Retail competition in UK Electricity: Differentiating the product through non linear pricing

1. Retail competition in UK Electricity: Differentiating the product through non linear pricing Stephen Davies, Catherine Waddams Price and Laurence Mathieu ESRC Centre for Competition Policy University of East Anglia

2. For a homogeneous good, one objective of competition is to lower price We observe past average price levels (1998-2004) for standard pay, London region We predict future from market structure and firm behaviour Are firms softening competition by targeting different parts of the market (differentiating through the price structure)?  We might care which/whose prices are lowered Average prices Price variance Observing the frontier

3. Retail prices fell, then rose again So did costs…

4. …margins also fell and then rose for both incumbent and best offer…

5. Incumbent increased mark up more than entrants while incumbents retain 50%-75% of home market

6. Average prices • Price variance Observing the frontier

7. Firm behaviour affects price variance Exp Unit rate Fixed charge X For a monopoly with non linear tariffs, average price varies with consumption P X X Var(p) = interdecile, intrafirm >0; variance arises only from tariff structure

8. Firm B P Exp Firm B Firm A Firm A X X For linear tariffs, variance arises from different firm offers Var(p) = intradecile, interfirm >0 Variance measures spread of offers, competitivity

9. P Firm B Exp Firm A B A X1 X1 X X In competition, with non linear tariffs, variance arises both from tariff structures and tariff levels Components of variance show how firms compete

10. Can split total variance with respect to deciles or firms Total variance of average prices across deciles and firms = av var of firms’ prices within deciles + var between the mean prices for each deciles = av var within firms (i.e. the av firm var across deciles) + var between firms (in their means across deciles) If firms use pricing structures to differentiate their offers, intra-decile variance will increase; if they are not competing vigorously, inter firm variance will increase Conversely, if firms price ‘competitively’ and move nearer the frontier, intra decile and inter firm variance will decrease

11. Variances have increased Increased inter-F firms locating further from each other on the frontier, reduced competitive pressure; Increased intra-Dmore specialised price structures

12. Observing the frontier London: drifting from frontier; specialisation less clear

13. Originally 14 regional monopolies

14. Industry consolidation