The rising price of loyalty to the Big Six
By Ovo Energy Wednesday 17 June 2015
Here at OVO, we think the UK energy market is broken.
Millions of loyal customers that don’t switch providers regularly, or at all, are paying hundreds of pounds too much for their energy. The UK’s most vulnerable people are more likely to be among them.
How did we get in this mess?
The Big Six energy companies inherited large customer bases during privatisation, and many of these customers don’t switch often, or perhaps ever. These ‘sticky’ or inactive customers have been increasingly overcharged, while a small number of active customers are offered heavily discounted tariffs. This tactic blocks newer energy companies, like OVO, from competing on a level playing field. Smarter, more efficient new companies can put competitive pressure on the Big Six to improve service and cut costs. Unfortunately, without competition, service keeps getting worse and most homes end up paying too much for energy.
In this article we are going to explain how the domestic energy market has become segmented between active and inactive customers. We’ll look at how much you can save by switching, how this has grown over time, the two tiers of active and inactive customers, and how the different providers measure up. Lastly, we'll describe some steps that we think can be taken to create a fairer marketplace for consumers.
The benefits of switching supplier
Public trust in energy companies is very low, down at the bottom of the tables with banks and estate agents. The Big Six have some of the worst customer service records across all UK business. But while we like to think you’d consider OVO’s award winning customer service when you’re switching, there’s another big reason: we charge all our customers a fair price, not the price we think we can get away with.
The majority of Big Six customers (between 50% and 90% depending on the supplier) are on a ‘standard variable tariff’ or SVT. Many of these customers were ‘inherited’ during privatisation, and never chose to switch to these companies in the first place.
Customers on the average Big Six SVT are typically paying £260 more a year than they would if they switched to the cheapest fixed deal available. And that's just the average. Big energy users could save much more.
Instead of paying almost £1,200 a year for energy, a UK home using the ‘standard consumption’ of gas and electricity could cut that bill to almost £900 each year, simply by switching to a competitively priced fixed deal.
This is based on standard consumption profiles from the energy regulator, Ofgem. If your home uses a lot of energy you stand to save even more money. The best way to find out is to get a quote.
The benefits of switching have grown
There has never been a better time to switch! Ok, so that’s exactly the type of thing you might expect to hear from an independent energy company like OVO. But don’t take our word for it. Just look at the data.
Over the last three years, the difference between the average Big Six standard variable tariff and the cheapest tariff on the market has grown considerably, to the point where customers prepared to switch can save an average of £260, and possibly much more.
The growing gap between standard variable tariffs and cheap fixed rate deals is evidence that the UK energy market has truly become segmented into two: one market for inactive customers that tolerate high standard variable tariffs, and another one for active customers who switch regularly. In this second market, pricing is fiercely competitive and many deals may, in fact, be below the cost of serving that customer and designed primarily to undercut competition.
The segmentation of the energy market
For the small minority of people who are willing to shop around regularly, the segmentation of the energy market into two separate tiers isn’t a bad situation. For active customers, there is fierce competition between the Big Six and new independent entrants, like OVO. Together with falling wholesale costs this competition has driven down fixed deal prices to levels not seen since 2012.
But the bad news is that only 11% of people in the UK switched last year, and switching rates have actually halved since 2008. If on the other hand you are one of the big majority of inactive customers that hasn’t shopped around recently, you are probably paying a high price for it. If you are currently stuck on a Big Six standard variable tariff, like much of the country, then the chances are you can save around £260 over the next year, maybe more, just by switching to a competitively priced fixed rate plan.
Comparing the tariffs of different suppliers
If you are looking to get a better deal on your energy then you should consider paying for your energy monthly by direct debit, and managing your account online. But the biggest savings are made by switching providers. The cheapest deals on the market tend to be online deals that fix the unit cost of your energy for a period, typically a year. This is the case with OVO’s Better Energy tariff.
Once a fixed price contract comes to an end, customers can renew or switch onto more competitive tariffs. But if they don’t, they roll onto to the more expensive variable tariff. At OVO, we try to avoid this by reminding our customers when their fixed deal is ending and doing all we can to encourage you onto a new cheap deal. In fact, only 14% of our customers are on our standard variable tariff, compared to between 50% and 90% of Big Six customers. And even for those customers, we try to keep costs to a minimum (see below).
In this chart you can see the difference between each provider's cheapest available deal and their standard variable tariff. OVO tries to distinguish itself by giving all our customers a better deal, not just charging the price we think we can get away with depending on whether a customer is likely to switch or not. We think that is fair.
Fixing the energy market
The segmentation of the energy market, discrimination between active and inactive customers, is harming both customers and competition.
The Big Six have estimated to Ofgem that it costs them around 6-7% extra to serve these standard variable customers. So the fact that many energy companies are offering fixed rate deals in excess of 20% cheaper than their standard variable tariff implies that some tariffs on the market may in fact be ‘loss-leading’. This means the supplier is willing to make a loss on the customer to hook them in or stop them from going to a competitor. This damages competition, which means there’s little pressure on the Big Six to cut costs or improve service.
OVO’s business model is different because it’s built around what’s best for our customers. So instead of rolling the majority of our customers onto expensive variable tariffs, we actively push to make sure every customer is on the best deal available.
As a company that prides itself on having as many of our customers as possible, on the best rates possible, we find it disturbing that many of our competitors are able to offer highly attractive rates to new customers simply by overcharging their loyal ones, rather than by innovating or becoming more efficient. The energy market will only work for customers when there’s real pressure on all suppliers to cut costs, offer innovative products and improve customer service.
As part of our submissions to the ongoing Competition and Markets Authority Investigation into the energy market, we have highlighted a number of potential reforms to address these problems:
- Moving from the fiendishly complicated, burdensome regulatory system we have today (which just encourages suppliers to look for loopholes) to a more ‘principles based’ system, with a strong, catch-all principle of ‘preventing harm to consumers’
- The introduction of a regulated social tariff for all suppliers to protect the most vulnerable customers who are hit the hardest by overcharging
- A cost-reflective pricing principle, making sure suppliers have to justify whatever they charge by reference to the actual cost of doing business, not just the price they think they can get away with
As a company we are doing our bit to change the market, by building a different type of energy company that puts customers first. We look forward to seeing the outcome of the Competition and Market Authority investigation, and hope it can form the basis for progress towards a fairer marketplace for all consumers.
In the meantime why not see what you might save by switching?