Small suppliers: survival of the fittest

The five cheapest tariffs identified by Which? offer significant discounts, but how are these suppliers able to undercut the market? And are such tariffs sustainable?

Smaller suppliers have been getting a lot of attention recently – not all of it good. The highly publicised demise of Iresa has raised questions from both the media and customers about which could be the next to fold.

The Iresa saga echoes the earlier fates of Future Energy and GB Energy, and the purchase of Flow Energy by Co-op Energy. The market is now saturated with suppliers, reckoned to be about 70 at the last count, which means the water is becoming a lot murkier for customers when it comes to switching provider.

Many suppliers, both large and small, have announced price increases, blaming a steep and sudden rise in wholesale prices – which have gone up by around 20 per cent since April.

Then there are those that have come under criticism for failing to serve their customers properly because they are struggling to cope with demand. Reports of three-hour hold times, inaccurate billing and other technical issues have resulted in thousands of frustrated customers. This led to a warning from the Energy Ombudsman to those suppliers looking to grow quickly that they must ensure the correct infrastructure, resources, systems and people are in place to cope.

What’s more, the trouble experienced by some small suppliers has sparked concern that Ofgem’s supplier licence regime is not fit for purpose, with consumer advocate groups saying it is too easy for small suppliers to gain licences. As a result, Ofgem recently committed to reviewing its approach to supplier licensing, meaning tougher rules could be on the cards to protect consumers against poor customer service and financial instability.

“Not many small suppliers are actually making any money yet,” says Ryan Thomson, a partner at Baringa. “Some have come in and have a niche area they’re focusing on, but for many it will be a while before they’re profitable.”

He tells Utility Week: “It appears the business model hasn’t changed – suppliers enter the market with a very cheap tariff, which is potentially loss-making, to draw customers in and they hope they stay long enough to make money. The general assumption is that most suppliers experience a 35 per cent loss at point of renewal. For some, it’s a case of them having to build up a portfolio of customers quickly and hoping someone comes in and values them high and buys them.”

Using loss-leading tariffs to draw in customers is alright in itself, as long as suppliers are sufficiently hedged against fluctuating wholesale prices and have enough cash flow to be able to stay afloat. Ian Barker – managing partner at BFY Consulting – says: “We’re able to see from our analysis that a number of suppliers are using loss-leading tariffs to gain market share. Some of those suppliers appear to be well hedged going into winter – which given that prices have risen by circa 45-50 per cent since the start of the year will be crucial. Suppliers who aren’t hedged or have poor forecasting capability and are selling at a loss are placing themselves at risk of failure if they don’t have deep pockets to get through the winter.”

He warns that suppliers acquiring customers with discounted prices and offering poor service are at risk of “service meltdown”, as happened with Iresa, which didn’t have enough cash coming in to be able to service customers adequately.

Survival strategies

In this tough environment, how do those offering the cheapest tariffs expect to survive?

Challenger brand Outfox the Market – which is on target to reach 100,000 customers – is on Which?’s cheapest tariffs list for August. It insists that sustainable and strategic growth are key to survival. “Our efficiency as a business allows us to provide a cheap but sustainable pricing structure,” the company’s operations director, Brad Goodfellow, says. “We didn’t enter into this with a smash and grab philosophy looking to make a quick profit. We have invested in the right technologies; the best people and decisions are always made with a long-term perspective.”

Outfox the Market is a renewable energy company, which launched in September 2017 with a business model in which members pay wholesale prices for their energy in exchange for a monthly membership fee based on estimated annual consumption. It operates as part of Foxglove Energy Supply, the licensee that includes Fischer Energy, Fischer EV and Eco 7 Energy. Foxglove has a deal with Orsted, which supplies 100 per cent renewable electricity to customers of all four brands.

“Cheap prices aren’t everything,” says Goodfellow. “A mistake some smaller suppliers make is to promote rock bottom prices without having the infrastructure in place to meet the demand. As with all industries, sometimes things go wrong and if you haven’t got the numbers or experience to deal with issues, it doesn’t matter how cheap you are, people will soon get tired of poor service and leave.”

He says one of the main objectives of the supplier is to end hold times. “Our live chat system has an average wait time of 20 seconds and we respond to all emails within two hours.”

Another key to its success, it says, is that it is “upfront with its customers”. “We recently raised our prices, and this has generally been accepted without much complaint. There is no getting away from the increases in wholesale costs and operating at a loss is only going to end one way. You can have millions of customers but if the outcome is going out of business it’s not good for anyone.”

Smarter energy purchasing

Other firms point to a strategy of buying their electricity more smartly, which allows them to offer the customer cheaper deals. Buy energy cheaper, buy smartly.

Usio Energy, another supplier featured on Which?’s August list – with two of the cheapest tariffs – says the reason it can offer such low prices is that it leverages new regulations that allow it to buy energy in 30-minute slots. “This means that, when we install smart meters for our customers, we get very precise data on how much our customers consume and therefore can buy precisely the amount of energy needed. This speaks to the core idea of our business: we don’t waste money buying more energy, and thus we pass that saving on to the customer,” says Ana Nanu, a business analyst at Usio.

The company also says a robust focus on customer service will be key to its survival. “The reason Iresa got shut down was because its customer service was not meeting customer needs at all. Usio puts customer service at the heart of the business. We are very aware that customers are the most important factor in a business, and we do our best to offer good service.”

Meanwhile, Eversmart Energy, another supplier on the Which? list, points to a different strategy, though gives scant details. Chief executive, Barney Cook, says it plans to survive by using the smart meter rollout to “inject cash into the business to supplement its negative gross margin tariffs”.

Baringa’s Thomson suggests that one way of firms leveraging the smart meter rollout is to become asset managers – where they own the smart meters and rent them to other suppliers. However, he cautions, the market for this is “quite small currently”, and the opportunities limited. “They would have to ensure they created a very large asset base in order to make it worthwhile.”

Another way he suggests small suppliers could try and weather the storm would be to take advantage of variances in the types of customer profile. “Many domestic customers look the same in terms of customer profile,” he explains. “A company could capitalise if it found customers with different shapes, which it could use to trade differently in the market. But it’s not easy to find customers with beneficial shape.”

The big question is the impact on the looming price cap – where opinions are divided. Simon Virley, partner and head of energy and natural resources at KPMG says: “The price cap will present significant challenges for the larger suppliers in terms of the need to cut costs. But for smaller suppliers it presents an opportunity to attract customers by using their lower cost to serve and targeting specific market segments.”

“It will be interesting to see the effect the price cap has on the smaller end of the market. It could result in a drop in ­switching,” says Thomson. EY’s energy leader for UK and Ireland, Rob Doepel, agrees the price cap will have a negative effect on those at the smaller end of the market. “There was no doubt a moment in time when the wind was with new, smaller energy suppliers, with government and regulators actively trying to attract new entrants and waiving some of the more onerous and expensive energy efficiency commitments.

“With the price cap now being implemented, the spread between high and low tariffs has contracted and any supplier operating a “trap and trip” business model – of attracting on a lower tariff and letting their customers then trip on to a more expensive SVT tariff – will no doubt hit cooler air.”

The road ahead looks bumpy, and like many others Thomson and Virley feel consolidation is inevitable after the “very rapid growth” of recent years.

Doepel suggests that companies entering and leaving is a key indicator of a functioning market, so “we shouldn’t fear company failures, nor consolidation”. “The energy market is in many ways no different to any other market – to thrive, companies must develop a compelling customer proposition, at a competitive price, and deliver flawlessly on their promise at a cost that leaves them with a sustainable profit.”

However, he warns, smaller suppliers growing market share by offering below-total cost-to-serve tariffs is a “recipe for creating a customer base with expectations that can only be disappointed”.

Strategy, then, is key, and small suppliers would do well to heed the old marketing adage to “get big, get niche or get out”.

Ted Hopcroft, energy and utilities expert at PA Consulting, says: “Smaller suppliers have made significant inroads into the market but trying to compete with the, soon to be, “big five” on their home ground is unlikely to be a successful long-term strategy. The lack of a natural hedge and absence of large-scale purchasing power will remain barriers for even the nimblest organisation.

“Targeting prepayment customers with smart meters has been a fruitful market for some. Others are now embracing the opportunities offered by new distributed energy. Companies like Ovo are offering a holistic energy supply with smart chargers for electric vehicles and home energy storage. Octopus has started an initiative to offer half-hourly tariffs ahead of the introduction of half-hourly settlement. These innovative approaches attract customers and increase the likelihood of retaining them.”

After a long wait, smaller suppliers have finally broken through and seized a 22 per cent share of the energy market. However, warns Hopcroft, they will need to continue to innovate to meet the challenges of declining profits during the hot summer and to prepare for the emergence of a new major player.

What do the analysts say?

Rob Doepel, energy leader for UK and Ireland, EY

“The energy market is no different to any other market. To thrive, companies must develop a compelling customer proposition, at a competitive price, and deliver flawlessly on their promise at a cost that leaves them with a sustainable profit.”

Ted Hopcroft, energy and utilities expert, PA Consulting

“Smaller suppliers have made significant inroads into the market but trying to compete with the, soon to be, “big five” on their home ground is unlikely to be a successful long-term strategy.”

Simon Virley, partner and head of energy and natural resources, KPMG

“The price cap will present significant challenges for the larger suppliers in terms of the need to cut costs. But, for smaller suppliers, it presents an opportunity to attract customers by utilising their lower cost to serve and targeting specific market segments.”

Ryan Thomson, partner, Baringa

“It appears that the business model hasn’t changed – suppliers enter the market with a very cheap tariff which is potentially loss-making to draw customers in and hope they can stay long enough to make enough money.”

Ian Barker, managing partner, BFY Consulting

“Suppliers who aren’t hedged or have poor forecasting capability and are selling at a loss are placing themselves at risk of failure if they don’t have deep pockets to get through the winter.”