How will smaller players survive in a highly competitive Energy sector?

The UK’s Energy sector has undergone unprecedented change over the last five years with the supply market opening up to new competitors.

In addition to the Big 6 (soon to be five following the CMA’s provisional approval of the deal between SSE and nPower to merge their retail businesses), there are now over 60 'smaller' players who control over 20% of the gas & electricity market [1]. But the market is volatile and customer appetites are changing - churn rates are at an all-time high, with an average of 160k domestic consumers switching tariffs every week [2]. This is due to high tariff price perception, poor customer service, a lack of brand loyalty (it’s much easier to switch energy supplier) and government’s increased support for switching.

So how will these factors affect the number of players in the long term? Smaller suppliers are expected to continue to increase their market share, and there is likely to be an increase in M&A activity as companies merge in order to compete more effectively.

What are the drivers of M&A in the Energy sector?  

1. Ofgem’s introduction of an energy sector price cap (until 2020) is an attempt to protect consumers, on standard variable tariffs, from high energy bills [3]. This price cap could reduce competition, and price smaller suppliers out of the market entirely, leading to increased sector consolidation.

2. Changes in regulations have allowed smaller suppliers to rapidly enter the energy market. Although great from a competition perspective, many of the smaller operators have expanded rapidly and are unable to provide effective customer service. Ofgem is increasingly intervening with smaller operators, requesting that they improve their services to customers.  In the case of Iresa Energy the regulator forced them to cease acquiring new customers[4]. This can lead to highly stressed organisations looking to be acquired and for larger players to consider acquisitions as part of their growth strategy.

3. Rising wholesale costs have affected all Energy Companies -  particularly gas, which has been increasing since 2004 [5]. This will put pressure on all companies in the sector, but particularly on smaller suppliers where it is difficult to increase tariffs. It may also cause procurement issues where wholesale gas and electricity suppliers are reluctant to supply the smaller players who have thin capital bases. The collapse of GB Energy in 2016 acts as an example of the continued challenges smaller firms face.  

4. The rapid growth of the Smart Home Market and increasing take-up of Electric Vehicles is driving sector convergence e.g. the recently announced acquisition of Vcharge by Ovo Energy is a good example of this diversification. Larger companies with solid track records are in a stronger position to implement government mandates such as smart metering [6] whilst smaller players will need to consider convergence as a viable option for meeting regulations.

5. Many smaller players set themselves up with a view to achieving exits within a 5-year time frame. Exits tend to happen in one of three ways: through a stock-market flotation, acquisition by the soon-to-be Big 5, or consolidation with another smaller player in the sector.

Growth by Acquisition  

For smaller energy companies, acquiring a similar sized organisation allows them to leverage economies of scale, expand their customer base, become more competitive and meet regulatory requirements around customer service and billing. To make themselves attractive for a sale, effective financial reporting and records, and their growth potential and scalability will all need to be considered. It is also likely that there will be an increase in energy companies being in a distressed state, either operationally or financially. This provides the more successful players with an opportunity to expand their customer bases through acquisition.

Where the Big 6 are looking at acquiring smaller energy companies they will do so with a view of reinventing themselves. This includes learning from the smaller players’ approach to areas such as customer retention strategy, customer service, technology user experience, and innovations.

A great example is Shell’s entry into the retail energy market through the acquisition of First Utility, which adds an interesting dynamic. It is believed that a number of the oil majors are looking at the energy and green energy sector in a potential response to electric vehicles and improved renewable technologies. The larger oil companies are increasingly keen to make smaller investments in order to minimise any difficulty around gaining entry to the market later on [7]. 

The acquisition of First Utility is a clever move by Shell, enabling them to diversify in an otherwise volatile Oil and Gas landscape. It allows them to expand their product offering and provides them with an opportunity to cross sell [6]. The latter opportunity will be key as they look at products in the Electric Vehicle, Gas and Electric, Renewable and Broadband markets, something that will no doubt make other Energy and Utility firms sit up and take note. Meanwhile it provides stability to First Utility in a climate of regulatory unrest, affording them room to grow and compete more effectively with the Big 6.    

Opportunities for consolidation

Smaller companies are currently grappling with fierce price competition and struggling to retain, and manage their customer bases. This, coupled with a lack of wide-scale infrastructure, makes the prospect of being acquired by those in stronger financial positions, an attractive proposition.

To date, there has been limited consolidation amongst smaller players. However, the recent announcement of Co-op Energy’s intention to buy Flow Energy (which would otherwise have struggled under the impending price regulation) potentially signals that further consolidations in the industry are right around the corner [8].

M&S Energy’s move away from the Big Six, ending their 10-year partnership with SSE in favour of challenger supplier Octopus Energy, is a clear demonstration that the smaller players are becoming increasingly more prominent and challenging the status quo.

If this proves correct, then smaller players need to prepare themselves to be part of consolidation activity. This might include reviewing marketing approaches and tariff structures, customer service and sustainable growth, showcasing cutting edge platforms and understanding IT system shortfalls.

Ensuring success post-acquisition

Integrating an acquisition will be key to future success in meeting growth plans and synergy targets. Mobilising and planning the integration needs to start early in the process. Too often companies fail to give this focus it requires, leading to poor profit trajectories, and fractured workforces. Indeed, almost half of all integrations are unsuccessful due to a failure to give proper attention to the integration [9].

We believe that there are five fundamental factors for a successful integration which companies need to consider:
1. Setting up a robust governance structure
2. Bottom up quantification of synergies and implementation costs
3. Detailed integration planning linked to delivery of the benefits
4. Tracking progress and performance
5. Early communication and cultural Integration

The energy market is one that is ripe for consolidation and there are a number of factors driving this. How this plays out remains to be seen. What will be key to M&A success is planning and implementing the integration in order to deliver the benefits.

References:
[1] https://www.ofgem.gov.uk/system/files/docs/2017/10/state_of_the_market_report_2017_web_1.pdf
[2] https://www.sas.com/en_gb/customers/edf-energy.html
[3] https://www.gov.uk/government/news/government-introduces-new-legislation-to-cap-poor-value-energy-tariffs-in-time-for-next-winter 
[4] https://www.ofgem.gov.uk/publications-and-updates/iresa-provisional-order
[5] https://www.ofgem.gov.uk/ofgem-publications/64017/why-are-energy-prices-risingfactsheet108.pdf
[6] https://assets.kpmg.com/content/dam/kpmg/uk/pdf/2018/01/a-turning-point-for-uk-retail-energy.pdf
[7] https://uk.reuters.com/article/uk-flowgroup-m-a-cooperative/britains-co-op-to-buy-flow-energy-as-energy-price-cap-looms-idUKKBN1HH1J0
[8] https://group.vattenfall.com/press-and-media/news--press-releases/pressreleases/2017/vattenfall-into-uk-energy-retail-with-acquisition-of-isupplyenergy
[9] https://www.bloomberg.com/news/articles/2018-01-12/shell-braces-for-change-by-expanding-its-foothold-in-electricity

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Author

Amelia Gillingwater Consultant