Sticking With You

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Power ECONOMICS

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Finnish Customer Loyalty march 2004

Sticking with you When Finland's electricity market deregulated, it was thought customers would leap to change suppliers. However, only one in 10 has. What’s the reason?.

By Dr Philip E. Lewis VAASA EMG

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HE ARGUMENT THAT CUSTOMERS do not behave rationally would seem to be confirmed within the Finnish residential electricity supply market. After five years of full deregulation, despite moderate customer satisfaction and price variations of up to 120 per cent, only one in 10 customers have chosen a new retailer. It is not as though choice does not exist either – around 50 retailers currently offer electricity to non-incumbent customers – and there are no significant barriers to switching.

After six years of analysis, researchers at VaasaEmg have concluded that the complexities of loyalty are such that we cannot judge rationality, nor predict loyalty or customer lifetime value based on simple indicators. Measurement of these issues requires far more rigorous analysis of more appropriate data than is commonly appreciated by systems today. The research indicates that the behaviour of customers is both explainable and logical if we look at the whole picture.

The Finnish microcosm The Finnish residential electricity market is interesting for several reasons. Not only is it one of the most deregulated markets in the world, but its three million customers were awarded choice at almost exactly the same time as the nearly ten times bigger UK market.

Whilst competition in the UK market resulted in net switching levels of over 40 per cent, Finland has only recently exceeded 5 per cent.

Yet comparative research indicates that

customer willingness to switch is similar in both markets, as are customer satisfaction levels and opportunities to save money.

Two commonly cited factors might explain some of these switching differences, namely the existence in Finland of ‘offer-pricing’ and ‘price-matching’ from incumbents upon request from individual customers, and the fact that customers who change retailer end-up with two bills (electricity and distribution) instead of just one. However, since only around 10 per cent of residential customers in Finland have actively asked for special offers from their incumbents, and very few customers are aware of the two-part bill, these commonly applied explanations seem weak. Furthermore, to argue that customers remain loyal because of a small price reduction from a firm which is up to 120 per cent more expensive than the cheapest retailers, seems preposterous.

A third factor that might explain switching differences between the UK and Finland is the initial price restriction that was placed on UK incumbent retailers, preventing them from reducing their prices to match those of competitors. No such restriction occurred in Finland. However, once again this is a weak argument when you consider that regardless of these restrictions, opportunities to save in Finland are at least equal to those in the UK. Furthermore, it seems that switching in the UK has continued strongly even after price restrictions were removed, and switching in Norway and Sweden has been far higher than

Loyalty drivers

Lifestyle more time, more money, less stress, more fun (requires customisation: flexibility, individual treatment responsiveness

in Finland without the UK ‘advantages’.

The evidence therefore suggests that whilst the above mentioned factors may well have reduced Finnish switching levels the primary explanation for differences in switching levels lies not in the pre-determined deregulated environment, but in two completely different factors: customer psychology and retailer marketing. To be more precise, the interaction between customers’ minds and retailers’ actions is at the heart of switching levels in Finland.

Psychological barriers Research indicates that in recently deregulated markets loyalty is the natural state for a typical residential electricity customer. There is not a single market in the world where the majority of customers have changed retailer.

In most markets, including Finland, the switching level is low and likely to remain that way in the foreseeable future. This is not to say the majority will never switch. As habits change and marketing improves active choice for electricity may become the norm, but habits change slowly.

In fact the findings of a forthcoming report for the Finnish Ministry of Trade and Industry suggests that psychological barriers to customers switching are inevitable and therefore even uncompetitive offerings may be accepted by incumbent customers. In line with this thinking, recent scientific research in the UK residential electricity market found that incumbents retain considerable market power due to the impact of the search and switching costs facing customers. Consequently, the likelihood of customers becoming disloyal, whilst not great, depends to a large extent on their perception of the relative costs and benefits associated with switching. If retailers are to control loyalty they must therefore exert control over customer perceptions through a measured interaction with customers.

Loyalty drivers Predictability security, consistency of service, proof of capabilities

Contact

Situation opportunity, environment & time

Loyalty

interaction, awareness & education

Relationship involvment structure & strength

Fairness equality, ethics (genuine), flexibility good intent, individualisation Source: Lewis, P.E. (2003)

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Unknown factors

Since 1997 detailed research at VaasaEmg on more than 30,000 Finnish residential customers has analysed customers’ perceived costs and benefits within the context of ‘loyalty drivers’, including customer motives, society and the marketing and regulatory environment. A simplistic summary of these drivers is given below There are many issues that matter to customers in the context of electricity purchasing decisions, but customers mentally aggregate the complex array of concerns to derive a more simplistic view on the situation.

In other words customers ultimately evaluate and are driven by broader issue categories or ‘need drivers’ that can be simply labelled.

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Finnish Customer Loyalty march 2004

VaasaEmg initially labelled these Lifestyle, Predictability and Fairness, but as research develops these labels will be reconsidered. It is the consideration of such issues by customers that leads to customers’ perceptions of costs and benefits relating to their choice of electricity retailer.

Whether or not there is a change in loyalty depends however upon the ‘Behavioural Facilitators’, categorised and labelled here as ‘Individual’, ‘Situation’, ‘Contact’ and ‘Relationship’. Except for Individual, these behavioural facilitators are largely the responsibility of competitive retailers, a reality which Finnish electricity retailers have largely underestimated.

Whilst some individuals may be more pre-disposed to switching than others, few could be considered to be actively concerned with the issue of electricity. Furthermore, customers’ generally hectic lifestyles typically preclude the development of sufficiently salient thoughts regarding changing electricity retailer. In most cases, the main individual characteristic that matters to a mass market retailer is whether a given customer is genuinely open to the idea of changing retailer or whether their predisposition prevents such consideration on the grounds of, for instance, risk, change avoidance or concern about saving money.

The identification of such negatively pre-disposed customers leads to the identification of ‘potential switchers’ who should in most cases be viewed as responsive only if led by the hand throughout the switching decision-making process.

Two factors which seem to be relatively minor (though not insignificant) determinants of loyalty are past loyalty relating to other services, and satisfaction. Concerning past behaviour, even though those who have switched electricity retailer in the past seem to be more likely to switch in future, we cannot say that those who switch in other industries are particularly likely to switch electricity retailer, nor can we say that just because a customer has not switched in any other industry they will not switch electricity retailer.

Concerning satisfaction, while this is closely related to loyalty it does not correlate closely with it and thus increasing satisfaction does not correspondingly increase customer loyalty. In fact dissatisfied customers often remain loyal and many switchers are satisfied.

Recent research found that customers who felt most likely to switch in future were generally very satisfied and customers who stated satisfaction as a reason for loyalty were generally only moderately satisfied.

Furthermore, to limit the role of satisfaction further, most customers are already satisfied enough and do not feel a real need for greater satisfaction, after all, customers do not buy electricity for extreme satisfaction.

What seems more significant than simple satisfaction is consistency, ethics and flexibility in service – areas where many retailers appear weak. Customers are increasingly concerned about the state of the industry and their feelings of helplessness in a depersonalised industry, something which may well be made far worse by poor use of CRM systems, are crystallising.

There are signs that these feelings may be

having some impact on customers’ propensity to switch. In Finland as well as Sweden and Norway, negative media publicity about prices has been extreme over the past year or two and coincides with reduced levels of satisfaction and increased switching levels. It would seem that the emotive issue of fair prices provides a good kick-start to customer switching activity.

When building checklists of likely switchers, we must be careful not to fall into the trap of relying too heavily on historical data and simple criteria. We should be mindful of the fact that customer loyalty is complex and heavily determined by directness of marketing, relationship complexities, as well as the ease and clarity by which customers are provided information and switching opportunities.

Dynamics of loyalty Another complication to the understanding of loyalty is that satisfied customers’ loyalty decisions appear to work differently to dissatisfied customers’. Whilst satisfied customers seem to become disloyal only if their perceived switching costs are lower than their perceived switching benefits, dissatisfied customers are likely to become disloyal only if perceived switching costs are lower than perceived loyalty costs. In other words, dissatisfied customers often appear remarkably accepting and aim primarily to reduce dissatisfaction.

In any case the balance of the complex variety of costs and benefits are normally weighted in favour of the costs. Retailers need to realise not only that costs and benefits are many and varied, but also that there can be no half-way house. Either the balance is right or it is not. Yet despite this reality, retailers tend to only have a vague knowledge of customers perceptions of costs and benefits.

It is already possible to be far more precise.

To complicate the dynamics, customers often add cognitions to their cost-benefit evaluations with the simple intention of avoiding change. Many customers simply do not wish to switch and if they can convince themselves that switching is pointless, then they will do just that. The long list of complications may also include considerations of the predictability of benefits and risks, including variable feelings of risk associated with different tariff formats. Complications may arise as a result of game changes imposed by competitors. Non-comparable or untransparent benefits, including environmental characteristics and inconsistent discounts, all add to the complexity of the switching. decision. Finally it should not be forgotten that the lowest risk option is normally associated with the incumbent retailer. All other things equal, customers feel safer where they are.

It is clear, when all is said and done, that attention, interest and desire do not alone determine loyalty in the electricity industry.

Communicating a relationship Loyalty should not be taken out of the context of the customer relationship. If retailers are to achieve loyalty and maximise customer lifetime value, customers must clearly perceive the relationships that they are in. Not only are service, satisfaction and price important in this respect, but customer attraction to differentiated and customised

Power

ECONOMICS

characteristics of the retailers’ offering, regular positive customer contact, loyalty schemes, successful public relations, billing quality, good service recovery, flexibility, the human touch and other requirements also matter. Nor can retailers forget that they are essentially perceived as simply electricity retailers and any attempts to broaden the relationship require extensive developments in trust.

Stages of loyalty Research has indicated that the Finnish electricity market, including loyalty levels, have passed through several stages of deregulation.

These stages indicate that loyalty also has a significant time-element attached to it. For everything there is a time and place, and the same seems to hold true for loyalty. Retailers should arguably consider these stages when timing their loyalty-related marketing efforts.

The value of loyalty One of the strongest arguments for strategies that build loyalty is that greater loyalty can allow higher prices and that smart loyalty related strategies can actually save money. Research has indicated that by understanding loyalty, it is possible to target spending on factors which efficiently deliver high levels of loyalty. In doing so, customers’ price elasticity can reduce, enabling higher prices and revenue. This super-value scenario may sound idealistic, but to a limited extent this approach is already being applied successfully by some electricity retailers.

Understanding customer loyalty is certainly an emerging focus for retail energy businesses. Most have not attempted to calculate customer loyalty beyond basic churn statistics, while others have tried and failed because models and systems for assessing individual customer loyalty have not been available. Paul Grey, chief technology officer at Peace Software, says: “Energy retailers who are able to adopt customer loyalty analysis systems will create for themselves a strategic competitive advantage. Their deeper insights into which customers are at risk will allow them to focus customer retention spend where it counts most: to increase the loyalty of highly profitable customers, thereby multiplying customer lifetime value.”

The Future for loyalty The future of loyalty within the Finnish residential electricity market is in the hands of the retailers. Unfortunately, few retailers truly appreciate the complexity of loyalty and the need to understand and accurately measure it.

Loyalty, relationship marketing and customer lifetime value are inextricably linked concepts that should be handled precisely and scientifically by marketers. A lot is now known about the dynamics of loyalty in deregulated electricity markets and whilst much remains still to be learnt, it is time to piece together evidence from around the world and to incorporate that knowledge into intelligent POWER loyalty management systems.

Biography Dr Lewis heads VaasaEmg, the Nordic Centre for Expertise in Energy and Utilities Marketing at the University of Vaasa focusing on Nordic and international markets, with a special interest in customer behaviour and psychology. Dr Lewis can be contacted via email on: philip.lewis@vaasaemg.com.

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