Confusion at a price

8th October, 2011

The UK energy secretary wants to reform the way suppliers charge customers. But his plans seem unlikely to give a dramatically better deal

Are we living in a confusopoly? You know what I mean: trying to figure out whether it’s cheaper to use one phone company’s “Armadillo Everyday 500” tariff or another’s “Supersava B”, with a special concessionary price for the first 15 minutes of the 25-year contract. (The term confusopoly was, I believe, first coined by Scott Adams, the creator of “Dilbert”.) Chris Huhne, the UK energy secretary, fears the confusopoly in energy prices, and in a speech last month, he announced his plans to do something about it.

Huhne has a point: we know that a well-functioning, competitive market is a good way to get prices down. If such a market is feasible it’s far more likely to deliver good results than regulatory diktats, with all their inevitable loopholes and unintended consequences. Yet if consumers are confused about prices then competition is unlikely to produce such glorious results.

But the story is – surprise, surprise – not quite as simple as Huhne suggested in his conference speech. There are two separate issues here: people feel that it’s a hassle to switch suppliers, and they are uncertain about whether they’d be better off if they did.

The first problem, switching costs, is less serious than it seems. Paul Klemperer, an economics professor at Oxford University, says that switching costs need not be bad for consumers or particularly good for companies. In a market with switching costs, what every company wants is a fat share of captive customers to exploit. But how to acquire those customers? The obvious solution is to offer fantastic deals, attract the suckers, and then gouge them for all they’re worth. (This is why your phone company will happily give you a £500 phone “free”; nobody has yet offered me a free laptop computer.) The early bargains partially – and sometimes fully – compensate for the later price gouging.

Perhaps we should not worry too much, as long as the introductory bargains are generous enough. I wonder what to make of the fact that Huhne has branded them “predatory pricing” and declared that the bargains will stop. I fear it will be hard to implement that policy sensibly. For instance, Michael Waterson of the University of Warwick reckons that a recent effort by the energy regulator to stop some kinds of predatory pricing simply backfired: the deals dried up but lower everyday prices did not materialise.

The second problem, confusion pricing, seems to be the curse of our age. There is certainly reason to worry: I’ve written in this column before about the research of the economists Catherine Waddams Price and Chris Wilson, who studied customers who had overcome whatever switching costs they faced and were determined to find a cheaper electricity supplier. Most people missed the lion’s share of the savings they might have achieved, and a quarter managed to make themselves worse off.

And yet, and yet. Eugenio Miravete of the University of Texas at Austin studies what he calls “foggy pricing” and reckons that competition is a pretty good antidote to the fog: new entrants typically have an incentive to offer simple prices to cut through the confusions, while incumbents do not retaliate by complicating their own offers.

I do sympathise with Huhne’s concerns and am sure he’s on to something. But his reforms seem unlikely to give us a dramatically better deal. According to VaasaETT, a global energy think-tank, energy prices in London are among the lowest of all major European cities. Low energy taxes are part of the reason – something Huhne might want to address if he is as serious as he claims about energy efficiency and climate change. But my casual inspection of VaasaETT’s figures suggests that low taxes do not explain the entire price discount. The confusopoly hasn’t quite got the better of us yet.

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