Daniel Legg
Datamonitor, UK

Understanding consumers’ attitudes towards price and service can help energy retailers to target the right type of customer. The result is improved cost control and lower rates of churn.

Any good energy retailer will be looking for ways to control its costs. We shall look at one way of controlling the cost-to-acquire: targeted acquisitions based on insight into the switching behaviour of SMEs. Knowledge of those SMEs that are likely to switch, what it would take to make them switch, and where they can be found will confer a commercial advantage to the utility that possesses it.

A switching career, showing the stages at which a customer is a valuable target, and the likely margin yielded
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There may be a number of factors that make a small business price sensitive when it comes to buying electricity. Datamonitor identifies two key factors: the industry in which the business operates and the amount that it spends on electricity. ‘Industry type’ needs further mention. Datamonitor found that industrial producers and restaurants were the most price sensitive, and that offices were the least price sensitive. Industrial producers and restaurants typically use a lot of power hungry machinery, and therefore spend a lot of money on electricity compared to their overall revenues. Offices, on the other hand, spend a lot less on electricity compared to their overall revenues. Therefore, we can conclude that price sensitivity is determined not just by the amount spent on electricity, but the proportion of total costs that it forms.

Service rating

One of the most interesting conclusions of Datamonitor’s research was that there is a relationship between price sensitivity and reported customer satisfaction. Respondents were asked to rate their supplier’s billing and customer service, and also its price competitiveness. Price sensitive consumers rated their supplier worse across all three ratings than did their less price sensitive counterparts. Datamonitor concludes that the more price sensitive a customer is, the less satisfied he or she will be with the service received from the supplier.

Why would a price sensitive person be less impressed with an electricity supplier’s customer service? There are a number of possible reasons. Because electricity is comparatively more important, these people may be more conscious of their suppliers, and their failings. They may have more complicated requirements and make more frequent use of customer service, and therefore actually need better service, which may not be forthcoming. Or they may simply think that they are entitled to better customer service because of the large amount of money that they are paying. Whatever the real reason, or combination of reasons, we should be aware that survey-based customer service rankings are not a straightforward description of actual levels of customer service provided.

The energy supplier whose customers are the least price sensitive will get the highest customer service ratings in all the independent tests conducted by the industry. Whether this is because its service really is the best or because of the type of customers it attracts does not matter. It gets a high score and will boast about it. But what of the company whose customers are the most price sensitive? It will do worst in the customer service ratings, so should it concentrate on price and ignore the fact that it is doing badly in the service ratings, or should it try to improve its service ratings, knowing that this is a difficult endeavour?

The important point to remember is the extent to which service quality matters to its customers. They may habitually criticise whatever service they receive, but they are price motivated. However, there will still be a point at which customer service is so bad that they will switch. The supplier needs to know what that point is.

Market churn

Datamonitor splits the SME market into six categories of switchers and non-switchers. The most numerous are churners – businesses that have switched more than once, comprising 33 per cent of the market. The once-only switches made up 26 per cent and 11 per cent have switched but been won back by the original supplier. The most numerous type of non-switcher is labelled ‘dormant’ – people who have been contacted by another supplier but refused the offer. They represent 20 per cent of the market. The remaining ten per cent are either ‘virgins’ or ‘negotiators’, people who have never been contacted by a rival supplier, and people that have been contacted, but negotiated a better deal with their original supplier instead.

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Dormant non-switchers are the least price sensitive in the whole market; churners and first-time switchers are the most price sensitive. This indicates that price sensitive businesses are more likely to switch than non-price sensitive businesses. Further analysis of the six different switching types, and subsections within them, lead to the idea of ‘switching careers’. This postulates that certain electricity suppliers are best suited to certain customers. It is a case of round pegs for round holes and square pegs for square holes. Before competition was introduced into the market, all business were supplied by the local supplier. In effect, pegs of all different shapes were squeezed into the same hole. But when businesses became free to choose their supplier, they moved to suppliers more suited to their needs.

However, the transition is not simple. Because switching is mostly the result of suppliers approaching consumers, not all businesses are matched with their ideal supplier after the first switch.

Percentage of different categories rated low risk – categories according to answers to the question: Do you think that you can save money by switching again?

What the analysis shows is that the key factor in this switching career is price sensitivity, which makes sense in a market where price is so important. The most price sensitive consumers gravitate to the new entrants, possibly after several switches. Winbacks are less price sensitive than first time switchers, and, interestingly, very similar to consumers that switch straight from one public electricity supplier (PES) to another.

The emerging picture is one of a market where the least price sensitive customers do not switch. Consumers that are slightly more price sensitive do switch, but decide that they are better served by a PES supplier, perhaps their original supplier but often not. Customers that stay with the supplier to whom they originally switch are more price sensitive than those that churn to a PES supplier; and the most price sensitive of all switch to a new entrant.

These findings enable suppliers to introduce more insight into their customer acquisition and retention strategies. Many PES suppliers keep their prices higher than those of the new entrants, and allow their customer bases to be eroded, hoping that the higher value customers will stay – the dormant ‘cash cows’ that constitute 20 per cent of the market. Now we can say that it is the price sensitive customers that will go, high value or not. We have said that industrial producers and restaurants tend to be more price sensitive than offices. Given this information, a PES supplier could decide to invest heavily in retaining restaurants, knowing that these are the most vulnerable customers. On the other hand, it may decide that they are as good as gone, and that it should concentrate on retaining the offices. It also knows that it has little chance of winning back the restaurants and industrial producers, but has more chance of winning back any offices that do switch away.

Different market, different price

We must remember that local competitive features will render each market different. One may take the view that a hotel is always a hotel, and a bar is always a bar, and they will go about buying energy in the same way wherever they are; but each business operates in a competitive environment peculiar to its own region and industry. A restaurant in Ireland and a restaurant in Indonesia may use the same equipment, and have the same electricity bills, but if the Indonesian restaurant industry is booming while the Irish industry is enduring crushing competition, Irish restaurants will feel their energy bills more than will Indonesian restaurants, and will therefore care about them more.

The maturation of a market can be divided into three stages:

Infant markets: In this market, customers are not aware of the implications of market deregulation, even to the extent that they do not understand how the supply chain has been split up or the fact that they can choose a supplier. They may not even be aware that the market has been deregulated. Larger businesses with large energy requirements should be aware of the situation, considering the difference it can make to their businesses, but most of the businesses under consideration have ten or fewer employees, and often know as little about their electricity bills as do domestic customers.

Because electricity suppliers have had a captive market until this point, they have not required a customer acquisition or retention strategy. And because of conservation issues, suppliers were not even impelled to encourage the use of electricity. The result is that they do not have much brand awareness and they have very unsophisticated marketing strategies, compared to companies like Microsoft or Intel.

Nor is the switching process simple. Suppliers are not used to interacting with customers outside of their home regions and are often struggling with the extra managerial and operational tasks required of them, without having to oversee switching as well. All this combines to keep switching levels low. So what should incumbent utilities and their competitors do?

  • Incumbents can rely on customer apathy and confusion to keep prices high and maintain large margins.
  • If a customer attempts to switch, they may be persuaded to stay by offering a discount.
  • Suppliers might consider putting their most valued customers onto contracts, in order to improve retention rates through the next stage.
  • Competitors will find price-sensitive customers the most eager to switch – the eventual churners and first-timers. They will still have to tackle customer confusion.
  • One favoured way of acquiring many customers quickly is through mergers and acquisitions.

Improving strategies

Markets in flux: This is the stage at which switching takes off. Customers still only have vague ideas about the constitution of the electricity retail market and the pricing models of the various suppliers. But at least they are likely to have heard of some of the companies involved, know that they can switch, and may have received offers to switch, and thus have some idea of the potential savings.

The suppliers are improving their marketing strategies and becoming more aware of the needs of their customers. They are beginning to tailor their products to suit their clients, and are hitting on the most appropriate sales strategies, although they will not always have perfected them.

Practice has made suppliers better at handling the switching process, although they have not entirely come to terms with the new market, and there are still many bureaucratic glitches. This is the stage at which switching levels are highest, so the task is made difficult by the sheer volume that has to be handled. However, many of the most price-sensitive customers will already have switched, and others will continue to do so. Some of them will already have found their preferred supplier, and the other switchers will be one step closer to the end of their switching career.

Mature markets: Although the market is mature, customer awareness in the domestic and SME sectors is not well developed. Customers still find the web of ownership across the supply chain difficult to understand (assuming that generation, transmission and supply have been unbundled and are often owned by different companies). They are still not aware of all the suppliers in the market or all of the tariffs and products available.

Nevertheless, suppliers have developed their marketing strategy admirably. Their retail businesses are now wholly customer-centric, and they have arrived at product mixes that their customers want. Switching levels are declining, so suppliers are turning to better-targeted sales techniques. The switching process itself is relatively hassle-free, although customers on contracts may be unaware of its precise terms, and may run into difficulty when they try to switch. Most customers have reached the end of their switching careers, and, in future, will switch only if their supplier changes its product mix or raises its prices, or if their own product needs change.

  • Since switching is declining, suppliers can be more certain of their customers’ loyalty, and therefore concentrate on forcing cost-efficiencies and increasing margins.
  • They may want to develop their product mix (energy efficiency advice etc.) in order to provide new reasons for customers to switch to them and stay with them.

Each customer type as a percentage of all UK respondents
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Segments identified

Thus, as European energy markets mature, targeting must be the future. Utilities need to segment the customer base and decide which segments they can best serve. By identifying their preferred segment, and understanding what that segment wants, suppliers can set about making sure that they are the best at satisfying those wants. By ensuring that they do everything that is necessary, and not a bit more, utilities can maximize the value of their existing customer bases. And by knowing which types of customer are likely to switch to them, utilities can make sure that they do not waste money pitching to customers that will not switch to them in any event.