ponents).
The vertical
v
bars in
i the backgrround of Figgure 2.2 show
w the total mo
onthly gains that could
be acccessed by switching to
o the cheap
pest supplierr. The gainss from swittching are
calcullated as the difference in price between each supplier an
nd the cheap
pest offer,
multip
plied by thee market sh
hare of retaillers that aree not the ch
heapest. Thiis analysis
assum
mes that each
h customer consumes 8,0000 kWh per year, and thaat all custom
mers are on
the most
m
commo
on residentiall plan. Altho
ough there arre a range o
of residential electricity
plans available an
nd consumpttion levels w
will depend on
o householld size and appliances,
a
these assumptionss provide a first-order
fi
esttimate of likeely savings.
he Kapiti Co
oast, the saviings from sw
witching betw
ween 2000 aand 2009 haave ranged
In th
from $200,000 to
o $800,000 per month in total, which
w
amoun
nts to an avverage per
customer saving of between $120 and $200
$
per yeaar. Savings throughout
t
2
2006
were
particcularly high following
f
the entry of Genesis
G
Enerrgy to the arrea. Since co
ompetition
was introduced,
i
the
t market share
s
of Con
ntact Energyy (the incum
mbent) has faallen from
100 percent
p
to aro
ound 45 perccent.
Figurre 2.2: Poten
ntial Gains from
f
Switch
hing in Kapiti Coast (Ellectra Netwo
ork)
Sourcee: MED Quarrterly Survey off Domestic Elecctricity Prices, Electricity
E
Regisstry
Anoth
her examplee (Northlandd) is shown in Figure 2.3, where Meridian
M
Eneergy is the
incum
mbent retaileer. In North
hland customers could have savedd a total off between
$200,,000 and $1 million
m
per month
m
by sw
witching to th
he cheapest retailer, which
h amounts
to an average per customer saaving of betw
ween $80 andd $200 per yeear. Incumbeent market
share has fallen to
t around 422 percent in this area. Allthough therre appears to
o be some
conveergence in prrices over paast ten years, incentives ap
ppear to rem
main for the incumbent
i
to priice at a prem
mium.
Figurre 2.3: Poten
ntial Gains from
f
Switch
hing in Northland (Nortthpower Neetwork)
Sourcee: MED Quarrterly Survey off Domestic Elecctricity Prices, Electricity
E
Regisstry
Incum
mbent prem
mium pricing is commo
on, suggesting some cu
ustomer stick
kiness
Our analytical
a
fraamework wouuld predict th
hat if the deeviations from
m the law off one price
are exxplained by customer
c
sticckiness, then
n the incumb
bent will havve the highesst prices in
each area, and will
w be defeending itself against new
w entrants (by definitio
on, in the
electrricity retail market
m
all new
w entrant cusstomers mustt have made the decision
n to switch
at leaast once, wh
hile many in
ncumbent cuustomers maay have nevver made a conscious
decisiion about eleectricity retail). If custom
mer stickinesss is not a faactor then prrice trends
would
d be more raandom.
We th
hink it is usefful to analysee customers aas falling into
o three broadd groups:
ƒ Active switchers—
—those who will switch from the inccumbent forr a modest
financial gain, and who
w are likelly to initiate the
t switchingg process
ho will switcch if presentted with an offer that
ƒ Passivve switcherss—those wh
represeents a reason
nable financiial gain. Gen
nerally these customers need
n
to be
approaached or hav
ave a particuularly negatiive experience with theeir current
retailerr
ƒ Non sw
witchers—ssticky custom
mers that willl never switch
h and will reemain loyal
to the incumbent
i
despite
d
direct approaches.
The analysis
a
comp
pleted in prep
paring this reeport shows that the incuumbent retailler sets the
premiium price in
n more than 60 percent of
o the retail pricing
p
areass analysed, co
overing 42
perceent of total reesidential cusstomers.
The pricing
p
areas that do not fit this patterrn are analysed further in
n Appendix B.
B In some
cases (such as in the
t Wellingto
on area) the incumbent retailer
r
no lon
nger has a significantly
w entrants. T
This obvioussly reduces the
t value off premium
largerr market shaare than new
pricin
ng. We note that Genesiss Energy is th
he incumben
nt retailer in most of the areas that
do not fit the model of incumbent premium pricing. This could indicate that responding
to competitor pricing may be part of a deliberate strategy pursued by some market
participants, and not others.
In those areas where incumbents are not the most expensive retailer, they still tend to
price towards the top end of the distribution of offers. The reasons that a new entrant
would price above the incumbent are unclear, as there would be little chance of acquiring
market share by pursuing this strategy (more active consumers would not be likely to
switch to retailers for the privilege of paying more). One possible conclusion is that some
retailers post nationwide prices, while not wanting to acquire customers in all areas (due
to the risks associated with purchasing from the wholesale market in areas that could
experience transmission constraints and where the company has no generation capacity).
Pricing at particularly low levels could also result from a retailer’s lack of attention to its
posted prices, rather than as part of an active strategy to acquire customers. If this was
the case, the lowest-priced retailer would likely respond to rapid customer acquisition by
raising its price above the level charged by the incumbent because the retailer does not
actually have the objective of increasing its business in that area. The data used in this
report suggests that the savings from switching observed across New Zealand are not an
accident of history:
ƒ All retailers frequently review their prices throughout the country. On average,
retailers change their prices every 9 months. Price changes are slightly more
frequent in areas with more customers, although the regularity of price
changes differs more depending on the retailer (Trustpower, Contact and
Mercury Energy change their prices every 6-7 months on average, where
Meridian and Genesis Energy have commonly left prices unchanged for 10-12
months). This suggests that even in remote areas, retailers pay considerable
attention to posted prices and do not allow low prices to remain in areas
where they do not want to grow their business
ƒ The cheapest retailer in each area is consistently cheaper than its competitors.
Within the general upward trend of electricity prices, the new entrant retailer
that posts the lowest price generally pursues a discounting strategy for several
years, except in areas where new entry provides further discounts (relative to
earlier market entrants). In either case, the price discounting forms part of a
deliberate strategy to acquire customers and is not the result of historic pricing
decisions.
Retailers that want to post a price in a particular area, but do not want to actively acquire
customers, will therefore tend to price above market.
Overall, with a few exceptions, pricing evidence supports the view that propensity to
switch (rather than only wholesale market imperfections) is one explanation for the law
of one price not prevailing.
Savings from switching at a national level are substantial
The pricing graphs for Kapiti Coast and Northland show that the savings from switching
can be sustained over long periods. Although data is not available on price differences
between retailers across other customer groups (such as small commercial customers),
anecdotal evidence from stakeholder interviews indicates that savings of a similar
magnitude are available.
In recent years, the savings from switching to the cheapest retailer have increased. The
graphs below highlight average savings during 2009 per residential customer in the North
9
and South Islands, and in the ten regions where savings are greatest. This analysis does
not include the savings offered by switching to Powershop (a wholly-owned subsidiary of
Meridian Energy) because MED only provides Powershop prices from August 2009.
This means that the actual savings may have been higher than shown in areas where
Powershop is the cheapest retailer.7
Figure 2.4 shows that this increase occurs predominantly in the South Island—where
average savings per customer have increased from around $150 in 2004 to more than
$250 per customer in 2009 (total savings have increased from $37 million in 2006 to
$94 million in 2009). Over the same time period, average savings from switching have
remained around $150 per customer in the North Island.
Figure 2.4: Average Savings from Switching by Island (per customer)
The reason that this gap has emerged between savings in the South Island and North
Island is unclear. One possibility is that successive dry years in 2001 and 2003 highlighted
the risks of retailing in the South Island, where the high reliance of hydro generation and
relatively limited southward transmission capacity on the HVDC link combined to drive
up wholesale prices in the South Island. The finding that South Island customers could
gain more from switching (but do not switch) is consistent with the conclusion drawn in
the Ministerial Review that the South Island retail market appears particularly concerning.
Figure 2.5 shows the ten pricing areas with the greatest potential gains from switching
per customer (seven of these areas are in the South Island). A full list of savings per
customer and total savings in each pricing area is provided in Appendix A. It is important
to note that these savings represent average savings across a network area, and the actual
level of savings will vary for each customer (depending on their plan type and current
retailer). Furthermore, because retailers change their prices frequently, the savings shown
have been calculated at the date of this report and may have subsequently changed.
7
See Powershop http://blog.powershop.co.nz/?p=152
10
Figurre 2.5: Ten Areas
A
with Highest
H
Potential Gainss from Switcching (per customer)
c
Note:
Loyalty ben
nefits offered byy retailers are allso not factored
d into this analyysis
Receent trends in
n competitivve activity an
nd customeer switching are encouraaging
Despite the conccerns with reetail market competition
n, recent tren
nds in retail electricity
petition in New Zealand are positive. The numbeer of retailerss operating in
n different
comp
parts of the country has inccreased, new
w retail offerrings have eemerged (inccluding an
increaase in the use of smart metering
m
tech
hnologies), an
nd there are signs of greater brand
differrentiation bettween electricity retailers..
Two indicators suggest
s
thatt these chan
nges are flow
wing througgh to betterr deals to
customers. First, the number of customerrs switching supplier hass increased. Figure 2.6
show
ws the numbeer of custom
mers switchingg each montth, and highllights that th
he trend in
the number of cuustomers switching retaileer has been increasing
i
ovver the past two years,
and has
h reached leevels almost double the rrate observed
d between 20004 and 2008.
Figure 2.6: Customer Switching Rates in New Zealand
40,000
Number of Customers Switching Supplier
35,000
30,000
25,000
20,000
15,000
10,000
5,000
Jan‐10
Apr‐10
Jul‐09
Oct‐09
Jan‐09
Apr‐09
Jul‐08
Oct‐08
Jan‐08
Apr‐08
Jul‐07
Oct‐07
Jan‐07
Apr‐07
Jul‐06
Oct‐06
Jan‐06
Apr‐06
Jul‐05
Oct‐05
Jan‐05
Apr‐05
Jul‐04
Oct‐04
Jan‐04
Apr‐04
0
Source: Electricity Authority
The second indicator of a generally more competitive retail environment is falling
incumbent market shares. The two network areas where the incumbent has experienced a
larger decline in market share are the Top Energy area (where new generation capacity
was commissioned and contracted to a new entrant), and the Delta network (which
experienced a particularly strong reaction to the proposed simultaneous increase in
Contact prices and directors’ fees in 2008).
2.2
Defining the Role of the Switching Fund
Despite increasing trends in customer switching, the government has identified that
competition between electricity retailers in New Zealand has failed to deliver efficient
outcomes. In particular, concerns focus on the fact that competition has not placed
sufficient competitive pressure on prices to residential electricity consumers.
In this section we consider the role that the Switching Fund can play in improving
outcomes from retail electricity market competition. This leads us to recommend that the
Switching Fund focus on increasing the propensity of customers to switch electricity
retailer.
Switching numbers only tell part of the story
While the increase in customers switching away from incumbent suppliers is
encouraging, focusing on the switching rate provides an incomplete analysis of
competition. In fact, relatively low rates of switching may be observed in highly
competitive markets for a number of reasons:
ƒ Retailers may be directly responding to the threat of losing market share (or
even the possibility of loss) through more attractive offers to their customers
ƒ Retailers may be keeping their customers satisfied through good customer
service and competitive pricing
12
ƒ Retailers may have loyal customers due to a range of non-price aspects of their
supply arrangements, such as community support initiatives.
Online industries provide good examples of where low rates of customer switching may
not point to a failure in the competitive process. Despite relatively low barriers to
discovering and using other search engines, Google has established dominance in the
market by using a superior search tool and continuing to develop its product. A recent
study also concluded that online brokerage firms have been able to reduce switching
rates by offering a breadth of product options and ensuring high quality service.8
Switching numbers also suffer from measurement error because switches attach to a
particular meter (or ICP), and not a particular customer. As a result, when a customer
moves house a switch may be recorded even though that customer has not changed
retailer (but has ensured that the new premises are supplied by his or her current retailer).
For the same reason, a switch will not be recorded if the premises are supplied by the
existing retailer, although the customer may have effectively decided to switch.
The common feature of competitive markets is therefore not any absolute level of
switching. Rather competitive markets foster an environment where suppliers regard
customers as being highly mobile and well informed, causing them to pay close attention
to their prices and service offerings in anticipation of switching.
This desirable feature of the competitive process is captured in the Electricity Authority’s
aim to promote “informed and active consumers.”
Focusing on propensity to switch and the resulting convergence in prices
Given the limitations of targeting a particular rate of switching, the Fund should aim to
increase competitive activity among retailers by increasing the propensity of customers to
switch. This will help to create sustained competitive pressure on retail electricity prices
by ensuring that suppliers have limited ability to increase prices above competitive levels,
and that suppliers search out the lowest cost ways to provide the services that customers
demand.
Increasing the propensity of customers to switch may differ from the actual level of
switching observed in the market. If customers go through a regular thought process to
ensure that they are satisfied with their current retailer compared to competing offers,
then this decision making process will force discipline on supplier behaviour. This regular
consumer thought process really defines what we mean by propensity to switch.
In economic efficiency terms, measures that increase propensity to switch and hence
retail competition will have three effects:
ƒ Increasing consumer surplus by squeezing retail prices—More
competition places pressure on retailers’ prices, and to retain customers a
retailer may be forced to cut its margins. In economic efficiency terms this
transfers wealth from producers to consumers, so does not in itself create
additional welfare. The Electricity Commission estimated that retail margins
vary from five percent in larger urban centres (Christchurch, Auckland, and
Hamilton) to more than 15 percent in other places (Masterton, Waipa, Buller).
8
Chen and Hitt (2002). “Measuring Switching Costs and the Determinants of Customer Retention in InternetEnabled Businesses: A Study of the Online Brokerage Industry”. Information Systems Research, Vol 13, No 3,
September 2002, pp255-274. Available online at: http://www.econ.jhu.edu/People/Harrington/375/ch02.PDF
13
Increasing the propensity of customers to switch could put pressure on retail
margins in a relatively short time period9
ƒ Lowering costs to serve—Greater competition should also increase the
incentives on retailers to find lower cost ways of serving customers. This
represents a gain in economic efficiency because consumers benefit from
lower prices without reducing producer profits. This outcome may take
varying lengths of time to materialise, depending on the availability of ways to
reduce costs
ƒ Increasing innovation—Competition drives better outcomes for consumers
in the long run by encouraging suppliers to invest in technology that either
increases quality or reduces cost (often known as dynamic efficiency gains).
Partial equilibrium analysis, of the type typically used to understand the welfare effects of
competition in a market, draws a distinction between the transfer of surplus from
producers to consumers and the increase in consumer surplus which results from lower
costs. As mentioned above, within this framework a squeeze in retail margins would not
be seen as an improvement in efficiency if it represents a transfer from producers to
consumers.
However, while partial equilibrium analysis is often a useful tool, it is theoretically
incomplete. Transfers of surplus from producers to consumers in one market will have
an effect on spending, and hence consumer surplus across other markets. This is
particularly true of the electricity market. Since electricity ranks high in the hierarchy of
needs (electricity is commonly referred to as an “essential service”), it is not surprising
that the demand for electricity is not very responsive to changes in price. However, lower
spending on electricity leaves consumers with greater disposable income to spend on
other goods and services, which may be highly responsive to changes in income. Overall,
it is reasonable to expect that such income effects will create additional consumer surplus
in other markets.
Moreover, since retailers tend to offer the same price to a large proportion of their
customers, increasing the propensity of customers to switch between retailers will benefit
all electricity consumers—even those that don’t switch. Unless retailers can identify those
consumers that are active switchers, they will adjust their prices and service offerings
across their entire customer base.
This insight is important in developing an appropriate approach for the Switching Fund.
The strategy should focus on measures that cause more expensive (typically incumbent)
retailers to respond to competitor offerings. This will lead to a convergence in prices
towards the cheapest retailer, but may or may not change market shares (depending on
participant responses and strategies).
The Fund is only one of several measures that the government has put in place to
increase retail competition. Other measures are summarised in Box 2.1.
Box 2.1: Complementary Measures to Increase Retail Competition
In addition to establishing a Switching Fund, the government has recently implemented the
following measures to increase retail electricity competition:
ƒ Physical and virtual asset swaps. State-owned generator retailers are required to
9
Electricity Commission “Market Design Review”
14
transfer assets and write hedge contracts to ensure that all three companies compete as
national electricity retailers, rather than focusing on more narrow regional markets
ƒ Creating a liquid hedge market. All generators with more than 500 MW of capacity
are required to offer standardised, tradable contracts with a maximum buy/sell spread
ƒ Removing structural separation with lines businesses. Electricity distribution
companies are now permitted to enter the retail electricity market, subject to complying
with arms-length rules.
Participants are also required to process switching requests in shorter timeframes. The
previous rule gave retailers 23 days to process a switch. Now retailers are required to
switch customers within 10 working days of being asked, and half of all switches must
occur within five working days (over a rolling 12 month period).
Source: Office of the Minister of Energy and Resources, Cabinet Paper (available online at
http://www.med.govt.nz/upload/71002/cabinet-paper.pdf)
International evidence on switching in electricity markets
Retail electricity markets overseas have also been opened up to competition over the last
twenty years, with varying degrees of success. In some markets, the increased efficiency
and lower consumer prices sought through deregulation has been threatened by a lack of
consumer switching. Much of the research conducted on factors linked with switching
behaviour relate to the experience in Nordic countries, specifically Norway and Sweden,
which both deregulated their electricity markets in the 1990s.10 More recently, Australian
research has shown higher rates of switching than in the Nordic countries.11
Norway––Norway deregulated its electricity sector in 1991. The primary drivers for
deregulation were price discrimination across consumer groups, inefficient regional price
differences, inflexible end-user prices, and inefficient investments in new generation. The
key elements of the reform agenda (as in New Zealand) included unbundling and
separating generation, transmission, distribution, and retail activities.
Following deregulation, a series of policies targeted small residential customers to
encourage competition in the market through increased switching. The fee for changing
supplier was eliminated. Restrictions on the frequency of customer switching were
eliminated, metering requirements were relaxed for small users, and monthly price
information is now published by the Competition Authority. One result has been that
retailers are now more flexible in their approach to adjusting prices to more closely
reflect hydrological variations and the balance of demand and supply.12
Sweden––Sweden deregulated its electricity market in 1996. By 2005, the total electricity
costs for a typical household had increased by over 50 percent.13 This is largely
considered to be due to a lack of competition in the market, despite the efforts of the
Swedish Energy Markets Inspectorate and the Swedish Consumer Agency to promote
consumer awareness.
A recent survey of Swedish electricity consumers was conducted to understand the
determinants of household behaviour in relation to switching. The results show that both
economic and psychological factors contribute to customer behaviour in the electricity
market. Consumers that have more to gain from switching are more likely to exercise this
choice, whereas those with smaller potential gains are less likely to renegotiate a contract
10
11
12
13
Ek & Soderholm, 2008; Gamble et al, 2009; Jonsen, 2002
Datamonitor, 2010, “Customer switching trends in the Australian household electricity market, 2010”
Johnsen, T. (2002). Residential Customers and Competitive Electricity Markets: The Case of Norway, The
Electricity Journal, Elsevier Science Inc.
Swedish Energy Markets Inspectorate, 2006
15
or switch supplier. Access to information and understanding of electricity costs is also
important. To many households, the opportunity cost of time allocated to search for
alternatives outweighs the potential reduced cost of the alternate supplier.14
A further study conducted in Sweden hypothesised that because electricity is a product
with little variation among suppliers, any price differences in electricity should encourage
switching. The study explored barriers to switching in the electricity, landline telecom,
and home insurance markets in Sweden in an effort to untangle the relationship between
certain barriers. The study found that factors of loyalty to the incumbent, information
search costs to compare suppliers, and expected economic benefits from switching varied
across all three industries, but that the relationship between each of the factors was the
same.
ƒ Lower levels of customer loyalty are associated with lower perceived
information search costs (explained by the fact that consumers already have an
intention to switch)
ƒ Lower levels of customer loyalty are associated with higher expected
economic benefits from switching (potentially to justify the respondent’s
feeling of dissatisfaction)
ƒ Higher perceived information search costs are associated with higher expected
economic benefits from switching (respondents know that unlocking
economic benefit will come at a cost in terms of their time).
The researchers account for the differences between the sectors as stemming from the
fact that many former monopoly electricity suppliers are still dominant in their region.
This means that consumers may not realise that they can switch, or may feel a stronger
sense of loyalty because they are not accustomed to switching in the electricity sector.
The researchers recommended placing restrictions on loyalty programmes and facilitating
measures to negotiate contracts.15
Australia––In contrast to the Nordic examples discussed above, switching rates across
Australia’s deregulated states are considered to be high, and increasing due to the impact
of price rises. High switching rates are also attributed to the profile of switching that is
raised by door to door sales, although customers are becoming increasingly proactive in
the switching process including visiting price comparison websites. Figure 2.7 shows that
customer churn has been increasing in New South Wales, and has reached an annual rate
of more than 25 percent in Victoria.
14
15
Ek & Soderholm, 2008
Gamble et al., 2009
16
Figure 2.7: Churn in Australia’s Household and SME Electricity Market (2009-2010)
June 2006
June 2007
June 2008
June 2009
June 2010
New South Wales
Victoria
South Australia
Queensland
Total
0%
5%
10%
15%
20%
25%
30%
Annual churn
Source: Datamonitor / AEMO (data shows annual churn through to end of each year)
While switching rates are high (and surveys project that they will remain high), the
percentage of people citing inconvenience as their main barrier to switching has risen to
the same level as people who cite happiness with their current supplier. These results
suggest that suppliers could invest in making switching easier for customers in Australia.
3
Barriers to Switching
In Section 2 we found that there are significant benefits to customers from switching to
the cheapest retailer in their area, which are not currently being accessed. This section
asks why consumers are not switching retailers despite the ability to save significant
amounts—what are the barriers (or costs) that are preventing switching?
The Ministerial Review reached the following conclusion on why customers do not
switch despite the opportunities for financial gain (page 53):
… A combination of lack of information on what is available, a view that it is too
hard and a hassle to switch, and a perception that all electricity suppliers ‘are as bad as
each other’ (so that any savings would be temporary as the new retailer would be bound
to put up their price).
In this section we identify and discuss the barriers to switching from the academic
literature on switching and from stakeholder interviews. We divide these barriers into
two categories—barriers that are comprised of financial and transaction costs incurred by
customers in the switching process, and barriers that are not directly linked to any cost
(psychological impacts and product differentiation). In Section 3.3, we consider whether
a particular level of switching costs is likely to achieve an efficient level of switching.
3.1
Financial and Transaction Costs
Switching electricity retailer always comes at a cost. Customers need to identify the best
deal, transition to their new supplier, manage any outstanding debts, and may also need
to purchase new equipment. We discuss each of these costs under the following
subheadings.
17
Searching for the cheapest retailer
Finding the cheapest electricity retailer has a cost. This cost is borne in the time taken to
identify the retailers operating in a particular area, finding which retailer offers the best
deal, and deciding that switching is worthwhile.16
Consumer surveys have highlighted that customers find it difficult to compare what
different electricity suppliers offer due to the use of industry terminology, company
specific pricing plans, and the apparent complexity of the electricity sector. This message
was also expressed in the stakeholder interviews conducted for this research.
Individuals will attach a different value to their time—this value is commonly considered
to increase with income. This means that search costs are a function of both the time
taken in deciding to switch, and the value of an individual’s time. These parameters can
both vary significantly by customer—an internet-savvy, consumer with a good
understanding of the electricity sector could use the Powerswitch website to relatively
quickly discover potential savings. However, the same consumer may prefer to use
his/her time in alternative ways because of the high value attached to her/her time.
Search costs can be particularly high for small businesses. Electricity costs represent a
relatively small proportion of their total costs, and the time of small business owners has
a high opportunity cost (SME owners are commonly described as “time poor”). These
factors mean that small businesses may rarely see sufficient value in putting effort into
searching out the best deal or closely managing their electricity bills. It is also likely to be
more time consuming for small businesses to discover which retailer is the cheapest.
Online comparison tools (like Powerswitch) currently only provide data on residential
rates, and although the general trends in pricing are similar across customer classes, small
businesses need to contact retailers to obtain quotes directly.
Learning and transition costs (the “hassle” factor)
There are costs associated with learning how a different retailer operates, which apply to
both residential and small business customers.17
Retailers can use regular and predictable meter reading dates, bill format and
presentation, and other customer interactions to increase the real or perceived cost of
switching retailer. These costs are likely to be even higher when consumers switch to new
market entrants or unique business models (such as Powershop), where the customer
needs to learn about the new firm or business model as well as the brand. Where delays
occur, or billing cycles are not well managed in the transition, customers can become
frustrated and disillusioned with the switching process.
Figure 3.1 presents the results of research from Australia that suggests that
inconvenience is a major barrier to switching retailers. The respondents to this survey
indicated that the hassle factor has the same level of importance to customers that do not
switch as search cost and satisfaction with their current retailer.
16
Parmer et al. 2000. Exercising Consumer Choice: Switching gas suppliers in the UK residential market. Centre for Management
under Regulation: University of Warwick.
17
Klemperer, Paul (1995). Competition when Consumers have Switching Costs: An Overview with Applications to
Industrial Organization, Macroeconomics, and International Trade. The Review of Economic Studies, Vol. 62, No. 4 pp.
515-539
18
Figure 3.1: Reasons for Not Switching Electricity Retailer (Australia)
28
Happy with current supplier
28
Switching seemed too much inconvenience/hassle
28
Have not yet got round to looking into this
23
Did not want to get locked into contract
15
Concerned there may be a problem with my supply if I
switch supplier
2010
11
2009
2008
New offer(s) was/were no cheaper
21
Other
0
5
10
15
20
25
30
35
40
45
Share of non-switchers (%)
Source: Datamonitor (2010)
Debt management issues
Consumers may believe that switching electricity retailer will result in a direct financial
cost, through a cancellation or disconnection fee. In New Zealand this perception is
generally incorrect. Where a customer has entered into an agreement for a specified term
there can be costs in cancelling the contract before the term expires. However, such
contracts are relatively rare in the New Zealand retail electricity market.
Unsettled debts with retailers can also act as a deterrent to switching. Consumers may
believe that they are not entitled to switch unless the debt is paid (which is incorrect),18 or
they may feel better able to negotiate repayment terms while they are still a customer.
These barriers are more likely to be felt by consumers in lower socio-economic groups
that struggle to pay their electricity bills by the due date. These barriers are likely to be
less important to small businesses.
Financial costs (such as purchasing new meters and other equipment)
Transaction costs may also arise through the need to change equipment. For example, in
some parts of the country, only one retailer (the incumbent) provides a prepay metering
option. Switching away from the incumbent in these areas can have an additional cost if a
post-pay meter needs to be installed.
3.2
Other Non-financial Costs
The previous category of costs can be broadly described as “rational” barriers to
switching. People may rationally consider that the benefits do not justify incurring those
costs. Customers can also experience an “irrational” group of barriers: barriers which
relate to perceptions and customer world views, rather than to the underlying economics
of switching.
Psychological factors
Psychological factors can prevent consumers from switching, even when it appears
rational to do so. For example, consumers may alter their preferences to favour products
that they have previously chosen (or been given) to avoid internal conflict that arises
from other options. If consumers are initially indifferent between competing products,
18
Customers are still legally bound to pay any debts owed to their retailer after they switch.
19
consistently using a single brand will change consumers' relative utilities for the products
to such a level that that they perceive a cost of switching brand.19 Consumers may also
favour particular products or suppliers consistently favoured by their peers.
The evidence (both from the literature and from the material presented in the Ministerial
Review) indicates that there are psychological barriers that affect the performance of the
electricity retail market in New Zealand. The recent case of publicity about the fees paid
to the Directors of Contact Energy, and the effect it had on customer willingness to
switch, provides an interesting case study of psychological factors.
The left hand graph in Figure 3.2 shows price trends for an average household on the
most common plan in an area of New Zealand commonly considered competitive
(Auckland), having a large number of customers and retailers. In this area, retail prices
have increased over the past two years within a relatively narrow band. The right hand
graph shows that in Dunedin, the psychological shock of a high profile media issue led to
different outcomes. The Contact directors’ fees issue raised the customer propensity to
switch, inducing market entrants to become more aggressive. As a result, price reductions
were implemented by Genesis Energy, Mercury Energy, and Powershop.
Figure 3.2: Average Household Electricity Bill (Auckland and Dunedin)
Source: Powerswitch (www.consumer.org.nz/powerswitch)
Product differentiation
At least some of the price differences observed between electricity retailers is associated
with product differentiation. For example, retailers offer a spectrum of standard
products, green products, ‘dual fuel’ contracts (gas and electricity), and retail packages
that bundle electricity with other services such as telecommunications or paidtelevision—each with different pricing structures.20
Some electricity retailers in New Zealand provide inducements, such as customer loyalty
bonuses, awards programmes (such as Fly Buys), free subscriptions and prizes (currently
Meridian has instituted a prize giveaway to induce switching to Meridian in Wellington).
Discounts and other offers tend to vary depending on the length of a contract. Some
19
Klemperer, Paul (1995). Competition when Consumers have Switching Costs: An Overview with Applications to
Industrial Organization, Macroeconomics, and International Trade. The Review of Economic Studies, Vol. 62, No. 4 pp.
515-539
20
In Australia, the ACCC noted that a broad array of retail market offerings exists in its State of the Energy Market Report
2009. Available online at http://www.accc.gov.au/content/index.phtml?itemId=904614
20
retail products offer additional discounts for prompt payment of bills or direct debit bill
payments.
Retailers also seek to differentiate themselves as providing a higher quality service.
Mercury Energy has monthly meter reading (while others may read meters every two
months), Trustpower provides strong community support and trust pay-outs (in
Tauranga and Western Bay of Plenty), and Meridian promotes its commitment to
renewable energy sources to differentiate it from competitors.
All of these initiatives are examples of non-price competition. These aspects of the
competitive landscape appear to be more relevant to residential consumers than small
businesses. A small number of businesses place a high priority on supporting renewable
electricity generation and community support, but the majority determine their preferred
electricity retailer based on price.
3.3
Reducing the Barriers to Enable Efficient Switching
From our analysis of transaction costs and non-financial barriers to switching, we draw
two key conclusions:
ƒ Some barriers or costs in switching retailer will remain even if the Fund
achieves its objectives. It is not efficient for customers to switch for
particularly small financial gains because the costs of some switching activity
will outweigh the benefits. Therefore, the Fund should not seek to
completely eliminate all barriers to switching
ƒ The substantial benefits of switching retailer in New Zealand indicate that
barriers to switching are unnecessarily high in some areas (or for some
customers). Reducing the barriers to switching is therefore a priority to ensure
that consumers receive the full benefits of retail electricity competition. The
Fund should focus on reducing barriers or costs to a level that enables
efficient switching behaviour.
We define an efficient level of switching as all cases when the benefits of switching
outweigh the costs. Given that there will always be some cost associated with switching,
and that some barriers to switching may be consistent with competitive market
conditions (such as product differentiation), we would expect that some price differences
will remain even with more vigorous competition between retailers. However, as
identified in the Ministerial Review—the current price differences observed in many
areas are unlikely to be explained by community support initiatives or perceptions of
higher service quality.
Retailers also incur costs when customers decide to switch. The cost of collecting debts
tends to increase when a customer switches, which is due in part to the fact that retailers
no longer have the threat of disconnection to encourage payment. Higher switching may
also increase costs to serve, such as the cost of acquiring customers (for example through
a marketing campaign) and retention offers to convince customers not to switch.
Figure 3.3 uses geographic data to test whether particular pricing areas have barriers to
switching that are higher (or lower) than an assumed efficient cost of $100 per year. Put
another way, Figure 3.3 highlights the areas where the average gains from switching
retailer are currently higher than $100 per year. The average savings from switching range
from around $50 per year (less than $5 per month) in the Bay of Plenty, to more than
$400 per year (more than $30 per month) in Dunedin. The data shown in Figure 3.2 is
21
for 2009,
2
althouggh areas witth high savin
ngs from sw
witching preddominantly have high
savinggs from switching over th
he last ten yeears.21
Figurre 3.3: Areass to Lower Barriers
B
Assu
uming an Efficient
E
Swiitching Costt of $100
Sourcee: MED Quarrterly Survey off Domestic Elecctricity Prices, Electricity
E
Regisstry
In ouur view, the different savvings from sw
witching in different
d
priccing areas arre likely to
reflecct a combinattion of the fo
ollowing facttors:
ƒ Wholeesale electriicity markett imperfecttions. Witho
out a deep and
a liquid
hedge market,
m
the optimum
o
straategy for a reetailer-generaator in New Zealand is
to try to
t match rettail load with
h generation capacity. To
o be “long” or
o “short”
on gen
neration riskks significantt revenue volatility.
v
Forr similar reaasons, the
absence of an effe
fective instruument to miitigate the riisk of price variances
betweeen nodes leadds to a low riisk position for
f a retailer generator byy matching
retail lo
oad to geneeration at thee same nodee or at electtrically adjaccent nodes
where the
t risk of material
m
price variations is low
ƒ Incum
mbent priciing strateg
gy. Differen
nt retailers will have different
inform
mation and views
v
on thee cost of suupply and th
he margin th
hat can be
earned, and will make
m
differentt judgementss on when to respond to
o entry by
lowerin
ng price. This could lead to an incumb
bent respondding to what may seem
a low level competiitive threat, or
o in retailerss entering areeas that appeear to have
21
The only pricing areaas where high savvings from switcching have been a recent occurren
nce are Nelson, Marlborough,
npower (Kaiapoi)) and Scanpowerr. Savings from sswitching have in
ncreased in Nelso
on and Marlborouugh following
Main
markket entry by Genesis Energy in 20008.
low margins. As observed above, Genesis Energy appears to have taken an
aggressive approach in responding to competition, while other retailers (most
notably Trustpower) prefer to maintain higher prices.
ƒ Barriers to switching. For the reasons discussed above, consumers may not
perceive that the financial and non-financial costs borne by changing
electricity retailer are greater than $100, and are therefore not outweighed by
potential savings.
From the data above, it appears that none of these factors provides a complete
explanation of the geographic differences in savings from switching. Some of the regions
with the highest savings from switching are relatively remote (such as Wairoa,
Marlborough, Buller) while others are located close to major generation sources with
multiple owners (Taupo, Waipa Networks in the Waikato). Some of the regions have
state-owned incumbents, while others are privately-owned.
Throughout this report we focus on the geographic dimensions of retail competition by
analysing market data in different pricing areas. Similar analysis could evaluate how
different customers (industrial, commercial, residential) respond to potential savings, and
whether different socio-economic groups are more or less likely to switch given a
particular discount from a competing retailer. Unfortunately, combined data on prices,
customer groups, and demographic segments are generally not available.
One useful source of data on consumer attitudes is the survey conducted for the
Electricity Commission by UMR in 2008(“the UMR Survey”). The UMR survey asked
respondents whether they were generally non switchers (generally stick with the same
companies), passive switchers (stick with the same companies unless they experience
poor service or prices increase), or active switchers (change companies often and will
almost always take a better deal if that comes along). The results are presented in Figure
3.4 by age group. Most consumers in each age group consider themselves to be passive
switchers. However, a much greater proportion of older consumers consider themselves
to be non switchers, while younger consumers more frequently consider themselves to be
active switchers.
Figure 3.4: Consumer Attitudes to Switching Electricity Retailer
Source: UMR (2008)
23
The use of survey data to monitor changes in customer attitudes over time is discussed
further in Section 6.
The different gains from switching in different parts of the country, and the different
attitudes towards switching among different demographic groups, confirms that by
focusing on increasing the propensity of customers to switch the Switching Fund could
help to achieve more competitive outcomes and competitive pressure on prices.
4
Customer Switching in Other Industries
Electricity is not the only sector where concerns are raised about the impact of customer
switching on competition. Similar concerns have been raised in the telecommunications
sector, and in other deregulated markets like banking and insurance. This section
considers the experience in the telecommunications and banking industries, and evaluates
the measures taken in those industries to promote customer switching.
4.1
Telecommunications
Consumers in New Zealand have been able to choose between telecommunications
providers since 1990, when Clear Communications (now TelstraClear) entered the fixed
line market. This was followed by the entry of BellSouth (now Vodafone) into the mobile
market in 1993, and the recent entry of pre-pay mobile provider, 2 Degrees.
What savings can customers make by switching telecommunications provider?
The Commerce Commission monitors and reports on prices charged for
telecommunication services in New Zealand. Their most recent reports suggests there is
a significant potential for consumer savings in the mobile pre-pay, post-pay and fixed line
telecommunications markets. In the most extreme case, mobile users, in the high use
category, on a Vodafone pre-pay plan could save up to $1,800 per year by switching to 2
Degrees.
Table 4.1: Estimated Annual Cost of Mobile Telecommunications Services
Mobile Pre-pay
Mobile Post-pay
Low User
Med User
High User
Low User
Med User
High User
Vodafone
600
1,280
2,600
190
330
580
Telecom
380
900
1,900
390
680
1,170
2 Degrees
210
380
800
N/A
N/A
N/A
Source: Commerce Commission (2010) “2009 Telecommunications Market Monitoring Report”
In the fixed line market potential savings are also significant. The “2008
Telecommunications Market Monitoring Report” report estimated the annual cost of
residential services for medium intensity users. This shows potential savings of up to
$400 per year.
24
Figurre 4.1: Annual Cost of Fixed
F
Line S
Services (Ressidential Ussers)
Sourcee: Commerce Commission (22009) “2008 Teelecommunicatiions Market Mo
onitoring Reporrt “
Whatt are the com
mmonly citeed barriers tto switching
g telecommu
unications provider?
p
The major
m
reason
n many consuumers do not switch is th
hat they requuire a very higgh level of
savinggs to justify the cost off switching p
providers. Reesearch condducted by Ofcom
O
(the
teleco
ommunicatio
ons regulatorr in the United Kingdom
m) found thatt fixed line consumers
c
requirred a 75 perccent savings to motivate a switch in providers
p
(X
Xavier, 2008). A report
by th
he United Kingdom
K
Naational Auditt Office (NA
AO) reachedd similar, th
hough less
extrem
me, findings. The resultss of a surveyy conducted by the NAO suggest th
hat almost
half the
t populatio
on would be “highly likelly” or “fairlyy likely” to sw
witch for a 25
2 percent
savingg.
Tablee 4.2: Likelih
hood of Swiitching Supp
plier
Likelih
hood of switcching supplieer (%)
Levell of Saving
Highly Unliikely
Fairlly Unlikely
Fairly Likeely
High
hly Likely
10 %
34
34
25
7
25%
24
23
38
15
40%
19
19
26
42
Sourcee: NAO (20033), The Office of
o Telecommun
nications: Helpiing Consumers Benefit from Competition
C
in the Teleccommunication
ns Market
The exact
e
nature of switchingg costs variees widely dep
pending on the individual and the
comm
mercial and regulatory
r
en
nvironment. The most commonly
c
ciited costs arre (Xavier,
2008)):
h and evaluation costs—
—Determiniing which prrovider and package
p
is
ƒ Search
the besst for a particcular user is often time co
onsuming an
nd arduous. The
T task is
made more
m
difficullt by compliccated pricingg schemes, suuch as bundliing, which
make comparison
c
m
more
difficullt
ƒ Changing phone number—The hassle and disruption of changing
telephone numbers is often cited reason for not changing providers. This
barrier has largely been overcome throughout most of the world, including in
New Zealand, with number portability (the ability to transfer numbers
between providers)
ƒ Having to change handset—Handsets are not universally compatible with
all networks. Consumers switching between different types of network may
have to change handsets (which comes with the associated cost of learning to
use a new phone)
ƒ Disruption and delays—There can be substantial delays in switching from
one service provide to another. This is especially noticeable in the market for
internet services
ƒ Contractual obligations—Service providers may deliberately ‘lock in’
consumers through contracts that have hefty penalties for terminating the
contract early
ƒ Same provider discounts—Many providers discount the cost of calling
other people within the same network. As a result, switching to a new
provider may disadvantage friends and family on the same network.
A survey of mobile phone users by Ofcom (2000) provides support for the relevance of
these barriers to switching in the UK mobile phone market. Of particular interest,
14 percent of customers found it difficult to compare supplier offers.
Table 4.3: Barriers to Switching Mobile Supplier (United Kingdom)
Source: Research conducted by Ipsos-RSL (April 2000) available online at
http://www.ofcom.org.uk/static/archive/oftel/publications/1999/consumer/mobile06.htm
How does telecommunications industry encourage switching?
The most obvious way industry encourages switching is through simply providing lower
prices. However, these deals are generally indistinguishable from deals that simply
promote greater use of the network. On the other hand some promotions are clearly
intended to encourage switching. Some of the ways the telecommunications industry in
New Zealand is currently seeking to encourage switching include:
ƒ Free handsets—Both Vodafone and Telecom offer free handsets to new
customers who sign up for a post-pay plan. This is especially useful for people
26
who want
w
to switch to a nettwork that iss incompatib
ble with theeir current
handseet (this is th
he case bettween Vodaafone and th
he standardd Telecom
networrk)
ƒ Refer a friend creedit—Vodafo
one providess a $75 crediit to any custtomer that
refers a friend, and a further $755 to the frien
nd (the new customer)
c
ƒ Creditt for moving number between neetworks—Teelecom provvides $500
free creedit to anyon
ne who movees their num
mber across frrom Vodafon
ne to their
XT nettwork and siggns up to a 224 month plaan
ƒ Introd
ducing com
mpetitor compatiblee network
k/handsets—
—Telecom
introduuced their XT
X network in 2009. Unlike
U
the ollder networkk, the XT
networrk can use Vo
odafone handdsets by simp
ply swappingg SIM cards. Following
the lauunch of XT another com
mpetitor, 2 Degrees,
D
also entered th
he market.
Custom
mers of 2 Deegrees can usee both Vodaafone and XT
T handsets. The
T impact
of thesse changes is highlighted in the graph
h below, whicch shows po
orting rates
(changiing supplierr while rettaining the same phon
ne number) between
April 2007
2
and Marrch 2010.
Figurre 4.2: Mobille Number Porting in New
N Zealan
nd (2007-20110)
Sourcee: Telecommuunications Carriier Forum
Whatt has the government done
d
to enco
ourage switcching in teleecommunications?
Vario
ous approach
hes have been
b
adopteed by goverrnments to encourage switching
includding:
mer NZ is currently
ƒ Establlishing pricce compariison websittes—Consum
buildin
ng a telecom
mmunicationss price com
mparison web
bsite. The Commerce
C
Comm
mission has provided $75,000 in fund
ding to the C
Consumer NZ
N for this
purposse as part of a settlementt with Teleco
om.22 Ofcom
m, in the UK, has taken
similar approach esstablishing th
he Billmonito
or website (w
www.billmon
nitor.com),
22
See http://www.con
h
sumer.org.nz/neews/view/telecom
mmunications-co
omparison-websiite
which looks up online billing data for mobile phone services, and tells the user
which provider would be cheapest given their patterns of usage
ƒ Supporting standards to speed-up switching—Although often an industry
function, government can intervene to ensure the process for switching
providers is not unnecessarily difficult. An example is the requirement from
Ofcom that British Internet Service Providers (ISPs) disclose Migration
Authorisation Codes to their customers when they want to switch to another
provider. This significantly speeds up the switching process
ƒ Mobile Number Portability—In 2005, the Commerce Commission decided
that mobile phone providers would need to provide portability of numbers
between different providers.
In summary, both industry and government initiatives have sought to increase customer
switching in the telecommunications sector. Despite these measures, barriers to switching
remain and some customers could lower their bills by taking advantage of more
competitive offers. Equipment-related barriers appear particularly high, which is due in
part to a high level of engagement between customers and their mobile phones. Other
barriers are more consistent with experience in the electricity sector, such as the difficulty
in understanding complicated pricing schemes and which deal would represent the best
value.
4.2
Banking
Banking is another industry in New Zealand perceived to have high barriers to switching.
Customers need to ensure that their wages are deposited into their new account,
automatic payments need to be reprocessed, and new bank cards need to be issued. It
can also be difficult for consumers to evaluate different bank offerings due to the range
of service fees, interest rates and other charges levied by their bank.
What are the potential customer savings from switching banks?
There are currently 19 registered banks in New Zealand, offering plenty of options for
customers. Bank fees and charges vary widely among product and service types, and the
type and activity of the customer. Fees are often based on transaction levels, account
balances and general account maintenance.
Although it is impossible to estimate potential customer savings due to the subjectivity of
fees, Table 4.4 shows that the non-transaction based fees charged by banks differ widely.
These differences could lead to significant savings:
ƒ Customers that carry a high monthly balance would save by switching from
National Bank to Kiwibank (since the monthly fee is set on a percentage basis
rather than a set rate)
ƒ Customers with overdrafts face a lower monthly fee with Westpac or TSB
than National Bank
ƒ Customers that incur penalty fees could save by switching (particularly with
reoccurring penalty events). Cheque dishonour fees are highest at BNZ,
although BNZ has the lowest bill payment dishonour fees. Late credit card
payment fees of $25 are charged by all banks, except TSB which charges $20.
28
Table 4.4: New Zealand Monthly Bank Fees (excluding transaction fees)
ANZ
ASB
BNZ
Kiwibank
National
Bank
TSB
Westpac
Stop Cheque
20
15
25
20
15
10
25
Cheque dishonour
30
25
35
30
30
25
25
Bill Payment
Dishonour
None, if
internet
banking
25
5
30
7.5
7
25
Overdraft
Establishment Fee
20
25
30
15
1% min
25$
400
25
Monthly Fee
5
0.12%
of
limit
5
3
0.12%
2% on
amount
of
unused
overdraft
5
Monthly Fee
(Overdraft)
10
0.12%
(min
20)
5/mth
+ 20
per
item
15 if more
than 30
over
15
5
5
Credit card late
payment
25
25
25
20
25
25
25
Over Credit Limit
20
20 if
greater
than
10%
of
limit
20
20
None
20
25
Source: Kiwi Money Savers website, http://kiwimoneysavers.com/aboutus.aspx. Kiwi Money Savers
provides pricing information across a number of services including travel, broadband, mobile
phones, banking services, insurance and energy. The site appears to be independent from
suppliers and funded by revenue from Google Ads (search engine based advertising)
The launch of Kiwibank in 2002 provides a recent example of considerable customer
switching in the banking industry. Kiwibank’s value proposition rested on its New
Zealand ownership (the five large trading bank operating at the time were all Australian
owned), its initial no fee promotion for transaction accounts (which subsequently
changed), and the offer to handle all administration associated with changing direct
debits and other account information.
What are the commonly cited barriers to switching banks?
The main reason cited by customers as a reason not to switch banks is the perception
that transferring account information and direct debit payments is difficult or costly.
A survey conducted by University of Auckland in 2005 found that while 15-20 percent of
New Zealanders have considered switching banks, only about 3-5 percent of the total
New Zealand population actually switches banks each year (Matthews, 2009; Rogers,
29
2008). This suggests that customer inertia is a particular issue in the banking industry. In
a pilot study conducted by PSIS in 2001, only 12 percent of customers included in the
pilot opted to enrol in the switching programme run in the trial. The principal barrier
noted by customers for not joining the programme was a concern regarding privacy
around granting PSIS access to financial information at their previous institution
(Matthews, 2004).
There are a number of switching costs in banking, depending on the accounts held by the
customer and the type of banking services they consume. The most commonly cited
costs are:
ƒ Hassle––The time and effort of transferring account information, direct debit
payments and online payments
ƒ Learning costs—Familiarisation with the new bank and systems can seem
daunting and time consuming for consumers, especially for consumers with
multiple banking products or accounts. These costs might include learning to
navigate the bank’s website and using on-line banking
ƒ Search costs—Searching for and evaluating new institutions is perceived to
be time consuming and confusing, although the internet has lowered these
costs in some cases
ƒ Uncertainty—The risk that the new bank may be worse or no better is
particularly evident with customers who are considering switching as a result
of a negative experience with their current/previous bank, and have generally
lost faith in banking institutions as a whole
ƒ Loss of benefits—The loss of accumulated privileges and reward schemes
for being a long-standing customer can be a deterrent to switching. This often
differs based on business level and time with an institution so will vary based
on customer attributes
ƒ Monetary loss—Fees for terminating a banking relationship, such as
mortgage discharge fees, and potentially fees for starting the new one such as
automatic payment establishment fees, can be a real financial deterrent to
switching. This could also include external fees associated with legal and credit
establishment costs, especially in terms of mortgages or loans
ƒ Brand relationship––The connection that the consumer has developed with
the specific brand or reputation of the banking institution can result in
customers staying with institutions even if they might want to switch. For
example, there may be a particular aspect of the bank’s reputation that the
consumer associates with, even if there are other aspects of the institution that
the consumer may find fault with
ƒ Personal relationship—Many customers (particularly older customers) value
the personal relationships that they build with bank staff such as tellers, and
loan officers. Switching would involve losing these relationships. This barrier
is somewhat lower with the growth of online banking and the corresponding
decline in personal relationships between bank staff and consumers
ƒ Service disruption—Consumers are concerned that automatic payments or
direct debits/credits won’t arrive on time or will be missed during the
transition from institutions. Additionally, if the set-up process does not
30
include access to a debit/credit card immediately, this can be seen as an
inconvenience.
How does the banking industry encourage switching?
Banking institutions have attempted to reduce the hassle of switching. Some examples of
initiatives banks have introduced include:
ƒ
Increasing information availability––The National Bank has
effectively created a guide to switching by establishing a page on its
website called “Switching to The National Bank”, and advertising that
they were making it “really easy to switch to us”(National Bank of New
Zealand, 2008)
ƒ
Facilitating information transfer––In 2006, the BNZ launched a
process that would offer consumers wishing to switch the ability to sign a
power of attorney delegating BNZ with the authority to do everything
necessary to move the participant’s banking relationship to BNZ.
Additionally, PSIS ran a pilot study in 2001 of a switching programme
called ‘Like for Like’ where PSIS could then facilitate the transfer. This
was previously standard practice in the New Zealand banking industry up
until the late 1980s. It is thought that this practice largely stopped as
banking relationships became more complex with online payments
ƒ
Instant debit/credit card at sign-up––Banks are increasingly offering
temporary debit/credit cards available immediately at sign-up in order to
ease the transition and reduce this barrier to switching
ƒ
Cash incentives––Many banks in the United Kingdom have advertised
waiving application fees and covering transactional costs, in a “switching
cost offer” (Kerin 2006)
ƒ
Simplifying the switching process A new company (Payments NZ) has
been established to document operational agreements and arrangements
among member banks for clearing electronic credits and direct debits.
This will allow banks to hand over customer details, including any direct
debit payments, to another bank when requested to by the customer.23
What has the government done to encourage switching?
There has been limited action by regulators in New Zealand and overseas to encourage
customers to switch banks. The following areas have been suggested as areas for future
intervention (either by the Commerce Commission or industry bodies such as the
Bankers’ Association) to reduce switching costs and improve competition:
ƒ Comparative tables of banking products and services––One area that is
thought to assist in reducing the search and hassle costs, is in the provision of
an aggregated listing and comparison of the various products, services, fees,
and potential rewards offered by banks. In New Zealand, there are already a
number of private organisations offering comparative information, including
Consumer NZ (www.consumer.org.nz)
ƒ Independent verification of credit-worthiness––The government could set
up an independent verification process to allow the transfer of credit
information between institutions. This would apply specifically to mortgage or
23
See NZ Herald http://www.nzherald.co.nz/business/news/article.cfm?c_id=3&objectid=10679000
31
loan customers and would target the financial costs associated with exit/entry
fees
ƒ Bank account number portability––Bank account number portability would
eliminate much of the hassle and fear of service interruption of switching.
Bank account number portability was discussed in New Zealand by market
participants in the 1990s, but due to the costs to establish this system and how
costs would be paid, the system has not moved forward. Regulators could
require the development of this system and specify how the associated costs
should be allocated.
Although the charges imposed by banks differ significantly, New Zealand consumers
switch banks relatively infrequently. This is due to the hassle and uncertainty involved,
which remains despite industry efforts to promote switching. Inconvenience barriers
appear higher in banking than in the electricity sector, while general awareness of the
ability to switch banks is very high.
5
Measures to Address Barriers to Switching
This section explains a number of possible initiatives that the Switching Fund could
support to achieve its objectives. Quite naturally, the discussion in this section follows
the problem definition in Section 3. Hence, we group possible measures into those that
address direct financial and transaction costs (Powerswitch promotions, information
provision, and using intermediaries to handle the switching process) and measures that
address non-financial costs (through direct incentives).
The proposals in this Section are aimed at targeting the specific problems which reduce
the propensity to switch. In our view, there are likely to be relatively cost-effective
information campaigns that could be run to increase consumer awareness of switching
and the relative ease of the switching process. These types of programmes would be a
logical starting point for financial support from the Switching Fund.
Because the Switching Fund will be “contestable”, the Electricity Authority does not
need to develop an exhaustive list of possible interventions. Instead, it can rely on market
innovation to respond in a way that is consistent with commercial incentives (where the
value to consumers will come close to outweighing the costs). This section therefore only
intends to provide a broad overview of possible programmes that might help to direct
proposals from parties seeking funding.
Due to data availability, many of the measures discussed in this section apply more
directly to residential consumers than small businesses. This suggests that further
research would be valuable on how the barriers to switching affect small businesses, and
how the Switching Fund could address these barriers.
5.1
Measures to Reduce Financial and Transaction Costs
The following measures would help to address the financial and transaction costs
identified in this report.
Upgrading and promoting the Powerswitch website
As mentioned above, the Government has decided that $1.5 million per year will be set
aside to upgrade and promote the Powerswitch website. This represents a significant
increase in funding for Powerswitch from the level provided in 2009.24 This funding will
24
Powerswitch Evaluation 2009
32
be administered by the Ministry of Consumer Affairs (which currently contracts
Consumer NZ to operate and maintain the Powerswitch website). Improving
Powerswitch will help to reduce the costs borne by customers in searching for their
preferred electricity retailer.
Stakeholders provided a number of suggestions on how best to develop the Powerswitch
website to be more user-friendly and provide a wider set of price comparisons. These
suggestions are discussed in Box 5.1. Some stakeholders expressed concern that
significantly expanding the services that Powerswitch provides could adversely impact on
their business. For example, if Powerswitch adds the ability to compare commercial
electricity tariffs then advisors that currently provide this service might suffer a loss in
business.
Powerswitch receives levy-payer funds because it provides a service that is not
considered to be commercially viable. However, the activities of Powerswitch are
intersecting more with private companies due to the emergence of new businesses,
raising concerns about competitive neutrality between Powerswitch and private
businesses. In our view, the Ministry of Consumer Affairs could help to resolve some of
these concerns by clearly defining the core services that the Powerswitch site provides,
and its primary audience. Upgrading the site should then focus on providing those
services to users in the most effective way.
One development mentioned as an example in the Ministerial Review is to provide a
Freephone service that supports the Powerswitch site. Users would call this service to
guide them through the price comparison on the website, or simply have the comparison
conducted over the phone. We understand that Powerswitch has previously run a pilot
Freephone number, which worked well but was not sufficiently cost effective to be
continued.25 The additional funding provided to Powerswitch could build on the pilot
Freephone service, perhaps with additional marketing to those consumers that would be
most likely to use phone rather than internet for price comparisons (lower socioeconomic groups and senior citizens). Expanding the Freephone service from a pilot to a
full programme would provide economies of scale that would bring down the perconsumer costs and help to make the service more cost effective. Ultimately, the Ministry
of Consumer Affairs will need to decide whether such a Freephone service represents
value from the additional levy funds received given the core services and audience
targeted by the Ministry.
One relatively low-cost way to develop Powerswitch might be to link the site with price
comparison websites for other products. For example, Consumer NZ is currently
developing a site to compare telecommunications providers, and already has a site that
compares broadband internet plans.26 Combining these different sites would help to
attract consumers to Powerswitch that are primarily interested in getting the best deal on
another product or service, but would also be interested in saving money on electricity.
Promoting the Powerswitch website will be very important. The UMR survey in 2008
found that only 13 percent of electricity consumers had heard of Powerswitch.27 This is
lower than in Australia, where around 20 percent of customers used a price comparison
site in the past 12 months (and presumably more knew of their existence).28
25
Powerswitch Evaluation 2009
26
See http://www.consumer.org.nz/reports/broadband-internet/products/testtable
27
See Electricity Authority www.ea.govt.nz
28
Datamonitor (2010).
33
The Ministry of Consumer Affairs has previously considered how to target the
advertising dollars that it spends. Previous promotions of Powerswitch have been run in
the lead-up to winter, a time when consumers are preparing for higher power bills. The
Ministry has also considered how other websites have been promoted, such as the
campaigns for the Sorted website (which has had an annual budget of $2.6 million, which
was increased to $4 million to promote the KiwiSaver scheme), and found that
comparable value for money is being achieved by Powerswitch advertising campaigns.29
The additional funding available for Powerswitch will enable the Ministry to consider
additional media channels for marketing (particularly television), and should enable
longer advertising campaigns to be run.
Box 5.1: Stakeholder Responses on Powerswitch
In addition to asking questions regarding the Switching Fund (see Box 1.1), we also asked
stakeholders for their views on the best ways to upgrade and promote the Powerswitch
website ($1.5 million per year has been appropriated for this purpose).
Stakeholders generally reported positive impressions of the services provided by
Powerswitch. The site is used not only by power consumers directly, but also by
organisations that provide advice to consumers—including electricity retailers, budget
advisors, community support groups, domestic energy advisors, and energy efficiency
specialists. Many stakeholders understand that the Powerswitch site has had limited
funding for promotion and development in the past, and are supportive of measures to
increase funding for Powerswitch.
Suggestions on how to improve the site generally fall into three categories:
ƒ Simplifying the site. Several stakeholders observed that the site is unnecessarily
complicated, and uses electricity industry terminology that is unfamiliar to most
consumers. These stakeholders commented that the process of entering details into
Powerswitch could be made simpler, even if this meant sacrificing some precision in
estimating savings
ƒ Enabling comparisons across plans. Stakeholders observed that the Powerswitch
website does not currently identify whether a different type of plan (low-user, hot water
controlled, day/night) would save consumers money. Several stakeholders that use the
site said they would like to be able to determine not only the cheapest supplier, but also
the most appropriate plan for a customer’s electricity usage
ƒ Expanding functionality. The site has recently added the capability to process a
switch (by sending information to the retailer gaining the customer), and also now
provides graphs on price trends over the past four years to help consumers identify
whether the savings identified are likely to last. However, the site currently only
compares suppliers for residential consumers. Some stakeholders said they would like
to see Powerswitch expanded to also compare suppliers for small commercial users.
One stakeholder thought it would be useful for the Ministry of Consumer Affairs to tender
out the provision of a free electricity price comparison for all New Zealanders (Consumer
NZ currently provides this service through its Powerswitch website). This could generate
ideas from the market on how best to take the site forward, while also ensuring value for
money from the additional funding.
In terms of promoting the Powerswitch website, stakeholders considered this to be very
important. While stakeholders were all aware of the site (due to their involvement in the
industry), many observed that Powerswitch was not well known among the general public.
29
Retirement Commission www.sorted.org.nz
34
Other price comparison websites
Powerswitch is not the only website that compares electricity retailers in New Zealand.
Other providers of online price comparisons include SwitchMe (www.switchme.co.nz),
and Connect Now (www.connectnow.co.nz). These websites also help to reduce the
costs borne by customers in searching for their preferred electricity retailer.
It could be argued that because a significant amount of money has been directed at
upgrading and promoting Powerswitch, the Switching Fund should not provide support
to other sites providing similar services. It is true that to ensure value for money the
Switching Fund should be applied in a way that does not duplicate the funding provided
to Powerswitch.
However, other price comparison sites operate quite different comparison tools than
Powerswitch, and target consumers with a different profile from those that use
Powerswitch. It would not make commercial sense for other price comparison websites
to target the same consumers that use the Powerswitch website, so in practice the target
audience tends to be quite different. These businesses also earn revenue using different
models—some rely mainly on site advertising revenue, while others charge service fees to
retailers or customers.
SwitchMe promotes incentives associated with particular retailers to generate more
switching, and also provides useful information on different plan types.30 The site has a
blog that discusses recent market trends and provides other information. Connect Now
targets consumers that are moving house, compares prices across a range of services
(electricity, gas, phone, pay TV, internet), and arranges for the services to be provided to
the new property.
In our view, other price comparison websites could be supported by the Switching Fund
in order to achieve the overall objective of increasing propensity to switch.
Information provision and media channels
In addition to providing more information on supplier prices, there are a number of
other initiatives to provide information that the Switching Fund could support. These
initiatives could include providing information on:
ƒ Ability to switch. Many consumers are unaware that they are able to switch
their electricity company. The UMR survey found that around 50 percent of
consumers could not name another electricity retailer operating in their area
(this percentage is significantly higher for Pacific Island households)
ƒ Gains from switching. Many consumers are also not aware of the financial
savings they could make by switching supplier. Almost half of the consumers
surveyed in the UMR survey were highly confident that other companies
charged similar prices to their retailer, and around 60 percent said they were
likely to switch for a gain of $150 per year. In Section 2 we found that
consumers in a number of pricing areas could save more than $150 per year,
confirming that consumers do not fully understand the actual savings that
could be made by switching
ƒ Ease of the switching process. A number of consumers perceive that
switching electricity retailers is a risky process that causes inconvenience.
Some of this perception may relate to customer experiences in the first few
years of electricity retail competition in New Zealand, when the switching
30
See http://www.switchme.co.nz/plan_types.php
35
process was less effective than it is today. In fact, the time to process non half
hour (NHH) switching requests is now consistently less than 10 business days
on average. Figure 5.1 shows that the rolling three month average time to
process a switching request fell to 3.3 business days in October 2010. Reports
of inconvenience (for example from delays in billing) are also now relatively
rare
Figure 5.1: Average Business Days for Consumers to Switch Retailers
Source: Electricity Authority http://www.ea.govt.nz/industry/market/statistics-reports/
ƒ Information on price trends. The price increases imposed by all retailers
over the past several years have led to a perception that any gains from
switching will soon be eliminated once the new retailer raises its prices.
Powerswitch now provides information to users on price trends over the past
four years, as well as the most recent date that each retailer changed its pricing.
More information of price trends could help consumers make decisions on
the merits of switching.
There are a number of media channels to provide this information, and each channel will
target different consumer groups with a different level of effectiveness. The UMR survey
asked respondents which channels would be most useful in providing information on
different price offerings. The proportion of respondents that rated a channel 7 or greater
(on a 10 point scale) are reported in Figure 5.2. The graph also highlights the proportion
of respondents aged over 60 years that consider each channel to be highly useful. This
highlights that although some channels (such as public notices) appear ineffective across
the population; these channels could be relatively more effective in targeting a particular
customer group compared to others (such as a dedicated consumer website). Other fast
growing marketing channels, such as social media websites, also need to be considered.
36
Figurre 5.2: “High
hly Useful” Electricity Prices Com
mparisons
Sourcee: UMR surveey (2008)
Using
g intermediiaries to red
duce switchiing costs
A ran
nge of organ
nisations pro
ovide servicees to consum
mers to help
p them searcch out the
cheap
pest retailer and
a switch when
w
it wouldd be in their interests. Th
hese providerrs typically
offer this advisoryy service as part
p of a packkage that focuuses on otheer objectives, such as:
ƒ Energyy efficiencyy. Several orgganisations (such
(
as the Home Enerrgy Advice
Centre, www.energgyadvice.org.n
nz) provide advice
a
primarrily focusing on energy
ncy (insulatiion and heeating optio
ons, ventilattion, wall insulation,
efficien
second
dary glazing and
a curtain banks).
b
Part of the servicce involves comparing
c
supplieers and explaiining to conssumers how to switch
ƒ Budgeeting advicee. Organisatiions such ass the Citizen
ns Advice Bureau, the
Federaation of Fam
mily Budgetting Servicess, and Age Concern alll provide
budgetting advice to
o their memb
bers that inclludes advice on reducingg electricity
bills byy switching to
t the cheap
pest supplier. The Citizens Advice Bureau
B
has
previouusly been used as a porttal for the Powerswitch
P
website, alth
hough this
service was disconttinued due to
o cost constraaints
ƒ Energyy advice to small com
mmercial cusstomers. Sm
mall and med
dium sized
enterprrises (SMEs)) are known to be a uniqque customeer segment, with
w small
businessses being hiighly respon
nsive to chan
nges in prices while haviing limited
time to
o search out the best offfer. Some websites
w
targeet this markeet segment
explicittly (such as Save a Waatt, www.savveawatt.co.nzz), and otherr member
organissations also provide advvice on electricity costs ((such as thee Retailers’
Associaation and RD
D1 for farm b
businesses)
ƒ Integrated utility billing servvices. Comp
panies are beeginning to emerge in
New Zealand
Z
thatt offer to co
ombine houssehold bills into a single bill that
reflectss the best deal offeredd across varrious utility or financiaal services
(electricity, gas, teelephone, teelevision, in
nternet, insuurance). For example,
Onebilll currently offers
o
an eleectricity serviice, and inteends to exten
nd to gas,
telepho
one, and otheer householdd services (ww
ww.onebill.co
o.nz)
ƒ Movin
ng aggregato
ors. Moving house requirres making a conscious decision
d
on
the co
ompany that will providde utility serrvices (electtricity, gas, telephone,
internet) to the property. There are a number of firms that offer to make these
decisions easier by searching out the best and cheapest offers, Fast Connect
(www.fastconnect.co.nz) and Connect Now (www.connectnow.co.nz).
Bundling advice on switching with advice on related matters is inevitable, and ultimately
helps to reduce the cost of increasing information on switching. When an advisor is
approached in relation to one topic (such as energy efficiency) it is relatively low cost for
that advisor to extend the discussion to address switching. The Switching Fund should
be prepared to support initiatives that combine advisory services, provided that these
organisations can clearly demonstrate that the funding is being used to promote
switching (and not to provide their other advisory services).
5.2
Measures to Address Other Non-financial Costs
Addressing the non-financial barriers to switching will be challenging. Psychological
factors and product differentiation respond to consumer attitudes that are not influenced
solely by price, so these barriers cannot be lowered by focusing on switching costs.
That is not to say that there are not effective measures that could potentially reduce these
barriers. One of the strengths of a contestable fund is that it can access innovative ways
to increase propensity to switch. In our view, one area for possible innovation is for
players that understand the non-price aspects of electricity competition to propose ways
to use these factors to improve outcomes for consumers.
However, contestability could also reduce the ability to deal with the psychological
barriers. While it is easy to see how and why market participants would compete for
funding to reduce actual switching costs or to provide direct support, it is more difficult
to imagine what incentive they would have to promote broader psychological changes. In
particular, electricity retailers obviously have an incentive to invest in creating the
impression of product differentiation. By contrast, increasing the propensity to switch
may need educating the public on how largely undifferentiated the retail product is (for
example, explaining the difficulty in making “green” claims within the overall wholesale
market). It is unlikely that any market participant would have an incentive to focus on the
psychology of product differentiation. In this context, it may be useful to set aside a small
proportion of the Fund for educational activities by the Electricity Authority.
One possible way to address non-financial barriers to switching could be through the use
of direct incentives. While incentives often have a financial component, they can also aim
to stimulate competitive activity in an area by changing customer psychology. For
example, temporary bounties could be provided to give people a taste of switching, and
to make the willingness to switch the “new normal”. The aim of these initiatives would
be to turn non switchers into passive switchers, and passive switchers into active
switchers. Such a scheme was tried in South Australia, where pensioners were entitled to
a $50 cash payment for switching retailer.31 The scheme was run for a period of 10
months, and a high-level assessment by the Australian Energy Markets Commission
(AEMC) in 2008 found that it had likely stimulated some additional switching activity
that remained even after the rebates were discontinued.32
31
See http://www.abc.net.au/sa/news/200311/s1000308.htm
32
AEMC (2008). “Review of the Effectiveness of Competition in Electricity and Gas Retail Markets in South
Australia: First Final Report” at page 111. Available online at:
http://www.aemc.gov.au/Media/docs/First%20Final%20Report%20-%20Appendices-f166c14f-d1da-4307-b73831706b886415-0.pdf
38
6
Monitoring and Evaluating Performance
Adequately monitoring and evaluating the performance of the Switching Fund is essential
to ensure that the objectives of the Fund are being achieved, and that the initiatives
supported by the Fund are providing value for money. The monitoring and evaluation
undertaken by the Electricity Authority should provide regular feedback on whether the
Fund is achieving its goals, identify problems at an early stage and propose possible
solutions, and incorporate lessons learned as the Fund evolves.
The Ministerial Review provides a high-level measure of success stating that (at page 59):
[The Fund] should only continue if it can be demonstrated that it generates at least
double its value in customer benefits. That is, if $5 million is spent, then $10 million
of real savings for customers must be demonstrable.
In this section we consider performance measures for projects that receive support from
the Switching Fund, and we provide some practical suggestions on ways to monitor and
evaluate the performance of the Switching Fund itself. We recommend using price
convergence and savings from switching as the primary measure for evaluating the
success of the Fund. This should be supported by analysis across other indicators (such
as switching rates, incumbent market share, and other evidence of competition), and
should be complemented by a regular (annual) survey of customer attitudes.
We recognise that there a number of changes occurring in the electricity retail market,
which would help achieve the Fund’s objectives without any contribution from the Fund.
Rising electricity prices are driving greater interest in switching to lower cost suppliers.
The emergence of smart meters may also make electricity customers into more active
consumers. Changes in the wholesale electricity market, including improved hedging,
should also promote greater retail competition. As a result, there may be a greater
baseline trend towards more switching activity and a more competitive retail market.
Ideally, the impact of the Fund would be evaluated by reference to changes against the
baseline trend.
However, in practice, it is difficult to establish such a baseline trend. For this reason, we
recommend against a mechanistic approach to monitoring and evaluating the Fund’s
performance. Rather, as we explain below, it would be desirable to monitor trends in the
key indicators of retail market competitiveness, bearing in mind that trends need to be
considered against a moving baseline, rather than against a flat level. This indicates that
some judgement will inevitably be required in interpreting the results, and that no single
measure would provide a full picture.
Monitoring performance of projects that receive support
Clear performance measures need to be in place for the projects supported by the
Switching Fund. These measures will be project specific, and should be suggested by
project proponents as part of their funding proposals. The evaluation criteria for
allocating funding could include a score for proposing clear and measurable performance
indicators.
Project-level performance indicators could include:
ƒ Customer savings—the amount of money that an initiative saves customers
per dollar of support from the Fund
ƒ Conversion factors—the rate of switching / website hits / responses per
dollar of support from the Fund
39
ƒ Take-up of services—the number of customers using the service supported
by the Fund.
To ensure value for money, projects will also need to be additional to naturally occurring
market activities (known as “additionality”). If a project would have taken place without
the Fund for purely commercial reasons, then any support from the Fund will simply
transfer money from levy-payers to the project proponent without a corresponding
improvement in market outcomes. Additionality will be difficult to measure, and requires
a view of what would have happened to a particular project without the support of the
Fund.
We recommend that the Authority take a practical approach to additionality:
ƒ If the activity is not currently occurring in its proposed form, or the
proponent can show that a service that is currently provided will be
discontinued, then the project should be considered additional to naturally
occurring market activity
ƒ If the service is currently being provided, or is likely to be commercially viable
without support, then the project should be considered to be part of naturally
occurring market activity that does not require levy-payer support.
In our view, the marketing initiatives of electricity retailers would fall squarely into the set
of naturally occurring market activities that do not require levy-payer support. A new
business activity from another player that is not yet shown to be commercially viable
could potentially be additional, while non-profit initiatives without other funding
arrangements in place would be likely to be additional.
The primary measure of greater propensity to switch is price convergence
In Section 2 we highlighted that the benefits from switching arise because incumbent
retailers have commercial incentives to price above competitive entrants. As long as an
incumbent has sufficient market share and customers are sticky (there are a sufficient
number of non switchers in the area), it will be commercially rational to pursue this
strategy. The Switching Fund aims to increase customers’ propensity to switch (even if
they decide to stay with their current retailer), providing stronger pressure on the pricing
and behaviour of retailers.
Financial gains from switching are used in Section 2 and in the Ministerial Review to
evaluate the benefits of customer switching. These gains effectively measure price
convergence—where the prices offered in a particular area diverge, the gains from
switching are high. Where prices converge, gains from switching are reduced.
Figure 6.1 provides an example of one pricing area where more informed and active
consumers drive greater competition, and where prices converge as a result of this
competition. Auckland is known as a particularly competitive market for retailing
electricity—the city’s large population allows fixed costs to be spread among more
customers and locational risks are relatively low due to the proximity of generation and
transmission. According to the UMR survey, Auckland also has relatively few non
switchers (19 percent compared to a national average of 21 percent), and more active
switchers (21 percent compared to a national average of 17 percent).
As a result of these market features, prices offered by retailers in Auckland (including the
incumbent, Mercury Energy) have tracked within a relatively narrow band. Price
differentials of 20 percent or more observed in other parts of the country have not been
present in the Auckland market. As a result, the average customer would have saved only
40
$58 in
n 2009 by sw
witching to th
he cheapest retailer.
r
Merccury Energy currently has a market
share of around 67 percent in the Aucklan
nd area.
ntial Gains from
fr
Switchiing in Auck
kland (Vecto
or Network))
Figurre 6.1: Poten
Sourcee: MED Quarrterly Survey off Domestic Elecctricity Prices, Electricity
E
Regisstry
In ouur view, this analysis of price convergence shouuld be the prrimary measuure of the
perfo
ormance of th
he Switchingg Fund. If thee Fund is havving the desirred effect, reetailers will
need to respond to
t competito
or offers or lo
ose valuable customers. T
The analysis presented
u
acro
oss all pricingg areas, and aggregated
a
up
p to an islandd-wide and
abovee should be updated
nation
nwide level to evaluate whether
w
the Fund’s activvities are stiimulating rettail market
activity.
mpetition sh
hould also be
b monitoreed
Otheer measures of retail com
In adddition to priice convergen
nce, there arre several oth
her indicatorrs that shouldd be taken
into account
a
wheen monitorin
ng and evaluaating the imp
pact of the Switching
S
Fuund. These
includde:
hing rates. For the reaasons discusssed above, switching ittself is an
ƒ Switch
incomp
plete measurre of succeess for the Fund. How
wever, switch
hing does
providee a general in
ndication of activity in th
he retail marrket, and is an
a intuitive
indicato
or of the undderlying prop
pensity to sw
witch
ƒ Incum
mbent markeet share. Inccumbent maarket shares sshould contin
nue to fall
as longg as incumb
bents contin
nue to pricee above com
mpetitors. With
W
more
inform
med and activee consumers incumbent market
m
sharees should falll at a faster
pace, providing impetus
i
forr incumbentts to respo
ond to low
wer priced
competitors. Fallingg incumbentt market sharres may therrefore providde advance
notice of price convvergence
ƒ Price convergence between residential, commercial and industrial
consumers. Previous market studies (including the Ministerial Review) have
identified that the prices charged to residential electricity consumers have
increased at a faster rate than price charged to other customer groups,
particularly industrial consumers. The activities of the Switching Fund will
focus on residential and small commercial consumers, so we would expect to
see more consistency in the price trends between different customer classes if
the Fund’s activities increase the pressure on suppliers to the levels observed
in more competitive market segments
ƒ Event analysis. Data alone will not tell the full story of the Fund’s impact.
There will be other events in the market that will have a material impact on
retail competition, and these need to be considered when evaluating the
performance of the Fund. For example, the announcement that Contact
directors’ fees would be increased was the catalyst for increased switching
(particularly in Dunedin). Similar events need to be explained as part of the
monitoring and evaluation of the Fund.
A regular survey should be completed to complement analysis of market data
Customer attitudes and drivers are an important part of the Switching Fund, but are hard
to measure through market data. We recommend that the Authority undertake a survey
to measure changes in customer attitudes and switching behaviour over a period of 12,
24, and 36 months. The results of the first survey will make two important contributions.
First, the results will provide a baseline to measure the success of the interventions
supported by the Fund across subsequent surveys. Second, the results will help to shape
the design of programmes that will address the major barriers cited in the survey.
An example of information that can only be obtained through surveys is provided in
Figure 6.2, which shows the results from an Australian survey that asked—what triggered
your most recent decision to switch your electricity supplier? This question would enable
the Authority to assess changing drivers for customer decisions, and whether initiatives
to promote switching through particular channels are having the desired effect.
Figure 6.2: Reasons for Switching Electricity Retailer (Australia)
42
Door to door visit from electricity retailer
20
High bill from previous electricity retailer
18
Moving house
12
Poor customer service experience from previous electricity retailer
10
Recommendation from Friends/family/work colleagues
9
Desire to have gas and electricity from the same supplier
8
Telephone call from electricity retailer
8
Visit to utility price comparison website
6
Direct mail from retailer (e.g. brochure, flyer)
4
Wanted to purchase green energy
3
Visit to industry/counsumer group website
3
Advertisement in newspaper, magazine, TV, billboard
Visit to electricity retailer website
2
Visit to retailer offices
2
6
Other
0
5
Source: Datamonitor (2010)
42
10
15
20
25
30
35
Share of respondents (%)
40
45
A survey would also allow demographics to be considered (income groups, age groups,
urban / rural consumers), and could provide information on the switching experience for
customers that have switched (timeframes, convenience, overall impressions).
43
References
AEMC (2008). “Review of the Effectiveness of Competition in Electricity and Gas Retail
Markets in South Australia: First Final Report” at page 111. Available online at:
http://www.aemc.gov.au/Media/docs/First%20Final%20Report%20%20Appendices-f166c14f-d1da-4307-b738-31706b886415-0.pdf
Chen and Hitt (2002). “Measuring Switching Costs and the Determinants of Customer
Retention in Internet-Enabled Businesses: A Study of the Online Brokerage
Industry”. Information Systems Research, Vol 13, No 3, September 2002, pp255274.
Available
online
at:
http://www.econ.jhu.edu/People/Harrington/375/ch02.PDF
Datamonitor (2010). “Customer Switching Trends in the Australian Household
Electricity Market, 2010
Defeuilley, C (2009). “Retail Competition in Electricity Markets” Energy Policy, Volume
37, Issue 2, February 2009, pages 377-386
Ek, K. And Soderholm, P. (2008). “Households’ switching behaviour between electricity
suppliers in Sweden”, Utilities Policy, Vol 16 (2008) 254-261
Gamble, A.; Asgeir Juliusson, E.; Garling, T. (2009). “Consumer attitudes towards
switching supplier in three deregulated markets”, The Journal of Socio
Economics, Vol 38 (2009) 814-819
Johnsen, T (2002). “Residential Customers and Competitive Electricity Markets: The
Case of Norway”, The Electricity Journal, Elsevier Science 2002
Kerin, P. (2006) “Taking Care of Business”, BRW, 12/01/06, 24
Klemperer, Paul (1995). “Competition when Consumers have Switching Costs: An
Overview with Applications to Industrial Organization, Macroeconomics, and
International Trade”. The Review of Economic Studies, Vol. 62, No. 4 pp. 515539
Littlechild, S (2000). “Why we need electricity retailers: A reply to Joskow on wholesale
spot pass-through” Faculty of Economics, University of Cambridge, Cambridge
Matthews, C. (2009) “Switching Costs in Banking: The Regulatory Response”, Centre
for Banking Studies, Massey University
Matthews, C. (2004) “Helping Bank Customers Switch: A New Zealand Case Study”,
Centre for Banking Studies, Massey University
Ministry of Economic Development (2009). “Improving Electricity Market Performance,
Volume
One:
Discussion
Paper.
Available
online:
http://www.med.govt.nz/templates/MultipageDocumentTOC____41697.aspx
National Bank of New Zealand. (2008). “Switching to
www.nbnz.co.nz/personal/product/index/switching.aspx
National
Bank.”
Rogers, I. (2008) “Not much demand for switching accounts” The Sheet,
http://www.thesheet.com.news_print.php?selkey=6173
Xavier. P (2008), “Enhancing Competition in Telecommunications: Protecting and
Empowering Consumers”, A Ministerial Background Report for the OECD
44
Appendix A Savings from Switching
Table A.1: Average Annual Savings from Switching per Customer (2009 data)
Rank
Pricing Area
Savings per
Customer
1
DELTA
$437
2
Eastland Network (Wairoa)
$341
3
POWERCO (Tauranga)*
$320
4
MARLBOROUGH
$305
5
Otagonet
$249
6
UNISON (Taupo)
$240
7
WAIPA NETWORKS
$228
8
BULLER ELECTRICITY
$222
9
NELSON ELECTRICITY
$203
10
ELECTRICITY ASHBURTON
$175
11
SCANPOWER
$170
12
WESTPOWER
$166
13
Unison (Rotorua)
$159
14
CENTRALINES
$145
15
POWERCO (Hawera)
$128
16
ORION
$124
17
COUNTIES POWER
$121
18
ELECTRA
$117
19
Eastland Network (Eastland)
$104
20
NORTHPOWER
$103
21
MainPower
$102
22
MainPower (Kaiapoi)
$102
23
TOP ENERGY
$102
24
Unison (Hawke's Bay)
$90
25
The Power Company
$87
26
POWERCO (Manawatu)
$84
27
POWERCO (Stratford)
$83
28
POWERCO (Wanganui)
$83
29
POWERCO (New Plymouth)
$83
30
POWERCO (Thames Valley)
$81
31
NETWORK TASMAN
$80
32
Wel Networks
$80
45
Rank
Pricing Area
Savings per
Customer
33
ALPINE ENERGY
$79
34
POWERCO (Wairarapa)
$78
35
NETWORK WAITAKI
$65
36
Vector
$58
37
UnitedNetworks (Waitemata)
$44
38
HORIZON ENERGY
$42
Not
included
THE LINES COMPANY (King
Country)
n/a
Not
included
THE LINES COMPANY
(Waitomo)
n/a
Not
included
UNITED NETWORKS (North)
n/a
Not
included
UNITED NETWORKS (South)
n/a
Note: * Does not include the impact of the TECT rebate, discussed further below.
46
App
pendix B Analyysis of U
Unique Retail
R
Prrice Tren
nds
This Appendix presents
p
info
ormation on
n areas wherre the usuall trend of incumbent
i
d
not firsst apply. Theese areas broaadly fall into two lower categories–
c
premiium pricing does
–wheere incumben
nts have resp
ponded to low
wer priced en
ntrants, and second wherre entrants
have increased theeir prices to match
m
the in
ncumbent.
Mark
ket entry and
d gains from
m switching
g provoke a competitive
c
e response
Usingg the same grraphing convventions as described
d
forr Figure 2.2, we show thee different
price offerings an
nd savings from
f
switchiing in Hamilton (the WEL
W
networrk area) in
Figurre B.1. In contrast to mo
ost other pricing areas, th
he incumben
nt retailer in Hamilton
has reesponded to lower price offerings.
o
Merid
dian consisteently offeredd the lowest price in thiss area since 2002. The incumbent
i
retaileer (Genesis Energy) clo
osely matcheed this offeer from 20002-2006, meaaning that
savinggs from swittching were relatively
r
sm
mall. In 2007 a larger pricce differentiaal began to
emergge, which leed to an inccrease in savvings from switching
s
fro
om the incuumbent to
Merid
dian. Howevver, since latte 2007 Gen
nesis Energy has only im
mplemented one small
price rise, and hass reduced savvings from sw
witching from
m more than
n $2 million per
p month
in 20008 to just over $500,000 per
p month in
n 2010.
Figurre B.1: Estim
mated Gainss from Switcching in Haamilton (WE
EL Network
k)
Sourcee: MED Quarrterly Survey off Domestic Elecctricity Prices, Electricity
E
Regisstry
A sim
milar trend of incumb
bent respon
nse to comp
petition by dropping prices
p
(or
substantially mod
derating pricee rises) is ob
bserved in other
o
Genesis Energy priicing area.
p of that company’s
c
This suggests thaat an active response to competitor pricing is part
retail strategy.
p
rises
Gains from switcching removved due to ccompetitor price
witching are eliminated due
d to the aactions of co
ompetitors
In otther areas, gaains from sw
ratherr than the inccumbent.
Figurre B.2 showss that the gaains from saaving to the cheapest rettailer within the Delta
pricin
ng area havee historicallyy been quitee low, due to
t incumben
nt pricing th
hat closely
match
hed competiitor offers. However,
H
in November 2008 Mercurry Energy en
ntered the
markeet offering a substantiaal discount (more than
n 5c/kWh cheaper
c
than
n Contact
Energgy). As a resuult of this market entry, ccustomers in
n the Delta arrea could havve saved a
total of
o more than
n $2.5 million
n per month if they all sw
witched to M
Mercury Energgy. In fact,
Mercuury Energy successfully
s
attracted maany new custtomers as a result of this offering,
and built
b a markett share of aro
ound 14 perccent. Howeveer, these gain
ns from switcching were
elimin
nated when Mercury
M
Eneergy increasedd its prices in
n 2010 by mo
ore than 4c/kkWh.
Figurre B.2: Estim
mated Gainss from Switcching in Du
unedin (Deltta Network))
Sourcee: MED Quarrterly Survey off Domestic Elecctricity Prices, Electricity
E
Regisstry
Gains from Switching in Taauranga and
d the Impactt of TECT Rebates
R
The PowerCo Tauranga
T
area would aappear on its face to have an incumbent
i
(Trusstpower) thatt prices at a premium
p
to competitors.. However, tthe incumben
nt supplier
in Tauuranga (Trusstpower) is unique in provviding custom
mers with a rrebate.
In th
he PowerCo Tauranga prricing area, Trustpower
T
offers prices that are co
onsistently
3c/kW
Wh higher th
han the cheapest retailer, and more reecently up to
o 5c/kWh hiigher. As a
resultt, savings fro
om switchin
ng using thee approach described
d
in
n Section 2 above are
consistently high – averaging more
m
than $112 million peer year for th
he region, andd reaching
m
in 20009.
$22 million
Howeever, Trustpo
ower custom
mers in the T
Tauranga cityy area (and W
Western Bay of Plenty)
receivve rebates frrom the Tauuranga Energgy Consumerr Trust (TEC
CT). TECT funds this
rebatee from the dividends
d
received from itts 33 percentt ownership of Trustpow
wer. TECT
distrib
butes 80 percent of its income bacck to Trustp
power custom
mers in the PowerCo
Tauraanga pricing area. In the past six yeaars, the annuual rebate perr customer has
h ranged
from around $16 per month to
t more than
n $29 per mo
onth. This meeans that Truustpower’s
Tauraanga custom
mers effectiveely pay a low
wer retail prrice than suuggested by the MED
pricin
ng survey (or the prices lissted on the P
Powerswitch website).
The graph
g
below
w highlights the
t magnitudde of the Trustpower reb
bate in Taurranga. The
solid light blue lin
ne represents Trustpoweer’s quoted price—which
p
h is consisten
ntly higher
than most competitors. The light blue dotted line treats the TECT rebate as a subsidy for
each unit of power purchased by a Trustpower customer. Once the rebate is taken into
account, Trustpower is no longer the most expensive retailer in the area.
Figure B.3: Estimated Gains from Switching in Tauranga (Powerco Network)
Source: MED Quarterly Survey of Domestic Electricity Prices, Electricity Registry
49
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