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Consumers’ ability to choose in newly liberalised markets : some empirical

evidence

Catherine WaddamsESRC Centre for Competition Policy

University of East Anglia, UK

How Can Behavioural Economics Improve Policies Affecting Consumers?DG Health and Consumer Protection, Brussels, 28th November 2008

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Consumers’ ability to choose in newly liberalised markets

How far have consumers exercised their choice?Are they motivated by ‘rational’ considerations?

How well do consumers switch, based on their own estimates of expenditure (consumption)?

Do consumers know their own expenditure?

Is there enough switching?Has there been consumer overload?

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Switching in different markets, 2006

From Special Eurobarometer 260, 2007

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Survey of 2027 adults in GB, 2005, for eight utilities and financial products: not experiment, dependent on recall

Did they: Have a choice of suppliers ‘in their region’? = aware Had they searched around for better deals = searched Switched supplier in last three years =switched

usual households characteristics: age, gender, education (high income refusal)

Are consumers ‘rational’?

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Awareness, searching, switching

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What were the expected benefits and costs?

Potential Benefit: How much is the most you think you could save per month if you shopped around?

Search cost: How much time do you think it would take you to search around to find the best deal?

Switching cost: How long do you think it would take of your own time to switch once you had all the necessary information?

Note: included any financial switching costs; all based on consumers own estimates

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average

elecmobile

fixedcalls

broadbandcar ins

mortgagecurr acc

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£s/ month,

hours

Expected gains and costs of search/switchingin each market

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Were they rational?

Yes…. Searching and switching more likely if expected

gain was higher (weaker than using actual potential gain, indicating importance of advertising); and

less likely if expected time to switch and search was higher

Expected switching time a greater deterrent than expected search time: an extra hour of time needed to switch had three times the deterrent effect of an extra hour needed for search

………….. but

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Other factors also important

Most important: whether had switched in other (of our) markets, particularly for men and those with more education

Age: familiar U-shape: young and old more likely to switch

Education/income: increased likelihood of switching

Interpret as confidence: individuals’ variance around central estimates of gain and pain may be as important as central estimates themselves

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Do consumers who switch choose ‘well’? Evidence from the electricity

market Used consumers’ estimate of expenditure (so no

error from not knowing consumption), old and new suppliers and our own knowledge of tariffs

Calculated the change in expenditure from old to new supplier for consumers who switched only to save money

Plotted gain made against choosing the best deal for that consumer

Tested for sensitivity to changing demand, different timing of switching

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Actual Gains Made versus Maximum Gains Available

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Less than a fifth selected cheapest supplier Switchers gained less than half of maximum

available. Consistent with rational decisions and search costs

BUT At least a fifth chose a more expensive supplier,

losing an average £14-35 per year, excluding switching costs

No evidence of learning from errors (2005 no better than 2000; second switching no better than first)

Consistent with Ofgem finding (2008): 17% active; half rest will switch in response to direct marketing, often poorly

Suggests some confusion/consumer overload

How well did the switchers do?

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Who did best?

U-shaped age curve: young and old did better than middle aged

Owning own house better than rented

Experience of switching gas supplier had a detrimental effect, so no evidence of learning from related markets in terms of quality of decision

No explicit income/social class/education effect

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Consumer vs company estimates of electricity expenditure

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Comparison with supplier data

Compared consumer estimates of expenditure on gas and electricity with supplier records 1113 consumers and 12 energy companies in 2000Consumers tended to think they spent the average amount

low users overestimated expenditurehigh users underestimated

Errors bore no (other) relation with income, social grade, age, tenancy

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Has there been enough switching?

To discipline markets? Evidence from UK energy: remaining incumbent

mark-ups from old monopolists 10% (reduced to 6% during recent regulatory inquiry)

If lack of rivalry & all prices raised, switching ineffective

From consumer perspective Unknown search/switching costs make assessment

difficult Increased confidence would have same effect as

lower search/switching costs

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Evidence of consumer overload?Yes: from any underswitching

(so incumbents benefit from endowment effect); consumer errors; and direct questions.......

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Policy Implications

To increase switching:

Raise expectations of gains (supplier advertising) Lower perceptions of costs, especially switching

costs Increase consumer confidence Explore role of branding in consumer loyalty Exploit externalities across markets to increase

confidence, so work on the ‘next group’ likely to switch to leverage discipline

Explore annual reminders, format of billing information

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Policy Implications

To improve quality of switching:

Enforce existing consumer protection laws, eg to avoid mis-selling

Explore: form of information to help decision making in

practice standardisation of information (eg price per unit)BUT beware unintended consequences; use pilot

studies to identify effects of proposed remedies ex ante

Recognise benefits of fewer choices on demand side (though may reduce rivalry on supply side)