Why learning economics is of no use, or how Flexstrom managed to fleece me

I had a really interesting experience dealing with Flexstrom (http://www.flexstrom.de), a German electricity provider. Flexstrom attracts customers with low prices for electricity supply, combined with the promise of a bonus after one year.

1. The story

I switched to Flexstrom from the city provider, Stadtwerke Jena (http://www.stadtwerke-jena.de) on the 1st of April 2010. Prices at Stadtwerke were of about 9 euros per month plus 0.23 €/kWh so that my expected expense for the year, given my consumption of about 2200 kWh per year, was 611 euros.

Flexstrom’s offer was much more advantageous: Their price was of 0.175 €/kWh, which, combined with a monthly fee of €7.70, meant I would be spending 477 euros for the year. Not only this, but I would receive 100 euros back if I kept on with the company after this (see note 1 whereby I was made to believe this would be paid even if I left).

This looked like a really good deal: even if I did not stay with Flexstrom after one year, I still saved 133 euros compared with my contract with Stadtwerke Jena (see table).

Starting date	Contract	Price / kWh	Monthly payment	Consumption (KWh)	Yearly expense
28.09.2009	StadtWerke Jena	€ 0.229	€ 8.93	2200	€ 611
01.04.2010	DeutschlandsBest Tarif 2	€ 0.175	€ 7.70	2200	€ 477
01.08.2010	DeutschlandsBest Tarif 2 Regio (Zone 6) BK	€ 0.226	€ 8.70	2200	€ 602
01.04.2011	DeutschlandsBest Tarif 4 Region 23	€ 0.254	€ 9.50	2200	€ 673
01.04.2012	DeutschlandsBest Tarif 4 Region 23	€ 0.272	€ 9.50	2200	€ 713

However, Flexstrom guaranteed the price only for the first 3 months, and, surprise, 4 months after the start of my contract, I received a letter stating that prices would be increased on the 1st of August for the remainder of the year (see table for the new prices). It turns out this was not a perfectly legal move on their part (see http://de.wikipedia.org/wiki/FlexStrom#Rechtsstreite_seit_2011), but as a newcomer in Germany I did not know this.

My projected expense for the year was now about 560 euros. I still would make savings compared to my contract with Stadtwerke Jena if there was no further raise in price. However, this was not to be. Flexstrom raised its price again at the beginning of the second year (see table) so my expenses for the second year would be 673 euros.

At that point, I contacted Flexstrom to change my contract to one of their better offers, which I had found via a price comparison engine, Verivox (http://www.verivox.de). They emailed back to me that they would forward my request to the appropriate person in their company (see note 2 for their wording).

I waited and came back to them after a while, at which point they told me it was actually not possible to change my contract. Not only this, but it was now too late to cancel it, so there I was, stuck with Flexstrom for a second year.

I immediately sent them a letter to terminate my contract so it would at least not be prolonged into a third year. This was with good reason: the price I would have paid for my third year would have resulted in expenses of 713 euros (see table), compared to the 480 euros I will (hopefully) be paying this year with my new provider.

To recapitulate: I spent 560 euros for the first year, to be compared with the 480 euros that were originally contracted for and the 611 euros I would have paid at Stadtwerke Jena. I received the one year 100 euros bonus at the end of the first year and spent 672 euros in the second year. This means that, over two years, my expense was of 1133 euros, or 567 euros per year. I therefore still managed to pay slightly less compared to what I would have spent at Stadtwerke Jena, but much more than I was led to expect, and probably more than if I had chosen a more honest competitor.

2. Interpretation

The way I interpret this is as follows: Flexstrom undercut Stadtwerke Jena so as to attract me as a new customer. I switched to them because, even if they raised their prices after one year, I could still switch out of them and make savings even if that meant the one year bonus would not be paid.

The mistake I made was not to cancel my contract with them when they increased their prices after four months. At that point indeed, their prices were not competitive any more, and it was only the prospect of getting the 100 euros bonus that kept me in. My second mistake was not to pursue my request to change my contract with them more forcefully. They cleverly delayed responding until it was not possible for me to change provider, and then advised me that I could not change contract.

Flexstrom’s strategy can thus be summarised as follows: attract customers with advantageous prices and a one-year bonus, raise prices as soon as “legally” possible, discourage customers from leaving after one year through a combination of delay and obfuscation when dealing with customer requests, and finally, recover the money lost in the first year by raising prices above the competition in the second year.

3. Analysis

Flexstrom makes very fancy footwork indeed, which I analyse below in terms of the academic literature on the topic. Let us begin with Farrell and Shapiro’s “Dynamic Competition with Switching Costs” (1988).

The difference between my case and Farrell and Shapiro (1988) is that they assume the firms cannot discriminate between old and new customers, while Flexstrom proved perfectly able to identify me as an old customer when I tried to change my contact via a price comparison engine (I tried this twice, it did not work, see note 3!). Secondly, switching cost with Flexstrom are not so much due to the difficulty in switching provider (one has to take care of this three months in advance, but this is eased by the use of price comparison engines). Switching is made costly because the payment of the one-year bonus is conditional on contract renewal. Switching out meant losing the one year 100 Euros bonus in my case (again, this was not clear when I first signed the contract, see note 1).

Flexstrom’s strategy is better described in Klemperer (1995) on page 535, where he makes the clever point that “committing to give some consumers a future discount is not directly costly in the absence of any commitment to future prices”. In lay terms, it is easy for the firm to raise its prices in the second period in order to recover the cost of the bonus. This is exactly what Flexstrom did.

Klemperer (1995), with this quote, directs me back towards section 3 of Caminal and Matutes (1990), where it is stated that such bonuses (“coupons” in their terminology) “decrease the competitiveness of markets”. Interesting, but one would have to rework a bit their model to look at the case where one firm (in my case, Stadtwerke Jena) decides not to offer any bonus. Also, Caminal and Matutes (1990) consider a Hotelling location model, that is, they assume there is differentiation between products, which is not the case with electricity.

After a bit of research, I found a reference that is a really good fit with my situation: section 4.4 of Fong and Liu (2010), which deals with repeat-purchase discounts. They state in their paper that what they call “loyalty rewards” are a collusion device, that is, their use is anti-competitive. Whether Flexstrom, and more generally German electricity companies, should be banned from offering rewards for old customers, is something that the German competition authorities (http://www.bundeskartellamt.de/) should pay attention to. I do not see any indication that this is on their radar.

4. Extension

One thing missing from most of the economic analysis of such situations, in my opinion, is their behavioural aspect. I suspect that many customers, like me, did not understand that the one-year bonus was a loyalty reward, payable only in the second year if the contract was renewed. Rather, they incorrectly subtracted it from their first year expense when making comparisons with offers at the competition (see note 1).

On this matter, price comparison engines may not be making their job properly. While Verivox (http://www.verivox.de) seems to now have excluded Flexstrom from its listings, it appears to let other companies, such as Stromio (http://www.stromio.de), advertise new customer bonuses as if they were not conditional on renewal. For example, Stromio now advertises contracts with a 25% rebate on the total expenses paid after the first year. However, when reading the contract, I noticed that this rebate would be repaid on expenses in the second year, which is not not how Verivox described it, instead stating that this would be reimbursed at the end of the first year (see note 4 + note that Verivox disagrees with my interpretation). Other price comparison engines are worse. For example, StromVergleich (http://www.stromvergleich.net) still lets Flexstrom get to the top of its listing by falsely deducting its bonus from first year expenses.

This means that a firm may be able to attract customers with such loyalty bonuses even while offering exactly the same price as the competition in the first year. They can do this by making sure that customers incorrectly believe the bonus is to be subtracted from their first year payment. This incorrect belief is encouraged both by the companies and by price-comparison engines which subtract the loyalty bonus from the first year payments as a default.

Missing from the models, therefore, are deceptive practices by firms. Flexstrom trying to pass a 100 euro second year rebate as a 100 euro reimbursement after one year is only one example. Flexstrom also responded ambiguously to my requests for a change of contract. As mentioned in note 3, it also pretended to be confused when I tried to select a new contract and tried to force me into a less advantageous contract instead.

Other examples of dubious practice at the moment includes the owners of Flexstrom setting up other companies (for example Löwenzahn Energie GmbH) in order to escape the reputation they have developed over recent years (see http://de.wikipedia.org/wiki/FlexStrom). I suspect they do this also in order to artificially inflate their presence on price comparison engines.

They are not the only electricity company to adopt exploitative, dishonest or misleading practices: A favourite strategy of electricity providers seem to be to give a different name to the branch of their company that offers “ecological” tariffs. Those “ecological” tariffs are yet another completely different kettle of fish that would need some serious attention, if only German regulators had any teeth.

5. Epilogue

It seems to me indeed that the electricity market in Germany lacks decent consumer protection. Overall, consumer protection seems much less effective in Germany than in the UK, where I have had good experience with the Ombudsman system and where the OFT is at least aware of and concerned about exploitative practices by firms. One seems to have to go to court to seek redress in Germany, while less extreme and less expensive solutions are available in the UK.  Flexstrom seems to have been sued successfully by some consumers (see http://de.wikipedia.org/wiki/FlexStrom#Rechtsstreite_seit_2011), but remedies were only applied to those consumers who took the time and expense to sue the company.

This means that Flexstrom has been left more or less free to profit from its deceptive and anti-competitive practices. The owners of that company, the brothers Robert and Thomas Mundt, were already accused in 2003 to have operated a Ponzi-scheme (see note 5 for more details). That they would be allowed to keep on doing business seems rather strange to me.

Notes

1. In fact, at the time, I did not know that those 100 euros would be paid only if I stayed. It seems I was not the only one to believe those would be paid at the end of the first year whether I left or not, cf. http://de.wikipedia.org/wiki/FlexStrom#Rechtsstreite_seit_2011 (in German).

2. “Ihr Anliegen zum Tarifwechsel haben wir zur Bearbeitung an die entsprechende Abteilung weitergeleitet.”

3. I tried to use a price comparison engine as an intermediary to change my contract with Flexstrom as Flexstrom did not offer any way on their website to perform such a change. Rather than simply saying the terms I had found via Verivox were not available to me, Flexstrom took this as a pretext to renew my contract with them under the old terms of the contract I had cancelled in writing beforehand! The email they sent me is available here.

I therefore had to write yet another letter to cancel a contract I had never entered into in the first place. Flexstrom made this difficult by sending me several letter with different contract number but the same terms, so that I had to cancel three contracts rather than just one…

4. Stromio’s AGB states, in §4 (1): “Sofern ein prozentualer Bonus zugesagt wurde, wird dem Kunden nach Ablauf des ersten Belieferungsjahres ein prozentualer Rabatt auf die Gesamtkosten des tatsächlichen Stromverbrauchs innerhalb des ersten Belieferungsjahres durch eine Gutschrift im Rahmen der Jahresverbrauchsrechnung gewährt.”. The term “Gutschrift” corresponds to the term “credit” in English, meaning that it may be used only on future expenses with the company. Verivox (http://www.verivox.de) however deducts this credit from first year expenses in its ranking (see screen capture here for the ranking, here for how the bonus is described by Verivox, and here for further explanation by Verivox, which professes that they take into account only those boni that are paid within the contracted period…).

Note however that Verivox stated to me that “… we are (still) convinced that “Gutschrift“ means nothing but entry on the credit side of the account. The term does not include any time connotation and does not have to be used on future purchases only. Therefore the use of the term “Gutschrift” does not imply a second year contract. This also means the tariff is compliant with our consumer protection code and correctly displayed in the Verivox energy price calculator.”

5. It appears that the Brothers Mundt were convicted of having used a system by which clients were rewarded for bringing new clients to their old company, Innoflex AG. (see https://de.wikipedia.org/wiki/FlexStrom#Sonstiges). It is interesting to note they still operate a very similar programme, “Kunden werben Kunden”, which is detailed on their own website here: https://www.flexstrom.de/kundenbereich/kunden-werben-kunden.php.

References, in order of appearance:

Joseph Farrell and Carl Shapiro (1988), “Dynamic Competition with Switching Costs”, The RAND Journal of Economics, Vol. 19, No. 1, pp. 123-137. Free access here, or on RePEc at http://ideas.repec.org/a/rje/randje/v19y1988ispringp123-137.html.

Paul Klemperer (1995), “Competition when Consumers have Switching Costs: An Overview with Applications to Industrial Organization, Macroeconomics, and International Trade”, The Review of Economic Studies , Vol. 62, No. 4, pp. 515-539. Free access here, or on RePEc at http://ideas.repec.org/a/bla/restud/v62y1995i4p515-39.html

Ramon Caminal and Carmen Matutes (1990), “Endogenous switching costs in a duopoly model”, International Journal of Industrial Organization, Vol. 8, No. 3, pp. 353-373. No free access available, sorry. On RePEc at http://ideas.repec.org/a/eee/indorg/v8y1990i3p353-373.html.

Yuk-fai Fong and Qihong Liu (2011), “Loyalty Rewards Facilitate Tacit Collusion”, Journal of Economics & Management Strategy, Vol. 20, No. 3, pp. 739-775. Working paper version at SSRN here: http://dx.doi.org/10.2139/ssrn.1562239.

Related links

“5000-Euro-Klage gegen Flexstrom” – About how Flexstrom attempts to hide price increases into promotional flyers

“Neuer Tarifrechner verspricht Transparenz” – About unfair practices at price comparison sites by companies such as Flexstrom or Stromio

Flexstrom verklagt ehemalige Kunden – Schlichtung gerät zum Bumerang  – An article about how Flexstrom tries to intimidate those of its clients who go to an arbitration board to complain about its practices.

Allgemeine Zeitung – Immer das Kleingedruckte lesen – A consumer defence group makes a presentation to old people to warn them about Flexstrom’s exploitative practices.

test.de warnt vor Flexstrom und Teldafax – An article which confirms my suspicion that Flexstrom systematically increases its prices three months after a contract is signed with a customer. There is a whole list of articles on Flexstrom at Test.de here: http://www.test.de/suche/?q=flexstrom

Die dunkle Seite von Flexstrom – “The dark side of Flexstrom”, quite self-explanatory.

FlexStrom erwirkt Gerichtsbeschluss gegen Vergleichsportal – The German “justice” system comes to the help of Flexstrom and prevents Verivox from warning its customers against this company.