By Yoonhee Tina Chang and Catherine Waddams Price

Since the mid-1990s, liberalisation of energy and financial markets across Europe and in many other countries has opened up opportunities for consumers to switch supplier with a view to obtaining better deals. Yet levels of switching activity have varied substantially across markets. The effects of this variable activity are twofold: not only are many consumers potentially missing out on energy packages which are advantageous to them, but, with a relatively stable customer base, suppliers have less of an incentive to compete. In other words, the anticipated benefits of liberalisation are not being fully realised.

In response to this evidence, several competition authorities have introduced a variety of so-called “informational remedies” with the objective of making it easier for consumers to compare alternative deals and select the one which best suits their needs. The assumption underpinning such remedies is that consumers who are provided with more information and with simpler, less time consuming switching procedures will react by becoming more active. But is this necessarily the case? Our study reveals that consumer behaviour is more complex than is generally assumed and that when designing remedies to increase the level of consumer activity in markets, it is important to take into account consumers’ attitudes, perceptions and abilities.

Time to switch

Participation, awareness, searching and
switching across markets

Survey
The findings are based on the analysis of a specially commissioned large-scale survey administered in the summer of 2005. The survey was carried out among a nationally representative sample of 2,027 adults, interviewed face-toface in their own homes across the UK (excluding Northern Ireland). Respondents were asked which products the household consumed and paid for from a list including not just gas and electricity, but fixed and mobile phone services, internet service provision, house contents insurance, car insurance, mortgage, current bank account and piped water supply. Respondents were then asked whether they had a choice of supplier for each product in their region as a means of testing their awareness of competition in the market. Virtually all respondents had a choice for all products, except for water where no choice is available. Respondents were selected for the next stage of the survey if they were aware that choice was available in the relevant market and they were solely or jointly responsible for making decisions about who supplied that product (see figure for descriptive statistics).

Further questions were asked about all these markets except water, gas and house contents insurance. In particular, respondents were asked whether they had searched around for better deals and whether they had switched supplier in each market during the previous three years (other than when moving house). They were asked how long such search and switching had taken, or how long they would expect it to take. Questions were also asked about how much respondents thought they could save in each market if they shopped around. The survey and analysis are unusual in seeking explanations for consumers’ switching behaviour in the expectations that they themselves hold about the time needed to search the market to find the best deal and then switch to an alternative supplier, and the potential monetary gains from changing supplier.

Some justification is found for the optimism of competition authorities in imposing informational remedies. Consumers who thought the potential gains were higher and it would take them less time to search and switch were more likely to change suppliers. The implication of this finding is that inactive consumers might be motivated to become more active by greater potential rewards and reductions in the time they expected to have to invest in searching around for the best deal and making the switch.

However, the influence of a consumer’s expected gains and costs provide only a small part of the explanation for the probability that they will be active in a market. The confidence with which consumers predict their likely gains and costs seem to be much more influential in determining whether or not they will switch. This is supported by evidence from energy roadshows held as household prices were rising in 2008. Many consumers, offered impartial advice on the cheapest energy supplier for their circumstances, had already undertaken considerable research for themselves, and had a good idea of the best deal available. But they went to some trouble to seek confirmation of their choice from an impartial source.

It is possible to identify both how each factor affects consumers’ overall activity, and to distinguish their influence on each of their search and switching decisions. While similar factors affect the decisions to search and to switch, their influence on the two activities is not always identical. Expected gain (with age) is more likely to stimulate searching than switching; Expecting to spend an extra hour switching appears to have a greater deterrent effect than searching, but these marginal effects are not statistically significantly different from each other.

The U-shaped effect of age is similar for both search and switching. Experience of switching supplier in other markets increases the likelihood of searching more than that of switching. Since a direct measure is available of expected search time it is possible to interpret the importance of experience of activity in other markets as increasing the confidence that consumers place in their central estimates of time needed and likely gain rather than affecting those estimates directly.

Switching variability betwen markets
Even allowing for the different expectations, attitudes, characteristics and experience of consumers, the probability of switching varies substantially between markets. Consumers are more likely to be active in the car insurance market than in electricity and mobile phones, and less likely to search and switch for fixed line products, broadband, mortgages and current bank accounts. The market effects are large, raising the probability of any one consumer’s activity by 9% in the car insurance market, and lowering it by 20% for current bank accounts. These market dummies do not merely reflect the difference in activity rates between markets, as shown by the chart. The additional activity predicted by the model for car insurance relative to electricity is much greater than the raw comparisons suggest, while the difference the model predicts between activity in the mortgage and electricity markets is less than the relative proportions described in the chart indicate.

It can be concluded that consumers’ decisions to become active in a market can be partially explained by higher expected gains and lower anticipated costs in switching supplier. This provides some justification for the optimism of competition authorities in imposing information remedies. However, the influence of a consumer’s expected gains and costs, even when these are measured individually for each person (rather than based on external assessments) are swamped by other factors in explaining the level of activity in any market. Confidence seems to be much more influential in determining whether or not they will switch. Such motivation is consistent with the wish to reduce their “regret” in switching decisions. Experience of switching in other markets exerts a major and positive influence, which may be interpreted as reducing the variation of a consumer’s estimate, rather than affecting its central value. To encourage activity in any one market, competition authorities need to provide consumers with good information, in which they have confidence, about the likely costs and benefits. This will provide positive externalities for other markets, building further confidence through experience.

Other positive influences on switching include knowledge about which markets are competitive and level of education, indicating the importance of good general education about consumer matters and opportunities. Authorities who wish to punish inappropriate firm behaviour by publicising bad experiences of switching through a “name and shame” process may face a conundrum, if such publicity lowers consumer confidence and deters market activity.

Differential approaches
The significant and substantial differences between markets do suggest differential approaches. All the markets included in this study are subject to sector regulation: from the Office of Gas and Electricity Markets (electricity), the Office of Communications (mobile and fixed line phone services and broadband), or from the Financial Services Authority (car insurance, mortgages and bank accounts).

The greatest propensity to switch is in the car insurance market, though the influence of anticipated savings from switching is particularly small in this market. Car insurance is the only market in the sample where annual reminders for renewal are required, even if the consumer need take no action to stay with the current supplier. Such reminders seem to prompt some consumer activity, and competitors may target advertising at the time of contract renewal. Regulators might wish to consider imposing similar reminders in other markets, though they would need to balance potential gains against the cost of the exercise. The greater influence of savings on activity in mobile phones may indicate response to high profile advertising, a function more appropriate for firms than authorities. The reduced probability of activity for fixed line products and in current bank accounts, compared with electricity, confirms that the lower level of switching in these markets is not explained by differences in the expected gains or costs, or in the other personal characteristics and experience variables included in the regression; consumers are more reluctant to be active in these markets, regardless of these factors. To increase activity here, authorities need to explore further the particular features of these markets that render searching and switching less attractive. In contrast, the lower level of switching for mortgages and broadband (well under half that reported for electricity) are explained by the expected gains and costs and other factors, rather than by differences in the markets themselves. In this case, any remedial action would be less effectively targeted to market based campaigns unless they specifically affected these other factors.

In terms of addressing the search and switch activities directly, there is weak evidence that consumers may be more deterred by switching than by search costs. The factors affecting each are broadly similar, so there is no clear indication that market activity would be improved by targeting one process rather than the other. Remedies to increase knowledge and confidence, as identified above, should address both the search and the switching processes.

Many factors, in particular the confidence with which consumers hold their estimates of gains and costs, are important influences. The use of informational remedies by competition authorities does not seem misplaced. The importance of consumer confidence, the role of other factors and the differences between markets indicate the need to tailor action carefully to each situation.

Based on “Gain or Pain: Does consumer activity reflect utility maximisation?” available at:
http://www.ccp.uea.ac.uk/publicfiles/workingpapers/CCP08-15.pdf.
Thanks to Judith Mehta for her help in writing this article and the UK Economic and Social Research Council for financial support. The authors alone are responsible for the interpretation presented here.