Bad switching

Published: Mon 28 Oct 2013
A blog entry by Sasha Bermann

Contributed by:

Sasha Bermann
Chief Dissemination Officer

Sasha Bermann's Blog

written by Anna Bogacka, Analyst 
The generally accepted logic around the world is that high switching rates in energy markets are a sign of high competition and consequently a healthy economic situation. Indeed this can be the case, and switching provides many benefits to energy markets.  However, we at VaasaETT have been collecting and intensively analysing switching data for many years already, switching rates for all fully liberalized markets since market opening, and one thing we have noticed is that high switching rates are not always a sign of efficient competition.
Far from it, in some cases for instance, the reason for an increase in switching rates is an enormous increase in energy prices with questionable justification. No wonder that people start looking for a “cheaper” energy supplier following a large increase in their energy bills, at least to some extent. In other cases, the announcement of large profits, or directors’ salaries, or the failure of billing systems have led to dramatic jumps in the rate of switching.
So, how should we interpret high and low switcing levels? Well think about this situation: a national electricity market is fully liberalized and consumers can easily switch supplier, taking about 10 or 20 minutes of their time to save perhaps tens or even hundreds of euros, but most who can save do not switch. These low switching rates are then reported to officials and it is suspected that there are issues with healthy market competition - the market is not competitive enough, perhaps customers are are disillusioned? perhaps there are barriers to switching or the entry of new competitors? perhaps there is collusion between incumbents or overwhelming incumbent advantage? But while there is no doubt that all of thse and more are reasons for inactivity, and while economic theory dictates that companies should not be able to retain excessive profits in an efficient market, the context of high switching levels is not always as black and white as it might at first appear. For a start, high switching rates typically do not exist without sufficient margins, a discovery that explains why markets with higher rates of switching typically have higher margins. Also, markets with the highest rates of switching often display some of the lowest levels of customer satisfaction – though to be fair customers in lower and higher activity markets may remain loyaly because of satisfaction. Furthermore, markets with higher rates of switching do not necessarily display lower prices or even substantially moderated price increases. 
In fact, through 16 years of analysis we have developed a tool for the analysis and predictability of switching called the ‘Churn Radar’, which enables utilities to predict real-time switching rates. The tool that applies 176 parameters reveals that margins, dissatisfaction and price volatility are some of the key pre-requisites of the most active markets rather than the issues that are solved through market activity. High switching levels can therefore be a symptom of market failure rather than a cure of of it, a perpetuation made worse if utilities are consumed with the objective and cost associated with churning customers rather than serving them.
But healthy switching levels, and the fear of them can also lead to greater customer focus, the development of new services, the empowerment of customers who finally realise the power of choice, and reduced underlying cost-to-serve, that can be passed onto customers. 
High switching rates are therefore not always a good sign and low switching rates are not always a bad sign, but in the right hands, a healthy level of competition will bring benefits to all customers in the long term.
For more information on switching please visit our switching project site
For more background information on the research of VaasaETT please visit our website