Economic Theory

The price mechanism revisited: banning ‘loyalty penalties’ in the energy sector

Amid all the turmoil in the domestic energy markets, a relatively little-noticed change in regulation is that Ofgem has – as it puts it – stipulated that for the time being, “All suppliers will have to offer existing customers the same deals available to new customers”. The great thing about this – so says the Ofgem press release – is that it will “ensure customers can benefit from all tariffs available in the market”.

One way of looking at it is that this bans the “loyalty penalty” by which customers who do not go looking for the best prices, but stick with their current supplier, end up paying more. On that basis, the regulator earned itself some nice headlines: Energy regulator Ofgem cracks down on loyalty penalty, said The Independent, for example. But one household’s “loyalty penalty” is another’s “shopper’s discount”. So another way of looking at the move is that Ofgem has banned discounts for new customers. “Regulator in new customer discount ban” would not have been such a good headline, though it describes the same policy.

There is more to it than a presentational nicety, though, since regulations like this, if maintained, surely damage consumer welfare. The first question is whether Ofgem really thinks it has regulated which customers can have which deals without thereby affecting the range of deals the energy companies choose to offer. The energy companies are, more or less, and subject to all the usual uncertainties as well as any distortions created by the regulatory environment, profit-seeking. We may assume they have been offering discount deals to new customers because they believe it is profitable to do so. Plainly, if Ofgem says that if they do that, they must also reduce the prices charged to their existing customers, the discounts policy will no longer be profit-making, and the deals will cease to exist.

The point is that when Ofgem said its rule would ensure that customers “benefit from all tariffs available in the market”, it was not addressing the question of how the rule would affect which tariffs are available. But that is crucial.

When the discount tariffs are withdrawn – as they will presumably have to be – it is possible the standard tariffs will fall slightly. That would seem to mean that some customers will be winners and some losers. The “loyal” ones who were on the standard tariff will be slightly better off, while the “disloyal”, or “shopping around” – those who switch provider to get the best deal – will be slightly worse off.

If that is how it turns out, one might think there is not much in it. But there are two more issues. One concerns what kind of customers are likely to be amongst these “loyal” and “shopping around” groups. It is safe to assume that the “loyal” ones who, under the old rules, ended up paying more, were the ones who were disinclined to spend their time looking for the best deal. There were better deals available for them, but they did not want to take them, or did not bother looking. The shoppers, on the other hand, were the ones who were disinclined to spend their money on inferior deals, and were willing to spend the time checking the prices. That is very suggestive that the “shoppers” are relatively time-rich and money-poor; while the “loyal” are money-rich and time-poor. But what that means is that Ofgem’s new rule makes the money-poor pay more money, and the money-rich pay less. That deserves headlines along the lines of “Regulator makes poor pay more so that rich can save money without needing to check the prices”.

That is a policy outcome that few will welcome once it is understood what Ofgem have really done. But potentially a larger problem still is that the effective prohibition on new-customer discounts removes a key means for energy firms to compete for customers. But competition for customers is of the essence of the way in which the market system provides benefits to the customers. With this measure, Ofgem has taken a step in the direction of telling the companies that they can relax because henceforth all the other energy companies will find it that bit harder to take their customers away from them. Good news for the producers, then, whatever the headlines say.


Dr James Forder is Academic and Research Director at the IEA. He has taught economics and sometimes politics at Oxford University since 1993 and is Andrew Graham Fellow and Tutor in Political Economy at Balliol College. His principal research interests have been in central bank independence, and the history of macroeconomics ideas, including especially those following from the work of A W H Phillips; and the work of Milton Friedman. He has also written on the merits of the first past the post electoral system. He believes that public policy could be enormously improved by greater recognition of the power and utility of price mechanisms, as compared to regulatory controls such as prohibitions, licensing rules, and obligations on public bodies to pursue specific quantitative outcomes.

1 thought on “The price mechanism revisited: banning ‘loyalty penalties’ in the energy sector”

  1. Posted 01/03/2022 at 20:56 | Permalink

    I like the price mechanisms part of the bio of Mr Forder. It’s a good little article too which switches the regulator’s logic around.

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