Residential retail lessons from other markets

In considering the costs and benefits of competition, we looked at what happened when other markets opened.

We commissioned an independent study into the opening of the energy market and reflected on the history and recent Competition and Markets Authority report into the sector.

Key findings from this work showed:

  • There is a need for a strong and effective regulator.
  • New entrant retailers need to be actively engaged and the regulator must ensure they are not disadvantaged in any way.
  • Energy markets benefitted from phased opening to learn lessons as the market progressed.
  • Considerations should ensure the benefits of competition reach as many customers as possible.
  • Considerations towards the needs of potentially vulnerable customers ahead of market opening are needed.
  • Customer engagement is central to the success of a competitive market.
  • Facilitating entry from established players in other markets (such as gas and electricity) will be important to stimulate competition.

The differences between introducing competition in water and energy sectors

The water sector is often compared to the energy market. But, although they are both utilities, there are big differences.

  • In energy, about half of the bill is exposed to volatile global wholesale prices. This is not the case in water, where water resources are procured within the UK, and where the commodity is harder to trade (because it is bulky to move). Furthermore, we regulate wholesale prices and these make up about 90% of the cost of a water bill. So we would expect customer bills to be more stable and for differences in bills to be smaller.
  • While there are a number of energy and other service providers who could quickly compete for market share in the water sector, it could be argued that there is no one company in quite the same strong position as British Gas was at the opening of the electricity market, in terms of its ability to challenge regional incumbents.

Points to consider following the experience in the energy market

  • British Gas, which had a national presence, was ready to enter and challenge incumbents at the opening of the electricity market, just as the electricity incumbents had targeted gas customers in their regional areas. In the absence of this rivalry in the water sector, facilitating entry from established players in other markets, such as gas and electricity, will be important to stimulate competition.
  • Consistency and clarity in regulation across different sectors is needed to encourage entry from established players in other markets, allowing for benefits from bundling of services. • There is a need for the regulator to be active in the market and provide strong, effective regulation on behalf of customers.
  • The energy markets benefited from phased opening to learn lessons as the market progressed, and water may also benefit from this approach.
  • It became clear as the market developed that regulatory interventions needed to be changed to protect certain customer groups. It would be beneficial to consider the needs of potentially vulnerable customers ahead of market opening.
  • As prices rose and company practices – such as doorstep selling – came under scrutiny, customer engagement stalled. As customer engagement is central to the success of a competitive market, this experience of flawed practice and companies withdrawing from customers must not be allowed to be repeated.
  • As with the banking sector, those who have not engaged with the market have not benefitted as much from the potential savings. The challenge for water is to consider ways to ensure the benefits of competition reach as many customers as possible.
  • One reason it has been difficult for companies to enter the energy market is that the rules governing the day-today running of the market are heavily influenced by incumbents. The water sector needs new entrants to be actively engaged and must ensure they are not disadvantaged in any way.

Other considerations to shape a residential water retail market

© Getty
© Getty

When assessing the costs and benefits of a residential water retail market in England it is important that lessons are learned from other open water markets. There are two such markets from which we can draw valuable experience and knowledge. The Scottish retail water market for business and the opening of the business market in England in 2017.

Learning from Scotland

The Scottish retail water market for businesses opened in 2008 and as a result has delivered large retail cost efficiencies. In January 2012 Business Stream reported that retail costs had been lowered by 18% since its introduction.

New water efficiency services have been popular with Scottish business customers. Business Stream and other retailers in Scotland were able to reduce consumption by an average of 2% for all customers, (not just business customers switching or renegotiating), with these savings being largely attributed to increased incentives to help businesses lower their water bills.

Few customers initially switched retailers when the Scottish market opened, but many were offered better deals by their existing supplier with about 40% of the market renegotiating their tariff. And as of 2013 60% of business customers were benefitting from lower bills than would have been the case without competition. This shows that it is not necessary that customers change retailers to realise the benefits of a competitive market.

Learning from England

Companies are currently preparing for the introduction of competition in the business market in England. This market opens in April 2017. We know through engagement with the sector that companies and their investors would welcome an early indication of whether competition will be extended to the residential retail market, as it will allow them to plan ahead and minimise cost by identifying the best approach.

Many of our cost estimates are based on the costs of the business market opening costs. But how much influence this will have remains uncertain at this stage as no detailed estimates have been made at this stage. However, some market opening tasks, for example, may cost less to implement, if lessons can be successfully applied from business market opening.

Taking all of the available factors into consideration, we assume that upfront costs for residential retail market opening would be higher than for business market opening, by a factor of two in the low costs estimate and a factor of four in the high costs assumption. Full details of how work undertaken to open the business market in England are available in the full report.

Further information

Ofwat household market review: Lessons from the energy sector, KPMG, July 2016