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23/03/2015

New Pricing Strategies in the Dutch Energy Market

 
As a result of the intensified competition that followed the liberalization of the retail power sector in 2004, the traditional business model of utilities is losing ground. Alongside complementary products and services aimed at saving energy, power retailers now try to increase revenue with new pricing models. But how do these new value-based pricing models work? And why would they be successful?
 

Since the liberalization in 2004, a change occurred in the Dutch B2C energy market from a field with local monopolies to a market with intensified competition. Currently 30 suppliers are active, offering a range of 200+ products to households. This intensification of competition has resulted in high switch behaviour of certain client groups. In 2013, 12% of Dutch households switched supplier, while this percentage was only around 5% in 2006 (Energy Trends 2014). Internal switching (same utility but migration to a different product) has also increased significantly, but no public data is available on this development.

This new market situation of intensified competition required a radical change in the way energy suppliers have to deal with customers, and calls for a deeper understanding of customer needs in combination with adaptation of their strategies and related offerings. Besides diversification in the product offering (energy displays, programmable thermostats, energy efficiency products) utilities are adapting the way traditional energy contracts are priced.

Innovative pricing structures

As energy is considered a low interest product with a difficulty to differentiate on the basis of quality, incumbents and challengers focused in the first years after liberalization mainly on competing on price. This race to the bottom is beneficial for consumers, however it is not considered the best business model for the utilities. More recently, some energy companies are trying to step out of the price war by offering products with a different pricing structure.

  1. The two utilities with the highest market share are offering a product that has a fixed kWh rate, but if the underlying wholesale index drops, the fixed kWh rate decreases proportionally. Consumers have the certainty of a fixed price, plus an optionality that the tariff can become lower.
  2. Another price proposition rewards loyalty. A well-known frustration of consumers is that marketing and promotion budgets are focused on and almost solely dedicated to gaining new prospects. This frustration has been acknowledged by some energy companies, and their loyal customers are rewarded with a reduction on their energy tariff up to 25%.
  3. A final proposition that is quite new in the market is a fixed monthly fee regardless of the energy consumption. In this monthly fee a budget is incorporated for energy efficiency measures that will be implemented during the contract period. Due to the applied efficiency measures, the total consumption level will drop significantly.

The above examples underline that a development is taking place in pricing strategies at Dutch energy suppliers. In the period before the market liberalization, tariffs were cost-based. Post liberalization, the price levels were predominantly influenced by competition (also known as: "me-too pricing"). The new pricing propositions are focused on the perceived value of the product. This development is visualized below.

Figure 1: New pricing propositions

Source: Sia Partners

Value-based pricing is a pricing strategy which sets prices primarily on the (perceived or estimated) value to the customer, rather than on the cost of the product or competition prices. The three previously described propositions are good examples of setting prices on perceived value. The new propositions anticipate on the value of 1) loyalty 2) a fixed tariff combined with downward potential and 3) a fixed fee for energy regardless of the consumption.

The underlying principle of value-based pricing is that customers do not choose solely on low tariffs. They buy according to customer value, which is the difference between the benefits a company gives customers and the price it charges. So, the higher the perceived benefit and/or the lower the price of a product, the higher the customer value and the greater the probability that consumers will select that energy product. A sophisticated model has been developed to implement value-based pricing*. The first step is to map benefits versus price, as perceived by the customer. The two visuals below describe the first action to implement the pricing strategy.

Figure 2: Value-based pricing

Source: McKinsey Consulting

Each dot represents a competitor's product or service. Higher-priced, higher-benefit competitors are toward the upper right; lower-priced, lower-benefit competitors are at the lower left.

Dynamic Pricing

Another price proposition that is to be expected shortly is called dynamic or smart pricing. Peak demand for electricity in Europe is estimated to grow due to the deployment of electric vehicles and heat pumps for heating and cooling purposes. This challenges power utilities to supply this demand in a cost-effective and reliable manner. Therefore, there is growing interest of utilities in strategies to decrease peak demand by reducing electricity consumption, or shifting it to periods of lower demand. This strategy is known as "peak shaving". For households a common strategy is demand response via Smart Pricing. This strategy aims to encourage on-peak consumption reduction by providing an economic incentive for such behavioural change. It forms a move away from the traditional flat rate per kWh to a pricing structure that closely follows the real price of electricity. For example; charging a higher price for electricity consumed during peak periods, or providing a rebate per kWh not consumed during peak hours. These structures should be designed in such a manner that an average consumer who is not changing his behaviour would pay the same under the new tariff structure. Already available Smart Pricing variants include Time-Of-Use (TOU), Critical Peak Pricing (CPP), Real Time Pricing (RTP) and Peak Time Rebate (PTR).

Future expectations

Overall it can be concluded that the era of basic energy products with a single and unified price is rapidly disappearing. Our expectation is that in the near future innovative products in combination with new ways of pricing will more and more flood the Dutch B2C market.

Sia Partners

*Price advantage, by Walter L. Baker , Michael V. Marn , Craig C. Zawada

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