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The Road to Confusopoly

Professor Joshua Gans University of Melbourne

Confusopoly
• Scott Adams: “a group of companies with similar products who intentionally confuse customers instead of competing on price.” • Examples: telecommunications, insurance, mortgages, credit cards, etc. • But what about energy retailing?

Search Model
• Consider an industry with several producers of an homogenous product • A consumer considering switching suppliers will switch if: Pold + D > Pnew
– where D are switching costs including any disconnection fees

• A consumer will only search for a new supplier if: Prob[Pold + D > Pnew] > S
– where S are search costs

Diamond Paradox
• With many suppliers, why would you expect to get a better deal?
– If all highly competitive, then can’t do better – Only if you think firms will offer you a customer specific deal; but will they?

• According to Diamond (1971): each firm won’t lose many customers by charging a slightly higher price than other firms
– In equilibrium: all charge the monopoly price and no search occurs.

‘Sleepy Incumbent’ Model
• Customers may expect to get a better deal if switching from an incumbent
– Implication: entrant’s should advertise pricing deals – Incumbent may accommodate this by charging higher prices (Guilietti, WaddamsPrice, Waterson, 2005)

• Should see incumbent retailers charge a higher price than entrants in an area

Which Model? Sample of One
• Which model applies in Victoria? Diamond Paradox or Sleepy Incumbent • With this in mind, I decided to revisit my own gas retailing choice in Victoria
– I was aware I had choices – I had never researched options before – I utilised the Essential Services Commission Energy Comparator

Sample of One: which is cheaper?
Component
Supply charge 1st Step

Origin TRU Energy (from bill)
$18.70 per two months $10.26 per month

AGL (w/ GST)
$20.526 per two months

0.946c (0.946c)/MJ for 1st 1.12c (1.042c)/MJ for 1st 1.11991c (1.04192c)/MJ 6000 per two months 3000 per month for 1st 6000 per two months 0.869c (0.781c)/MJ for 0.943c (0.863c)/MJ for next 3000 per two monthsnext 1500 per month 0.94292c (0.86295c)/MJ for next 3000 per two months

2nd Step

3rd Step

0.66c (0.5836c)/MJ for 0.6771c (0.642c)/MJ for 0.67694c (0.64196c)/MJ more than 9000 per two more than 4500 per for more than 9000 per months month two months No disconnection fee or loyalty rebate Disconnection fee of $50- $50 service voucher and $90 and loyalty reward of $30 loyalty rebate per $25-$35 annum

Other

GST and Time Adjust
Component
Supply charge 1st Step

Origin TRU Energy (from bill)
$10.26 per month $10.26 per month

AGL
$10.264 per month

1.12c (1.042c)/MJ for 1st 1.12c (1.042c)/MJ for 1st 1.11991c (1.04192c)/MJ 3000 per month 3000 per month for 1st 3000 per month 0.943c (0.863c)/MJ for next 1500 per month 0.943c (0.863c)/MJ for next 1500 per month 0.94292c (0.86295c)/MJ for next 1500 per month

2nd Step

3rd Step

0.6771c (0.642c)/MJ for 0.6771c (0.642c)/MJ for 0.67694c (0.64196c)/MJ more than 4500 per more than 4500 per for more than 4500 per month month month No disconnection fee or loyalty rebate Disconnection fee of $50- $50 service voucher and $90 and loyalty reward of $30 loyalty rebate per $25-$35 annum

Other

Compare with Cap
Component Origin (w/ GST)
Supply charge 1st Step $20.53 per two months

Cap (w/ GST)
$20.53 per two months

1.12c (1.042c)/MJ for 1.12c (1.042c)/MJ for 1st 6000 per two 1st 6000 per two months months 0.943c (0.863c)/MJ for 0.943c (0.863c)/MJ for next 3000 per two next 3000 per two months months 0.6771c (0.642c)/MJ for more than 9000 per two months 0.6771c (0.642c)/MJ for more than 9000 per two months

2nd Step

3rd Step

Total Saving = $22.64; S = 3 hours
Component Origin Origin (new offer) (from bill)
Supply charge 1st Step $20.53 per two months $10.26 per month 1.098c (1.021c)/MJ for 1.12c (1.042c)/MJ for 1st 6000 per two 1st 3000 per month months 0.924c (0.846c)/MJ for 0.943c (0.863c)/MJ for next 3000 per two next 1500 per month months 0.664c (0.629c)/MJ for 0.6771c (0.642c)/MJ more than 9000 per for more than 4500 two months per month No disconnection fee No disconnection fee or loyalty rebate or loyalty rebate

2nd Step

3rd Step

Other

Periodicity
• TRU Energy and Origin not equivalent
– One month versus two months

• Example: April-May
– Suppose my demand is 4000 (April), 8000 (May) – TRU Energy: pay total of $127.19 – Origin Energy: pay total of $128.20

• Origin potentially has a weaker price cap than TRU energy

Victorian Gas Demand
Gas Demand 35000000

Areas of Bimonthly Variation

30000000

25000000

20000000

Gas Dema 15000000

10000000

5000000

0 Jan-04 Feb-04 Mar-04 Apr-04 May04 Jun-04 Jul-04 Aug-04 Sep-04 Oct-04 Nov-04 Dec-04

Summary
• Difficult to compare price offers
– Prices are the same but ‘shorter period’ yields a lower overall bill; need information on month by month demand to work this out.

• Prices still at the cap
– Whether asking to switch or a new connection

• 2% discount available if ask • ‘Diamond Paradox’ (rather than ‘Sleepy Incumbent’ model) alive and well in Victoria Would we have been better off keeping a single incumbent and inviting entry (as per telcos)?

Behavioural Economics
• New economic approaches for dealing with consumer irrationality • Basic idea:
– When faced with an upfront cost and future options, consumers with over-weight option value and spend too much upfront – When faced with an upfront benefits and future avoidable costs, consumers will underweight ability avoid costs and spend too little upfront

Implications for Switching
• Consumers will under-weight importance of disconnection fees • Consumers will under-weight ability to opt out of automated payments to switch in the future • Consumers will under-weight future switching costs • Consumers will fail to invest in information to make choices transparent
– And firms will not have an incentive to provide transparency as consumers will demand more upfront to compensate for switching costs later on.

Policy Responses?
• Likelihood of consumer choice providing a locus for effective competition is bleak
– Energy retailing looks like a confusopoly

• Would a regulated pricing structure that forced simplicity and transparency be better? • Would a consumer choice regime that required a choice be effective?
– E.g., an audit of individual choices or an annual auction for customers?