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Using Auctions to Jump-Start Competition and Short-Circuit Incumbent Market Power

Fortnightly Magazine - February 1 1999

Ohio's proposal for retail marketing areas would give all customers meaningful choice and all suppliers even footing.

When grocery shoppers go looking for a can of tuna fish, they must decide which brand to buy. No particular brand will jump off the shelf into their shopping carts. The same is true with automobiles or any other consumer good. First you choose a make and model. Electricity and other utilities, however, are a special case. In the transition from monopoly to competition, consumers face a different prospect. If they fail to make a choice - and if the rules fail to anticipate such an occurrence - the right to serve the customer will fall by default to the incumbent, the former monopolist.

We know from experience with long-distance telephone deregulation that even after many years an incumbent monopolist can retain a substantial share of the market. This customer inertia appears unique to this type of case: It occurs where competition has been introduced to a product market in a geographical area in which an incumbent utility has long retained close to a 100 percent market share.

For example, the Federal Communications Commission reported last year that by 1996, AT&T's market share of operating revenues for long-distance carriers had dropped only to about 48 percent.fn1 It took 12 years for share to fall from a figure of 90 percent, where it had stood in 1984, the year of AT&T's breakup. This same pattern is beginning to emerge in state retail electric markets, according to early reports/fn2/, and may be especially true for residential and small commercial customers.

There may be many different reasons why customers are unwilling to choose from among competitors in deregulated markets. Customers can be faced with a bewildering amount of information, at least in the beginning, or the potential savings may be too small to be bothered with. Both of these reasons may be related in that the expected transaction costs for customers to search for their best options may exceed the expected savings.

Of course, no one expects incumbent electricity suppliers to maintain a 90 to 100 percent market share over time - any more than AT&T did. But it is likely that retail electricity markets will follow a similar pattern of gradual market share erosion. Considering that electric supplier incumbents start out with nearly 100 percent of market share, it may take years to decline to where there would be general agreement that market dominance is not a problem.fn3

Why this customer inertia? Quite simply, it is inherently difficult to penetrate an incumbent's market.

In telecommunications, service providers were assigned randomly to customers that did not choose a long-distance carrier - an effective but arbitrary remedy. In electricity, however, no state has yet to solve the problem of these "default" customers.

In electricity restructuring, at last count, alternatives to random assignment appeared to be under consideration in Mississippi, Missouri, Nevada and Ohio. While these proposals vary somewhat, the basic idea is to have a competitive bidding process to determine who will serve the retail customers who did not