Energy Retailers: Delivering a trusted service whilst managing OPEX pressures

Graham Mathie - 18/12/2023

Exploring how to deliver for consumers whilst managing the operating cost cap and mitigating downside pressures to margin.

The first of a series of blogs that seeks to support suppliers in answering this question, this blog sets out the context and the headline challenge.

Background

In 2014, almost 90% of the U.K was supplied by the traditional ‘big 6’ energy suppliers triggering a referral to the Competitions and Markert Authority. Against a backdrop of profitability concerns and deteriorating customer service levels, the findings and recommendations ultimately culminated in the 2018 Ofgem decision to introduce what we all know as ‘The Price Cap’. For consumers, the price cap was designed to encourage engagement in the market and protect from over-charging while providing suppliers the means to finance their license activities whilst remaining modestly profitable. Since inception, the price cap has contained an operating costs allowance (OPEX) based on an ‘efficient supplier’ and the market conditions at the time, in this blog we will explore existing and emerging downside pressures to margin and if the allowance within the price cap is realistic for suppliers to remain profitable while servicing retail customers.

The ‘Efficient’ Supplier

The original 2018 price cap methodology¹ centred largely around the premise of the ‘efficient supplier’. For each component of a customer's bill, an allowance was set that was deemed reflective of supplying energy in an efficient manner to consumers. Arguably, within these bill components OPEX is the main thing that suppliers are in control of with retailers now incentivised to cut costs and encourage efficiencies to protect their operating profit (EBIT allowance of 1.9% included in the cap). While the price cap includes headroom for risk and uncertainty, is the OPEX allowance reflective of the current landscape of servicing customers as a retail supplier? A review of the elements that are included in the allowance, the unlimited downside risks, and the requirement for substantial improvement in customer experience (the industry was voted the lowest performing sector in the U.K for customer satisfaction levels in 2023²) would suggest that this is a real challenge for even the most ‘efficient’ supplier.

Margin Analysis

Table 1.1 outlines the current (11a) and next (11b) price cap allocations by bill competent, OPEX and EBIT combined is £263 currently, rising to £264 in the next period.

Table 1.1 ³

Table 1.2

The downside risk is unlimited, table 1.2 details what is included in the OPEX allowance and what other potential costs a supplier may incur, whether this is for service penalties or the cost of providing services for consumer groups it puts pressure on the £43 per dual fuel EBIT allowance per customer in the cap (period 11b).

We have conducted analysis (table 1.3), that demonstrates that with the current OPEX allowance, even a high performing supplier, operating efficiently and achieving all external and typical internal metrics, will have margin erosion of approximately 20%. We have been conservative in our approach, given this is what would be considered a model supplier, not all downside risks have been incorporated:

It is worthwhile noting, that the original design of the opex cost cap presents a challenge to suppliers achieving the maximum 1.9% EBIT. The methodology included taking the costs of a lower quartile performer, hence benchmarking the opex costs below 75% of the market at that time- and then deducted a further £5 per duel fuel customer. The graph below illustrates the reality of the maximum margin that can be retained for a supplier who is not only high performing in terms of efficiencies in operating costs but is also a model supplier in the provision of service.

Consumer Standards Reform - Additional Margin Pressure?

The September 2023 Citizens' Advice supplier ratings scored 89% of suppliers less than 3.5/5 for overall service and more than half of suppliers rated 1/5 for complaints, coupled with a sharp decline in consumer trust in the industry to ‘do the right thing’ ², this reform is welcome. There is no denying there is a need for a shake up in the level of service given to consumers as we look to rebuild trust in the industry, although it could be argued that a review of current CAB bandings is needed against a backdrop of tumultuous market conditions, customer anxiety and the cost-of-living crisis.

During the original 2018 consultation some suppliers highlighted concerns that under the price cap there could be a decline in customer service. Driven in part by constrained Opex, increasing risks, increased demands driven by the wholesale market crisis and covid, and declining external performance ratings, it could be said this has come to fruition. The new Consumer Standards Reform launching this month will place additional expectations on suppliers around customer service to deliver reduced wait times, extended opening hours and more proactive support of vulnerable customers with no increase in OPEX allowance. Concerns were raised during the reforms however the regulator declined to review OPEX allowance in line with the new licencing conditions.

Controlling Your Downside Risk

While there is discussion to be had around whether policy makers need to assess their recommendations on additional services, increased commercial exposure and an expectation of increased investment within the context of a sustainable market, our upcoming blog series will share our operational expertise to provide insight into how to survive current industry conditions. We will share insights on how to reduce OPEX and control downside risk, protecting margin from being decimated at the same time as committing to delivering a great customer experience.

Clyde Ventures has recognised these areas as key levers suppliers can pull to minimise margin erosion and we will explore each challenge with tactical and strategic recommendations in a dedicated series over the coming weeks:

• The Debt Challenge.
• Cost to Serve challenge: Service and Complaints.
• Cost to Serve challenge: Metering and Settlement.
• Cost to Serve challenge: Billing & Back Billing.
• Servicing Vulnerable Customers.

For more information on how we can help you reduce your cost while transforming your customer operations for excellence, contact Graham Mathie or Ross Bern.

References