Dynamic pricing: the facts are in, Part III

Data over perception = billions of $$ in savings

Phil Carson | Aug 07, 2012


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. 

For the first two installments in this three-part series, please read "Dynamic Pricing: The Facts Are In," which ran Monday, and "Dynamic Pricing: The Facts Are In, Part II," which ran yesterday. 

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.  

Phil Carson
Intelligent Utility Daily

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Customer Engagement Is Central To Adoption

I think Ahman Faruqui’s dynamic pricing information is spot on and of course, we at Smart Grid Consumer Collaborative (SGCC) agree with him that utilities should begin to work towards understanding customer preferences through customer segmentation and segment-specific messaging. Once consumers understand what the smart grid is and the benefits it provides, our research shows broad support for implementation. I think we all can agree that dynamic rates could provide customers with greater choice for managing their energy costs as they inevitably arise. SGCC’s recent Consumer Pulse and Segmentation research program identified five main segments of consumers with three of the segments immediately interested in smart grid programs and services. Every population segment has opportunities for engagement, however. Our findings highlights the specific messaging to appeal to each of these segments. At the SGCC, we focus on producing research that supports the needs and interests of consumers and then communicate that to utilities, regulators and the stakeholder community to easily and more quickly transform. Increasing customer engagement is a central part of the transformation, especially in an environment where energy prices are sharply increasing. In October, the SGCC is releasing a Spotlight on Low Income Consumers which will gauge their smart grid journey from awareness to engagement and the adoption of smart grid-enabled programs the U.S.

Two opposing views

Hmmm. One reader basically alleges that Ahmad Faruqui is twisting facts for profit, while the other sees dynamic pricing as a significant means to achieve customer control and utility benefits to boot. 

I won't address ad hominen attacks, though the issue of price elasticity is legitimate. Studies that we've featured in this space -- Karen Herter's work at SMUD, e.g., -- show that a price signal alone can spur customer response and that it doesn't need to be a high one. 

As for the Smart Grid Consumer Collaborative, I'm more open to viewpoints that are formed as a result of actual investigation and data, rather than simple naysaying. But let's hear from the folks whose work is cited in the first comment. That'd be a healthy addition to the conversation.

Regards, Phil Carson 

Are the facts really in?

According to IEEE , Green Tech, Mosko and Bellotti July of 2012

Based on research by the Palo Alto Research Center. In an attempt to avoid being anecdotal I will simply quote their conclusion:

"At one time, managers at electric utilities thought they could change consumer behavior by making elec­tricity more expensive at certain times of day. That hasn’t worked. The price premium needed to spur conservation seems to be higher than utilities will—or can—charge."

It appears, like me, they are also clueless to the assured success of TOU and CPP enabled by advanced metering. Maybe Dr. Faruqui should allow some peer review to see why fact is so varied by researcher.

One last anecdotal point: It is interesting how often the facts support the researchers long held or prudential beliefs. Consultants, like the good Doctor, need change since change breeds revenue in that arena.