Is Energy Retail a Mug's game?

Big 6

This week’s profit warning from Centrica, followed gloomy results from SSE, Scottish Power and Npower and the announcement that SSE and Npower are planning to hive off and merge their retail businesses.

Whilst disappointing results are to date largely a result of customer losses, the effect of further announcements from E.ON, SSE and Centrica (with others expected to follow) that SVTs are effectively being abolished, are yet to be felt- and the effect will be substantial.

Without a doubt, the Big 6 are feeling the pressure, from competition, the regulator, government, media and shareholders. Gone are the days of year on year growth as the direction of travel has reversed.

Mid Tier

You would think that smaller suppliers, particularly those who were first mover challengers, such as First Utility and Ovo would be celebrating, as they historically have been the beneficiaries of customers who have switched away from the Big 6. However, here too the impact of competition is being felt, with substantial operating losses reported. With growth comes increasing regulatory obligations as well as increasingly complex and costly operations to manage high volumes of customers. The squeezed middle is not necessarily a comfortable place to be.

Small suppliers

The big news of the last three years, has been the number of new entrants that have entered the market, with more than 60 active suppliers now operating. Without a doubt these new entrants have had a massive disruptive effect and have being fighting hard to grow their customer bases. However, few, if any, are yet to turn a profit, and some are showing increasing signs of stress. Whilst the darlings of the sector, the costs of set up are high and take time to recover, many have grown too quickly and are suffering the financial effects of operational challenges, and some were just too naïve when entering the market, and have not put sufficient focus on the inherent risks of running a business in this market- profit, cash and breakeven are the victims.

A pretty gloomy picture all round- however the optimism behind the gloom can forsee a very different shaped, functioning and valuable market, which will include some of the players already operating in it and many more who are yet to emerge.

There are two key things critical to this new world:

1) Redesign of the historic ‘supplier hub’ model: OFGEM, have finally launched a consultation on the ‘supplier hub’ model. Whilst a late start to a journey, it is a hugely welcome action and has the potential to unlock transformational change. Currently market design, at its simplest level, places the supplier at the heart of all energy related transactions- whether directly relating to the consumer experience, or not. The supplier, therefore requires complex risk management processes and operations to manage the recovery of many ‘pass through’ costs, all of which are baked into fixed priced tariffs. The supplier bears all the risk. In addition, and to increasing frustration for those who are not suppliers, the supplier holds the keys to the traded markets. We are increasingly seeing supply licences being taken on to access these markets, with little interest in the actual customer end of the business. The sooner change is made, the sooner the market will be released. A changed model can provide opportunity for best in class specialists to aggregate technical services for suppliers at lower cost, with the genuine retailers released to develop and sell innovative new products and services to consumers.

2) ‘Energy as a service’ as the new norm: Eroding margins driven by increasing competition are here to stay. Whilst the most operationally effective businesses will be able to squeeze margins upwards, the reality is that as a rule the market will need to diversify and deliver new revenue and margin streams. The good news is, that with technological developments, in metering, storage and assets we’re rapidly entering a world where you can envisage a remote controlled home, with fridges, cars, heating and lighting powered from a combination of self generation, storage and control systems. As has ever been thus, customers only really care about the ability to light and heat their home at the most affordable cost. The market is ready for a model where customers buy an efficient, warm, lit, low cost home- not an incomprehensible contract for supply.

Without a doubt the retail market transition is gaining pace and we are likely to see winners and losers over the coming months and years. However, the potential for the winners is worth the pain that is currently being experienced by all participants. Those who develop low cost and efficient models now, deliver great customer service, and concentrate on the emerging rather than the current market, have many reasons to be cheerful.