Electric dreams for BGT

Next Monday, 200 homes in northern England, East Anglia and Scotland will switch from the regional electricity suppliers they have used for years to British Gas Trading.

On that day – September 14 – the complex process of opening the UK’s electricity market to competition begins. These 200 homes are among the 750,000 households which are being offered the chance to choose their electricity supplier in this first phase.

Competition starts in regions served by Eastern, Yorkshire, Manweb and its parent ScottishPower, and will spread across the UK up to next June, when all the UK’s 26 million electricity users will be able to choose their supplier.

It is an important date for Centrica, the company which owns British Gas Trading, and comes five days after its interim results, which are published tomorrow. The company’s success in attracting electricity customers will be a measure of whether it can apply its monopolistic grip on the UK gas market to electricity.

But deregulation will also test the ability of the 12 regional electricity companies to fight off the encroachments of a company which has 16 million gas customers, a 19m advertising budget and a name recognised from Land’s End to John O’Groats. It will pit local brands against a national superbrand. Robert Pieczka, business manager at Eastern, says this leaves the RECs with three options: “to get big, get niche, or get out”.

In the penny-pinching economics of electricity and gas supply, scale is everything. Average household electricity bills have stood at about 350 a year, though some say this will come down to about 270.

According to consultant John Geoghegan, of computer network company Cap Gemini, the average profit to the electricity supplier on a 270 bill could be just one or two per cent – as little as 3 per customer. Customer service, he says, accounts for about 18 of each bill. Compare this with the 40 it costs the companies to win each new customer, covering the cost of advertising, marketing and customer processing. At this rate, it would take 13 years for companies to pay back their initial investment on winning new customers. But he says action taken by the companies to cut costs will reduce this period to about five years.

BGT, with its vast gas customer base, will find it easier to keep costs down than the regional players, given its scale economies in marketing, billing management and customer service call centres. The company claims it has already signed up 400,000 electricity customers across the UK in advance of deregulation. Even before competition has started, BGT is nearly the size of a small REC.

Comparing budgets does not do justice to the whole marketing story – all the same, it is worth noting that BGT’s ad budget is nearly three times that of rival ScottishPower. Geoghegan says: “People trust BGT because it delivers the goods every day and electricity companies do not have the same scale. BGT is a national brand which gives it an advantage. The RECs have local brands. In a national campaign, BGT could do well against any new national entrant.” BGT’s advertising campaign for its “Home Energy” brand can switch between gas and electricity, promoting itself through “umbrella” branding and giving it further economies of scale.

So the RECs are under pressure to squeeze costs in order to comp-ete effectively with the BGT juggernaut. One route is industry consolidation.

According to consultants at Price Waterhouse Coopers, there could be just five RECs within a few years, with ScottishPower and Eastern emerging as the strongest followed by Norweb, Northern Ireland Electricity and Southern Electric. The latter is planning a merger with Scottish Hydro-Electric.

There are other ways to cut costs, such as improving processing through new IT systems – Geoghegan wants them to buy systems from Cap Gemini. Estimates suggest the electricity industry has invested about 1bn in updating computer systems to enable customers to switch suppliers. But it could be years before they recoup this huge investment through new signings.

The RECs can also cut the costs of obtaining new customers by affinity tie-ups with consumer brands. Eastern Electricity has just announced a tie-up with Barclaycard that offers the credit card’s customers ten per cent reductions on Eastern electricity bills.

However, such tie-ups can be fraught, as ScottishPower found out after its partner, the Automobile Association, pulled out of its deal earlier this year. This reverse can only have damaged ScottishPower’s attempts to present a strong brand image.

Tomorrow’s interim results are expected to show that Centrica, the company which owns BGT, was badly hit by the double whammy of the past year’s warm weather combined with the loss of market share in the gas market. Some 3 million customers have deserted BGT since gas competition was introduced in 1996. This may lead to a decrease on last year’s turnover, which was 7.4bn, already down from the previous year’s 8.125bn. Profit before tax was 212m in 1997, while in 1998 a full-year figure of about 195m is expected. While this may represent a margin of under three per cent, the City is upbeat about Centrica’s prospects – Europe is opening to cross-border gas competition, and UK gas companies will be able to supply European markets through the Interconnector pipeline.

Analyst Liz Butler at Panmure Gordon says: “Centrica will do extremely well out of electricity deregulation, not least in Europe. It is unlikely to lose much more market share and it has got the infrastructure for electricity deregulation.”

BGT’s massive in-built advantages in the gas and electricity markets are the legacy of the Thatcher government’s privatisation policy and underline the inability of regulator Ofgas to dismantle the quasi-monopolistic market power the gas giant has inherited. Ofgas argues that the introduction of competition is sufficient to clip BGT’s wings, forcing it to keep its prices competitive. True, the company will not allow a wide discrepancy between its own and competitors’ prices to develop. But then again, in electricity, there is precious little margin for players to give significant price reductions.

The prospect of the Labour administration doing much to dilute the concentration of power in Centrica’s hands seems slim at present, though this may change with the appointment of a single “super regulator” covering electricity and gas.

A spokesman for BGT accepts the company has advantages when it comes to electricity deregulation. “The brand is a benefit,” he says. “People are familiar with it across the country. We are used to handling these volumes of customers. But I don’t think it is an unfair advantage: a lot of those with whom we compete are now nationally known.”

BGT marketing director Jon Kinsey says that, taken as a whole, the company has a 30 per cent share of the energy market. “We are the brand leader in a sector – there are brands with higher shares in other sectors.”

According to regulator Offer, cutting prices is not the only reason for introducing competition. Indeed, some observers believe the price savings from switching supplier could be as little as two or three per cent. But the regulator says that the knowledge that consumers can change supplier will “keep them on their toes” as far as customer service is concerned.

For the RECs, retaining customers will be partly a case of promoting the local strengths of their brands. Manweb and Yorkshire Electricity say that they are well-known locally and are big employers in their regions. Yorkshire’s ad campaign through Rapier – soon to break on TV – will promote positive images of the county. Manweb, which uses parent company ScottishPower’s ad agency Bartle Bogle Hegarty, is also going to promote local loyalty as a means of retaining customers.

While some of the smaller RECs concentrate on holding onto their existing electricity customers, Eastern and ScottishPower will be attempting to build their status as national brands. Eastern claims it has already pre-signed 200,000 electricity customers across the UK, adding to the 3.1m customers in its region. It already has about one million gas customers. ScottishPower says it is already a national brand, providing electricity, gas, water, or telecoms to one in five UK households.

But the real test for these players will come with the introduction of joint bills for electricity and gas. The “dual fuel” offers will enable further cost savings in processing and bills, though BGT says it will wait to see how customers take to this development before introducing it nationally.

Matthew Eastlake, head of marketing at gas supplier Calortex, says: “Consumers buying dual fuel take a lot more interest in the pedigree of the gas supplier, because they see it as more dangerous than electricity. BGT, as a national gas supplier, is well-placed.” BGT aims to sign up to two million electricity customers in the next two years, nearly 10 per cent of the total.

Analyst Nigel Hawkins of Williams de Broe says: “Centrica has a better chance than most, though the average five per cent savings in electricity offered by competition will make people wonder whether it really is worth shopping around.” But he adds that in the long-term, BGT’s 70 per cent share of the gas market will be seen as unacceptable by regulators.

Centrica may be tempted to swap some of its gas supply interests for electricity supply, for example with Eastern. Hawkins predicts that

Centrica may eventually settle for 40 per cent of the gas market and 30 per cent of the electricity market so that the company can head off a monopoly investigation.

There is little doubt, however, that Centrica has been handed a formidable power base from which to launch its electricity offer.

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