Making markets murky.
This recent article in the Guardian got me thinking about how much I don’t like markets where hardware is subsidized by long-term, locked-in service contracts. The most ubiquitous of these are those for mobile telephony, cable/satellite television and (to a lesser extent as the necessary hardware is cheaper…) broadband internet access. Now it looks to be coming to power markets with the introduction of ‘smart metering‘:
Householders switching power companies face having to sign broadband-style contracts from today after the energy regulator told the power companies they can now force customers to sign long-term agreements.
Ofgem yesterday said it was removing the rule that ties a customer to an energy supplier for just four weeks. Industry observers immediately expressed concern the move will allow the big six companies to impose year-long minimum contracts and financial penalties for getting out early – typical conditions that apply in the mobile phone and broadband markets.
Ofgem said it had removed the restriction to encourage the power firms to introduce energy efficiency measures and smart meters in their customers’ homes. So far, the power firms have been reluctant to install energy-efficient boilers or loft insulation because there was nothing to stop the customer switching to a rival after the work was carried out.
The scrapping of the 28-day rule will allow companies to make such improvements, Ofgem said. In return firms will be able to demand the customer signs a long-term supplier deal. “We see this as a very positive thing for consumers,” said an Ofgem spokesman. “We consulted widely on this issue and all the interested parties have agreed that its removal will stimulate future investment in energy efficiency measures.”
I understand why this kind of pricing policy is so seductive to most consumers – it is a variation of the classic installment plan and basically exploits the fact that the vast majority of people either don’t understand or fail to apply the principals of net present value in assessing the cost of the goods and services they purchase. (The same lack of financial literacy drives many to borrow long term on credit cards at close to 20+%, when even the weakest could probably borrow at unsecured rates of 10-12% through specialist non-prime providers.) It’s not a question of cash flow – although I suppose many would use this as an argument (in favour of subsidized hardware) along the lines of: “yes I know the long term costs will be higher but I just can’t afford £300 up front for a phone/cable box/smart meter/etc.” Well, yes that is certainly true but you would be better off borrowing the £300 to finance your capital investment, as the implicit financing costs built in to the ‘lock-in’ model are probably north of 30%(!) I think the problem is that most people don’t think of these purchases as capital investment, not that (they think) this type of purchase financing is the optimal structure. If it were or deemed so, we’d see cars given away by BP in exchange for a long term commitment to buy petrol (gasoline) from BP at above market rates. Or maybe they could team up with Norwich Union and offer a package…
I would like to see (especially in regulated markets where there is particular risks of collusion and/or significant barriers to new entrants – ie telecoms, energy, satellite tv, etc.) providers be required to offer unbundled packages and/or where relevant unlocked hardware. Let the customer decide. It may well be that consumer ignorance or apathy would mean that there would be few takers but at the very least it would drive further transparency into the embedded (and I suspect) usurious financing costs embedded in the bundled offerings. More importantly, it would allow a true decoupling of the pricing of distribution from the price of the underlying commodity, allowing the retail customer to manage these price risks separately and professionally, aided almost certainly by intelligent and automated agents.
Indeed, over the past year or so I have been educating myself as to the somewhat arcane issues involved in creating intelligent, real-time electricity markets (via the use of intelligent meters, real-time pricing and load management) as I see the modernization of this enormous risk market as a fascinating laboratory – for technology, business models and risk quarks – with the potential (along with financial services) to drive a paradigm shift from centralized, institutional, standardized risk management to distributed, individual and customized. (For those of you interested, I have found the Utilipoint briefings – which you can subscribe to online – very informative.) I’m pretty sure however this transformation will be somewhat long and painful as you have the all to familiar issues of turkeys-not-voting-for-Christmas coupled with various shades of regulatory capture and, at least for now, a relatively docile and uninterested population of consumers. Here is somewhere where ambitious regulators and legislators could really help in getting the ball rolling, something they don’t yet seem inclined to do.
