Customers balk at jumping ship, cost and red tape to blame

Kathleen Davis, Associate Editor

Market competition remains a spoil promised by the deregulation soldiers in the rash of restructuring skirmishes across the country, from the bloody battleground of California to the cease-fire calm of Pennsylvania. The cry to open markets is snuggled tightly in every speech pushing restructuring. However, true competition relies on one tenacious and unpredictable factor outside of deregulation: the customer.

While customers may desire choice between providers to be in the equation, actually getting customers to switch is the true hurdle. In an effort to encourage customers, some energy companies are now resorting to that classic old standby for peddling wares: advertising.

In June Consolidated Edison began an advertising campaign called “Power Your Way.” The ads are meant to educate customers about choices in the electricity and gas marketplaces.

“Power Your Way will help customers make informed choices that may impact the bottom line on their energy bills,” said Marilyn Caselli, vice president of customer operations for Consolidated Edison.

But, while “Power Your Way” may be a new program, outside suppliers are not new to the New York area. Not only did Consolidated Edison include brochures about energy service companies (often referred to as ESCOs) in previous billing statements, but restricted electric customers have had an ESCO option since 1998 as well. And gas customers were first introduced to ESCOs in 1996.

There are more than 15 licensed ESCOs in the New York City area, which may seem like a lot of hunters vying for a geographically small prey. However, with more than three million customers in Consolidated Edison’s territory alone, no one hunter should go hungry, at least hypothetically. (Consolidated Edison puts the number of customers in their area who have chosen different energy suppliers at around 100,000.) One has to keep in mind, however, that most of those 15 or so hunters are out for the big game: large commercial and industrial customers, the ones heavy on load.

All hope and optimism for a good hunt aside, the question remains: Are any customers actually switching?

AGA gives a nod to small businesses

The American Gas Association (AGA) reported that “an increasing number” of small businesses and other commercial customers are purchasing their natural gas supplies from someone other than the local utility, according to a recent AGA study.

AGA director of policy analysis, Bruce McDowell, explained the small business-focused conclusion. “Between 1998 and 1999, the number of commercial customers who bought natural gas from non-utility suppliers jumped by 60 percent,” he stated. “But, because the actual volume of gas used by customers who buy gas supplies from a non-utility rose only slightly, we concluded that an increasing number of small businesses now take advantage of the natural gas customer choice option.”

The AGA report, “Growth in Customer Choice Natural Gas Volumes,” found that more than 80 percent of the total volume of natural gas consumed in 1999 could be purchased from sources other than the local natural gas company under either current or proposed programs.

“During the last 10 years, the volume of natural gas that’s being purchased from unregulated suppliers has doubled, which shows that natural gas customers are becoming increasingly comfortable with the concept of purchasing their gas from someone other than the local utility,” McDowell added.

McDowell also pointed out that customer choice doesn’t adversely affect local gas utilities because the utilities base profits on volume, not mark up.

The AGA report has a number of other interesting conclusions as well:

  • The customer choice option is, or soon will be, available for about 72 percent of all commercial gas volumes and 50 percent of all residential volumes.
  • Roughly 35 percent of all commercial gas purchased in 1999 was under the customer choice option.
  • More than 26 million of the nation’s 57 million households with natural gas service have, or will soon have, a customer choice option.
  • To date, about one of every five households eligible to purchase natural gas from a non-utility supplier has actually made the switch.
  • The AGA pointed to a number of factors contributing to low residential participation, including limited choice and customers satisfied with the service and price of the local gas utility.
  • Larger customers are most likely to exercise customer choice, according to the AGA, as they are more likely to have the resources to manage energy. Also, savings may be more of a factor for larger volume customers since the dollar-per-unit-of-gas difference for a smaller volume customer may be fairly miniscule.
  • The total number of customers choosing alternative suppliers increased 85 percent in 1999 compared to 1998.

Although the numbers of switching customers are indeed increasing, the report concluded “commercial and residential customers have, to date, been less likely to use gas utility transportation services or purchase gas directly from non-gas utility sources.”

Power to the people

It seems the AGA’s “less likely” analysis may cross over into electric deregulation as well. According to a study from Insights Unlimited, a Pennsylvania communications and marketing firm, the rate of customer switching is more dependent on the structure of the marketplace than it is on the act of deregulation itself, and in a number of key states those rules are very constricting.

“Once legislation has been passed many rules and procedures must be made to determine how the marketplace works,” stated Eric Malm, co-author of the study and research director of Insights Unlimited. “Rules regarding when and how customers can sign up for service, for example, impact how many customers will end up participating.”

“Generally we find there’s not much choice for smaller customers,” he stated. “About 10 percent of residential customers switched providers in Pennsylvania. This isn’t a large segment of the market, but it’s much higher than Massachusetts, where less than one percent have switched.”

“Rules and procedures governing competition have an important impact on whether competition makes the leap from the law books to consumer pocketbooks,” he added.

The study, which Malm co-authored with David Loomis, assistant professor of economics at Illinois State University, is entitled “The Devil in the Details: An Analysis of Default Service and Switching.” Attempting to develop a model of behavior for customer switching, the study noted that although industry groups like National Energy Marketers have lobbied for national standardization, rules and requirements for switching remain a state domain.

Starting with an examination of Massachusetts, Malm and Loomis label the state’s switching system an “interesting approach to weaning customers away from default service,” which separates old and new customers. New customers are ineligible for “standard offer rates” and must purchase a default service that is flexible. Existing customers who chose not to switch remain under the “standard offer rates,” which are fixed by law.

Although Malm suggested that the Massachusetts format is a “good way of introducing competitive choice at the time a customer is first signing up for service,” the study noted that the state has seen almost no activity in the market. As of January 2001, only .0014 percent of residential customers were receiving service from a competitive generation company.

The study also looked at Pennsylvania, widely touted as a successful example of deregulation. One energy company in that state, PECO, saw the highest switching rates at the birth of restructuring (around 15 percent). However, PECO has recently seen a downturn in this high number with the increase in wholesale prices; most suppliers have simply left the market and many no longer solicit business.

Malm and Loomis noted a number of views in the industry regarding the low rate of customer switching in general among states that are in the process of deregulation, including an examination of the design of a state’s default service program. The study suggested that one integral part of the design not often recognized is the switching cost, which can elicit a negative consumer reaction.

“Switching costs are significant,” Malm reiterated. “They can be overcome either by increasing shopping credits [the spread between the incumbent and wholesale prices] or by simply making it easier to switch.”

The study gave six important factors for a deregulation plan that not only allows customers to switch, but also encourages it. They included:

  • Default service prices should be tied to wholesale prices.
  • Default service prices should include marketing and service costs.
  • Default service prices should include a premium necessary to bridge to large-scale economies.
  • The plan should utilize new customers to phase in cost-based pricing.
  • Customers should be given the ability to choose during sign-up.
  • Uniform rules should be established.

In the end, however, it is still the customer who will choose, and they seem to be sending the same Thoreau-based message they give every industry when it gets bogged down in rules, procedures and technology: simplify, simplify, simplify.

More information on the AGA and its recent study can be found at www.aga.org. Malm can be contacted directly at 610-476-0705.

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