Public energy company: outline business case

12 Appendix E – Approach to Economic Model

In Section 4.7.14 and below we have detailed our reasoning behind the initial inputs to the model.

Customer Revenue

Initial customers

Initial customers are those who would be with the Public Energy Company when it is created. This has been set at zero as the Public Energy Company will be a new creation without an existing customer base.

However, it may be possible for the Public Energy Company to negotiate the acquisition of a base of customers prior to go live who will be switched to it at go-live to provide an initial pool of customers over which to defray their costs. For example, this could include social housing or housing associate properties being switched as a group. Such an activity would incur a supplemental cost, which is not considered here.

Annual customer growth

Annual customer growth is the number of customers the Public Energy Company acquires within a year. For the purpose of this analysis, we have assumed a flat acquisition profile with an equal number of customers acquired every month, although in practice we would anticipate intra-year peaks and troughs.

We have assumed that the target for the Public Energy Company would be to secure a 5% market share of domestic Scottish consumer energy contracts within three years of go-live. This target has been based on the targets that have been set by other Publicly Owned Energy Companies^[32]. Based upon Scottish census data^[33] there are 2,451,869 households in Scotland, giving a target customer base of 122,600 customers by the end of Year Three. This equates to 41,000 customers per year.

However, we have assumed that the Public Energy Company will benefit from higher switching rates in Year One as the public recognition of the supplier and media coverage of the launch increases consumer awareness and switching rates.

For the later years, we have assumed a slightly increased switching rate (45,000 customers/year) due to a combination of population growth, the continued trend of increasing switching rates through growing customer engagement fostered by the wider aspirations of the Public Energy Company, and the 'proven' nature of the Public Energy Company following several years of successful operation.

Percentage dual fuel

This variable sets the percentage of customers who switch both electricity and gas meters to the Public Energy Company. This value is based upon government data on the percentage of customers who are connected to the gas grid in Scotland (80%^[34]) and Cornwall Insight data on – of those customers who are connected to the gas grid – the percentage of Scottish customers who are supplied under a dual fuel arrangement (86.8%^[35]). This provides the figure of 69.45% expected dual fuel customers.

Revenue

Based upon Cornwall Insight's experience in the market, White Label Suppliers are typically remunerated in one of two different payment structures:

• Acquisition payments. These are payments made by the partner licensed supplier to the White Label when the customer is acquired. These are similar in structure to the payments seen by other potential routes to market for licensed suppliers, such as price comparison websites. These are typically set between £15-30/meter (£30-£60 per dual fuel customer) depending on a range of factors, including:
  • Thetariff signed up for, with longer-term tariff deals and/or higher margin tariffs providing a greater payment;
  • Agreed terms and conditions between the White Label partner and the White Label Supplier (i.e. the Public Energy Company in this case);
  • The licensed supplier's growth ambitions; and
  • The strength of the brand the White Label Supplier can bring to the partnership, with a stronger brand typically able to receive higher payments.
    • For the Core case, we have set these at £25/meter to reflect not only the strength of public sector brand, but also the Public Energy Company's objective to be a social enterprise with lower tariffs and social offerings
• Ongoing retention payments. Under this system, the White Label Supplier receives an ongoing (typically monthly) payment for each customer meter they retain. This payment is lower than the upfront acquisition payment but provides an ongoing reward for retaining the customer and provides higher lifetime value if the customer can be retained for a number of years. The typical values seen for these ongoing payments is £0.80-£1.10/meter/month (equivalent to £19.20-£26.40/year for a dual fuel customer).
  • As with the acquisition payments these are typically based on the strength of the White Label Supplier's brand, the licensed supplier's growth ambitions, and potentially the tariff being offered.
    • For the Core case we have set the value at £1/meter/month

As with other aspects of White Label supply, the potential payment structure and value will be based upon the individual negotiation and contract agreed between the Public Energy Company and the partner supplier.

Therefore, while the Economic Model values represent Cornwall Insight's understanding of the current market situation, they may not reflect the final agreement secured for the Public Energy Company at the conclusion of any tender exercise and subsequent negotiations for a White Label partner.

Set-up costs

These represent the costs incurred to establish the Public Energy Company.

Internal costs

In addition to the costs incurred with external specialists, Scottish Government will also need to dedicate internal resource to the establishment of the supplier. This value reflects the commitment of Scottish Government resource to the Project.

The Core Case value of £50,000 has been based on upon a dedicated Project manager for the establishment and ongoing oversight of the Project.

Legal support

White Label supply is at its heart a contractual relationship between the White Label Supplier and the partner Fully Licensed supplier (i.e. the White Label partner). Therefore, legal support to ensure the robustness of the contract between the Public Energy Company and its White Label partner will be essential to provide reassurance to Scottish Government regarding the supply arrangement.

The Core Case value has been based upon Cornwall Insight's discussions with parties in the public sector and Local Authority arena who have been through the process.

Energy advisers

In addition to legal support, expert energy adviser services will be needed to provide a commercial review of the White Label partnership agreement, the tariff offerings proposed, and the broader market situation the Public Energy Company is entering.

The Core Case value has been based upon Cornwall Insights experience with parties in the public sector and Local Authority arena who have been through the process.

Tendering for partner supplier

There will be a requirement to undertake a full tender exercise for a White Label partner in compliance with prevailing rules on public sector procurement.

On the assumption that Scottish Government undertakes the tender based upon the Restricted procedure (or equivalent), we assume that this will take a minimum of 60 days to complete from the point at which the tender notice is published through to the completion of the ten-day standstill period.

This period does not include time which may be required for the Public Sector investors to undertake negotiations as to their requirements or specific criteria for the Public Energy Company, which we anticipate will be undertaken via COSLA.

The stated figure in the model therefore represents the assumed cost of hiring specialist advisory support for the procurement process, reflecting Cornwall Insight's expectation of a comparable public sector body. In the event that this tender process was managed in-house by Scottish Government, a corresponding cost would be incurred through staff time and resources.

System costs

White Label supply does not require the White Label Supplier to procure or utilise specialist industry facing systems. Instead the White Label Supplier utilises the Fully Licensed supplier's industry and CRM systems. Therefore, there is no 'direct' system cost associated with White Label supply.

However, due to the desire for the Public Energy Company to be a partnership with a number of different Local Authorities and the need to internally track progress for the Public Energy Company we have assumed a low system fee for Scottish Government to expand a system it currently owns or acquire a simple off the shelf CRM system to track the Public Energy Company's progress.

In the event of no such pre-existing system being in place, this would of course represent a supplemental cost for inclusion in the model.

Staffing

Due to its partnership with the Fully Licensed supplier the staffing requirements for a White Label Supplier are relatively low.

Typically, White Label Suppliers operating in the market employ a Project manager to oversee and coordinate the White Label Supplier's activities. In addition to this role there are a number of support staff, who are normally linked to the number of customers the White Label Supplier has gained.

Based on our understanding of the Publicly Owned Energy Companies operating in the market to date we believe that one support staff per 20,000 customers is a representative figure (i.e. 1 x FTE per annum or part thereof per 20,000 customers).

Marketing

The marketing values represent the spend expected to establish the Public Energy Company's brand within the market and the ongoing costs associated with marketing activities.

Strategy and brand identity

The high-level strategy and objectives for the Public Energy Company have already been defined by Scottish Government.

However, these will need to be translated into a workable engagement plan for the Public Energy Company as to how it will engage with customers and potential Local Authority (and wider public sector participants) alike. This is in addition to the general costs associated with creating the look and identity of the brand, e.g. fonts, document templates, graphic design etc.

While there will be an element of limitation associated with templates due to the use of the White Label partner's systems, we assume that the Public Sector investors will either wish to secure the development of these services on an in-house basis or through an external agency. In both cases, there will be a need to coordinate the activities of the Local Authority participants to ensure consistency of message.

The Core Case value of £20,000 has been based on upon a marketing and brand manager/agency for six months to establish the Project.

Web design

Under a White Label arrangement, there is relatively little required for the establishment of a website, as the partner supplier provides the customer enrolment portal and (typically) the provision of the website for use by the White Label partner. Therefore, this spend has been set at a low level to reflect personalisation and branding of the website rather than its complete design and build.

Set up/miscellaneous costs

This category represents other spend needed to establish the identity and strategy of the Public Energy Company and to provide flexibility and reserve for the establishment of the Public Energy Company.

Ongoing marketing spend

This figure represents the ongoing spend by the Public Energy Company for marketing activities. We have assumed that for the Core scenario the Public Energy Company will undertake relatively little national marketing activity, relying instead more on local campaigns aligned with the partner Local Authorities, the brand of the Public Energy Company, and the free marketing activity received as Scottish Government supplier from media coverage.

Therefore, there is assumed to be no direct centrally incurred expenditure, although we anticipate that there will be a cost incurred by the Local Authorities – for which no explicit allocation has been made.

Acquisition

Cost per new customer

This cost represents the additional cost per customer the Public Energy Company faces to attract a customer beyond the marketing budget and the support staff time. This reflects further activities such as face to face sales, local workshops, pop-up/physical stores.

Given the social objective of the Public Energy Company we have assumed that it will be predominantly targeting the harder-to-engage consumers and so will face a higher cost per new customer than we would typically see for a supplier as it will be more focused on face to face sales and engagement events.

Additionally, in order to reflect the combination of fixed and marginal costs for customer acquisition we have assumed that the cost to acquire the first customer meter will be higher to reflect the need to recover the sunk fixed costs, while the cost of acquiring the second meter in a dual fuel arrangement will be lower as it will predominantly be the marginal cost of acquisition.

Annual customer churn

This represents the percentage of customers who switch away from the Public Energy Company on an annual basis. As with the acquisition rate we have applied this as a flat monthly figure. The average annualised customer churn for a domestic-only energy supply is approximately 20% (as at the Q2 2019 figures, it was 21.9%). Given the assumed target customer base of the Public Energy Company and the anticipated level of engagement with the energy market, a lower figure was applied to the model.

Acquisition fee

We are aware that a number of White Label contracts have in place protections to prevent against incomplete, frequent or erroneous switching.

These typically block the payment of the acquisition fee if the switch does not occur within 60 days, or the customer switches away from the White Label within the same timescale.

This is accommodated by the ability to apply such protections (by typing "Yes" or "No") in the applicable cell.

It is assumed that this takes effect from Year 2 onwards.