The Impact of Consumers on Competition
Submitting InstitutionUniversity of Warwick
Unit of AssessmentEconomics and Econometrics
Summary Impact TypeEconomic
Research Subject Area(s)
Economics: Applied Economics, Econometrics
Commerce, Management, Tourism and Services: Banking, Finance and Investment
Summary of the impact
Professor Michael Waterson demonstrated how two consumer activities —
search and switching — are necessary if competition is to benefit
consumers. He showed how search and switching costs inhibit the
competitive process; highlighted how firms increase these costs in retail,
banking, insurance and energy markets, and recommended government measures
to empower consumers. Regulators around the world have used Waterson's
research to enhance the consumer benefits from competition. Professor
Gregory Crawford also analysed switching costs, estimating the costs of
automatically renewable contracts in the UK telephone market. Based on
this analysis, Ofcom banned rollover contracts for all residential and
small business customers of voice telephone and broadband services,
reducing households' and small businesses' switching costs by at least
In standard economic models, increasing the number of firms in a market
is sufficient to increase competition. Waterson challenged the received
wisdom that more firms automatically increase competition and make
consumers better off, using existing studies to highlight how search and
switching costs inhibit the competitive process, and demonstrating this
effect in several industries. He identified how firms increase search
costs — by obscuring information about prices and the whole cost of a
contract — and impose prohibitive switching costs, and showed how these
costs make it difficult for consumers to make efficient choices,
regardless of the number of firms. Waterson argued that regulators should
explore novel strategies to empower consumers and discipline firm
behaviour to improve the functioning of markets.
His first paper, Waterson (2003), showed how search and switching costs
can keep prices high even with a large number of firms, and highlighted
firms' strategies to enhance these costs, from persuasive advertising to
failing to list prices to the introduction of loyalty programs or
bundling. He further demonstrated how differences in search or switching
costs — in industries from insurance to banking to energy — could explain
differences in firm profitability across these industries.
Waterson subsequently demonstrated these effects in the newly deregulated
UK gas and electricity markets. In Giulietti, Waddams, and Waterson
(2005), he collected survey data to analyse consumer awareness of new
entrants into the natural gas market and their willingness to switch
suppliers. He found that consumer beliefs about the functioning of the
market are important and that under realistic scenarios about search and
switching behaviour, consumers would be no better off despite the
increased competition. Giulietti, Otero, and Waterson (2010) analysed
deregulated electricity prices and found significant variation in prices
across incumbents and entrants over time consistent with large search and
switching costs. They concluded that price and product information, and
consumers' willingness to exploit it are necessary for these markets to
function adequately, and recommended regulatory policies ranging from
making prices more transparent to changing the terms for continuing supply
from the same provider.
Professor Crawford demonstrated that switching costs are also an issue in
telecommunications markets. The UK telecommunications regulator, Ofcom,
became concerned when BT, the largest telecommunications provider in
Britain, introduced and marketed heavily automatically renewable, or
"rollover", contracts for residential and small business telephone and
broadband internet service. In exchange for a discount on their service,
these contracts imposed significant early termination charges on a
recurring basis unless households acted in a short window at the end of
each annual contract. Ofcom commissioned Professor Crawford to evaluate
the impact of rollover contracts on household switching behaviour,
controlling for the discount provided by the contracts and other
potentially confounding factors (Crawford, Tosini, and Waehrer (2010a,
2010b)). This work was subsequently submitted for academic publication
(Crawford, Tosini, and Waehrer (2011)).
Crawford and his co-authors evaluated switching behaviour among a random
sample of BT customers. They found, controlling for other factors that
influence switching behaviour, that rollover households switch after their
first contract period 34.8% less than comparable customers on standard
plans, inducing switching costs on the order of 33.0% of the monthly price
of the average BT fixed-voice telephone service. This raised significant
concerns about the competitive effects of such contracts in
References to the research
2. Giulietti, M., Waddams Price, C., and Waterson, M., 2005, Consumer
choice and competition policy: A study of UK energy markets, Economic
Journal, v115, 949-968. DOI: http://dx.doi.org/10.1111/j.1468-0297.2005.01026.x.
3. Giulietti, M., J. Otero, and M. Waterson, 2010, Pricing behaviour
under competition in the UK electricity supply industry, Oxford
Economic Papers, v62n3, 478-503. DOI: http://dx.doi.org/10.1093/oep/gpp029.
Evidence of research quality:
There are three academic papers and two sponsored research reports and an
academic paper submission, the latter three of which are substantively
related. The academic research papers are all published in excellent (3*
or 4*) journals. The IJIO is ranked 37th among
economics journals in the Association of Business Schools (ABS) rankings,
47th in the Kalaitzidakis et. al. (2003, JEEA)
rankings, and 62nd in the REPEC rankings. The EJ is
ranked 13th, 18th, and 15th and OEP
is ranked 52nd, 53rd, and 64th in the
same rankings. While as yet unpublished, the academic submission listed
above has received a revise and resubmit from the EJ, as above
ranked 13th, 18th, and 15th in the ABS,
JEEA, and REPEC rankings.
Details of the impact
Waterson's research and policy recommendations have been used by
competition and sector regulators to reduce search and switching costs and
promote competition, both of which benefit consumers. Dr Amelia Fletcher,
Chief Economist at the Office of Fair Trading (OFT) from 2001-2013 noted,
"Since 2001, the OFT has had a remit to carry out market studies where
competition does not seem to be working well for consumers. As Chief
Economist at the OFT [in] that time, I was involved in developing our
framework and methodology for carrying out such studies. Waterson's work
on search and switching costs ... was very influential in this...
including recent studies into personal current accounts (2008-9) and
consumer contracts (2011)" (Fletcher (2013)).
Under UK competition law, the OFT may refer a market to the Competition
Commission (CC) for investigation. Robin Finer, Director of Economic
Analysis at the CC, said "Waterson's work on consumer behaviour,
particularly in relation to search and switching, has had an important
impact in several of the CC's market investigations... Some important
examples of investigations where we have identified substantial barriers
to consumer search and/or switching are: store cards, domestic bulk liquid
petroleum gas, home credit, personal current account banking services in
Northern Ireland, and payment protection insurance...1 In all of
these cases, it was important to identify the relevant barriers to
search and/or switching, to understand their impact on competition, and
to identify suitable remedies to help customers overcome them. Professor
Waterson's work contributed heavily to providing a sound theoretical
basis for all of these steps in our analysis and in improving outcomes
for consumers" (Finer (2013).
Finer concluded, "The influence of Waterson's work on the CC's approach
to market investigations can be seen from our recently updated guidelines
for market investigations (April 2013), where we outline the potential
importance of customer behaviour, particularly in terms of search and
switching, in making competition work effectively, ... both in terms of
our competitive assessment and our choice of remedies" (Finer (2013)).
The Government's centrepiece economic policy, `Plan for Growth', also
cites Giulietti, Otero, and Waterson (2010) in support of its statements
about the importance of competition and that "markets rely heavily on
active and informed consumers to drive competition" (BIS (2011, p12)).
Waterson's work has been prominently cited in government documents in
Finland, Australia, the European Commission, and the World Bank. Former
Australian Competition and Consumer Commission Deputy Chair, Louise
Sylvan, concluded "Waterson's published work on the ways in which...
consumers drive competition... were seminal to our initial thinking and
the direction of our subsequent work both in the recommendations on
superannuation regulation in Australia in 2010 and more globally through
the... Economics of Consumer Policy work that I chaired... at the OECD [in
2010]" (Sylvan (2013)).
Professor Crawford's research directly impacted Ofcom's decision to ban
rollover contracts. Ofcom concluded, "Our research, in particular the
econometric analysis that we commissioned on the switching behaviour of BT
customers [i.e. the Crawford research], indicates a clear causal link
between ARCs and reduced levels of consumer switching. We believe ... that
any example of such a contract is likely to be harmful to consumers and to
effective competition" (Ofcom (2011, p1)). Based on these conclusions,
Ofcom prohibited automatically renewable contracts in the fixed voice and
fixed broadband small business and residential sectors from 31 December
Dr Andrea Coscelli, Director of Economics at Ofcom, said of this process,
"Professor Crawford and his colleagues were able to use sophisticated
econometric analysis to separate out and identify the effects of rollover
terms and showed that they did in fact materially inhibit [consumer]
switching [behaviour]... We had wrestled with these issues prior to the
involvement of Professor Crawford and without his input we would have
found it difficult to make a robust case (both internally and externally)
that [rollover] terms [in consumer contracts] were having an adverse
effect... The impact of the work was enhanced by the clear presentation of
the final results to key decision makers within Ofcom and this had a
significant effect on our final decision" (Coscelli (2013b)).
Policymakers responsible for enhancing competition are direct
beneficiaries of this research, but the reach and significance extend to
consumers for whom a reduction in such costs provides tangible benefits.
For example, reporting on the consequences of remedies introduced after
the payment protection insurance investigation, the CC concluded, "the
total consumer detriment to be addressed would be significantly more than
£200m per year. The remedies package as a result incorporated significant
information provision requirements to enhance search and switching.
Implementation necessarily involved costs but the net benefit of the
measures taken was evaluated as being substantially positive" (CC (2009)).
The estimated direct benefit to consumers of eliminating the switching
costs induced by BT's rollover contracts was 33.5% of the price of
telephone service, equal to at least £120 million/year (Crawford et. al.
(2012)). Ofcom has banned or threatened to ban rollover contracts in
residential and small business broadband services and mobile services
(Ofcom (2011, p5)), which would extend the value of consumer benefits by
an additional £220 million/year, for a total of £340 million/year.2
Sources to corroborate the impact
BIS, 2011, Better Choices, Better Deals: Consumers Powering Growth, pp 1,
12. URL: http://www.bis.gov.uk/assets/biscore/consumer-issues/docs/b/11-749-better-choices-better-deals-consumers-powering-growth.pdf.
Competition Commission (2009), Market Investigation into Payment
Protection Insurance. URL: http://www.competition-commission.org.uk/assets/competitioncommission/docs/pdf/non-inquiry/rep_pub/reports/2009/fulltext/542
Director of Economics, Ofcom, letter (re: Greg Crawford) to Professor
Abhinay Muthoo, Head of Department, Department of Economics, University of
Warwick, dated 20 March, 2013.
Director of Economics, Ofcom, letter (re: Mike Waterson) to Professor
Abhinay Muthoo, Head of Department, Department of Economics, University of
Warwick, dated 21 March, 2013.
Director of Economic Analysis, Competition Commission, email to Professor
Michael Waterson, Department of Economics, University of Warwick, received
14 June, 2013.
Former Chief Economist, Office of Fair Trading, email to Professor
Gregory Crawford, Director of Research Impact, Department of Economics,
University of Warwick, received 14 June, 2013.
MarketLine (2012a), Industry Profile: Telecommunication Services in the
United Kingdom, September 2012. Available from the Marketline database.
MarketLine (2012b), Industry Profile: Internet Access in the United
Kingdom, September 2012. Available from the Marketline database.
Ofcom, 2010, Strategic review of consumer switching: A consultation on
switching processes in the UK communications sector, pp 1, 2, 84. URL: http://stakeholders.ofcom.org.uk/binaries/consultations/consumer-switching/summary/switching.pdf.
Ofcom, 2011a, Automatically Renewable Contracts: Research into their
effects and proposals for a General Condition, p 1. URL: http://stakeholders.ofcom.org.uk/binaries/consultations/arcs/summary/arcs.pdf.
Ofcom, 2011b, Automatically Renewable Contracts: Decision on a General
Condition to prohibit ARCs, pp 1, 2, 30. URL: http://stakeholders.ofcom.org.uk/binaries/consultations/arcs/statement/ARCs_statement.pdf.
Ofgem, 2008, Energy supply probe: Initial findings report, pp 1, 13-14.
Former Deputy Chair of the Australian Competition Commission and former
chair, Economics for Consumer Policy, OECD, Letter to Diana
Egerton-Warburton, Research Impact Manager, Department of Economics,
University of Warwick, received 25 January 2013.
These reports are from 2006, 2006, 2006, 2007, and 2009, respectively. The
remedies imposed applied throughout the current impact period.
Marketline (2012a, 2012b) estimates the fixed voice market
constitutes 35% of the overall communications (fixed and mobile voice and
broadband Internet access) market.