Rachel Fletcher speech at Utility Week Conference: "The future of retail energy market regulation - a greater focus on principles"
Agendas, minutes and presentations
Publication date
Industry sector
Supply and Retail Market
Rachel Fletcher, Ofgem senior partner for consumers and competition, was speaking on 19 October 2016 at the Utility Week Conference: Innovating for Greater Customer-Centricity.
Good morning and thank you to Utility Week for inviting me along to talk about the energy retail market.
From the title of this session some of you might be expecting me to focus my entire address on the steps Ofgem is taking to make more use of principles and less use of prescriptive rules in regulating energy suppliers - what we are calling our “Future Retail Regulation” programme. I will touch on that work. But first I want to talk about the key challenges in the energy retail market which I think are more profound than they have been for some time.
A greater reliance on principles is only part of what we are doing to address these challenges.
Three key challenges in energy retail regulation
As a regulator, whose duty it is to protect the interests of current and future energy consumers, we see three broad challenges at the retail end of the energy sector.
- Improving supplier service standards and building greater customer trust and satisfaction – this is an old chestnut which has proved difficult to crack.
- Ending the two tier market where only 30% of customers capture the benefit of vigorous competition – although not new, this is the issue of the day. Reading the papers and listening to party conference speeches suggests that this issue needs to be addressed urgently.
- Laying the groundwork so that future consumers can benefit from the innovation we are already beginning to see – and which we expect to accelerate, particularly as more smart meters are rolled out. This is the issue for the future which could challenge the current supplier hub model.
Supplier service standards
Energy is an essential service. The public’s expectations about the level of customer service are quite rightly higher than for many other sectors. This is one reason we have a supply licence and an energy regulator in the first place.
There have been some important improvements of late. Customer complaint figures are about half the level they were two years ago. I am beginning to hear charities commend certain suppliers for the work they are doing to support people in fuel poverty. But there is still a long way to go before the industry has gained the trust it requires from its consumers.
Satisfaction with complaints handling remains poor, there is evidence of some suppliers taking too long before helping people in debt. Only 44% of customers trust energy suppliers, below the equivalent figure for water companies, land line providers and banks. Only insurance companies fare worse. Frankly, energy consumers deserve better.
Our work on principles based regulation is aimed at addressing this problem. But on its own it won’t be enough. We are encouraged to see some (but not all) of the new entrants raising the bar on customer service. But we would like to see competition doing more to drive up standards. We are working with Citizens Advice as they develop a new comparison tool which will allow customers to pick suppliers on the basis of their service track record as well as their price. This should be available on the Citizens Advice website in December and be ready for price comparison sites to use in March next year.
Two tier market
Inevitably, retail competition has been focused on gaining the business of the 30% of customers who switch regularly. As a result there is very little competitive constraint on the prices charged to non-switchers and a wide dispersion between the prices for active and sticky customers.
This feature is not unique to energy. Other services (including financial services, telecoms, and dare I say it, perhaps water when competition is introduced) - which lend themselves to easy customer segmentation - suffer from the same problem.
The issue for energy is not just that it is an essential service. Many families find that energy costs are rivalled by only housing and food as a proportion of their disposable income.
In the last few years falling wholesale prices and the burgeoning of new entrant suppliers has driven down the level of acquisition tariffs. This has only served to highlight how much consumers who stay for years on standard variable tariffs are losing out.
The two-tiered market is not a new phenomenon. We highlighted it back in 2009. Its persistence is why we referred the market to the Competition and Markets Authority (CMA). This June the CMA concluded that the large suppliers have unilateral market power over their sticky customers and that this is having an adverse effect on competition. And if a finding from the CMA wasn’t enough, our new Prime Minister has spelled out loud and clear that markets should work for all consumers in society.
I hope that all energy suppliers – but particularly the handful who have millions of customers on standard tariffs - have heard the message, are looking to get behind the CMA remedies, and are thinking hard about how to solve this issue as quickly as possible.
Interventions to fix the two tier market will not be comfortable for suppliers. Nor will they resemble what you see in other markets. Very soon the CMA will require suppliers to hand over customer details to us so that rival suppliers can market to them. These remedies are meant to be disruptive and change the dynamics of the retail market. As we go about implementing them, success is not as simple as reducing the number of customers on Standard Variable Tariffs. We need to be satisfied that even those who do not engage in the market are benefiting from competition.
Future consumers
For all the concerns I’ve raised so far, this is undeniably a very exciting time for the industry. We are about to reach the starting line for smart meter roll out. We are already seeing a growth in new business models (intermediaries as well as retailers). As well as the end of frustrating estimated bills, technology is developing at pace to allow businesses and householders to control how much energy they use and when they use it. We can already see how innovation will make it easier for people to produce energy, store it and sell it back to the grid. This will benefit not only the household purse but also the environment, security of supply and overall system efficiency.
But getting to these “sunny uplands” will require fundamental changes to the way the industry operates. In Ofgem we are pushing hard to bring about this change.
This includes changing the industry systems and processes for switching supplier and for settlement which have been in place since market opening. Left as they are, they will constrain the benefits people get from smart technology. The current 21 day switching time and poor reliability – although improved somewhat recently – already compares unfavourably with other industries and puts many people off switching supplier.
Engaging with the change process and reconfiguring back office systems so that they can talk to the new industry arrangements is not an optional extra for energy suppliers. This is an area where you should expect us to be prescriptive and highly interventionist – no amount of high level principles will bring about the scale of change needed.
With that overview of the key challenges, let me return to the title - the shift to principles based regulation. I will talk briefly about why we are making this shift and then reflect on the progress we have made so far.
Rationale for a shift towards principles
There are three drivers for us relying more on principles and looking to reduce the number of rules in the licence.
The licence has ballooned in recent years and is becoming unwieldy. In 2007 we cut the licence from 160 to 70 pages. Following a series of EU and government interventions – but also adding our own rules – the retail licences now stand at around 500 pages.
This means the licence is now a very poor way of communicating with suppliers about what is expected of them. This is particularly concerning given that we now have around 40 suppliers who have not been around to witness the organic growth process over the last decade. And if you think about where we are in terms of meeting society’s expectations about the level of service from energy suppliers, it is important that we address this as fast as possible.
The extent of change expected in the industry means that the approach we have at the moment to licensing and regulation is not sustainable.
We know from experience that overly prescriptive regulation can get in the way of suppliers innovating in the customer interest.
Prescriptive rules often become ineffective in protecting consumers when new technology or business models come along.
As smart meters are rolled out time of use tariffs and further innovation happens, we expect new risks to emerge for consumers. We do not think it is possible – or appropriate - for these to be addressed by yet more prescriptive rules.
Thirdly and fundamentally, a rules-based approach hasn’t been a terribly effective way to drive better customer service. Some rules are important and we will continue to impose them where there is genuinely only one acceptable way of doing something or where consistency is required across the industry for whatever reason. But:
Suppliers can and do get around prescriptive rules. It has been depressing to witness the effort some suppliers have put into dodging the requirement to give their customers’ messages about cheaper tariffs they offer. We’ve tried to plug loopholes as they’ve emerged but this has been like squeezing a balloon.
Most importantly, even if the supplier is focused on complying with the rules, it means they are focused on doing what we want, rather than meeting the customers’ needs. I cannot overemphasise how important it is that we get to a place where suppliers – which have the relationship with customers and hear from them thousands of times a day – are doing the detailed thinking about what customers need. Not a team of civil servants in Ofgem.
In short, what we are aiming to achieve is to:
- Facilitate innovation and competition
- Provide effective protection for consumers in a rapidly changing market
- Encourage suppliers to take responsibility for achieving good consumer outcomes.
Obviously this programme involves redrafting the licence and we are making good progress in doing that.
Since 2013 we have had a “treat customers fairly” principle in the licence.
By the end of this year we will have removed 60 pages of licence conditions relating to marketing and tariff structures and will have replaced it with a simple principle.
We are also about to consult on a new broad principle in the front of the licence. This will make it clear that suppliers need to identify customers in vulnerable situations and do all they can to address their needs. With such an unwieldy licence, I am concerned that new entrants in particular may struggle to understand the expectations around how they treat vulnerable consumers. We are seeing a number of worrying trends as mid-tier suppliers in particular pick up more consumers in vulnerable situations.
Reforming a 500-page licence and identifying the key principles to govern supplier conduct is a mammoth task. But this is only the tip of the iceberg. The central challenge in the shift to principles is one of culture change – for suppliers, for Ofgem and for how we relate to each other.
Observations on progress on the cultural shift so far
So a few thoughts on what I see so far. Let’s start with the cultural change required within Ofgem.
We need a mind-set change so that when new issues emerge, we look for principles and focus on customer outcomes first and only use rules where absolutely necessary. We need to get comfortable with suppliers taking different approaches to achieving the principles. And we need to think carefully about the tone of our media messages where suppliers have been proactive in addressing problems their customers face.
These changes will take time and we won’t always get it right. I encourage you to give me and my team feedback where you think we have missed the mark.
In the transition to a world with fewer detailed rules we need to get better at engaging with suppliers who are trying to do innovative things. In the past we have been too ready to tell people to “go away and get your own legal advice”. I’ve had some positive feedback from suppliers recently who’ve had helpful conversations with us (but of course, not legal advice) ahead of launching new products. We need to build on and embed this experience.
Principles-based regulation will not be successful if, particularly in this transitional phase, Ofgem steps back and only gets involved once things have gone seriously wrong. Working with Citizens Advice and the Ombudsman, we are improving our near-term monitoring of customer experiences.
We know we can play a role in helping suppliers with the culture change they need to make. Not by providing detailed guidance which introduces prescription through the back door. But by holding up the mirror to flag areas the industry or particular suppliers might need to pay attention to and by pointing out examples of good practice. You will see us doing that more and more.
Observations about the responsibility of industry to produce good consumer outcomes
Finally, some observations about industry and how well it is doing in taking on responsibility for good consumer outcomes.
Generally, the level of supplier support we have for principles-based regulation is encouraging. We had a senior roundtable a few weeks ago which was well attended and showed many companies are thinking actively about this.
But I have three main concerns to end on.
Industry-wide issues will continue to crop up – either because of human error or on the back of smart roll out and other innovation. If Ofgem is to give industry collectively more space to sort these issues out, suppliers will require a strong trade body. One question I leave with you is whether Energy UK is sufficiently resourced and empowered to do this job and how non-member suppliers can be brought into the fold?
I remain worried that suppliers are still mainly focused on managing the risk of enforcement under a principles regime rather than thinking about how to use the opportunity to put their customers’ needs at the heart of their business. If this thinking prevails, it will severely limit how far we can get in using principles instead of rules.
Suppliers should look at our track record.
- We have enforced our existing principles where supplier conduct has resulted in major consumer harm not where there is a technical or a minor breach.
- Where we have enforced the Treat Customers Fairly Principle we have not used the benefit of hindsight to impose an arbitrary definition of fairness. It has been because there was clear evidence that the supplier didn't pay enough attention to the consumer experience and this is what caused the consumer harm.
- There are lots of examples of us working with suppliers to bring them into compliance, where there is not significant consumer harm, or where an issue has arisen from human error or other factors outside the control of the supplier.
My last observation is that the success of a principles-based approach rests on suppliers driving wholesale culture change throughout the organisation – from the boardroom to the call centre - to put customer needs at the centre of their business. I am not convinced that this is happening consistently across the industry or as quickly as needed given the poor legitimacy the industry has in the court of public opinion. I recognise it is challenging.
For larger companies in particular, it requires a thorough overhaul of each and every process and governance arrangement.
It requires re-educating thousands of staff members and perhaps bringing in some new leadership capability.
It will require new approaches to understand customers and what they need. But three years into a principles based world, we should be well into this change process and there should be more evidence of it bearing fruit.
Summing up and circling back
In summing up and circling back to where I started:
We need an industry where leaders spend as much time thinking about how best to treat their customers as they do about maximising shareholder returns. While this is not the only thing needed to address the key challenges in the sector, it could go a long way to doing so and make the next few years less painful for everyone.
This cultural shift in suppliers is a more effective way of improving customer service and people’s trust in the energy sector than repeated high fines and further prescriptive rules from Ofgem.
There is a very strong and intensifying need to bring an end to the two-tier market. Suppliers should be putting their weight behind the CMA remedies which are aimed at solving the issue, and thinking hard about how they help their loyal customers engage in the market.
And finally, addressing the challenges in the sector involves thinking ahead to consider what consumers will expect in a few years’ time. If the supply industry has not shown itself willing and able to allow customers to benefit from smart and other innovation, there is a risk of the supplier being usurped by intermediaries or by other fundamentally different business models.
Thank you.