What would a good market look like?
Like many with an interest in the industry, I've wondered how effective is England's competitive water market. There are some very good signs, certainly. But matters for concern also, I dare say.
MOSL's public market data sets are very informative and give a very useful barometer for activity in the market. In this article, I dig a little deeper into the data to consider some potential measures for looking at the success of the market as it moves into stabilisation and on to maturity. Some may feel that's a narrow focus - I don't look at wider analyses or at some of the structural aspects of the market - but, hey, that's where I'm drawing the line.
As usual, the data used in this article comes from what MOSL publishes each month, which can be found here (with this assessment based on September's figures):
What tests could/would you apply?
New : Incumbent ratios
I assume that if there was perfect customer satisfaction - for price and service - there'd be no switching at all (except for those with multiple suppliers already, perhaps) but even if this "never-happened-anywhere" scenario were true, economists say that monopolies can stifle innovation so there is bound to come a point when new entrants make inroads of some kind to develop new products and approaches, even if those novel methods are quickly copied.
In any case, the legacy scenario was really one of multiple disparate monopolies (unlike in Scotland) so liberalising the market created competition even within the incumbent oligopoly, regardless of outsiders joining the party. The former monopolies had growth opportunity in other network areas and weren't just facing managed decline in the way that many monopolies are when competition is first introduced. It stands to reason that some new capabilities would be needed to market, sell and serve under the new conditions, but these companies have strong reputations and subject matter expertise to draw on - which means that they can gain customers while still evolving those capabilities.
A market with no gains for new entrants would be problematic and would suggest very stark barriers to entry and hurt innovation in the long run. But what share of gains would represent a healthy number is more a matter of conjecture. So how are new entrants getting on?
By now, 29.8% of all gains by SPIDs were to new entrants (including self-supply). This was 21.9% by volume. Healthy or not, who can really say? It does look positive, even if the majority of switches are to incumbents (and there is nothing intrinsically wrong with that, of course). An indicator, yes, but a fairly loose one in pure terms. It certainly shows that new entrants can gain access to the market and secure customers. And traction, at least by SPID, has increased over the last six months. There is work being done to improve, for example, the credit arrangements for retailers which may help improve working conditions so there are positive signs once new entrants make it past those difficult first few months of trading.
NB: These figures treat Business Stream and Castle Water as incumbents rather than new entrants because of their portfolio purchases before market opening. There will be different views on that but overall we consider that their experience and challenges in the market will more closely resemble those of associated retailers than 'growth from zero' new entrants, especially when you consider their strong positions in Scotland. Yes, they'll be further along that evolution curve but most of their work will still be serving existing customers.
Clearly the more that take the self-supply route, the greater the confidence in the viability of that particular option. Unsurprisingly, takers of this approach so far are organisations with high aggregate usage, many sites or both. For those companies, it can be a great option and it is notable that all have taken a 'managed service' approach - and all with Waterscan.
What does self-supply say about the health of the market? Does it talk to a lack of confidence in - or choice/competitiveness offered by - retailers? Some will be surprised by the seemingly high take up, some less so. It may be that there isn't much difference between self-supply as a managed service versus certain retailer relationships that offer a highly tailored service but it does give the companies involved a greater opportunity to influence the market.
Certainly, it would seem likely that more companies will adopt this, especially those in similar markets to those that already have, in particular those in the drinks and leisure industries. Perhaps we will see some 'stage 2' developments, whereby some of the companies move fully in house. Otherwise, we may even see some pull out and adopt a standard retailer model. As an added quirk, we look set to see a number of sites switch between self-suppliers with the sale of the Costa brand from Whitbread to Coca Cola.
Again, as a measure it is an interesting one, even if not necessarily instructive on how effective the market is (though no adoption at all would have been a bad sign, undoubtedly).
In the latest figures, self-supply accounts for 4.1% of the switches by SPIDs and 7.6 % by volume. By market share, they represent 0.23% (SPIDs) and 0.97% (Volume), though a number of new self-supply organisations have yet to take on their portfolio. On one hand that may seem like a disproportionate industry voice for each member of this community to have but the converse would be that each self-supplier's portfolio compares favourably to all but the fastest growing 'standard' new entrants, at least for now.
Market Segmentation by Usage
The contrasting relative shares of new entrants by SPID versus volume suggest a bias on the part of incumbents (and self-suppliers) towards higher consuming sites. Surveys by Ofwat and CCwater indicate a lack of engagement at the lower usage levels. MOSL's data also shows that lower users are under-represented in switching compared with their share of the market overall - with the differential between market share and switching share increasing with each incremental consumption band:
The higher usage groups are more motivated, mainly because a high water reliance presents opportunity to seek a lower price and/or get help to reduce consumption; some may also have many sites across the country and hence want a rationalised service. It is not surprising that these groups are more active, especially when the incentive is high on the retail side also, given the size of the accounts involved.
But is it a problem that lower users are less engaged, though? Often, those at the lower end of usage simply have less to gain from switching. If water is 'just' about covering the basics of hydration, hygiene and heat then you may see it more as a necessary overhead than something to actively manage, especially for micro businesses with many other competing challenges for their time. Heightened awareness is needed but even then, there may not be much of an incentive for some at the lower end to focus on water and sewerage versus their other priorities. Yes, as a society we share the environmental imperative to valuing water efficiency but at the lower end of the market, there may be a closer alignment to the motivations of the household sector than to the higher usage bands of the non-household market.
Retailer Average Customer Usage
What may be crucial is finding reasons for that SME community to be interested (at least once awareness is raised). And there is evidence of what that may look like when you take a closer at the customer segmentation choices of retailers. When you consider the average consumptions of users lost and gained, you can see differences between the retailers:
Firstly, we see confirmation of the apparent bias towards larger consumers by the incumbents. I first used this chart some months ago but we can still see now that, overall, the incumbents are signing up higher usage customers than they those are losing. It is marginal now, and generally more mixed, since some individual retailers appear to be adopting a more generalist approach or series of products/services than in the first year.
Then we can see the higher average usage levels of self-suppliers and The Water Retail Company, with its specialist water efficiency focus. This provides a useful contrast to the less specialist new entrant retailers, which tend to gain more customers in the lower to medium usage segments.
And of particular interest on the concerns about reaching the lower usage categories, is the Clear Business Water experience. Yes, they are picking up the lowest average but, to my mind, theirs has been (ahem) the clearest multi-service approach to observe thus far. Yes, there are others offering energy (and more) but multi-service is central to the Clear mission and may be most apparent in their portfolio than in those of others.
There is a traction to that message and they have consistently been one of the leading gainers over the past few months, an approach which offers a path to those otherwise less motivated consumers (and, to my mind, the only viable model for establishing interest at the household level). The message is simple: find value in the overall contract and even a minor save in water becomes worthwhile in the interest of customer simplicity. As more retailers offer this and more consumers become aware of the switching opportunity, the more we’ll see SMEs get better represented in the figures, I believe. Like I say, this is not exclusive to Clear Business, but theirs is the most obvious manifestation of it.
Customer Confidence/Regret - Gains & Retention
If looking at average volume helps to shed light on customer choices, another factor might be evidence of repeat switchers and those that return to their original provider:
The chart shows that overall, by SPID and from the gaining retailer's perspective, approximately:
94.9% are new switches that 'stick' (i.e. have stayed with the gaining retailer)
1.0% are new switches that switch again to someone else
0.8% are old customers that switched then switch back
3.3% are internal group transfers (i.e. where gainer and loser are corporate siblings)
That last group is perhaps misleading for now, since much of the activity pre-dates on one hand the Castle acquisition of Invicta and on the other, the CMA approval of the NWGB-AWB merger. It's an important category to keep in mind, though. In my experience of M&A in energy, companies don't always make an immediate switch to a single platform, often because the acquisition is ability capability as well as portfolio and each side's systems may favour certain customer groups. But even then, there can be movement between the two just to get individual customer accounts wholly contained in the right place. When there is large scale consolidation using industry processes, it can distort the overall sense of market activity. A useful distinction later, if nothing to see yet.
What can this view tell us? Well, firstly the analysis technique I used, while highly accurate, is unable to identify cases where a new entrant wins back custom but these can only be in very low numbers, based on the integrity cross-checks. So although the chart says only incumbents have 'win backs', that is a quirk of the report. All incumbents have them though, to a greater or lesser extent.
So what might this say? Does it play to the ability for the losing retailer to put together a suitable renegotiated package that encourages them back? Perhaps, but it does seem more likely that the process of switching - or the experience on the other side - has been underwhelming for some. That in turn may point to market inefficiencies, such as the data setup upon transfer.
And all but those retailers with the smallest portfolio sizes are losing some gained customers, which does point to more systematic issues at play, echoing what the market already recognises, such as the integrity of market data, the efficacy of bilateral interactions and the speed to perform new connections or expedite transfers.
There is a counter point: you could take the fact that customers go back into the market as a sign of confidence in the principle of the market, even if a specific experience was sour. But of the 1% that do switch again, 0.75% is going back to the place it came from, which I would consider a high portion, given that there is plenty of choice if you perceived your new retailer as the issue. It does feel like that group, small as it is, displays some regret.
A Zipf's Law Comparison
Ok, so it is way too early to talk about the mature distribution of market share but one measure of that would be to apply Zipf's Law to test the goodness of fit for the market. A Zipf distribution is a power law probability distribution that talks to the relationship between the most common instance of something to other instances in a population by rank. It has been shown to apply in diverse cases, such as the analysis of language, city populations within a country... and competitive markets.
There's an obvious flaw here: typically, Zipf's Law is used to describe populations, not as a target for them. But if it can be a good descriptor of a mature market with perfect competition, could it not also be a suitable test for how well deregulated markets are heading that way? The level of fit can be tested statistically and market observers might look for an overall trajectory in that direction over time. Would showing that this evolution is happening be positive? Probably, if you take that view that a good destination is towards a market that shares the characteristics of other mature, competitive ones.
Here's how it would look today (assuming 27 retailers on the Zipfian line):
It has a poor "goodness of fit" coefficient, even if it does look broadly the right shape. That's ok - that would hardly be a surprise at this stage. I certainly think that the energy market would look closer to this path now than it would, say, five-ten years ago as the range of viable energy retailers steadily increased - along with the market shares of the challengers.
There have been more recent studies that reject the premise that markets tend to follow Zipf's Law - even those far more mature than this water market. And even if they did, it would take quite some time before such an equilibrium were reached in water. That is not to imply that the 'Big 3' retailers are too large, though, even when considering that all 3 have involved some level of M&A activity. As the area under the curve of the tail gradually fills up, it's going to be driven by taking customers from the left hand side, simply because they have more to defend. And Zipf's Law really gets at numerical normalisation than any philosophical or political aspiration.
But in any case, there's always the twin view to keep an eye on - not just service points but volume as well. A volume-based Zipf Law comparison looks like this - seemingly more top-heavy than by SPIDs, as would be expected given what we see above:
If the Zipf's Law comparison looks negative, it is early days for the market. Nor do I promote losses by the Big 3 per se ... as always, a competitive price, customer services and product innovation should be key, regardless of who is providing them. But if competition is to stay healthy, clearly there needs to be a suitable foothold for others, whether new entrants or smaller incumbents to make headway in the long run.
At the current rates of switching, it would take many years to reach a point of good fit to Zipf's Law but a short term focus on how things are changing now, relative to the overall position might give food for thought for whether momentum looks encouraging in terms of there being an active market with engaged consumers.
From a SPID perspective, the last quarter (and shown with a comparison for the whole life of the market to date) looks like this:
The retailers with the highest net gain over the quarter are to the left, the lowest to the right.
The main net gainers over the past three months are a mix of incumbents and new entrants - and generally the ones with the most positive net position since market opening also.
The largest retailers suffer the highest losses - even those with strong gains of their own - but that is a function of arithmetic as much as anything else, given their dominant shares.
I don't pay too much attention to the flat middle just yet - that's expected for self-suppliers and a number of new entrants are gearing up.
And how about momentum by volume? By volume rather than SPIDs, some retailers go from positive to negative and vice versa over the period - again reinforcing that not all SPIDs are equal and that the incumbents fare better at gaining at the larger usage level.
So, as may come across through the article, none of these proposed views on the market actually offer up a 'target' as such, except perhaps towards a good fit to Zipf's Law. But they each offer a perspective on the market that may inform views on how well it is functioning. As things change, you may draw conclusions about how the market is maturing, in whatever way that may be.
Until his outburst towards Eva Carneiro, I was a big admirer of Jose Mourinho. One comment he made has always struck me:
“The transitions have become crucial. When the opponents organize defensively it is very difficult to score. The few moments after a team have lost the ball are the ones to exploit because some players are out of position. Everybody says that set-plays make the difference in the game. I say it’s the Positive Transition” - Jose Mourinho
It resonated both with my view on football and what I find most interesting in analysing data... that overall insights are great but it is the fine details, the emerging trends... the transitions that define what comes next. And so it is for the market, perhaps.
The mechanics are in place, innovation is apparent, competition is happening. There is still work to be done to get the message out there and there may be different views on whether the activity so far has been high enough or not. But the signs are there that choice is being acted on and as the market mechanics move to stabilisation and retailers further improve and extend their capabilities, confidence and awareness will surely grow.