Retail energy supply has reached a transition point. New technology has created fresh opportunities to engage customers: the roll out of smart meters and personalised energy usage data; the connected home which generates and stores its own electricity; and tools which provide automatic tariff switching services. This article looks at different areas that suppliers might compete in and identifies the competencies required for success. (Estimated reading time 5 minutes and 47 seconds)
1. Where might energy suppliers need to compete next?
Today’s retail energy consumer in the UK is disengaged. The ‘Big 6’ suppliers have 60 to 80% of their customers on a Standard Variable Tariff (SVT), despite the cost being £137 higher (12% of total bill) on average than non-standard tariffs offered for new customers.[1] Those that are engaged only want basic electricity at the lowest price possible. with only 13% of customers citing service as a reason for switching.[2]
Technology is, however, changing the way customers behave and what retailers can offer them. Figure 1 categorises change along these two dimensions – differentiation and customer engagement. We explore each of the domains areas in turn below.
Figure 1: Competition domains
2-tier pricing
2-tier pricing is the core strategy of UK energy suppliers today. Competition occurs through acquisition tariffs which last about a year and are priced cheaply, with low profitability margins (EBIT) of 0 to 2%. Low customer engagement means that many customers roll onto a retention product when the year is up and tend stay there. The ‘retention’ product, or SVT, has higher prices with typical EBIT margins of 6 to 8%.
Success in a 2-tier world requires a large proportion of disengaged customers who are on the most expensive tariffs. The ‘Big 6’ have an incumbent advantage from retaining customers from the days of pre-privatisation. British Gas has 74% of customers on the expensive tariff, compared to new suppliers, like Ovo Energy, which only has 35% of customers on the expensive tariff.[3]
Analytics is then key to keeping high value customers by pricing the tiered tariffs correctly in the first place according to customer lifetime models and then monitoring customers through predictive churn modelling.
Bespoke tariffs
Expect a rapid expansion towards hundreds of tariffs from the limit to four that the UK experienced over the past five years. The removal of Ofgem’s four tariff rule and the arrival of smart meters will enable suppliers to tailor a bespoke tariff to an individual’s preferences and consumption patterns – thus, creating a differentiated offering at very low cost.
Bespoke tariffs make it difficult for consumers to compare tariffs between suppliers, which may enable suppliers to charge profit margins which are more in line with SVT tariffs. In return, consumers receive more choice and a more suitable product for their needs.
Success with bespoke pricing requires seamless and insightful IT software. Smart meters will increase relevant customer data by several orders of magnitude from today’s analogue world. Retailers must be able to turn this mass of information into insights, then, in real time, accurately select and price tariffs based on how a single customer consumes energy.
Smart products and services
This strategy requires an active consumer who engages with the next wave of retail energy technology. All of the Big 6 and a number of Independents have their own smart thermostat product (e.g. Hive – British Gas, Nest – nPower, Touch – EON, Tado – SSE, Connect – Scottish Power). This is the start of the connected home which moves beyond the smart thermostat to an integrated system.
The uptake on products has been slow to date with Centrica having only sold a total of 360k products which represents 3% of its customer households.[4] This will increase rapidly with the next generation who value high quality, time saving technologies.
Bundling of products and services will become commonplace within the connected home. For example including energy within a home service package which could include broadband, phone, music, TV, security, and maintenance. This might also be priced in different ways, such as a monthly fee to deliver heating to a 21 degree specification rather than billing on a per unit of energy basis.
The smart technology wave also enables ‘prosumer’ activity. Increasing use of solar panels, battery storage (fixed and electric vehicle) and demand side response means that consumers generate electricity as well as consuming it. This provides an opportunity for energy suppliers to provide adjacent goods and corresponding tariffs which match to the installed technologies within each home.
Successful adoption of smart products requires high quality branding and functionality which is easy to use. Energy suppliers are not consumer goods companies. They are not used to creating sleek and simple products such as Apple or Amazon. The opportunity for suppliers is that they are already in millions of homes today. This access must be leveraged, but success requires either in-house creation of products to match the standard of Apple or Amazon, or partnering with firms that can.
Single price
This domain is low margin, where suppliers engage in a price shoot out for the supply of electricity or gas (i.e. no differentiation in product or service) for highly engaged consumers. The transition towards engagement could be caused by:
- automated rather than manual switching (e.g. a new service called Flipper, which automatically switches a customer’s tariff four times a year to the lowest cost option for a fee of £25 per year); or
- third parties removing energy suppliers from direct contact with the customer and instead requiring energy in bulk volumes (e.g. an energy supplier providing energy on behalf of Amazon which bundles home services into a single package)
In a single price competitive market, the lowest price wins. Therefore, suppliers with relatively low indirect costs can offer lower prices than competitors and will succeed in such an environment. Another important competency in this domain is risk management. The ability to understand and manage the risks within an energy supply contract is technical and thus, a potentially higher value-add activity. If energy suppliers get removed from domestic customers, those with strong risk management offerings will succeed.
2. Which strategy area will be most important in the future?
The majority of homes will have smart products and services within the next 10 years because the millennial generation embraces new technology and technology cost will fall. The challenge for energy suppliers is to remain relevant in this new world market and maintain contact with the end consumer. If they fail, then there is a high likelihood of energy suppliers being removed from people’s homes and transitioning to the single price domain and supplying energy through a third party.
The most profitable pathway in the short run for energy suppliers is likely to be through bespoke tariffs, while maintaining a 2-tier price for customers who remain less engaged customers. It is, however, imperative for energy suppliers to develop competence in multiple domains to spread their bets. The direct value in some areas may be low today, but the true value for energy suppliers is instead the increased likelihood of remaining relevant for the customer in future.
[1] Ofgem website, ‘Standard variable’ rate tariff information.
[2] Jefferies, UK Utilities: Increasingly Tough Out There, 22 Sep 2016
[3] CMA Energy Market Investigation
[4] GfK NOP customer survey report, 2015
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