5 August 2014
11 Chews Lane
PO Box 10568
The Terrace
Wellington 6143
New Zealand
Craig Evans
Genesis Energy Limited
Electricity Authority
Fax: 04 495 6363
WELLINGTON
By email: [email protected]
Dear Craig
Genesis Energy submission on saves and win-backs
Genesis Energy strongly opposes the Authority’s proposed Code change to
remove retailers’ ability to contact customers prior to switching being confirmed
(“saves”), and to restrict retailers’ ability to contact customers after they switch
away (“win-backs”).1
A consumer’s right to choose their retailer is a fundamental principle of New
Zealand’s competitive retail electricity market. The Authority’s proposal restricts
this right by limiting customers’ access to information that can help them make
better, more informed, decisions. Any intervention that limits consumer choice
needs to target a clear market failure, and should be carefully assessed to ensure
that it will improve outcomes. The cost-benefit analysis in the Authority’s
consultation paper does not clear this hurdle because it fails to identify or
quantify the full range of impacts that are likely to result from the proposed
restrictions.
In addition to the proposal infringing on a fundamental consumer right, we
consider that:
•
1
There is no evidence of a problem with the current retail market that is
caused by saves and win-backs. Retail competition remains strong –
evidenced by record levels of switching – and the market remains
attractive to new entrants.
Proposed Code Amendment – saves and early win-backs, 24 June 2014 (“proposed Code change”)
LE-SU14-048
•
The intervention proposed in the paper will negatively affect the quality of
competing offers made to customers. The Authority ignores the fact that
the behaviour of competing retailers is likely to change if they no longer
face any competitive threat from the current retailer – leading to higher
margins for competing retailers, but worse outcomes for consumers.
•
The proposed change removes an important source of discipline on
competing retail offers, while at the same time providing a valuable
source of information on competitive conditions. Without saves and winbacks, more switches that are predicated on incorrect or misleading
information will go unchecked.
We discuss each of these concerns in more detail below.
Consumer choice is fundamental to the New Zealand electricity market and
restricting this choice must not be done lightly
Consumer choice is fundamental to the New Zealand retail electricity market
It is a commonly accepted amongst market economists that, in the absence of
clear market failures, maximising consumer choice is expected to maximise
welfare. This stems from the well-known principle of consumer sovereignty,2 that
is, consumers can best maximise their utility by being able to select from a range
of options according to their individual preferences. In this market setting,
retailers or producers succeed or fail based on their ability to satisfy these
consumer preferences.
New Zealand has fully embraced the principle of consumer sovereignty
throughout its electricity market reforms. Electricity retailers compete for
customers across different geographic areas, offering different products and
prices in an attempt to best serve customer demands. Empowering consumers to
choose between competing retailer offers is at the core of the market reforms of
the last twenty years.
Given the importance of consumer choice to maximising welfare, the
circumstances when it makes sense to limit choice are very rare. The main
market failures that have been used in other markets and countries to justify such
regulatory interventions are information problems (customers are unable to make
good decisions) and market power (competing suppliers are unable to succeed
due to the actions of a single dominant player).
2
Lerner, Abba P. "The economics and politics of consumer sovereignty." The American Economic Review (1972): 258266.
2
Submission on proposed Code change “saves and early win-backs”
Even where these market failures are found, there are a number of high-profile
cases where regulators have lost sight of the negative effects of limiting
consumer choice.3 For example, a recent US study identified that regulations to
restrict the availability of energy products to improve energy efficiency actually
reduced welfare.4 New Zealand’s experience restricting consumers’ ability to
choose different light bulbs provides a similar example.
Restricting consumer choice should not be done lightly – it requires a high burden
of proof
In order to show that this proposed Code change would provide a net benefit, the
Authority must show that the costs of restricting consumer choice are
outweighed by the benefits of removing the supposed market failure. A closer
examination of situations where such interventions have been applied (such as in
the Canadian telecommunication sectors), reveals that a high burden of proof is
required for this threshold. In all of the cases cited in the Authority’s paper, the
intervention was to effectively open up the historical monopoly position of a
dominant service provider. In such circumstances, the regulators decided that the
cost of imposing this restriction on consumer choice was outweighed by the
benefit of promoting new entrants into an uncompetitive market.
However, the benefit of such an intervention will decrease over time as the
incumbent market dominance is reduced to levels more conducive to genuine
competition. This effectively means that any perceived benefits of limiting the
exercise of market power will be outweighed by the costs of restricting
consumers’ choice to be offered a better deal by the incumbent. This is borne out
by the Canadian example cited by the Authority, where the regulator reversed the
restriction on saves and win-backs once the former dominant retailer market
share was reduced to 70%.5
The Authority’s paper also lists a number of markets, both nationally and
internationally, that have this type of restriction in place. Equally, there are a
significant range of highly regulated services that do not have such a restriction.
But it is also worth considering these service markets against a similar
benchmark to which we hold the electricity retail market. For example, the
banking sector has no restriction on “saves”, yet has a much lower switching
rate (10.8 per cent in 2012), and a much lower rate of entry by new retailers
3
4
5
Stephen G. Breyer in “Breaking the Vicious Circle: Toward Effective Risk Regulation” Cambridge, MA: Harvard
University Press, 1993: 11–19.
Gayer, Ted, and W. Kip Viscusi. "Overriding consumer preferences with energy regulations." Journal of Regulatory
Economics 43.3 (2013): 248-264
http://www.crtc.gc.ca/eng/archive/2007/pb2007-111.htm
3
Submission on proposed Code change “saves and early win-backs”
(five6 in the last five years versus seventeen7 in the electricity market over the
same period).
The Authority’s proposal will reduce consumer choice
As identified by the Authority in the Improving transparency of consumers'
electricity charges Consultation paper (dated June 2014), ensuring that
consumers have sufficient access to information to make good decisions about
their retailer will lead to a better market outcome – notably “improved retail
competition”. In particular the Authority notes:
The availability of information that enables a consumer to understand whether they
are on the right plan for them (taking into account price, service levels etc.) is likely to
be an important factor in a consumer’s switching decision. The time and effort
required to obtain and understand information about the potential savings specific to
the consumer, and make comparisons across retailers, will influence the switching
decision. In relation to transparency of consumers’ electricity charges, a relevant
factor is whether retailers provide price information (including changes) in a way that
minimises search costs.
8
The Authority’s proposal will remove incumbents’ ability to provide information to
consumers following a decision to switch. It does this in two ways:
•
First, by restricting the ability of an incumbent retailer from contacting the
customer prior to switching being confirmed; and
•
Secondly, by restricting the ability of a losing retailer contacting an excustomer prior to 10 working days after that customer has switched. The
paper describes this as a restriction on early win-backs.
This will limit the information that is available to consumers immediately after they
have made a decision to change retailers. We discuss the costs of this restriction
on consumer welfare in more detail below, but fundamentally, consumers will not
be provided with any additional information about whether the new plan is, in fact,
“the right plan for them”, or whether they could actually be better off if they
receive the right incentive to stay with their current retailer.
6 https://www.rbnz.govt.nz/regulation_and_supervision/banks/register/
7
https://www.ea.govt.nz/operations/industry-participants/participant-register/
8
4
Page 8, “Improving transparency of consumers' electricity charges” Consultation Paper
Submission on proposed Code change “saves and early win-backs”
There is no justification for such a fundamental intervention
New Zealand’s electricity retail market shows none of the hallmarks of a
monopolistic market. The Authority’s own statistics show a vibrant competitive
market that has actually attracted new entrants over the last years. As noted
previously in our submission on the retail data project issues paper9, there is a
wealth of market information that supports the assertion of a healthy competitive
retail market in New Zealand, namely:
•
The highest switching rate in the world;10
•
The Authority’s own Herfidahl-Hirschman Index statistics identifying
consistent declines in market concentration. Retail electricity markets
throughout New Zealand have lower levels of concentration than
observed in other international jurisdictions;
•
The Authority’s analysis that $190 million of costs have been absorbed
by retailers since late 2010.11 This indicates retail competition is inhibiting
the ability of retailers to pass through increased costs to customers.
•
The entrance of four new retailers into the retail market in the last 12
months. This is a sign of healthy opportunities to add value and
innovation into the retail market, and of low barriers to entry.
Competition to attract and retain customers is fierce. This is clearly evident in the
net switching behaviour recorded by the Authority over the last two years. Figure
1 below highlights the net switching behaviour for the last six months. In fact, it
appears that smaller retailers have been more successful over the last six months
at increasing their net retail share than larger, “incumbent”, retail brands. A
similar trend can be observed for the preceding six months of July to December
2013.
9
Genesis Energy submission on the retail data project dated 11 March 2014
10
http://www.utilitycustomerswitching.eu/424/
11
http://ar2013.publications.ea.govt.nz/Retail+market+becomes+more+competitive/Retail+market+performance+price+a
nalysis
5
Submission on proposed Code change “saves and early win-backs”
Figure 1: Net switching activity January to June 2014
Nor is there any evidence of the exercise of market power in the retail electricity
market. The largest (incumbent) retailer in every part of the country is losing
market share. Any advantages that incumbent retailers might have enjoyed relate
to their specific location, but are being altered through a number of Authority
initiatives – such as expansion of the current FTR market. These solutions target
potential issues more precisely and with less risk of unintended consequences
than the current proposed Code change.
The costs of the intervention will be high,
high, particularly for consumers
Genesis Energy considers that the cost of the proposed Code change will be
high for consumers. This is because the restriction will encourage a drop in
quality of new retailer offers
Save and win back calls provide value to customers
As identified by the Authority’s own customer questionnaire, there are a variety
of reasons why customers choose to stay with an incumbent retailer after an
initial decision to switch. Figure 2 below sets out the different reasons that our
customers give for choosing to stay with Genesis Energy, rather than completing
a switch to a new retailer.
Saves and win-backs provide discipline on the quality of competing retail offers
The Authority does not acknowledge that the proposed restrictions on saves and
win-backs will change the way that competing offers are structured. We see this
as a major oversight in the consultation paper. Competing retailers currently face
the threat that the current retailer will make a counter-offer in an effort to retain
6
Submission on proposed Code change “saves and early win-backs”
their customers—and competing retailers need to structure their offers to protect
themselves against that competitive response.
If saves and win-backs are “taken off the table” by regulation, then we expect
competing retailers to make less competitive offers and increase their margins on
every customer acquired. This means that restricting the ability of current
retailers to counter-offer will increase the prices offered by competing retailers,
which would not be in the interest of consumers.
We have tested this concern by investigating retailer pricing behavior in two
recent events or “shocks” that may have changed the perceptions of competing
retailers. As a natural experiment, we compare the prices observed after those
shocks with the prices seen in other “control” areas over the same time period.
The two events where we consider competing retailers may have felt less
pressure from saves and win-back strategies are in:
•
Christchurch after 2011. Following the sale of Tekapo A and B on 1 June
2011, the incumbent retailer (Meridian) was widely known to be less
interested in retaining customers given its need to rebalance its retail
load away from the South Island (due to both the Tekapo sale and the
virtual asset swaps that took effect on 1 January 2011).
•
Dunedin after 2011. The incumbent retailer (Contact Energy) faced a
significant and widely publicised backlash after raising its director fees at
the same time as increasing retail electricity prices. As a result,
competing retailers would have been more confident (at least for a period
of time following the price increase) that any attempt on the part of the
incumbent to retain its customers would be unsuccessful because the
reason for leaving was a matter of principle.
We have selected control cases for these natural experiments that have similar
sized populations. Our control cases are all in the North Island, to ensure that
they are not as directly impacted by the same events (particularly the Tekapo
asset purchase).12 In the control cases, saves and win-back strategies would
have provided greater pressure on competitors to constrain their pricing.
The results of this analysis are shown in the figure below—which presents the
rate of change in the prices offered by the incumbent retailer and new entrants. In
both event cases (highlighted pale blue), incumbents decrease their rate of price
12
We have also attempted to use controls where the incumbents have a similar market share but as it is not possible to
match perfectly across these different characteristics, we prioritise these other factors and report three separate control
cases. A list of networks against the various factors is provided in Appendix A.
7
Submission on proposed Code change “saves and early win-backs”
increases following the event. However, over the same time period, on average
new entrants increase their rate of price increases. In contrast, in each of the
control cases, the rate of new entrant price changes either decreases, or is not
significantly different between these periods.
Figure 2: Price changes surrounding events limiting saves and winwin-backs
compared with control cases
Events
Controls
Christchurch
Dunedin
Wellington
Hamilton
Kapiti
Average New
Average New
Average New
Average New
Average New
Incumbent
Incumbent
Incumbent
Incumbent
Incumbent
Entrants
Entrants
Entrants
Entrants
Entrants
1.66%
5.68%
2.54%
4.48%
4.54%
4.50%
6.43%
4.76%
4.82%
Before 4.34%
3.58%
7.35%
-3.63%
3.42%
3.82%
4.73%
4.40%
4.43%
-0.08%
2.38%
After
For both event cases, the number of saves significantly decreases following the
events compared with prior save activity. This is despite the incumbent
significantly reducing its prices following the event in the case of Dunedin.
Whereas there is no clear pattern in the saves activity on the control networks
(any reduction appears to be followed by recoveries in save numbers).
This analysis suggests that saves and win-backs play an important role in
disciplining competing retailer offers. Similar rates of price increase observed in
Christchurch and Dunedin after 2011 should therefore be expected from all
competing retailers across New Zealand if the Authority’s proposal is introduced.
This is because restricting saves and win-backs shifts the relative focus of
growing retailers from customer acquisition to margin growth.
This outcome results from customer acquisition strategies targeting a particular
rate of return. The return comes from the number of customers that can be
acquired multiplied by the margin earned from each customer. If incumbent
retailers are able to respond to competing offers (as they are at present), then
competing retailers need to make their offer as attractive as possible to gain a
sufficient number of customers—these customers will be at a lower margin per
customer. This dynamic is in the interest of consumers. However, if competing
retailers are protected from a competitive response, then it will be profit
maximising for competing retailers to increase their margins per customer
because doing so is unlikely to significantly decrease the number of customers
they acquire.
Change in incumbent retailer behavior
The cost of acquiring a customer is not only borne by new entrant retailers. For
larger retailers, these costs are also very significant. Acquisition costs are borne
8
Submission on proposed Code change “saves and early win-backs”
on the assumption that customers will likely remain with the gaining retailer for a
nominal period – usually assumed to be beyond the point that the retailer has
broken even (whereby the acquisition costs have been recovered over time).
Prior to this point, the acquisition of this customer by a competing retailer will be
a significant risk, as it will equate to a net loss on the acquisition investment.
Retailers are well aware of the risk of losing customers and their ability to break
even. There are various ways of mitigating this risk, including being able to save a
customer if they are tempted away early; a fixed retail contract period; or
penalties for customers who switch before the end of an agreed period (usually
two years).
We urge the Authority not to underestimate the retailer benefit of being able to
save a customer. Saving is a more flexible response to switching risk than a
contractual option. This flexibility has benefits for both the customer and the
retailer. For the customer it enables negotiation of a better price with their current
retailer – for the retailer it avoids the cost of reviewing existing contracts.
Importantly, without the ability to save a customer, retailers will have to rely upon
other options for mitigating this loss, including increasing the use of set
contractual periods or penalty provisions for new retail offers.
The benefits are minimal and there is no clear way for them to be transferred to
consumers
In our view, the proposed change will not favour true new entrant retailers who
are likely to bring innovation to the market. Rather, it will benefit those retailers
who are looking to grow their existing market position.
Aside from being able to increase the margins they earn on new customers, the
benefit to retailers is actually relatively small. When re-examining the costing
used to justify the proposed Code change,13 our analysis is that retail campaigns
are still profitable with saves included. This is unsurprising, given the anecdotal
evidence that most retailers continue to run new acquisition campaigns and the
switching statistics that show these campaigns result in customer acquisitions.
13
9
Page 13 of the proposed Code change
Submission on proposed Code change “saves and early win-backs”
Campaigns are still profitable with saves
As established above, the threat of a save provides significant value to
consumers. In addition, we show that removing saves does not affect whether an
acquisition campaign is profitable or not, but may provide marginal value to the
acquiring retailer.
The proposed Code change suggests that saves make acquisition campaigns for
small retailers unprofitable. Genesis Energy considers that this hypothesis, and
particularly the worked example used to quantify this hypothesis, is flawed for
two reasons:
•
The scenarios are planned based on a ‘customers approached’ volume
which is unreliable for the purpose of this working. Cost per approach is
variable depending on channel. For example; we pay for clicks on paid
search, but we have never paid for ‘approaches’ in door to door, kiosks
or telesales as this will incentivise our agents or staff to focus on
approaches, rather than actual sales; and
•
Real campaign cost metrics are based on cost per acquisition based on
net sales. Net sales are the volume of sales once the cancellations have
been applied. Genesis Energy expects 10 to 15 per cent of its gross
sales to be cancellations. Cancellations include customers who change
their mind for any reason, including having been won back by their current
retailer. We understand from acquisition service providers that most (if
not all) retailers apply this approach via contractual claw back
mechanisms.
Using the same base figures from the proposed Code change paper, we have
reworked a truer reflection of how a campaign acquiring 250 customers would
stack up with a 20 per cent cancellation rate. But our model is based on a more
realistic cost per acquisition basis. This means that, even with ‘cherry picking’,
the campaign is still profitable.
10
Submission on proposed Code change “saves and early win-backs”
Figure 3: Effect of saves on the profitability of acquisition activity
No Saves
Customers approached
Conversion to new
customers
Number of customers
acquired
Cancellations (save rate)
Net number of new
customers acq
acquired
cquired
Cost per acquisition
Cost of campaign
Average time which
customers are retained
Average margin
Total value of new
customers
Campaign profitability
Saves Allowed
With Cherry
Picking
5,000
5,000
5,000
20%
20%
20%
250
250
250
0%
20%
20%
250
200
200
$250
$250
$250
$62,500
$50,000
$50,000
4 years
4 years
4 years
$150
$150
$120
$150,000
$120,000
$96,000
$87,500
$70,000
$46,000
The benefit to the acquiring retailer of restricting consumer choice equates to as
little as $17,500. But this net benefit is still based on the assumption of a 20%
save rate by the incumbent retailer. As identified in Error! Reference source not
found.,
found. such a significant cancellation or save rate is not guaranteed across all
retailers and across all campaigns.
An optional restriction is not viable
We do not consider that enabling retailers to choose whether or not the
restriction applies to their customers is a legitimate option. The Authority must
consider any restriction option as mandatory for all retailers. This is because:
11
•
The Authority must take responsibility for imposing
imposing such a fundamental
restriction on consumers. The proposal is an intervention that, in our
view, is likely to impose significant costs on consumers. If the Authority
considers that restricting saves and early win-backs is justified, then it is
a decision that they must make for all consumers. The Authority should
not delegate this choice to retailers on their consumers’ behalf.
•
Under an optional approach, all retailers will be forced to optopt-in.
in. Over
time, we suggest that retailers will be forced to opt-in to the restriction.
Retailers who are looking to grow their retail base will naturally opt-in, as
Submission on proposed Code change “saves and early win-backs”
it enables greater margins on both their new customer offers and some
small savings in marketing costs. Large incumbents may resist opting in
initially, but the cost of maintaining two different marketing approaches
(depending upon the retailer) will mean that, over time, such retailers will
also opt-in so that they can too enjoy the same benefits as growth
focused retailers.
Recommendation: reject proposed Code change
Genesis Energy strongly recommends that the Authority does not proceed with
the proposed Code change. For the reasons outlined above, Genesis Energy
considers that the proposed Code change does not produce net benefits
If you have any questions with this submission please contact me on 04 495
3340.
Yours sincerely
Jeremy Stevenson-Wright
Regulatory Affairs Manager
12
Submission on proposed Code change “saves and early win-backs”
Appendix A: Full set of pricing tables
Figure 4: Price changes surrounding the event for Christchurch
Year
2009
2010
2011
2012
2013
Orion - Annual Rate of Price Change
Incumbent
New Entrants
Meridian
Genesis
Mercury
6.17%
-8.56%
2.50%
-6.01%
5.79%
5.46%
2.49%
2.80%
-0.02%
13.15%
10.53%
-0.02%
24.12%
0.00%
Powershop
15.40%
4.27%
10.37%
3.74%
Figure 5: Price changes surrounding the event for Dunedin
Dunedin - Annual Rate of Price Change
Incumbent
New Entrants
Year
Contact
Genesis
Mercury
-0.40%
-1.11%
-1.42%
2009
11.76%
-5.26%
8.07%
2010
2011
2012
2013
-13.33%
2.46%
-0.03%
-0.01%
13.06%
0.00%
3.36%
5.07%
1.14%
Powershop
12.40%
2.48%
4.96%
0.70%
LE-SU14-048
Figure 6: Price changes surrounding the event for Wellington
Wellington - Annual Price Change
Incumbent
New Entrants
Year
Genesis
Energy Online
Mercury
3.11%
8.33%
4.66%
2009
5.85%
3.93%
2.55%
2010
2011
2012
2013
1.28%
6.36%
3.82%
0.01%
9.51%
5.89%
0.00%
10.77%
1.43%
Figure 7: Price changes surrounding the event for Hamilton
WEL - Annual Price Change
Incumbent
New Entrants
Year
Genesis
Nova Energy Powershop
3.97%
2009
5.03%
2.24%
10.63%
2010
2011
2012
2013
3.77%
5.04%
4.39%
-0.02%
7.94%
3.07%
3.77%
4.75%
7.08%
Figure 8: Price changes surrounding the event for Kapiti
Electra - Annual Rate of Price Change
Incumbent
New Entrants
Year
Contact
Mercury
TrustPower
-0.39%
-3.84%
2009
9.92%
9.93%
8.37%
2010
2011
2012
2013
2
-7.49%
2.87%
4.38%
4.35%
5.25%
4.48%
-6.58%
6.79%
0.00%
Submission on proposed Code change “saves and early win-backs”
Powershop
3.24%
3.25%
6.45%
5.25%