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Electric Retailing: When Will I See Profits?

Deregulation Abroad: Still Reaching Its Potential
Fortnightly Magazine - June 1 2000

preference for the product). Domestic customers tend to stick with their incumbent provider. As noted by authors of another study, "In the UK domestic gas market, even with discounts of 15-25 percent, just 20-25 percent of all customers have switched suppliers after a year of competition." (Keith Leslie, David Kausman, and Gustav Bard, "A New Generation in Europe," , 1999.)

Customers pay for value. Innovative electricity products tailored to customer preferences (for example, a product tailored to customers who want "to talk to a person when I have a problem or a question") can acquire 20 percent or more in market share even though they are priced at 30 percent price premiums. Of course, this fact shouldn't be surprising. Customers pay for value; the outstanding question is "What counts as value?" EPRI's latest research suggests that many value-creating opportunities exist in retail markets, and at much higher margins than retailers have seen to date.

Past EPRI research of the British market by Alex Henney found that there is "no value in value-added services," because most customers did not see a compelling reason to buy such services from their energy providers. ("Energy Marketing: Is there Value in Value Added?" , Sept. 15, 1997, p. 30.)The recent findings of "ShareWars" suggest that it might be worth revisiting this issue.

California - Savings Guaranteed. As part of California's Assembly Bill 1890, all residential and small commercial customers received a 10 percent reduction in their electricity bill, whether they switched or not. This was intended to appease opponents of deregulation who had argued that it would benefit only large power customers. It appears that no one estimated how big an obstacle to customer switching this 10 percent price cut would be. The new entrants had to come up with significant benefits for customers to overcome their natural aversion to switching. A substantial body of research indicates the first-best option for most customers is to stay with their incumbent provider, and simply get the same product at a lower price.

Enron Energy Services, one of the leading ESPs, exited the California market within two months of operation. Its value proposition for mass-market customers - two weeks of free electricity after one year of service - failed to attract even 1 percent of customers. Enron's market research studies had indicated that 10 percent of customers would switch without any price incentive, because most customers had a poor opinion of their incumbent providers. However, they had not factored in the incumbency bias that would be created by a 10 percent price cut. 12

While the ESPs could provide the same 10 percent price cut to a customer, in order to get the customers to switch they had to exceed that amount to overcome the transaction costs such as time, uncertainty, and risk-aversion. This proposition proved unworkable, because the enabling legislation, AB 1890, had imposed a rate freeze, and instituted a competitive transition charge (CTC) to recover stranded costs. The CTC is estimated as a residual in the interplay between the frozen rates and the time-varying wholesale cost of power,