The super-complaint was wide-ranging but focused on the issue that loyal customers may be penalised and pay higher prices than those who actively shop around and switch. As we have reported, this issue is already being looked at by Ofcom in relation to bundled smart phone contracts and is part of the concerns around price discrimination being investigated by the Financial Conduct Authority and the UK Competition Network of regulators.
The CMA’s report includes support for the ongoing work of Ofcom and the FCA. In particular, following Ofcom’s concern around bundled phone contracts, the CMA’s proposed interpretation of fair commercial pricing will impact on other consumer markets where fixed contracts roll over into a new period and consumers have to deal with their existing supplier in order to switch away.
What is a “loyalty penalty” and what is the concern?
The traditional approach of competition law enforcers has been that (other than in very concentrated markets) pricing is an issue best left to be resolved by market forces. In a properly competitive market, consumers will switch to different suppliers or cheaper alternatives if they do not consider that a particular product/service is worth the price tag. However, the increasing use of behavioural economics analysis has highlighted that pricing may not be fair even in competitive markets, because consumers do not always act logically or in their own best interests. Competition can become muted, and prices may be higher than they would otherwise be, because of consumer inertia. Competition can also be muted where vulnerable consumers have difficulty in exercising their buying power.
The “loyalty penalty” is an example of how inertia (or vulnerability) can be leveraged to facilitate higher prices. In the insurance sector, for example, customers who allow their existing policy to renew automatically each year will often pay a higher premium than if they had shopped around. Over time, the differential can become steadily larger. Even if they do not switch suppliers, challenging their existing supplier’s quotation with lower quotations from alternative providers will usually provoke a lower premium offer from the existing supplier. It can be counterintuitive to a longstanding consumer that their loyalty generates higher, not lower, premiums – which exacerbates the problem. Similarly, where customers for services such as energy or broadband do not check if a lower tariff contract is available at the end of an initial contract period, they may end up paying higher prices. Even in markets where consumers are more active, it may be more difficult to switch contracts or suppliers than it needs to be.
The CMA’s response to the Citizens Advice super-complaint
Citizens Advice made a “super-complaint” (which carries a statutory right to a response within 90 days) about loyalty penalties to the CMA in September 2018, highlighting concerns in relation to the consumer markets for mobile telecoms, broadband services, cash savings, home insurance and mortgages.
The CMA’s December 2018 response confirmed that “the loyalty penalty is significant” (as much as £4 billion in total across the five identified markets) “and impacts many people” (including 12 million people in relation to home insurance). Moreover, “not enough has been done in the past by the CMA and regulators: there needs to be a step-change to tackle these problems more effectively“. In particular, the CMA highlighted that the loyalty penalty might also be a feature of the consumer markets for pay TV, roadside assistance, other forms of insurance, pensions and other subscription services such as online gaming, software and magazines.
The reforms and recommendations announced by the CMA
The CMA could have launched a more detailed six month market study into this issue, but has instead made eight general recommendations, plus more specific recommendations for each of the five markets highlighted in the Citizens Advice complaint. Each of those five markets is already the subject of work by other regulators and the CMA’s recommendations suggest specific work which those reviews should incorporate (Ofcom on unbundling mobile phone contracts and on broadband services; FCA on cash savings, insurance, and mortgages).
The general recommendations include: a call for “bolder use” by regulators of existing enforcement powers to tackle harmful business models; calls for greater analysis and transparency about the size and impact of loyalty penalties in key markets; initiatives to make switching easier for consumers; and a recommendation that price controls such as limiting price differentials or price caps should be considered in markets where there is clear harm, particularly to protect vulnerable consumers.
The CMA’s proposed principles for fair pricing
The recommendations also include a proposal for principles for fair pricing which are applicable across consumer markets. These proposals are particularly important because they would reduce businesses’ freedom in setting commercial pricing strategies and contractual frameworks.
The CMA considers that adoption of these principles can be achieved through enforcing existing consumer law, since it is flexible and principles-based. However, it also notes that this flexibility allows for different interpretations of what causes harm or is a breach of the law. The report includes a clear warning that the CMA will recommend changes in law or regulation, if necessary, to ensure adherence to its interpretation of constitutes fair pricing, namely:
- it should be at least as easy to exit a contract as it is to enter it;
- auto-renewal should generally be on an “opt-in” basis so that it will not occur unless the consumer has expressly selected it when entering into the contract;
- exit fees should not be applied after any initial minimum or fixed term;
- auto-renewal should generally not lead to a fresh fixed term;
- customers must be sufficiently informed about the renewal and any price changes in good time; and
- switching should generally be managed by the supplier who is winning the consumer so that the consumer does not need to deal with the supplier that it wishes to leave.
Osborne Clarke comment
This case reflects the blurring of the intersection between consumer protection and competition law that behavioural economics has brought about. The traditional economic analysis – that consumers’ ability to switch suppliers protects their interests if prices are uncompetitive – has been nuanced by better understanding of the realities of human behaviour and the focus on consumer harm.
Businesses that may be at risk from an investigation into loyalty penalties should ensure that they are compliant with existing consumer and advertising laws, most notably the Consumer Contracts (Information, Cancellation and Additional Charges) Regulations 2013, the Consumer Protection from Unfair Trading Regulations 2008 and the Consumer Rights Act 2015. In particular, these businesses should ensure their pricing is clear, prominent and transparent.
This intervention by the CMA is also interesting given how consumer purchasing may develop as the Internet of Things grows and more of our consumer devices and appliances become “smart” and capable of automating many of our day-to-day purchases. Whilst it would be hugely convenient if our connected, AI-powered smart fridges or larders automatically reordered household staples whenever they sensed that they were running low, there are clearly legal challenges in ensuring this business model is compliant with relevant advertising and consumer laws (as shown by the recent ruling in Germany that Amazon Dash buttons do not comply with consumer law requirements).
More generally, if purchasing choices became automated and “passive”, there would be obvious scope for suppliers to apply a loyalty penalty because purchasers would be deactivating their power to switch to the lowest price supplier, in favour of automated ease. Of course, consumers could potentially also use price comparison software so that every potential automated purchase was first price-checked and the cheapest option selected, but this would depend on the future developments in market practice, inter-compatibility of systems and commercial relationships between suppliers.
The CMA’s response to this super-complaint makes it clear that the UK competition authorities are fully alerted to the potential harm from exploiting consumer inertia. Pricing strategies seeking to leverage the potential inattention of consumers may well attract regulatory attention and not be sustainable.