The Road to Confusopoly

Professor Joshua Gans

University of Melbourne
 Confusopoly
• Scott Adams: “a group of companies with
similar products who intentionally confuse
customers instead of competing on price.”
• Examples: telecommunications,
insurance, mortgages, credit cards, etc.
• But what about energy retailing?
 Search Model
• Consider an industry with several producers of
an homogenous product
• A consumer considering switching suppliers will
switch if:
Pold + D > Pnew
– where D are switching costs including any
disconnection fees
• A consumer will only search for a new supplier if:
Prob[Pold + D > Pnew] > S
– where S are search costs
 Diamond Paradox
• With many suppliers, why would you expect to
get a better deal?
– If all highly competitive, then can’t do better
– Only if you think firms will offer you a customer
specific deal; but will they?
• According to Diamond (1971): each firm won’t
lose many customers by charging a slightly
higher price than other firms
– In equilibrium: all charge the monopoly price and no
search occurs.
 ‘Sleepy Incumbent’ Model
• Customers may expect to get a better deal
if switching from an incumbent
– Implication: entrant’s should advertise pricing
deals
– Incumbent may accommodate this by
charging higher prices (Guilietti, Waddams-
Price, Waterson, 2005)
• Should see incumbent retailers charge a
higher price than entrants in an area
 Which Model? Sample of One
• Which model applies in Victoria? Diamond
Paradox or Sleepy Incumbent
• With this in mind, I decided to revisit my
own gas retailing choice in Victoria
– I was aware I had choices
– I had never researched options before
– I utilised the Essential Services Commission
Energy Comparator
 Sample of One: which is cheaper?
Component Origin TRU AGL
(from bill) Energy (w/ GST)
Supply charge $18.70 per two months $10.26 per month $20.526 per two
months

1st Step 0.946c (0.946c)/MJ for 1.12c (1.042c)/MJ for 1.11991c

1st 6000 per two 1st 3000 per month (1.04192c)/MJ for 1st
months 6000 per two months
2nd Step 0.869c (0.781c)/MJ for 0.943c (0.863c)/MJ for 0.94292c
next 3000 per two next 1500 per month (0.86295c)/MJ for next
months 3000 per two months
3rd Step 0.66c (0.5836c)/MJ for 0.6771c (0.642c)/MJ 0.67694c
more than 9000 per for more than 4500 per (0.64196c)/MJ for more
two months month than 9000 per two
months
Other No disconnection fee Disconnection fee of $50 service voucher
or loyalty rebate $50-$90 and loyalty and $30 loyalty rebate
reward of $25-$35 per annum
 GST and Time Adjust
Component Origin TRU AGL
(from bill) Energy
Supply charge $10.26 per month $10.26 per month $10.264 per month

1st Step 1.12c (1.042c)/MJ for 1.12c (1.042c)/MJ for 1.11991c

1st 3000 per month 1st 3000 per month (1.04192c)/MJ for 1st
3000 per month
2nd Step 0.943c (0.863c)/MJ for 0.943c (0.863c)/MJ for 0.94292c
next 1500 per month next 1500 per month (0.86295c)/MJ for next
1500 per month
3rd Step 0.6771c (0.642c)/MJ 0.6771c (0.642c)/MJ 0.67694c
for more than 4500 per for more than 4500 per (0.64196c)/MJ for more
month month than 4500 per month
Other No disconnection fee Disconnection fee of $50 service voucher
or loyalty rebate $50-$90 and loyalty and $30 loyalty rebate
reward of $25-$35 per annum
 Compare with Cap
Component Origin Cap
(w/ GST) (w/ GST)
Supply charge $20.53 per two $20.53 per two
months months

1st Step 1.12c (1.042c)/MJ 1.12c (1.042c)/MJ

for 1st 6000 per two for 1st 6000 per two
months months
2nd Step 0.943c (0.863c)/MJ 0.943c (0.863c)/MJ
for next 3000 per for next 3000 per
two months two months
3rd Step 0.6771c (0.642c)/MJ 0.6771c (0.642c)/MJ
for more than 9000 for more than 9000
per two months per two months
Total Saving = $22.64; S = 3 hours
Component Origin Origin
(new offer) (from bill)
Supply charge $20.53 per two $10.26 per month
months

1st Step 1.098c (1.021c)/MJ 1.12c (1.042c)/MJ

for 1st 6000 per two for 1st 3000 per
months month
2nd Step 0.924c (0.846c)/MJ 0.943c (0.863c)/MJ
for next 3000 per for next 1500 per
two months month
3rd Step 0.664c (0.629c)/MJ 0.6771c (0.642c)/MJ
for more than 9000 for more than 4500
per two months per month
Other No disconnection No disconnection
fee or loyalty rebate fee or loyalty rebate
 Periodicity
• TRU Energy and Origin not equivalent
– One month versus two months
• Example: April-May
– Suppose my demand is 4000 (April), 8000
(May)
– TRU Energy: pay total of $127.19
– Origin Energy: pay total of $128.20
• Origin potentially has a weaker price cap
than TRU energy
 Victorian Gas Demand
Areas of Bimonthly
Gas Demand
Variation
35000000

30000000

25000000

20000000
Gas Demand
15000000

10000000

5000000

0
Jan-04 Feb-04 Mar-04 Apr-04 May- Jun-04 Jul-04 Aug-04 Sep-04 Oct-04 Nov-04 Dec-04
04
 Summary
• Difficult to compare price offers
– Prices are the same but ‘shorter period’ yields a lower overall
bill; need information on month by month demand to work this
out.
• Prices still at the cap
– Whether asking to switch or a new connection
• 2% discount available if ask
• ‘Diamond Paradox’ (rather than ‘Sleepy Incumbent’
model) alive and well in Victoria

Would we have been better off keeping a single incumbent

and inviting entry (as per telcos)?
 Behavioural Economics
• New economic approaches for dealing
with consumer irrationality
• Basic idea:
– When faced with an upfront cost and future
options, consumers with over-weight option
value and spend too much upfront
– When faced with an upfront benefits and
future avoidable costs, consumers will under-
weight ability avoid costs and spend too little
upfront
 Implications for Switching
• Consumers will under-weight importance of
disconnection fees
• Consumers will under-weight ability to opt out of
automated payments to switch in the future
• Consumers will under-weight future switching
costs
• Consumers will fail to invest in information to
make choices transparent
– And firms will not have an incentive to provide
transparency as consumers will demand more upfront
to compensate for switching costs later on.
 Policy Responses?
• Likelihood of consumer choice providing a locus
for effective competition is bleak
– Energy retailing looks like a confusopoly
• Would a regulated pricing structure that forced
simplicity and transparency be better?
• Would a consumer choice regime that required a
choice be effective?
– E.g., an audit of individual choices or an annual
auction for customers?