Dynamic pricing: the facts are in, Part III
- Posted on August 7, 2012
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If you're open to the facts in the case, dynamic pricing can improve load factors, saving billions in capital investment, resolve inequities between ratepayers and shape loads to improve energy efficiency and lower the peak.
Ahmad Faruqui, a principal at The Brattle Group, addressed these topics at the Portland gathering of the National Association of Regulatory Utility Commissioners (NARUC) last month, whose attendees undoubtedly wrestle with these issues.
In the first article, Faruqui explained the implications of the power industry's low load factor and how dynamic pricing could improve it. In the second article, Faruqui presented evidence that consumer behavior over three decades of study is consistent: price signals alone can produce consistent changes in behavior. In this final article, Faruqui outlines steps to reach the benefits of dynamic pricing.
For NARUC, he used a simplified decision tree to illustrate his points. (Click here for Faruqui's slide deck.)
Utilities have either begun deploying advanced metering infrastructure (AMI) or they're still crunching the business case. When a utility and its regulators have moved ahead with AMI, in Faruqui's view that should produce a decision on whether to pursue an opt-in or opt-out policy towards dynamic pricing. (For more on the opt-in, opt-out debate, please see "Dynamic Pricing: The Facts Are In, Part II.")
If regulators decide on the cautious route of opt-in, that sets up a decision on whether to change pricing from a flat rate or leave it intact. If flat rates are left intact, you're done, there's nowhere to go to gain efficiencies in load factor, at least by involving the consumer.
If one is changing the default rate away from a flat rate, that sets up a decision on whether to offer a "shadow bill," which can document the contrast between the old, flat rate and the new dynamic rate.
If a utility and its regulators decide they want a "big win" and choose to embrace opt-out, they should consider whether to offer either a "single-part rate," in which all customer usage is exposed to the dynamic price, or a "two-part rate," in which some customer usage is priced at the standard tariff and the remainder is priced dynamically. If the former, then the utility would need to decide whether to offer bill protection. If the utility chose the latter option, they could set the first part equal to the customer's historic load shape or let the customer set that amount based on their attitudes toward risk and lock in the price for that amount by buying it on the forward market.
The key to understanding the outcomes of these decisions (and, not incidentally, customer acceptance and, thus, success) is to measure and verify the results. The "test and learn" approach is common in consumer product marketing, Faruqui pointed out.
"Regulators are concerned with `rate shock,' so I've tried to provide ways to make a transition," he told me.
In any case, whether regulators take action or no action, utilities should understand customer preferences, perform customer segmentation, send segment-specific messages, do outreach and education, listen and answer questions. That's a fundamental prescription that will stand a utility in good stead regardless of the direction it chooses, in Faruqui's view.
"Regardless of whether you do opt-in or opt-out, you still need to do this educational task," Faruqui argued. "Any business that markets a new consumer product - whether it's Apple or Starbucks - they all have to do market research and messaging.
"It doesn't have to be D-Day, when everything happens at once," he added. "You have a plan to segment your market, find out which segments are more receptive and which are less receptive and then take time to understand why the latter are less receptive. Some people call this the `test and learn' approach. It's commonly practiced in consumer product marketing and we have all been exposed to it, without knowing it. It's just new for electric utilities, even more so for regulators."
About that messaging. (Here's another controversial point, given that the power industry has largely phrased its communications to customers around smart grid as "saving money.")
If a typical bill is $100/month and savings thru end-user behavior change is 5-15 percent, that's only $10/month savings, Faruqui acknowledged. Little action can be expected from most consumers even though some will respond even with modest incentives. But if costs rise 10 percent, more consumers will take steps to prevent an increase on their bill, he suggested.
That means that utilities should sell customer behavior change as an opportunity to manage energy use in the face of inevitable rises in price. According to Faruqui, utilities could deliver legitimate messages that hew closely to reality.
"Prices, inevitably, are going to rise," he said. "So we're going to work with you to counter increases that otherwise will occur."
In addition to saving money, and mitigating price hikes in the future, other messages that will appeal to customers in other segments will need to be developed that talk about the beneficial impact of dynamic pricing on the environment and how it will give better control of their energy future.
We've covered a lot of ground in three articles on dynamic pricing. Readers, please continue to share your views.
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