Reflection: Gentailers, manuvisers and schadenfreude

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October 20, 2017

This week’s reflection was going to focus solely on the events of October 1987, from the perspective of someone who was there. That is, until the Australian Competition and Consumer Commission dropped its ACCC Retail Electricity Pricing Inquiry: Preliminary Report.

Three big vertically integrated retailers dominate the national electricity market (NEM): AGL, Origin and EnergyAustralia. Nationally, they control about 70 per cent of retail electricity customers, and about 48 per cent of generation capacity. It varies across the country; in NSW, they control about 90 per cent of retail customers, and about 62 per cent of generation capacity.

A vertically integrated generator and retailer is called a gentailer. In its report, the ACCC states it is concerned about the impact of vertical integration and gentailers on the ultimate cost of electricity to consumers.

While the regulator states it is not concerned by vertical integration per se, it adds that “in certain circumstances high levels of vertical integration raise concerns”. So it’s having a look at the extent to which vertical integration between the retail and wholesale levels of the electricity supply chain limits the ability of small, non-vertically aligned retailers to compete.

Manuvisers in financial planning

If there’s an equivalent of a gentailer in financial planning, it might be called a manuviser – a combined product manufacturer and adviser.

In the electricity business, being a gentailer has some commercial advantages, including creating a natural hedge against market volatility.

“The generation business typically sells the retail business electricity at a transfer price,” the ACCC states. “This can be used to allocate costs between the two parts of the business as the business considers appropriate.” That might be called a subsidy in other industries. In financial planning, it might take the form of, say, a reduced dealer group fee, with the shortfall between the fee and the commercial cost of providing services made up from profit on product.

One big difference between electricity generation and financial planning is obvious. It’s easier and cheaper to create (or to white-label) a new investment solution than it is to build new electricity generation. Small advice networks can become, essentially, little vertically integrated businesses to compete against manuvisers more effectively than small electricity retailers can generate their own electricity to compete against gentailers.

(In the electricity market, the rise of the gentailer has predictably led to a drying up of secondary markets for hedging contracts for small retailers, leading to a competitive disadvantage.)

But the concept in both industries is not dissimilar: the entity that controls supply of the product – be it investment solutions or electricity – also controls distribution and retail pricing.

Does the gentailer or manuviser model lead to a worse deal for consumers? According to the ACCC, that’s not a given, but it can happen, to the extent that it might stymie competition.

But surely manuvisers wouldn’t use control of manufacturing and distribution against their own consumers, would they?

If it’s true that Westpac financial planners have been selling insurance policies to bank customers at 4.5 per cent higher premiums than non-bank advisers are selling identical policies to their clients, then maybe they would. Westpac is the subject of a class action alleging that’s what it did.

An insurance lawyer was quoted this week as saying the case highlights concerns about banks acting as both the manufacturers and distributors of financial products.

“This is classic vertical-integration stuff,” he said.

***

1987 remembered

While vertical integration is the gift that just keeps on giving, and hard to go past as a key issue for this week, it seems there’s a bit of a trend at the moment for people who were there for the 1987 sharemarket crash to reflect upon it. Some things have changed in the intervening, but some things remain very much the same.

We’ve learned very little about bubbles. They just keep happening; some people get rich, some people lose a lot of money, the former having somehow managed to sell to the latter just before it all comes crashing down. (And if you EVER hear anyone tell you that ‘this time it’s different’, you should sell, right away.)

In 1987, the market decline was in the vicinity of 500 points, then representing about 23 per cent of the market’s value. At the time of writing, a 500-point fall in today’s market would represent a fall of less than 9 per cent. To understand the impact of the 1987 crash, realise that a fall of the same proportion today would be 1344 points. Think about that. It also underlines why it’s so stupid to use points when comparing movements of markets over long periods of time.

The 1987 crash started offshore and we could see it coming our way. Stock exchanges in Australia remained open, at least, unlike in some places, where they simply suspended trading. Closing a market and wishing a correction away is like responding to being attacked by a bear by sticking your fingers in your ears, closing your eyes and shouting “La, la, la, I can’t hear you”, and then being surprised that the bear is still there, only closer, and still hungry, when you open your eyes.

Watching the crash from the floor of the Melbourne Stock Exchange, I first realised that anyone who tells you they know with any sort of certainty what is going to happen in the future is either a liar or deluded. Even today, it seems futile to create a financial planning value proposition based on being able to predict markets or on a promise of producing the best investment performance.

The crash was also an instructive exercise in human nature – mostly my own. It may have been when I first experienced and learned to appreciate schadenfreude.

Newspapers used to put cadets on jobs like reporting ship movements or fruit and vegetable prices. Being employed on Business Review Weekly (later BRW, and then, later still, folded), my job in 1987 was the financial equivalent: reporting four times a day on the sharemarket – once before the open, once mid-morning, once at lunch and once after the close. In 1987, the stock exchanges still used the open-call system of trading: operators would take orders from clients and literally shout instructions to the chalkies, who worked on a mezzanine level that ran around the outside of the trading floor. The chalkies would write the transaction data – price, volume and so on – on a blackboard, where each company was listed.

To find out what was happening – who was buying, who was selling, where the big price movements were, and so on – you had to talk to the operators. And some of them were arseholes, taking glee in competing to provide misinformation to a young reporter. Practical jokes were not unheard of. Life could be miserable.

So on the morning of the crash, I spotted one particular operator – one of the worst offenders at giving me a hard time – sitting at a desk on the floor of the exchange in Melbourne. He had his head in his hands and he was crying. And I thought: “Maybe there is a god.”


TOPICS:  ACCCAustralian Competition and Consumer CommissionCrash of 1987Retail Electricity Pricing Inquiryvertical integration