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Tariff rationalisation: does it help the consumer?

23 November 2012

Getting the best energy deal. Is reducing the number of tariffs and giving consumers the best one entirely helpful?

Consumers should be ‘nudged’ into action in order to get the best energy deals according to new research published on Friday (November 23) by the University of East Anglia (UEA), as energy secretary Ed Davey unveiled the government's long awaited Energy Policy, which will inevitably see our fuel bills rise. 

The UEA study, which looked at the UK gas and electricity retail markets, also found that simplifying the number of energy products on offer does not necessarily help householders get the best deal.

The findings come just days after the government announced plans to force energy companies to reduce the number of tariffs they offer and place their customers on the cheapest price available for their tariff.

According to the study, consumers are likely to stick to their existing ‘default’ tariffs, even though they are not the cheapest, because they do not pay enough attention to the task of finding a better deal.

However, a ‘smart nudge’ policy of automatically switching default tariffs to the best one at regular intervals would address the problem of consumer inattention and inactivity, and achieve better results for consumers while leaving them free to choose an alternative tariff if they wish to.

Reducing the number of tariffs to as few as four in the market – a more drastic reduction than that proposed by the government - was found to improve the results for consumers, but when the problem of customer inattention was taken into account, even such a severe reduction only partially helped.

Ed Davey said firms would only be able to offer four core tariffs for both gas and electricity as part of government plans to get customers a better deal on energy. Customers would also be moved on to their best deals automatically, something Prime Minister David Cameron promised in a surprise announcement last month. Industry watchdog Ofgem had also announced plans to force suppliers to tell customers about the cheapest gas and electricity tariffs they have on offer.

Professor Daniel Zizzo, Dr Stefania Sitzia and Jiwei Zheng, of UEA’s School of Economics, suggest that the government should consider the feasibility of a smart nudge where consumers would be switched to the best deal at regular intervals unless they choose otherwise. Their smart nudge solution, while coming closest to David Cameron’s, is more radical and is likely to create greater competitive pressure between the companies.

The study - Complexity and Smart Nudges with Inattentive Consumers - published by the ESRC Centre for Competition Policy at UEA, found a significant proportion of people get a poor deal either because of sticking to their existing 'default' option or because of switching to a bad option. Even with the presence of a search engine to help them, consumers are likely to stick to defaults and achieve worse deals.

Professor Zizzo says tariff complexity and the number of tariffs matter, but inattention matters as well. "In order for consumers to reap benefits from competition in service markets, they have to be actively engaged in spotting the best deal that is available to them," he claims.

"The reason why reducing the number of tariffs, and therefore the complexity of the task, solves the consumer inertia problem only partially is because customers do not pay enough attention to the task in the first place and as a result just stick to the default option. 

“We suspect that time-constrained consumers may simply not pay attention to tasks regarding the choice of services. It may not be in their minds in the way in which saving money at a supermarket buying groceries is.

"And unlike the regular grocery shop, there is a not a point in time in the day, the week, the month or even the year where, as a routine, people are required to pay attention to the task of choosing energy supplier, as there is always a default supplier.

“Regulatory measures to reduce complexity are, therefore, likely to be of only partial value. A crucial issue from a policy viewpoint is to consider how to raise consumer attention or otherwise deal with consumer inattention.”

The researchers studied the UK gas and electricity markets to explore the psychological motivations affecting consumer behaviour. Using a series of experiments, involving 460 participants, they tried to identify whether customers are likely to stick to their default tariffs and so achieve a poor deal, why they do this, and what can be done about it.

They also tested the effect of complexity – in terms of tariff structure, number of tariffs and the bundled nature of products – and the impact of inattention on consumer behaviour.

Professor Zizzo's team shows that by using a ‘smart nudge’ which automatically identifies the best tariff and uses this as the default choice, and making the power of default work for, instead of against, consumer welfare, the best outcome can be obtained around 85 percent of the time.

Another smart nudge tested by the researchers was simple awareness-raising, by which participants were advised of the existence of a better tariff when they had made a worse choice. However, they found a generic warning that a better energy tariff exists in the market does not help consumer choice.

Participants in the experiments took the role of consumers deciding on tariffs, where a financial loss was incurred if they did not choose the best tariff.

While the study focused on the UK electricity and gas markets, the authors suggest the lessons drawn from it are likely to be more general and could apply to other service markets where choice is possible, such as internet services, bank accounts and mobile phone contracts.

Les Hunt
Editor


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