Goldilocks and the Three Bears


Goldilocks and the Three Bears works as a story. Goldilocks and the Thousand Bears wouldn’t work and neither would Goldilocks and the Bear. This is why, counter-intuitively, the proposed legislation for each energy supplier to have a single domestic tariff might be a good thing by making it easier to choose which supplier is just right.

With winter approaching, October seems to be the time when politicians’ thoughts turn to the price of energy. The Prime Minister, to some surprise (not least from ministers in the relevant department), announced in Parliament that:

We have encouraged people to switch, which is one of the best ways to get energy bills down. I can announce that we will be legislating so that energy companies have to give the lowest tariff to their customers – something that Labour did not do in 13 years, even though the leader of the Labour party could have done it because he had the job.

This looks like a strange policy from a Party and government which notionally is or ought to be in favour of competition. A sign of how strange can be seen in the unlikely support it has received from the influential and controversial “tax expert” Richard Murphy, here. However, it actually is somewhat less surprising than it sounds because it is implicit in Ofgem’s proposal last year for a budget tariff with a low fixed charge and single usage tariff for each supplier.

What the proposal isn’t, contrary to the Murphys of this world, is a retreat from the idea of choice and competition as a good thing.

What’s the problem?

Forcing all energy companies to give all customers their lowest tariff looks like it would save everyone who was already on a higher tariff some money. It wouldn’t save everyone money because realistically the energy companies would take the opportunity to get rid of any especially cheap deals they might have so the customers who had managed to get those would ironically find themselves paying more. This all sounds good for most people though.

However, the problem really comes when thinking about what happens next. The effect of requiring energy companies to give all customers their lowest tariff would be to remove any ability or need to have more than a single tariff (I assume that the obligation would be limited to domestic customers – the differences in usage between different sizes of business would surely justify differential tariffs for commercial customers). This would remove the prospect for any attempts to compete other than purely on price or even to design tariffs around different usage patterns.

That might be a merely hypothetical loss given the low level of switching that actually occurs and the complexity of price comparison being one of the reasons commonly given for such limited competitive response to high prices by either customers or suppliers.

More seriously, the risk would be that the existence of a single domestic tariff for each supplier would lead to there being even less downward competitive pressure on prices than there currently is. This would be because it would be too easy for suppilers to see exactly what competitors were definitely charging their customers and being able to set their prices accordingly. There is already a strong suspicion that this occurs now (hence all the allegations of there being a cartel – there’s no particular evidence of a cartel, just the price following that would be expected from a transparent market where undelying input costs are commonly known). But, now suppliers still need to make assumptions about which tariffs of their competitors are the ones which customers are actually on and which tariffs would be available to those who sought to switch away from them. That level of guesswork would be taken out of a system where each supplier had a single price*.

In such a transparent system, there would be no incentive for anyone, even a new entrant, to set their prices lower than the norm because they would know that they would only find themselves being undercut temporarily until they stopped doing so. The bigger energy companies which could afford to price below cost because of being vertically integrated with electricity generation/gas exploration and supply businesses would be in too strong a position to retaliate. Preventing this from happening would be difficult (it would involve a particularly knotty allegation of abuse of a collectively dominant position by a non-cartel).

So, there is a risk (or if you are Richard Murphy, an opportunity) that prices will tend towards an equlibrium point so that there would be little difference between suppliers and so no choices to be made and no competition.

If that happens, why not just nationalise the lot and do away with the charade of competition? Goldilocks and the Bear.

Or is it?

This gloomy look at the scope for competition after moving to a single tariff relies on the underlying costs for each supplier being sufficiently similar that there would be no scope for any to achieve cost savings or take substantially different margins on their retail prices. If that assumption is true, then there would be little scope for suppliers to do anything much other than gravitate towards a uniform price. It might be true to an extent in that the input costs of fuel and environmental levies will be uniform across the industry, but there may be ways of mitigating these costs or making savings elsewhere.

Even if prices do eventually find an equilibrium, there will still be a need for each of the suppliers to attempt to grow its business or at least to defend against loss of customers. With increased transparency from the move to a single tariff, switching suppliers would become a much easier decision so small tweaks of price might have more effect in getting customers to move than they do now.

Rather than reducing choice and competition, the proposal might increase the actual amount of choosing by making the parameters of the choices clearer to consumers. If customers would actually be making choices or it would be dangerous for suppliers to believe that they won’t, the effectiveness of competition to keep prices at the right level would be much greater.

Commodity markets tend to have high levels of price competition even though they are very price transparent and have little scope for other forms of differentiation. Moving to a pricing structure that makes a reality of switching even for the least engaged consumer so that all suppliers are continually jockeying for position would be exactly where competition law and theory would want things to end up.

Just because you can have too much of a good thing doesn’t mean you shouldn’t have any of it

If the problem today is that there are too many tariffs to make price comparison easy or attractive enough to generate sufficient competitive pressure on pricing, the move to a single domestic tariff for each supplier would be a good one. It doesn’t mean that choice is bad – removing choice and mandating a single tariff for all suppliers would almost inevitably involve setting it at the wrong level. Either that level will be too high and extract too much from customers, giving too much profit to suppliers, or it will be too low and make it impossible for suppliers to sustain supplies so that customers end up dealing with the resulting brown out and subsequently raised prices. Finding the “goldilocks zone” is something which competition is uniquely good at doing – not too high and not too low.

But, as the tale of Goldilocks shows for choice to be a useful mechanism, it has to be limited enough to be manageable. If the story had been entitled Goldilocks and the Thousand Bears, who would have blamed Goldilocks if she’d turned round and walked out of the door before trying the first bowl of porridge? Had it been Goldilocks and the Bear, it wouldn’t have been much fun if the Bear in question had been either Mummy Bear or Daddy Bear.

Update

*Ofgem has published its proposals for consultation in relation to energy pricing. Briefly they can be summarised as “Goldilocks and the Fifty Shade of Bear” – a reduction to a cap of 4 different tariffs per operator, an obligation to print on bills where there is a cheaper tariff offered than the one being taken and automatic transfer out from dead tariffs (ie ones which are no longer supplied to new customers and which are more expensive than the best deal). Ofgem is not recommending automatic switching to the best tariff a supplier offers, just providing information about it.

One of the proposals is that the “information about cheapest tariff” could extend to providing information about better tariffs offered by competing suppliers. This is possibly the worst idea Ofgem could have. It would formalise information sharing on pricing between competing suppliers so as to create a cartel even if there isn’t one already in place. For the obligation to be effective suppliers would have to tell each other their best deals on an ongoing basis.

The combined effect of the proposals looks to me like the worst of all worlds – retaining complexity in pricing (albeit somewhat less than current levels but with a compliance cost for suppliers) and formalising a cartel leading to a single best price (or maybe 4 best prices for the different tariff types).

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