Bright idea that may end up costing more

24th November, 2012

‘Under measures put forward by Ed Davey, the energy secretary, power companies will be limited to just four main tariffs per fuel type and will have to put customers on the cheapest price available for the tariff type they choose.’

Financial Times, November 21

Will this reduce my electricity bill?

Probably, but only if the prices of inputs such as coal and gas do not rise. And it may not reduce your bill for the reason that you think.

But if companies are forced to put me on their cheapest deal, I’m going to get a better price, aren’t I?

Not necessarily. Some deals are only offered because companies know the majority of customers won’t take them up. Starbucks, for example, has long offered a “short” cappuccino without listing it on its menu. It’s a less expensive drink, enjoyed by that rare intersection of people who know about coffee yet visit Starbucks. If the company was forced to advertise this secret cappuccino, it might not offer the product at all. It’s the same with utility groups, phone companies and banks: a keenly-priced product designed to win over the cognoscenti might vanish if the company was forced to sign everyone up for it.

So you think the “lowest tariff” rule is a bad idea?

I am genuinely not sure whether it will lower prices or not. I am quite sure it will be a crowd pleaser. My phone provider, Orange, has been reassuring me for years that I was on the cheapest tariff available given my pattern of usage. When I called them recently to ask why the phone bill was so damn high, they promptly informed me that I could be on a tariff at one-third of the cost.

How did they square that circle?

More of a loophole than a circle, I should say. The sales assistant sounded delighted with himself. If Mr Davey could also make that sort of thing a flogging offence, I’d be overjoyed, even if it doesn’t lower average prices – which it may well not.

Although it suggests that companies are good at finding loopholes.

They are. There are always cashback deals, loyalty cards, “sign up, get free loft insulation” and all the rest.

But you still seem to think that prices will fall?

Probably. If prices are easier to understand then competitive pressures should be more intense. Companies may try to target the same margins as before but they might fail, if customers see who’s offering the best deals.

And they can’t figure out the best deals now?

Indeed not. A few years ago, the economists Chris Wilson and Catherine Waddams Price studied 250 customers trying to switch electricity suppliers with the aim of securing a better deal. A quarter of them made themselves worse off, and the majority failed to spot the best deal. (One genius had the option of saving £150 a year but managed to make himself worse off than if he hadn’t switched.) Ofgem, the energy regulator, recently reached a similar conclusion. So there is good reason to believe energy markets would work better if things were simpler.

Will four price tariffs still be too complex? Or, alternatively, too crude to accommodate genuine business reasons for price variations?

The economist Eugenio Miravete once studied the behaviour of customers faced with a choice of two tariffs and a single phone provider, and concluded customers were usually successful at finding the best deal. I suspect four price tariffs will be more tricky, especially when multiplied by the number of companies: customers will still have to ponder 15 or 20 different possibilities. And there’s another problem: we don’t understand our energy usage patterns. Even if our chosen company puts us on its most appropriate deal, it will be hard to figure out whether we should switch providers.

Is there an alternative?

The behavioural economist Richard Thaler has been advocating a system of “smart disclosure”, whereby energy companies would have to supply users with a computer file of their recent usage in a standard format. Customers could then upload that file to a price-comparison website and be told which company would offer the best price given their own energy patterns.

Couldn’t we just have computerised smart meters that constantly seek out the best deal?

I suspect that day is not far off. There is a catch, though: the easier customers find it to seek out the very cheapest price, the more quickly energy companies will find out that they’re being outcompeted, and the easier they will find it to raise prices in a cosy tacit cartel. Not all markets work well.

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