In this blog series, we’ve covered the most important considerations of rate setting. Once all of these considerations are appropriately accounted for, customer enrollment kicks in. The two most common customer acquisition strategies that Retail Energy Providers (REPs) should employ during this process are: 1) mass marketing campaigns (both direct and indirect), and 2) competing for large commercial / industrial Requests for Proposals (RFPs) or brokered contracts.
Both strategies bring benefits and risks necessary to consider in both the forward pricing model used to set rates and in the overall risk management and portfolio optimization strategies employed. While revenue is typically tied to volume with both marketing strategies, there are key differences between RFP and mass marketing acquisition styles, which can impact both the initial enrollment and operational phases.
A successful mass marketing campaign is typically defined by enrolling a large number of small-volume commercial and residential accounts with simple contract structures and relatively high margins, but also at significant customer acquisition costs. For fixed-rate mass marketing campaigns, a dynamic pricing model can be used to generate a daily pricing matrix for the sales and enrollment teams. Since these campaigns involve large numbers of small accounts, many practical assumptions must be made to generate and offer fixed-rates to accounts which may vary in load shape, load factor, and peak demand.
The most straightforward approach is to model an ‘average account’ using utility-provided load profiles and rate class average peak load contributions (PLCs). This strategy relies on marketing to many accounts to ensure the statistical variations in load factor are normalized. To effectively capture the intended margin, continuously reevaluating the pricing model assumptions and monitoring the load factors of enrolled accounts are key. As the fixed-rate book of accounts evolves, pricing model assumptions may need to be revised. Many REPs will only offer standard 3, 6, 9, 12, 18, and 24 month fixed-rate contracts due to the difficulty in custom pricing each potential customer. This provides marketing opportunities to REPs willing to offer non-standard contract lengths. In addition, selective REPs may judiciously screen potential customers based on their load factor or volume to more meticulously control their fixed-book margins.
REPs looking to participate in targeted RFPs run by brokers or consultants encounter different enrollment and operational challenges. Unlike more open mass marketing campaigns, RFPs are typically defined by the account seeking a specific rate structure and term length. A RFP often limits the available margin as REPs compete to offer the lowest possible rate. To accurately capture the costs associated with serving an RFP, it is necessary to include account specific load-shape and peak-demand information into the pricing model. This is best accomplished by creating a load shape from intervalized hourly usage data (where available). Since margins are typically much lower on these larger accounts, it is important to account for all of the implicit market risks discussed in a previous article.
Once enrolled, distinct risk management strategies are required for mass market books and for large accounts won through an RFP. For fixed-rate contracts, it is advised that the supply costs associated with the forecasted load obligation are hedged in the forward markets. Since wholesale transactions can only reasonably be executed for larger volumes (over 0.1 MW around-the-clock), mass marketing campaigns must wait until a large enough number of customers have been enrolled prior to hedging. Furthermore, the REP must account for customer mid-contract breakage either in its costs of goods sold (COGS) or volume forecasts in a way that is less prevalent in larger contracts won through RFPs. In contrast, large accounts won in an RFP may meet the minimum executable volume and can therefore be hedged immediately upon enrollment to lock in a portion of the intended margin, assuming the REP’s wholesale desks have readily available information on the flow of new accounts and are in tight coordination with the sales teams. Once both customer types begin flowing, REPs must monitor their wholesale settlements to validate the intended margins, and if necessary, pass-through additional wholesale costs through a true-up mechanism.
To learn more about targeted mass-marketing strategies and the complex risks associated with retail supply for mass marketing and targeted RFP accounts, please be sure to contact us today.