Powerplay: Why M&A may hold key to survival and success in an ultra-competitive energy market

Mergers and acquisitions (M&A) offer lifelines for independent energy retailers grappling with today’s tough market conditions. How can they make the most of the opportunities and manage the challenges?

The influx of independents has injected fresh competition, with more than 70 small and medium-size energy suppliers capturing around a quarter of a market once dominated by the Big Six (see Figures 1 and 2).

Figure 1 

Source: Ofgem analysis of electricity distribution network operator reports. Information correct as of October 2018.

Figure 2 

Source: Ofgem analysis of Xoserve reports. Information correct as of October 2018. 

Yet, success is hard won. Many of the independents’ customers have been picked up through cut-price deals on price comparison sites, but it can be difficult to build up a loyal and profitable customer base out of frequent switchers.

In addition to the challenges of maintaining customer service standards and dealing with rising wholesale prices, energy retailers face prepayment and default tariff price caps. The narrow gap between competitive tariffs and the price cap makes it harder to win new customers.

Cutting costs and increasing market share could help independents to steer through the headwinds towards a more stable future. But cost cutting can sometimes risk undermining service quality, while the latter demands a level of cash reserves that few have at their disposal.

Increased regulatory demands as suppliers grow, such as the Energy Company Obligation (ECO) scheme (applies when customers reach 250,000 but coming down to 200,000 in April and 150,000 next year), have a distorting impact on costs and create the need for an even larger cash reserve to grow through to a more profitable scale.

The impact is already being felt – Ofgem announced that six independents ceased trading in 2018, followed by two more in January 2019. Others could follow unless there is a change in strategy.

What are the implications for deal activity?

While organic fixes haven’t been enough to prevent business failures for some, M&A may offer a solution:

1/ Consolidation amongst retailers

In a highly price-sensitive market, consolidation amongst equals could help independents to strengthen economies of scale - There has already been a form of consolidation activity with retailers picking up customer books from their failed competitors through Ofgem’s Supplier of Last Resort process. As growing businesses reach towards the ECO threshold, mergers may also enable smaller independents to ‘jump’ past the threshold and its distorting squeeze on margins. Opportunities may also arise for consolidation between Big Six retailers and the independents, especially if this enables them to move customer books onto lower cost and newer business models.

2/ More (and stickier) customers

Capital raising could be used to accelerate marketing and growth. It could also help to sharpen differentiation and strengthen customer loyalty by generating funds for investment in back-office functions, or enhanced customer service.

3/ Increased investment potential

The current market dynamic could offer attractive buying opportunities for investors. We’ve already seen deals closed by strategic oil and gas majors and power generators looking to get closer to the end customers through acquisition of independents. The need for growth capital is a natural fit for strategic acquirers with large balance sheets and financial investors who are looking for efficient platforms with high quality customer service.

Making the most of the potential

As the recent cancellation of the planned merger between SSE and Npower shows, it is not always easy to complete M&A deals. But with M&A set to play a decisive role in survival and success, the big questions are how to secure the right deal, at the right price and with the right outcomes.

The key is creating a clear and compelling strategy to create value – how can you ensure your business stands out and how can you win investor backing for this? If the selling point is cost and price, for example, what’s the plan for getting there (e.g. scale through consolidation), how can wholesale fluctuations be accommodated and how can service standards be maintained?

The energy retailers that stand the best chance of success will be those that can move quickly to achieve scale, have a low cost-to-serve, offer the best customer service and experience, and outlast their competitors. While highly differentiated independents can still go it alone, now is the time to pursue deal options that build the customer book as well as strengthen balance sheets to enable suppliers to steer through the storm of competition, price caps and wholesale price rises.