Consumers ability to choose in newly liberalised markets : some empirical evidence Catherine Waddams ESRC Centre for Competition Policy University of East Anglia, UK How Can Behavioural Economics Improve Policies Affecting Consumers? DG Health and Consumer Protection, Brussels, 28 th November 2008

2 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?

3 Switching in different markets, 2006 From Special Eurobarometer 260, 2007

4 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?

5 Awareness, searching, switching

6 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

7 Expected gains and costs of search/switching in each market

8 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

9 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

10 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

11 Actual Gains Made versus Maximum Gains Available

12 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?

13 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

14 Consumer vs company estimates of electricity expenditure

15 Comparison with supplier data Compared consumer estimates of expenditure on gas and electricity with supplier records 1113 consumers and 12 energy companies in 2000 Consumers tended to think they spent the average amount low users overestimated expenditure high users underestimated Errors bore no (other) relation with income, social grade, age, tenancy

16 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

17 Evidence of consumer overload? Yes: from any underswitching (so incumbents benefit from endowment effect); consumer errors; and direct questions

18 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

19 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)