Time’s running out to fix the loyalty penalty

We’ve been talking about this for years — and customers are still paying the price

The facts are clear — loyal consumers are overpaying by almost £1,000 a year for essential services like broadband and energy.

It’s the people who can least afford it who are more often paying the price: those on lower incomes, older people, and people with mental health conditions. These points aren’t contentious — most regulators now accept that the loyalty penalty hits the most vulnerable the hardest, and the government is catching up too.

We know why the loyalty penalty happens. Companies exploit their customers’ tendency to stick with the status quo and use a range of tactics — including complex pricing, poor information and barriers to ending contracts — to discourage them from shopping around.

The whole market is built around rewarding those companies who are best at serving their loyal customers the worst.

But the signs suggest the time is fast coming up for this unfair strategy. Yesterday, the new Chair of the Competition and Markets Authority (CMA), Andrew Tyrie, recognised companies overcharging customers and exploiting the vulnerable is a major challenge. The government’s recognised it too, setting itself the challenge to stop loyal customers from being taken advantage of. They’ve already taken action in the energy market to place a limit on companies overcharging customers.

Today, the Financial Conduct Authority (FCA) opened a discussion on a way to solve this problem in the cash savings market — by implementing a basic savings rate.

But there’s 2 things missing from this story that should convince regulators of the urgency of fixing this problem.

1. Regulators need to get ahead of the public mood

We need to think about the story the energy market tells us. Years of public disquiet about energy prices led the CMA to investigate the market — this made important reforms, but didn’t offer the protection consumers wanted. The national mood was way ahead of where regulators were comfortable going.

This can and will happen in other markets too. In fact, the energy market is around the middle of the pack when it comes to treating loyal customers unfairly. Think of the level of the penalty in the mortgage market — fewer people pay it, but those who do face a penalty of between £439 (according to our analysis) and around £1000 (according to the FCA). Even on our more conservative analysis, such market dysfunction isn’t sustainable in the long-run.

2. The clock is ticking on big data

How big data and predictive algorithms are going to change markets is set to be a big story over the next few years. A huge part is that these changes could make the loyalty penalty even worse. Companies could use this explosion of personal data to more precisely predict exactly how much they can gouge customers for their loyalty.

To be clear, we don’t think this is happening yet. But there’s every sign that it will, as companies realise the prize on offer to their bottom line. If we don’t act now, it might be harder and harder to put the genie back in the bottle.

Time for policy makers to start fixing it

The problem is an urgent one to solve and regulators need to get ahead of it.

Too often in the past, regulators have fallen back on traditional economic models, proposing traditional remedies that have a lot to recommend them theoretically, but haven’t taken enough account of how people actually behave.

A lot of progress has been made in recent years by regulators using behavioural economics to inform their approaches — the presence of Richard Thaler as the keynote speaker at the CMA’s event yesterday was a nice symbol of this.

Providing better information and trying to stimulate consumer action are classic examples. While theory suggests these proposals should help, the best evidence suggests a mixed picture.

Some well-designed and properly tested interventions have helped, but they haven’t changed the market enough.

Take this example from the energy market: the Behavioural Insights Team tested different ways of communicating with customers about the benefits of switching. One tripled the rate of switching — but only to 3%. These are cheap reforms to implement so regulators should definitely be doing them — but on their own they aren’t proportionate to the scale of the problem.

These are cheap reforms to implement, so regulators should definitely be doing them, but on their own these reforms can’t tackle a problem of this scale.

When markets are failing the vulnerable this much, it’s time to build proper solutions before trust in these markets is broken beyond repair. And these questions are hard: you want solutions that protect loyal customers without hurting competition in the market. When there are trade-offs, you want to be clear sighted about what they are and whether they’re worth it. Today’s announcement from the FCA shows that regulators are now engaging with these questions.

We’re doing our own work about what solutions might work, but ultimately, we can’t do that alone — others need to help test solutions and then implement them.

It will take action from the CMA, the government and the industry to create lasting change. We’d like to see:

• The CMA take the lead in investigating and introducing long-lasting solutions to these problems, that — at the least — protect vulnerable and low income customers from the worst impacts of the market.
• The government publish data that names and shames the worst performers in essential markets.
• Industry take the opportunity to act before the public lose patience. There’s been promising early signs on this from the insurance industry. But all companies need to go further, before the public makes the decision for them.

As a consumer advocate, we think that markets, with the right safeguards and protections, generally produce good results for people. But they need to be able to trust policymakers will act to stop them getting ripped off when the market fails. And these markets are clearly failing. It’s time to act.