Published: 27/02/2003

Competition Commission

06/03

27 February 2003

EXTENDED WARRANTIES MONOPOLY INQUIRY: ISSUES UNDER INVESTIGATION

INTRODUCTION

The Competition Commission (CC) has today sent a letter setting out
the issues under investigation in its inquiry on extended warranties
(EWs) on domestic electrical goods (DEGs). This "issues letter" is
attached. It has been addressed to those we currently understand to
be involved in the provision of EWs in the UK, including retailers of
DEGs, insurers and manufacturers. They are listed in Table 1 of Annex
1 to the issues letter. The letter has also been published on the CC
website, with commercially confidential information removed.

We were asked to undertake an inquiry into the supply of EWs on DEGs
under the Fair Trading Act 1973. The terms of reference require us,
in summary, to investigate and report on whether one or more
companies is involved in a monopoly situation in the supply of EWs on
DEGs in the UK; on any steps being taken to exploit or maintain such
a situation; and on whether this operates or may be expected to
operate against the public interest.

An issues letter is always sent to the main parties in an inquiry and
is designed to highlight those matters that have been identified by
the investigating group for further consideration, and to ensure that
no relevant matter has been overlooked. We will shortly hold hearings
with a number of the main parties individually to discuss these
issues. We are also planning to hold a public hearing in London on 25
April, to which we are inviting all interested parties.

The purpose of making the issues letter public is to give all
interested parties an opportunity to put any points to us that they
may wish to raise. No findings on any of these issues, nor any
conclusions as to whether any matter operates or might be expected to
operate against the public interest have yet been reached. Nor has
the inquiry yet reached the stage when (if at all) it comes to
consider any remedial action that might be appropriate.

We have commissioned a survey from NOP on consumers' experience of
EWs. The results of this survey are referred to in the letter, and
are published on the CC website.

POSSIBLE MONOPOLY SITUATIONS

On evidence received so far, we consider that a scale monopoly
situation may exist, as Dixons Group plc appears to supply at least
25% of EWs on DEGs both by number and value. This does not imply any
adverse findings in relation to Dixons Group plc.

We also consider that one or more complex monopoly situations may
exist, in favour of those providers of DEGs who supply EWs at the
point of sale of the relevant DEGs. This could arise from practices
that act to prevent, restrict or distort competition, where the
providers involved supply more than 25% of the supply of EWs. Only
the larger providers of EWs have been individually identified (in
Table 2 of Annex 1 of the issues letter); these are the larger
retailers of DEGs (Dixons, Comet, Powerhouse, Argos, Littlewoods and
MFI, together with the insurance companies involved with them in
providing EWs: Cornhill, Landmark, Pinnacle and London General). It
is possible that others involved in providing EWs may also be part of
a complex monopoly. This does not imply any adverse findings in
relation to any company.

Many EWs are sold at the same time as the DEGs to which they relate
(at point of sale). We consider that this may provide an advantage
which, taken with the practices outlined below, may amount to a
course of conduct that has the effect of preventing, restricting or
distorting competition.

EXTENDED WARRANTIES

EWs are supplied by most DEG retailers (including mail order and
internet sellers), manufacturers, some insurance companies, and to a
lesser extent, some banks, credit card providers and utility
companies. We estimate the annual sales of EWs on DEGs to be in the
region of #800 million.

EWs extend the initial manufacturer's or retailer's guarantee in time
(usually for a further two or four years after the typical initial
one year guarantee), and may also extend the scope of risks covered,
for example, to include cover against accidental damage, theft or
frozen food loss. In some cases technical or other support services,
such as a PC helpline, may also be included.

POSSIBLE UNCOMPETITIVE PRACTICES

The Commission has not yet reached any conclusions, but is
investigating whether some or all of those companies involved in
providing EWs at the point of sale of the relevant DEG are engaged in
any of the following practices, and whether this gives rise to any
outcomes which operate or might be expected to operate against the
public interest.

A. Restricting choice

Consumers may, at point of sale, be offered only one provider's
particular combination of cover and related terms on EWs. If so, this
may restrict their choice of cover and may mean, to some extent, that
they have to take cover they would not otherwise have bought. On the
other hand, there may be practical limits to what can be offered.

B. Contracting in advance

Consumers are often required to contract and pay in advance for
services, some or all of which will not be provided for some time.
Repair services (and in some cases other elements of the EW) are
already provided during the first year (and occasionally longer)
under the manufacturer's initial guarantee. In the case of EWs
provided at point of sale, this may restrict or distort competition,
because information about alternatives may not be readily available
until after a purchase has been made. On the other hand, consumers
may find it convenient to buy the EW that is offered at the same time
as the DEG.

C. Setting prices above competitive levels

If there is a lack of effective competition at point of sale, this
may mean that consumers are paying more than they would otherwise. In
assessing this, account needs to be taken of costs, how they relate
to the pricing of different elements of EWs, and how prices are set.
If there is scope to make profits in excess of competitive levels on
EWs, the issue arises as to the broader impact. If the result is
lower prices than otherwise in other competitive areas of business
such as DEG retailing, then this may cause further distortions or
restrictions on competition in these other areas.

D. Restricting information about alternatives

Information available to consumers at the point of sale about
alternative EW offerings may be restricted. Information is generally
available at the point of sale about the main features of the DEGs
available and their price. It appears that, in contrast, there is
very little, if any, information provided to consumers at the point
of sale to enable them to evaluate EWs of other providers. There may
be very limited scope for such alternative providers to obtain or
challenge a point of sale advantage. There could be competition
problems if consumers cannot make a reasoned and informed choice
about which EW to buy (or whether to buy one at all) because
information on alternative EWs is not made available, particularly at
the point of sale. Consumers' awareness of statutory rights may also
be low.

E. Selling practices

Retailers may engage in selling practices such as providing
misleading or incomplete information or excessive selling pressure
designed to increase the sales of EWs sold at the point of sale of
the DEGs. The consumer may have little, if any, directly useful
information on matters such as likely reliability, potential repair
costs, probability of theft or accidental damage. If so, consumers
may be more susceptible than otherwise to any statements made by
sales staff at the point of sale, and some practices could amount to
pressure selling. The point of sale context, with the potential for
bargaining over credit and DEG prices, may affect sales behaviour in
relation to EWs. Sales targets and commissions to staff may be
factors.

F. Unfair terms

EWs may include terms or conditions that are not fair to consumers
and would not be sustainable in fully competitive conditions.
Possible examples are: the termination of EW cover following a claim;
disproportionately small repayment on cancellation in relation to the
cost of the EWs; applying depreciation rates, or using reconditioned
products for replacement in a way which was not sufficiently
highlighted and therefore expected by some consumers. A further
practice, which we understand may have been largely discontinued, has
been offering cash back to consumers for making no claim during the
life of the EW, but with conditions that mean many consumers in
practice fail to meet the terms.

G. Uninsured cover

EWs may be offered in the form of uninsured service agreements rather
than in the form of insurance contracts in order to obtain
preferential tax treatment. Such agreements may provide consumers
with a lower level of protection in the event of insolvency. Many EW
providers have established ring-fenced trust funds that are intended
to mitigate this risk. We are considering the extent to which, if at
all, these arrangements fall short of providing in practice the
degree of protection afforded by insured schemes.

Notes to Editors

1. The reference was made by the Director General of Fair Trading
under s.2 of the Fair Trading Act 1973 on 2 July 2002 (see Press
Release 34/02). The Commission has been asked to report by 1 July
2003. 2. The inquiry is being carried out by a group of five
Commission members led by Sir Derek Morris, the Commission Chairman.
The other four members are Christopher Clarke, Dr Diane Coyle, Peter
Hazell and Dr Elizabeth Monck. 3. Further information can be found on
the Commission website:
www.competition-commission.org.uk/inquiries/warranty.htm


ISSUES LETTER

PART 1 - INTRODUCTION

1.1 The Director General of Fair Trading referred the supply of
extended warranties (EWs) for domestic electrical goods (DEGs) within
the UK (the reference services) to the Commission on 2 July 2002 for
investigation and report. This letter is to notify you of the issues
that the Commission has identified at this stage in its inquiry.

1.2 The Commission invites your views on the issues set out in this
letter. You need not repeat points made in earlier submissions,
although you may refer to them if you wish.

1.3 This letter is set out as follows:

Part 1 explains the overall position;

Part 2 presents the market and economic issues that form the context
of the inquiry;

Part 3 indicates the issues that the Commission is considering in
order to establish whether there is a monopoly situation, and how the
conduct of those involved might relate to that situation; and
indicates the public interest issues that are under consideration;

Annex 1 Table 1 lists the companies which we understand are involved
in the supply of the reference services; Table 2 lists the companies
currently identified as providing EWs at the point of sale of the
relevant DEG (point of sale), and having more than 1% of the supply
of the reference services. These, together with others who provide
EWs at the point of sale and are listed in Table 1, may be involved
in a monopoly situation;
Annex 2 gives background information on the market and economic
issues;
Annex 3 gives further detail of the evidence relating to the possible
uncompetitive practices under consideration, on the basis of
information available at this stage;
Annex 4 gives the text of section 7 of the Fair Trading Act 1973
(FTA), which sets out the circumstances in which a monopoly situation
is taken to exist in relation to the supply of services; and the
terms of reference for the inquiry;
Annex 5 gives information on some relevant tax issues.

1.4 Under the terms of reference for the inquiry, the Commission
has to determine whether there is a monopoly situation, and if so, in
favour of what person or persons that monopoly situation exists, and:

(a) whether any steps (by way of uncompetitive practices or
otherwise) are being taken by members of this group (those involved
in the monopoly situation) for the purpose of exploiting or
maintaining the monopoly situation and if so, by what uncompetitive
practices, or in what other way;

(b) whether any action or omission on the part of members of this
group is attributable to the existence of the monopoly situation and,
if so, what action or omission and in what way it is so attributable;
and

(c) whether any facts found by the Commission in pursuance of this
investigation operate or may be expected to operate against the
public interest.

1.5 If the Commission does find facts which operate, or may be
expected to operate against the public interest, it has to consider
what action should be taken for the purpose of remedying or
preventing those adverse effects.

1.6 The Commission currently considers that a scale monopoly
situation may exist in relation to the supply of EWs for DEGs within
the UK, in favour of Dixons Group plc (the Dixons Group). This is
based on initial evidence that the Dixons Group may supply at least
one quarter of the reference services. This does not imply any
adverse findings relating to the conduct of the Dixons Group.

1.7 The Commission also currently considers that a complex monopoly
situation may exist in relation to the supply of EWs for DEGs within
the UK. Companies currently identified as suppliers are listed in
Table 1 of Annex 1. Of these companies, the Commission currently
believes that those that are involved in supplying EWs at point of
sale may be members of a group that supplies at least one quarter of
the reference services. Of this group, those currently estimated to
have more than 1% of the total supply of the reference services are
listed individually in Table 2 of Annex 1. This does not imply any
adverse findings relating to the conduct of any of those companies.

1.8 The Commission currently considers that members of this group
may conduct their respective affairs in a way which prevents,
restricts or distorts competition in connection with the supply of
the reference services, and that the resulting complex monopoly
situation may exist in favour of the members of this group. The
conduct that the Commission considers may have this effect is set out
in Part 3 of this letter. (It may be that the Commission will
identify further possible complex monopoly situations during the
course of the inquiry; in which case they will be notified to you if
you may be affected, and you will be given a further opportunity to
comment.)

1.9 The issues that the Commission has identified to date as being
relevant to these matters are listed in Parts 2 and 3 of this letter,
with explanatory material set out in Annexes 2 and 3. If other issues
arise during the course of the inquiry you will be given an
opportunity to comment on them.

1.10 The Commission has not yet reached any conclusions on any of the
issues arising in the inquiry, on whether any monopoly situation
exists, on whether the parties concerned are taking any such steps,
actions or omissions as are identified in this letter to exploit or
maintain a monopoly, or on whether there are any facts that operate
or may be expected to operate against the public interest. Should any
conclusions be reached on the basis of which the Commission considers
that there might be a case for remedial action, you will be given a
further opportunity to comment on the practicability and effects of
any such action that the Commission might recommend.

1.11 I would be grateful if you would check that material relating to
your company contained in this letter is factually correct and if you
would inform the Commission of any developments that might affect the
accuracy of the information during the rest of the inquiry period.

1.12 All those companies listed in Annex 1 will be receiving the same
information as that contained in and attached to this letter, except
that which is commercially confidential to other companies. For this
reason you will see that some figures relating to individual
companies have been excised.

1.13 In order to inform other parties that may be interested in
putting forward their views, the Commission has decided to publish
this letter (with commercially confidential material excised). It is
proposed that it will be published on the Commission's website
(www.competition-commission.org.uk) at 7 am on 28 February. It will
remain confidential until published and should not be disclosed in
whole or in part or referred to publicly before that time.

1.14 NOP has also conducted a consumer survey on extended warranties
for the Commission. The results of this have been made publicly
available on the Commission's website.

1.15 The Commission has also asked PA Consulting to undertake an
international comparisons study, comparing extended warranty
provision in a number of countries. The results of this will also be
made publicly available in due course.

PART 2 - MARKET AND ECONOMIC ISSUES

The reference services
2.1 The reference services consist of extended warranties (EWs) for domestic
electrical goods (DEGs). An EW is defined in the Commission's terms
of reference as- "a contract, whether backed by insurance or
otherwise, which for a specified period provides consumers with cover
beyond that provided by a manufacturer's, retailer's, or importer's1
guarantee, to meet the cost of repairs or replacements that may
become necessary. It includes both contracts that provide cover
during the period of the manufacturer's, retailer's, or importer's
guarantee, and contracts where cover commences after this period. A
contract may provide cover beyond that provided by a manufacturer's,
retailer's or importer's guarantee where for example, the cover is
for a longer period or the cover extends to costs and risks other
than those covered in the manufacturer's, retailer's or importer's
guarantee."

The market context
2.2 As background to the Commission's current assessment of the
possible monopoly situation, some explanation of the market context
for the reference services, and the relevant economic issues may be
helpful. The inclusion of any particular issue means that it has been
raised for consideration, but it does not imply that any associated
problem has necessarily been identified with it or that there is
currently evidence to suggest this. Material and evidence, so far
available, which is relevant to the market context and economic
issues, is summarised in Annex 2 (material mainly covering market
issues) and Annex 3 (material mainly covering issues of conduct).

Statutory consumer protection
2.3 Consumers have statutory protection that requires retailers to
compensate them if goods were faulty at the time of sale2. The
provisions of this requirement extend for up to six years after the
date of purchase. However, the consumer is required to show that the
fault existed at the time of sale. It may therefore be difficult for
the consumer to make a claim successfully after an extended period.
Many faults develop from wear and tear, accidental damage or the
natural limited lifespan of some components, even where there was no
fault existing at time of purchase. Legislation does not protect the
consumer from such problems, although a lack of reasonable durability
may mean the product might not be regarded as fit for its purpose at
time of purchase.

Retailer/Manufacturer guarantees
2.4 Consumers may also have the benefit of initial guarantees from
retailers and/or manufacturers. These offer repair or replacement of
faulty DEGs, for a mechanical or electrical failure or similar,
irrespective of whether it can be established that the fault existed
at time of purchase, for a defined period, usually the first year.
The scope of the guarantee will be set by the manufacturer's or
retailer's terms and conditions: typically this will exclude misuse
and abuse, or wear and tear on items designed to be replaced. Some
manufacturers provide longer guarantee periods, or may provide free
parts for repairs.

Types of EW and sources of supply
2.5 EWs on DEGs extend the initial manufacturer's or retailer's
guarantee in time (usually for a further two or four years in
addition to the typical original one year guarantee), and may also
extend the scope of risks covered, for example, to include additional
cover such as against accidental damage, and to provide insurance
against theft or frozen food loss. In some cases technical or other
support services, such as a PC helpline, may also be included. The
EWs that are offered on the range of DEGs within the terms of
reference of this inquiry are broadly similar, although EWs on some
DEG products may have distinct characteristics, such as PCs (where
assistance may be provided to the consumer via service helplines) and
mobile phones (which typically include insurance cover for theft,
loss and accidental damage).

2.6 We currently consider that service contracts on fixed
installations such as central heating and alarm systems, the primary
purpose of which is to provide regular service and maintenance, are
not part of the supply of EWs because they are materially different
from EWs that primarily offer cover against mechanical and electrical
failure. Similarly, we consider that home insurance or other policies
that solely or primarily provide insurance cover against risks such
as accident, theft or loss, are not part of the supply of EWs,
because they do not provide cover against mechanical and electrical
failure, and are not extending the original manufacturer's,
retailer's or importer's guarantee. Non-EW insurance is not
necessarily irrelevant to the market analysis. Cover for theft or
loss is being included where such additional cover is provided as an
integral part of an extension of an original guarantee.

2.7 An EW covers consumers against the risk of unpredictable
expenditure to repair or replace a DEG were a fault to occur, whether
or not this would be covered by statutory rights, and sometimes
against other risks. The EW usually provides quick and easy access to
guaranteed repairs. It also obviates the need for consumers to
establish whether their statutory rights apply to their particular
case.

2.8 Risks such as theft and accidental damage may already be covered
under a consumer's household insurance policy, though making a claim
may have the consequence of bearing an excess and/or being charged a
higher insurance premium on renewal. Some statutory and contractual
protection may also be available if consumers buy the DEG using some
types of credit card.

2.9 EWs are supplied by most DEG retailers (including mail order and
internet sellers), manufacturers, some insurance companies, and to a
lesser extent, some banks, credit card providers and utility
companies. Some EWs are contracts underwritten by insurance
companies, and some EWs are uninsured contracts, often referred to as
service contracts3. Both broadly provide similar cover with similar
terms and conditions, and are sold in the same way. Some EWs involve
a mix of insured and service elements. Insurance contracts are
generally made between the consumer and an insurance company,
although a retailer, manufacturer or other party may act as the
agent. Service contracts may be made between the consumer and a
retailer or manufacturer, or another company appointed by the
retailer or manufacturer to administer the EWs, and may be backed by
a trust fund (a ring-fenced fund which is intended to provide
security to consumers that the EW will still be honoured even if the
retailer were to cease trading). In both cases the party that
provides the EW will often insure, or reinsure, itself against the
cost of claims. Some of the larger providers use captive insurance or
re-insurance companies that are part of the same group. It may be a
condition of business with third-party insurers that they re-insure
risks with a captive insurer.

2.10 Business models for the provision of EWs vary; for example, a
retailer may act as an agent for an insurer, or it may appoint
another company to sell service contracts, or it may sell service
contracts itself and cover its own risks with an insurer. The
contract with the customer may be with an insurance company or
another party rather than with the retailer. Often, several companies
are jointly involved in the provision of the EW. Nevertheless they
are all parties that may be involved in the sale of the EWs
concerned. Therefore we have linked the various parties that are
involved in the provision of each EW (where, for example, an
insurance company sells EWs through a high street retailer, both are
included as parties), and refer to these collectively as the EW
provider. We do not include in this other companies who may provide
ancillary services which allow for the providers to discharge their
obligations under the EW, such as repairers or claims administrators.

2.11 In recent years, many of the larger EW providers have structured
their operations to take advantage of tax or other benefits available
from the use of off-shore companies. In November 2002 the Chancellor
announced changes in legislation which will affect these
arrangements. These are discussed further in Annex 5. The relevance
of these arrangements to the inquiry is discussed in paragraph 2.50.

2.12 Most EWs are sold by retailers of DEGs at the point at which the
DEG covered by the EW is also sold, in the same or an immediately
connected transaction ('at point of sale'), see Annex 2. This may be
in a store, or as part of a phone, mail order or internet sale. EWs
are also sold by DEG manufacturers or associated insurance companies
following the return of the initial guarantee card to the
manufacturer, or through direct sales by insurance companies.
However, these sales need not be made when the DEG is new, and some
insurers (and occasionally other providers) offer multi-appliance
policies which cover a variety of existing DEGs, usually subject to
some age limit on the DEG, typically 5 or 8 years. There may be a
small number of sales of EWs by retailers after point of sale, some
of which could be on products bought elsewhere. One- year EWs are
sometimes offered as a free benefit by a few credit card issuers.
Finally, a small number of other entities (such as utility companies)
offer EWs.

Consumer behaviour
2.13 According to the NOP survey one in three of those who had bought
an electrical product for over 50 from a shop in the past twelve
months had purchased at least one of the items with EW cover, but
overall, based on OFT estimates, it appears that around 80% of DEG
purchases are not covered by an EW sale. Several large retailers
provided evidence of the proportion of DEG sales that were also
covered by an EW sale at the same time; these typically varied from
just over 5% to just over 15% (but these figures may depend on the
extent to which sales of smaller items such as DEG accessories are
included in DEG sales). However, in some categories of DEG, the rate
of sale of EWs is higher, particularly for higher-priced DEGs, or
ones incorporating new or complex technologies (see Annex 2). In the
NOP survey, 46% of respondents who did not take EW cover said it was
because the EW was too expensive, and 13% because they thought the
cost of repair was likely to be less than the cost of the EW, 13%
spoke of improved product reliability, and 12% were 'happy to take a
chance'. The rate of renewal of EWs on expiry seems to be low, with
figures under 20% being common.

2.14 The NOP survey of consumers found that 76% of those who had
recently purchased a retailer EW were happy with the cover they had
obtained. We asked those who had purchased EWs the reasons why: based
on Commission analysis of the NOP results, we found among other
reasons, 27% said because the cost of repair was likely to be high,
20% because of convenience, or the time and trouble involved in
arranging repairs, and 18% for peace of mind. Overall, 42% said that
having an EW made arranging repairs easier, compared to just 3% who
said it made repairs more difficult. For respondents with EW cover,
the expected repair cost for a product failure was nearly #85,
compared with just over 71 for those without EW cover. However, this
may have arisen because the value and type of DEG purchased differed
between these two groups. 18% of the consumers surveyed regretted
having bought a retailer EW; under a tenth of these had considered
cancelling the cover.

2.15 The available evidence suggests that there may be some features
of consumer behaviour that could allow retailers to benefit from
their point of sale position (see paragraphs 2.28 to 2.32). Whereas
consumers will often shop around for DEGs and compare prices, they
seem to be much less willing to do this for EWs, and appear to give
less thought to planning this purchase. Moreover, we have found that
many consumers seem to have little or no awareness of where EWs could
be purchased other than at DEG retailers. In any case, even if a
consumer were aware of an alternative source of supply, it may not be
regarded as an effective substitute, for example if they regarded it
as inferior or were unwilling to investigate it. Consequently the
availability of an alternative source of supply does not necessarily
mean that it is an effective competitive constraint. We have also
found that many consumers do not make up their mind to buy an EW
until they are in the store to buy the DEG. Some of these will have
given the matter no thought until the issue is raised by sales staff.
In such circumstances, the purchase of an EW can be essentially an
afterthought.

Market definition
2.16 In conducting our inquiry, we need to determine the economic
markets in which EW providers compete. Specifically we need to
establish the range of services where effective competition could
occur, for example all EWs, or a sub- set of these. We also need to
establish the geographic extent of the region in which competition
occurs. The limits of the market are defined by the ease with which,
in response to a change in relative prices: * consumers could
substitute other products or services for these EWs (demand
substitution); and * suppliers could easily transfer production
between different products or services (supply substitution). EW
providers have generally put it to us that all types of EW are in
one, single EW market.

2.17 There are several types of EW product available: multi-appliance
policies as well as single appliance policies, and policies - usually
applicable to relatively low-value items - that provide for the
replacement of faulty items rather than their repair. The Commission
is considering whether all these types of policy are in the same
economic market. Evidence to date suggests that it is fairly easy for
suppliers to move between offering different products of this type,
ie there is substantial supply-side substitutability. EW policies may
be service schemes or insurance-backed policies. Survey evidence
suggests that consumers are largely unaware of the difference between
such schemes, which usually offer similar terms and benefits to the
consumer. This suggests substantial demand-side substitutability.

2.18 Renewal policies, offered where existing policies have expired,
and hence applicable to older equipment, involve providers assessing
the same kind of risks and maintaining the same kind of service
infrastructure as for regular policies. However, it might be
difficult for potential providers to identify consumers to whom such
renewal policies might be sold. We note in this regard that retailers
and manufacturers may sometimes sell their EW customer lists to
insurers to enable them to offer renewal policies in their name. The
Commission is considering whether these facts may indicate that such
policies could be in a separate market.

2.19 On the usual single-appliance policies, consumers cannot
substitute between EWs on different types of DEG, eg an EW on a
washing machine is no substitute for one on a television. However,
most suppliers provide EWs on a wide range of DEGs, suggesting easy
substitutability on the supply-side. There are also multi- appliance
policies available where consumers can easily cover new DEGs of
differing types. EWs on some products have different characteristics.
For example because diagnosing the differences between hardware,
software and compatibility problems may be difficult for many PC
users, EW schemes for PCs are often primarily based around helpline
services. EWs covering mobile telephones may primarily offer cover
against theft, unauthorised calls and accidental damage, with repair
of mechanical or electrical faults making up only a small part of the
service offer. The Commission is considering whether the supply of
any such product, and the skills or resources required, are
sufficiently different in type from other products that there is less
easy substitutability in supply, in which case they may be in a
different market.

2.20 It could be that the additional cover (such as cover against
accidental damage, or insurance for theft and for frozen-food loss)
bundled with some EW policies could differentiate these sufficiently
to make these a different market. However, retailers have not
suggested this, and the NOP survey evidence indicates that consumers
tend not to place a great deal of weight on these features (see
paragraph 2.55). It appears that home insurance or similar products,
which offer cover similar to the additional cover attached to EWs,
are unlikely to be part of the relevant market, because they do not
replicate the primary purpose of the EW (to provide cover against
breakdown), and because the terms and conditions of home insurance
differs (eg making a claim under home insurance may also be subject
to an excess and a loss of no claims discount).

2.21 EWs offered on some credit card accounts require the consumer to
register the product, may not be available on all DEGs, and usually
only run for one year. Some retailers or manufacturers may also offer
free EWs, in that there is no explicit charge to the consumer. Free
EWs may be used as a temporary promotional tool, or may be a
permanent feature of a retailer's strategy. The Commission is
considering whether credit card EWs and retailer free EWs are part of
the same economic market as other EWs. In general, if some kind of
alternative extended cover were available to consumers automatically
then we are likely to regard this as a constraint on an EW market
rather than as being a service supplied within the market and a
substitute for other EWs.

2.22 Whether EWs from retailers, manufacturers, insurers and other
providers are all in the same economic market is addressed in the
section on point of sale advantage, in paragraphs 2.28 to 2.32.

2.23 In determining the extent of the relevant geographic markets, it
appears that all parties who offer EWs in the UK provide cover to
consumers regardless of where they live. While it may be necessary
for the provider to make arrangements with several repair
organisations in order to cover all areas, we have not seen any
evidence that EW providers place geographic restrictions on their
services. The distribution of retailer EWs may be constrained by the
location of the retail outlets, but several retail chains have broad
geographic coverage; internet and mail-order retailers sell
country-wide, and insurers, credit card providers and others also
have a national presence. EW providers generally do not market abroad
or offer cover for goods used abroad (except temporarily), and
generally do not provide cover for DEGs obtained abroad. This
suggests that the relevant market should cover the whole of the UK.

2.24 Some retailers have argued that they offer a range of DEGs and
associated services, including EWs, and compete on the basis of the
full range. Their DEG retailing business strategy is one of providing
suitable premises and infrastructure, generating consumer visits to
the retail stores,, the sale of the DEG, and presenting and selling
the after-sales support options and services (including EWs) as an
integrated operation. Thus they have suggested to us that retailers
compete across the whole range of their activities, and so
identifying a stand-alone EW market is inappropriate to an assessment
of the level of competition. In particular, they have argued that
there is intense price competition on DEGs, leading to low profit
margins on the sale of DEGs, and higher margins on sales of EWs are
then necessary in order to support the business overall.

2.25 While this may be some firms' strategy, this does not
necessarily mean that the relevant economic market for a particular
product or service is the same as the market in which companies
consider themselves to be competing. There are providers of DEGs who
do not supply EWs, and vice versa. Some types of EW, such as
multi-appliance EWs, are not targeted at simultaneous purchases of
new products. Few retailers appear to offer an all-inclusive DEG and
EW package; rather these products are priced and sold separately. The
exception is where a 'free' EW is included, and such retailers
usually still provide a price match promise on the DEG alone. As well
as insurers, some retailers have begun to attempt to sell EWs on DEG
products purchased from other retailers, or which are up to a year
old.

2.26 We also have evidence that consumers rarely perceive EWs and
DEGs as a package; most perceive them as separate. It appears that
consumers' preliminary information gathering prior to purchasing a
DEG does not often include EWs, and very few consider and compare EW
offers before the decision to purchase a DEG. As already noted, in
only around a fifth of cases are EWs purchased with a DEG.

2.27 Some parties have argued that there is considerable convergence
and intermingling of technologies between different categories of
DEG, for example between audio/visual equipment, TVs, camcorders, DVD
players, PCs etc. They told us this was a growing factor in terms of
the support services they provide to DEG customers. We will consider
whether any such developments impact on the appropriate market
definitions.

Point of sale advantage
2.28 As noted under 'consumer behaviour' (see paragraph 2.15), many
consumers may only consider the purchase of an EW at the time when
they are purchasing the DEG to which it would relate. The retailer of
the DEG is therefore able to target potentially interested consumers,
who may have little or no opportunity or inclination to compare the
EW sold at the point of sale of the DEG with that of any alternative
providers. This could apply to mail-order, telephone and internet
sales as well as to retail outlets. This situation gives rise to a
point of sale advantage.

2.29 It is possible that a point of sale advantage in relation to EWs
creates an environment where competitive pressures for the sale of
the EW are limited, thereby allowing higher prices to be charged than
would otherwise apply. The point of sale advantage may be sufficient
to prevent the alternatives of purchasing EW cover from other
providers being an effective constraint on the pricing power of
providers at the point of sale. That is, such alternative providers
could be outside the economic market for point of sale EWs;
alternatively, some providers may be able to use point of sale
advantage to set higher prices than others within a more widely
defined market. We will assess the evidence for and against such
propositions, where possible using the standard SSNIP test
methodology.

2.30 To express the point of sale issue in another way, whereas
retailers typically sell a variety of DEG manufacturers' products,
even where they stock own-label brands, many retailers have
vertically integrated into the supply of EWs and choose to distribute
only their own EWs, or alternatively have contracted for the supply
of EWs to just one provider. Such retailers only supply one brand of
EW, and information on alternative EWs is unavailable to consumers at
the point of sale, and other EW providers do not have access to the
point of sale of the DEG. We are therefore considering whether there
is effectively a degree of foreclosure in the supply of EWs, in that
most customers are offered only one provider of EW at the point of
sale of the DEG.

2.31 We are investigating whether there is evidence of active
competition between providers of EWs at the point of sale of the
DEGs, and between all providers of EWs. In contrast to the widespread
promotion of DEG sales by retailers, there is little advertising of
EWs other than in store. Retailers appear to have made very few EW
sales on DEG products purchased from rivals, and some major retailers
do not offer EWs except on products purchased in their own stores,
which may imply retailers do not seek any market other than their own
point of sale market.

2.32 From the consumer's perspective, the purchase of an EW at point
of sale is convenient and means they do not have to worry about any
terms in the small print that could exclude their particular
purchase. However, we are considering a number of related points: (i)
we are looking at whether consumers may be encouraged to buy an EW at
point of sale through sales techniques which might be perceived as
exerting 'high- pressure' on the consumer. (ii) there is also
evidence that the average discount on DEG prices tends to be higher
where the consumer is also purchasing an EW. We are considering
whether this may also be a factor that exerts pressure on the
consumer to purchase EWs. (iii) there may also be issues arising from
the facts that consumers generally pay in advance for an EW4, see
paragraphs 2.36 and 2.57, and Part 3.

Information and sales practices 2.33 Consumers may face difficulties
if they try to compare prices and coverage of EWs, particularly at
the point of sale. Different providers offer different terms andconditions,
such as cover against additional risks (primarily theft and accidental
damage); prices may be set in relation to product descriptions or
DEG price bands which are not comparable between providers;
and other factors such as cash-back provisions5 or depreciation
policies6 may differ. Price comparisons may also be complicated
as some consumers report that it is possible to negotiate
discounts, but these may be part of a combined purchase of DEG and
EW; and which, although relating to the EW, may be applied to the
DEG. Such behaviour does not appear to be retailer policy in many
cases, but may be retailer practice.

2.34 Consumers may be unable to make an informed assessment of
whether an EW provides good value for money in their case. There
tends to be no information available to consumers from either
manufacturers or retailers on the absolute or relative reliability of
brands or of particular models, or repair cost for different types of
fault. This may reflect the difficulties of compiling or presenting
such information; there can be considerable variability in
reliability over time and there may be no history of reliability for
a particular model, as model ranges are usually updated frequently.
Some information is available from the Consumers Association, which
conducts a survey of members' experiences of product reliability and,
sometimes, repair costs. Such surveys may be useful background
information for consumers, in allowing them to assess the suitability
of an EW. However, they do not necessarily provide the information
necessary to make an assessment of the value for money of EWs. For
example the surveys make no allowance for the costs of replacing a
DEG which has failed and is beyond economic repair. The cost of such
replacements may account for around 20% of the cost of claims under
an EW scheme. Some companies have provided evidence which suggests
the incidence and cost of repairs have been substantially understated
in such surveys.

2.35 The consumer is therefore likely to be reliant on whatever
information on prices, cover and related terms and conditions is
available in the form of written material, and advice from the sales
staff on EWs and DEG reliability. There would be concerns if this
were misleading or incomplete. Since 1996, there has been a British
Retail Consortium Code of Practice which requires that clear
information should be made available on the prices, scope of
coverage, and terms and conditions of EWs, and that staff should
follow clear guidelines on sales practices. However, the OFT found
that the code was not always followed. Major retailers have told us
that all their staff are trained to observe the BRC Code of Practice,
and that mystery shopper visits are used to check that it is being
observed. However, some noted that across the industry as a whole
there is scope for improvements in adherence to the code. Sales staff
are usually offered incentives to sell EWs. Although in general these
are not paid at a higher rate than on other products, in some cases
these may include additional incentives to reach threshold targets.
The sales staff training programmes we have seen show there may be
scope for an undue bias in sales techniques.

2.36 EWs are usually paid for in advance in full, even when some or
all of the cover provided by the EW does not start until after the
expiry of the manufacturer's guarantee. Purchases using store credit
are still likely to require full payment within a year and will
attract interest. Some insurers provide for annual payments, this is
common for renewals and multi-appliance policies.

2.37 The consumer could look around for a better deal after purchase,
and most providers offer a cooling-off period. However, this is
usually only 2 to 4 weeks for retailer EWs. In practice few consumers
seem to search for alternatives in the given time, even if they are
aware that such alternatives exist; no information on alternative
providers is normally available at the point of sale (see annex 2).
Consumers will usually be sent an offer of an EW from the
manufacturer or an approved insurer if they return the product
registration card. The rate of return of such cards is low, and any
subsequent approach by the manufacturer may not arrive until after
the expiry of the cooling-off period. No other EW provider will have
the opportunity specifically to target the consumer at this stage,
apart from perhaps a credit card company, as they will have no
knowledge of the consumer's DEG purchases. In general, access by
other suppliers to this market will be difficult as they can only
raise consumer awareness of their policies through general,
untargeted advertising.

2.38 After the expiry of the cooling-off period it may be difficult
or impossible to get a refund of all or part of the cost during the
life of the EW (although one provider told us it was willing to make
refunds during the first year of a policy provided no claim had been
made). Consequently there may be little opportunity for consumers to
change their mind, given the limited availability of information on
alternative providers, and any psychological barriers to moving once
a financial commitment has been made to one provider (such as a need
to contact the provider and a reluctance to ask for a refund).

Price setting
2.39 The process by which providers set EW prices is often quite
complex, and may differ between different types of provider.

2.40 Evidence received from large retailers suggests that most
monitor their competitor's pricing, monitor unit penetration rates
for EW sales by particular categories of DEG, and pay attention to
forecasted claims costs on a category by category basis, although
they do not usually break down claims by manufacturer or model.
Retailers do not offer price-matching guarantees on EWs whereas they
may do so on DEGs. We were told by some providers that they consider
that their EW pricing needs to be comparable to that of their
competitors but, in contrast to their policy on the related DEG
market, they do not see it as a priority to avoid being undercut.
Even where different EWs are broadly similar, the existence of
different features makes comparing prices difficult. Generally we
were told providers try to avoid pricing EWs below cost on any
individual DEG product category, although initial evidence suggests
there are occasional examples of this.

2.41 Some retailers said that the ratio of EW to DEG prices could
have a significant impact on sales-rates, and so they have target
price ratios for EWs, relative to DEGs, depending on the length of
the period of cover.

2.42 Smaller retailers may market an insurer's EWs. In some cases the
insurer will set and publish list prices for EWs, although the
retailer may have freedom to deviate from these list prices. The
retailer also has the option of approaching other insurers who may
offer different suggested EW retail prices and different retail
margins.

2.43 Insurers have indicated to us that although competitors' pricing
is monitored, in contrast to retailers they said this is of secondary
importance, pricing being primarily determined by an assessment of
overall risks and costs on a category-by-category basis, and the
addition of a target margin. The extent to which insurers break down
risks within a DEG category varies; some will consider risks by
price-band, or by the type of technology in the DEG, but none appears
to consider individual manufacturers or models in assessing risks for
their own or retailer EWs, preferring instead to pool these risks.

2.44 Manufacturers may offer service-scheme EWs, but most offer
insurance backed EWs. The insurer will then establish an appropriate
risk-premium based on the risks for that particular manufacturer, and
the anticipated reliability of particular models. The final consumer
price will usually be set by the manufacturer noting risk premiums
and competitor pricing.

2.45 EW prices need to cover the expected cost of claims, which will
in part reflect the number of claims made by consumers. There are
three reasons why consumers who purchase EWs may be more likely than
average to suffer their DEG breaking down. The first is where
particular consumers know in advance that they are at high risk of
product failure as they are likely to use a DEG intensively, under
adverse circumstances or without appropriate care. Second, there are
consumers who do not expect in advance that they will be more likely
to make a claim, but subsequently in using the DEG discover with
experience of that particular DEG that this may be so; for example
they may find a DEG is more useful than expected and use it more
intensively, or they may suspect that there is some latent fault in
the product which could make a subsequent failure likely. These are
both forms of so-called 'adverse selection'. Third, there is
so-called 'moral hazard', where consumers might take less care than
usual in operating their DEG as they anticipate that they can claim
for any damage sustained under their EW; indeed there is a risk that
some policy-holders might induce a failure on older equipment in
order to get a replacement, although policies will exclude wilful
damage.

2.46 To the extent that these factors operate, historical claims data
will reflect them. The second of these effects will be reduced,
however, because purchase of the EW at the point of sale precludes
consumers deciding later to purchase an EW in the light of experience
with the product. Consequently the overall risk of claims, and so
prices, would be lower. Where EWs are offered on 12-month old DEGs,
prices are typically higher than for new DEGs, which may support this
analysis.

2.47 It is possible that, rather than being constrained by those of
competitors, consumer prices are limited by the amount that consumers
are willing to pay. Consumers always have the option not to purchase
an EW and to accept the risk of having to pay for future repairs or a
replacement. Therefore pricing may tend to reflect 'preparedness to
pay' rather than underlying risks and costs.

2.48 In a competitive market, we would expect price dispersion for
broadly similar EW products from different providers to be limited.
The Commission is examining whether there is considerable variation
in the prices charged for EWs by different providers, although we
note that there are variations in the terms and conditions of
different EWs.

2.49 In a competitive market, it would be expected that EW providers
would set prices with regard to a range of factors, including
competitors' prices, rather than just pricing according to costs and
margins. There will also be a strong pressure, in such a market , for
prices to be driven down towards a level where an efficient operator
is achieving so-called 'normal' profits, ie sufficient to cover all
costs, sustain the business and provide investors and other providers
of finance with a return sufficient to maintain funding. Where such
pressures are intense, some providers may fall back on cost plus a
'normal' margin as being an easy way of identifying and maintaining
competitive prices. Irrespective of the specific pricing techniques
used, profitability can be a useful indicator of whether pricing is
subject to effective competitive constraints. The Commission is
therefore assessing the profitability of EW providers. We are
considering the appropriate level of disaggregation to do this,
whether to assess profitability of EWs on particular DEG product
groups, by type of EW, or for a provider's overall EW business, or
for all of the provider's activities.

2.50 It should be noted that the total profitability of an EW
business could include some or all of: agents' commission; profits
from the provision of repair and replacement services; profits from
administration services; from underwriting; and from reinsurance
services to the insurer (if an insured scheme). Profits need to be
assessed with regard to all areas where they could arise; some EW
providers realise some of their profits off-shore. In broad terms
this should make little difference to the Commission's analysis of
competition, provided any resulting tax advantages are not immune
from the competitive pressures emanating from the market.

2.51 It is possible that market prices are largely determined by the
major retailers, with other retailers, and other EW providers,
largely setting prices with reference to those set by the major
retailers. Some leading provider(s) could then be seen as broadly
signalling market prices. This may lead to 'umbrella' pricing, where
other market suppliers follow a broad pattern and level of prices set
by one, or several, market leaders. Competition might then be limited
to innovation on EW features.

2.52 Alternatively, there may be no clear market leaders in relation
to pricing levels, but nonetheless there could be limited incentives
for any individual supplier to undercut existing prices, even if they
were high in relation to costs. This would arise if it were
anticipated that a price cut would either have only a limited effect
on sales of EWs; or, if it were anticipated that there would be a
matching and offsetting price cut from competitors if it did start to
cause significant numbers of customers to switch suppliers. The
Commission is examining prices and sales data to see what light they
throw on price competition.

2.53 Evidence received from retailers indicates that there are a wide
variety of gross margins on EWs for different DEG product categories.
This could arise for a number of reasons: it may be that costs are
varying and unpredictable between product categories and so gross
margins vary; in some cases, for example PCs, this may in part
reflect higher indirect costs; and EW providers may be price
averaging, where the pricing policy may be to set EW prices as a
percentage of the DEG product price and accept differences in gross
margin, provided the overall average margin is acceptable. However,
the last of these possibilities still raises the question as to why
margins on some DEG products are not pushed down by competitive
pressure. We are examining whether different providers show a similar
distribution of gross margins across their products; this might
indicate that prices are accepted and copied industry wide, that is,
suppliers follow industry price levels rather than competing on a
category-by-category basis.

Product bundling
2.54 As noted above, many EW contracts include benefits over and
above repair of mechanical and electrical faults. These include
replacement of 'beyond economic repair' items on a new-for-old basis,
accidental damage protection, and insurance against frozen food loss
and against theft. Terms and conditions vary between providers.

2.55 The Commission is considering whether consumers value this
choice or whether it complicates their ability to make comparisons
and provides unwanted features. In our consumer survey, of those who
had purchased retailer EWs, only 3% stated that aspects such as theft
and accidental damage protection were important to them. It is rare
for an EW provider to offer the consumer a choice for the package of
benefits that they buy; rather it tends to be an all- inclusive
package. There are a few variants on this - for example it is
possible to purchase theft and accidental damage cover for mobile
phones without conventional EW cover against breakdown.

2.56 In the recent past, some retailers have introduced a variety of
packages: Dixons has been test-marketing multicare (a multi-appliance
policy) and PC Care (a multi-appliance policy for PC users). It also
has a repair and protect policy for consumers who contact Dixons for
a repair, which provides EW cover on a product up to 8 years old
after the repair has been completed. PC World offers PC Healthcheck
plus, which provides future breakdown protection where a PC has
received one of their 'healthchecks', which may be favoured by
consumers with older or heavily used PCs, or ones with a wide variety
of software or upgrades. All these packages are available on products
purchased from other retailers. The Commission will consider to what
extent these types of product have had an impact in the EW market(s).

2.57 In many cases, additional cover for events such as accidental
damage extends from the date of purchase of the EW, not from the
expiry of the manufacturer guarantee as is the case for repair and
replacement cover. However, it is not possible to purchase such
additional cover without the simultaneous contracting in advance for
the purchase of repair and replacement cover, which might, after the
cooling-off period, lock consumers into a contract of up to 5 years,
either because any refunds available may be less than pro-rata (this
may be due, at least in part, to up-front administration costs) or
because of any perceived or actual difficulties that consumers may
face in obtaining a refund.

Barriers to entry and exit
2.58 There have been a number of new entrants to the provision of EWs
in recent years, such as utility providers, and insurers supplying
consumers directly. Some have offered differentiated policies (such
as multi-appliance policies). These entrants have been able to
contract with pre-existing repair networks (or create networks from
other repairers) to undertake their servicing. However, it has been
suggested to us that there may be limited availability of trained
repair engineers who could be recruited if new entrants wished to
establish their own repair network. It has also been suggested that
the number of independent repair organisations has fallen rapidly in
recent years, although whether this reflects an overall reduction in
supply, or consolidation of suppliers in the industry, is not yet
clear.

2.59 Assessing risk and setting premiums and prices would be
difficult without prior experience, but there are insurers able to
undertake this task either for themselves or for others as new
entrants to the market. A new entrant could match competitor pricing
(on the assumption that costs will be similar) and adjust premiums as
a claims history is built up. Where an agreement is made with a
repair network, there appear to be no large-scale sunk costs to serve
as a barrier to exit, but where an entrant has developed its own
repair network, there would be a substantial sunk investment. The
same may apply if a provider has established support services such as
helplines for PC users. Providers have a liability to customers over
the life of the contract, although there have been cases where other
providers have taken over obligations where an EW provider has
failed.

2.60 Overall, however, the market penetration of new entrants remains
low; none appears to have managed to make significant inroads against
EWs supplied by, or on behalf of retailers. This suggests that there
may be a significant barrier to entry or expansion into existing
retailer's point-of-sale activity. This could be thought of as a
barrier to entry if point of sale EWs are viewed as a separate
market; or as a so-called 'barrier to mobility' into point of sale
selling of EWs in the context of a wider EW market . Strength in DEG
retailing might create a point of sale related customer base that
others cannot easily access. As DEG purchasers will often have
already been offered and may have bought an EW at point of sale, the
number of prospective EW customers remaining for alternative
providers after the DEG purchase will tend to be small. One possible
exception is where existing retailers, such as supermarkets,
diversify into the supply of DEGs and EWs. Such entrants can develop
their own point of sale advantage. Other entrants, such as insurers
and utility companies, have their own customer lists. These, however,
give the provider no information about whether the consumer is
purchasing a DEG or otherwise would have a particular interest in an
EW at any given time.

Differing profit contributions and effects on the market for DEGs
2.61 As noted earlier, we have found that consumers are not active in
shopping around and comparing prices for EWs, whereas retailers have
indicated that many consumers are active in shopping around for DEGs.
There may therefore be a lower degree of price sensitivity for EWs
than for DEGs. It is possible that many retailers experience ongoing
pressures to set DEG retail prices at or below competitor levels so
as to attract consumers. However, if consumers are not so price
sensitive when buying EWs (and possibly other accessories and
add-ons) then retailers could generate a significantly bigger profit
contribution from EWs relative to their scale of activity than from
DEGs. We are therefore investigating the profit contribution of EWs
in relation to that of DEGs. In addition, we are considering whether
the rate of return on EWs is higher than the rate of return on DEGs,
as well as any indicative evidence based on margins.

2.62 If evidence indicated that the profit contribution on DEGs were
low in relation to the cost of capital, but with the gap covered by a
significantly larger profit contribution from EWs, then it would
follow that EW sales are partly funding DEG sales. Such cross-funding
may enable DEG retailing to operate on lower margins than would
otherwise be sustainable in the long-term. Although the retailer
business model may in some cases be based on selling both products in
the same stores, only a minority of consumers of DEGs purchase EWs
and there is no obligation to purchase them together. EW customers
would thus to some extent be financing distortions in the DEG market
in a way which was unfair both for EW purchasers and for suppliers of
DEGs who do not supply EWs.

2.63 More specifically, a comparatively large profit contribution
from EWs could permit lower margins on DEGs, increasing DEG sales,
and thereby offering scope to sell more EWs, and so on. Competitors
with limited or no EW business would then find it increasingly
difficult to compete on DEG sales. In the longer term this might lead
to reduced choice of products and/or outlets, and less competition in
the DEG retailing market. The market share of the largest DEG
retailers has increased in recent years and there is already a
significant degree of concentration in the structure of DEG
retailing. Based on data in Mintel Retail Intelligence review of
electrical retailers 2001, including mobile phone and PC retailers,
the industry Herfindahl7 exceeded 1700 in that year.

Retailer relations with manufacturers
2.64 Retailers control access
to their final consumers, and may have market power over
manufacturers, arising from their capacity to influence or control
the extent to which each manufacturer's products are offered in
store, their positioning in the store, and the promotional policies
they run. Although many manufacturers offer EWs, there has been
little evidence received to suggest that they actively advertise the
existence of their EWs prior to sale. We also note that whereas it
might be expected that DEG manufacturers would have an incentive to
promote above average reliability through longer inclusive guarantee
periods or cheap EWs, this is comparatively rare (although there are
some instances such as Miele's 5-year guarantees and Dyson's 2-year
guarantees, and a few white goods suppliers - including Ariston,
Candy, Hoover and some Hotpoint products - which have a guarantee of
1 year parts and labour plus the following 4 years of parts only). In
certain other industries, such as cars, manufacturers make a merit of
the reliability of their products and provide warranties or
guarantees for 3 or 5 years or more - these form an important part of
the promotion of their products.

2.65 We have seen some evidence that for most DEG categories product
reliability continues to improve. However, there is also some
evidence that repair costs have increased due to the greater
technical complexity of some products. We are investigating the
overall impact of these factors on repair costs.

2.66 It is possible that, in the face of potential retailer power,
some DEG suppliers are reluctant to market EWs, and hence become
competitors to the DEG retailers; and, in the face of the retailer
point of sale advantage, the returns from promoting EWs may in any
case be limited. It may then be mutually beneficial for retailers and
manufacturers largely to keep to their own sphere of operation, with
EWs seen by both groups as largely for retailers. We are comparing
experience in the UK with that in other countries where retail
structures may differ.

2.67 There have been suggestions that retailers have in some
instances sought to limit the ability of manufacturers to compete for
EW business, by, for example, removing manufacturer EW details from
packaging, or removing publicity about manufacturer EWs from display
models. None of the major retailers has indicated that this is their
current practice, although it has been acknowledged that there have
been examples of such behaviour in the past. It has also been
indicated that retailers may be unwilling to allow retail pricing to
reflect longer inclusive manufacturer guarantee periods (by refusing
to accept increases in manufacturer's prices necessary to meet the
extra cost of the longer guarantees). Evidence on such behaviour is
anecdotal at present; however it would be an issue if it becomes
apparent that there have been more than a few isolated cases.


PART 3 - POSSIBLE MONOPOLY SITUATIONS

Introduction
3.1 Against the market and economic background presented
in Part 2 above, Part 3 of this letter considers possible monopoly
situations that may exist within the meaning of the Fair Trading Act
1973 (FTA - see Annex 4). Both the scale and complex monopoly
provisions relate to the share of supply of reference services, and
this is considered first. In determining shares of supply for
jurisdictional purposes, we are concerned only with the amount of the
reference services supplied, not with the definition of the market or
markets in which they are supplied. Market definition can be
important, however, in determining whether relevant conduct creates a
monopoly, and this is considered in paragraphs 3.8-3.12 below.

The reference services
3.2 Under section 10 of FTA, and to the extent
that the supply of EWs occurs through different forms of supply, the
Commission may disaggregate the reference services when it considers
that such differences constitute a material difference for the
purposes of the identification of a complex monopoly situation. In
the light of the issues discussed in Part 2, we currently propose to
treat the supply of reference services for the purpose of the
identification of a complex monopoly situation as the supply of EWs
by retailers, insurers, manufacturers, utilities and credit card
companies, where the EW extends the original guarantee to repair or
replace faulty brown and white DEGs, PCs and mobile phones, and
renewals of those EWs. It also includes EWs supplied at no additional
charge. It does not include agreements concerned primarily with
planned maintenance on fixed installations such as central heating or
alarm systems, nor home insurance. It does not include EWs supplied
to businesses.

3.3 On this basis, according to information provided to us to date,
the total supply of the reference services in 20018 was in the region
of 800 million in terms of sales net of tax (VAT and Insurance
Premium Tax (IPT)), and 15 million in terms of the number of EWs
sold. We are still awaiting information, and a provisional estimate
of the supply by companies from whom we do not yet have information
has been included in these figures.

Scale monopoly
3.4 Information supplied by Dixons Group plc (the
Dixons Group) currently indicates that it sold [ ] million EWs to
consumers in 2001, at a total sales value net of tax of [ ]
million. This indicates that the Dixons Group may provide more than
one-quarter of the supply of the reference services. The Dixons Group
may therefore be a scale monopolist under the provisions of section
7(1)(a) of the FTA. Any finding of the existence of a scale monopoly
depends only on the share of supply and does not imply any adverse
findings relating to the conduct of the Dixons Group.

Complex monopoly
3.5 A complex monopoly exists, under the FTA, where
at least one-quarter of the relevant goods or services is supplied by
members of a group who, whether voluntarily or not, and whether by
agreement or not, so conduct their respective affairs as in any way
to prevent, restrict or distort competition in connection with the
supply of the relevant goods or services (See Annex 4).

Complex monopoly - shares of supply
3.6 Information supplied by the
companies listed in the table in Annex 1 Table 2 shows the sales
value (net of tax) and number of EWs sold by them to consumers in
2001. It will be seen that taken together, these companies provide
more than one-quarter of the supply of the reference services. They
are all companies involved in the sale of EWs at the point of sale of
the relevant DEGs. We are considering whether the way in which these
companies conduct their respective affairs may amount to conduct
which prevents, restricts or distorts competition in connection with
the supply of the reference services. This would make them a group in
the terms of section 7(2) of the FTA (see Annex 4). The relevant
conduct is set out in the annotated list in paragraph 3.16 below;
further explanation is given in Annex 3. It is not necessarily
suggested that all the companies concerned conduct themselves in all
of the ways listed. Nor does membership of a complex monopoly of
itself imply any adverse findings relating to the conduct of any of
these companies. Other companies are also involved in selling EW at
the point of sale of the relevant DEG and it is possible that the
Commission may conclude that some or all of those other companies are
also complex monopolists.

3.7 The table in Annex 1 Table 2 includes both retailers and other
companies that are associated with them in the provision of EWs. As
explained in paragraph 2.10 above, business models vary, and the
consumer may contract with an insurance company or another party
rather than with the retailer. Nevertheless these companies are all
parties that may be involved in the supply of the EWs concerned,
linked to the sale of the DEGs that are covered by the EWs. Where,
for example, an insurance company sells EWs through a high street
retailer, both are included as parties who may be involved in the
complex monopoly and who may benefit from it. Values and numbers of
EWs sold are attributed to them jointly in Annex 1 Table 2.

Market definition
3.8 Whether any specific course of conduct, or
courses of conduct taken together prevent, restrict or distort
competition may depend on the economic circumstances involved,
including the economic market or markets involved. In Part 2 of this
letter above we set out a number of issues on the extent of the
market or markets. In summary these were: i) whether there are
separate markets for EWs on each different type of DEG.
Alternatively, whether there is a single market for EWs on most or
all white and brown goods, but separate markets for EWs on either or
both of PCs and mobile phones; ii) whether EWs with a wide range of
cover, such as both repair and/or replacement and additional cover
(eg accidental damage, theft, frozen food damage) are in the same
market as EWs with more limited cover, such as only repair or only
repair and/or replacement; iii) whether single appliance EWs are in
the same market as multi-appliance ones; iv) whether point of sale
EWs are in the same market as others, but with sufficiently
distinctive characteristics as to allow significant price
discrimination as between point of sale EWs and others; or whether
there is such a point of sale advantage for retailers that point of
sale EWs form a separate market v) whether renewals of EWs are in the
same market.

3.9 The issue was also raised whether EWs are in a separate market
from the DEGs to which they relate, or whether they are just one
amongst a number of attributes of DEGs which influence customer
choice of DEGs, such that EWs are an integral part of the DEG market,
rather than in a separate EW market; or are at least so
interdependent that they cannot be considered separately.

3.10 Determining the boundaries of the market or markets involved in
the light of the above may or many not turn out to be critical to our
inquiry. While competition pressures will normally arise within an
appropriately defined market, important competitive pressures may
arise from outside a market, particularly if it is more narrowly
delineated. Conversely, competition concerns may arise in relation to
part of a more broadly defined market.

3.11 Based on our work to date, we currently consider that: i) the
principal market comprises all EWs in the UK, as described in
paragraph 3.2 above, supplied by retailers, manufacturers, insurers
and credit card companies; whether single or multi-appliance, whether
paid for or free, and including renewals; ii) this market is distinct
from the market or markets for DEGs: iii) within this principal
market, separate markets may exist for EWs on white and brown goods,
EWs on PCs, and EWs on mobile phones. iv) retailers (and companies
involved with them) enjoy a substantial point of sale advantage
which, at the least, significantly affects the extent of competition
between point of sale EWs and others and which might justify
regarding point of sale EWs as a separate market.

3.12 It is on this basis that we are considering whether one or more
complex monopolies might exist. We do not currently believe that the
issues for discussion on complex monopoly would be greatly affected
by alternative market definitions, but this point may itself be an
issue to be pursued.

Point of sale advantage 3.13 As we currently regard point of sale
advantage as an important factor in the market, with a potentially
powerful bearing on the scope for various courses of conduct to
restrict, prevent or distort competition, this issue is briefly
addressed next, before listing practices that may amount to courses
of conduct in a monopoly.

3.14 In Part 2 above it was suggested that the sale of EWs at the
point at which the DEGs covered by the EWs are also sold provides
'point of sale advantage'. The OFT drew particular attention to this
factor in its report when making the reference. This may provide the
opportunity for companies to act in ways that prevent, restrict or
distort competition. Moreover, some conduct that might be commonplace
in other markets, with no detrimental effects on competition, may
prevent, restrict or distort competition if it occurs in the context
of a point of sale advantage. In addition, such conduct may exploit
or maintain a monopoly, or be detrimental to the public interest in
such a context even though it might not have such an effect in the
absence of a point of sale advantage. In such circumstances,
companies involved in a complex monopoly would consist of those whose
courses of conduct are linked to point of sale advantage. In
addressing this issue, we are considering whether companies selling
EWs but without a point of sale advantage have other advantages which
partly or totally offset the point of sale advantage.

3.15 It may be that others apart from those directly involved in
point of sale EW transactions also engage in or benefit from
uncompetitive conduct associated with point of sale advantage. For
example, other providers may also be in a position to benefit from
uncompetitive conduct by following the market if retailers with a
point of sale advantage overprice EWs.

Possible uncompetitive practices 3.16 Under the terms of FTA, forms
of conduct, which prevent, restrict or distort competition constitute
uncompetitive practices. We list below possible uncompetitive
practices in relation to the supply of EWs, which may constitute the
basis of a complex monopoly. Not all the relevant evidence has yet
been received; further analysis is still to be carried out, and all
such propositions will only be decided upon after hearings designed
to give the main parties full opportunity to express their views and
after the proposed public hearing. However, relevant material so far
available is summarised in Annex 3. Possible uncompetitive practices
include the following:

A. Restricting choice At the point of sale, consumers may generally
be offered a restricted choice of EW products and a specific
combination of cover and related terms, typically: (i) only EWs
provided by the retailer; (ii) EWs covering repair or replacement of
faulty DEG, together with specific additional services dependent on
the retailer and relating to the DEG involved (eg accidental damage,
theft, frozen food loss, PC help line); (iii) EWs providing cover for
either 1 plus 2 years or 1 plus 4 years. This may restrict or distort
competition in that it may: (i) restrict consumers' ability to
acquire an alternative provider's EW; (ii) restrict consumers'
ability to acquire cover for the separate elements of risks. For
example, a consumer may be confident of the reliability of a product
and may not want protection against breakdown other than as provided
under the manufacturer's guarantee which comes free, but may wish to
obtain cover for accidental damage or theft; (iii) restrict or
prevent consumers acquiring alternative periods of cover, for example
an option of one additional year on a one year manufacturer's
guarantee in a case where the consumer may intend to replace the
product within a relatively short period; (iv) as a result require
consumers purchasing at the point of sale to acquire some elements of
cover that they do not need (because they are already duplicated by
statutory rights, other insurance or the manufacturer's guarantee) or
would not otherwise buy, in order to acquire other elements they do
want to purchase at the point of sale; (v) effectively prevent
competition for the service for the 3 or 5-year period of the EW, in
the absence of cancellation, (which may be costly and appears to be
rare). This contrasts with the situation that would exist if, as in
many other areas of insurance, contracts were annually renewable,
providing annual opportunities for others to compete on terms or
price. If consumers regard themselves in practice as committed for
the 3 or 5-year period, then effective competition may have to focus
on the point of sale, but to the extent that there is a point of sale
advantage for the seller of the DEG, this may prove difficult. In
assessing these issues we are taking into account the extent to which
consumers find it advantageous, primarily in terms of convenience, to
purchase EWs at the same time as DEGs. We are also considering to
what extent any of the possible restrictions listed above are a
necessary consequence of providing EWs at the point of sale.

B. Contracting in advance At the point of sale, consumers may be
required to contract in advance for services, provision of some or
all of which will not start for some time, in that repair services
(and in some cases other elements of the EW) are already provided for
the first year (and occasionally longer) by the manufacturer's
initial guarantee. (i) Contracting in advance for a service
frequently occurs and is not inherently likely to constitute
uncompetitive conduct. However, in the case of EWs, this may restrict
or distort competition, in so far as EWs provided by or for the
manufacturer are not recognised by consumers as ready substitutes,
although they may be significant potential alternatives. Detailed
information about them may not be readily available until after a
purchase has been made. At that stage, switching to an alternative
provider would require cancellation of the original EW. If any
'cooling-off' period has expired, this may mean only partial
reimbursement. Such reimbursement may or may not reflect the split
between those services already provided (eg accidental damage since
purchase) and those yet to be received , either in terms of their
cost or of their value to the consumer. To this extent there may be a
deterrent against searching for alternatives. (ii) In many cases
contracting in advance is associated with payment in advance; once
such payment has been made consumers are unlikely to search actively
for EWs that better meet their needs or do so at a lower cost.
Although purchase on credit terms delays most or all of the payment
made, this may make little difference, given that the consumer is
committed to the full credit arrangement (which, in any event, will
often be for less than a year, and usually entails the payment of
interest).

C Setting prices above competitive levels. This may arise from point
of sale advantage or any other element or feature of the market.
(i)Evidence supplied to us suggests that retailers, to varying degrees,
take into account a range of cost, demand and competitive factors
when setting or modifying prices for EWs, with the cost factors
including both the likelihood of repair or replacement, as well as
repair or replacement costs themselves. This general approach is
likely to mirror pricing methods in numerous other markets. However,
one additional, and therefore distinguishing factor may be the
relationship between the price of the EW and the price of the DEG to
which the EW is attached. Most EW pricing appears to be carried out
in terms of price 'banding' where the price bands relate to the price
of the DEG, and evidence has been submitted that a significant
element of customers' evaluation of the price of an EW is the price
as a percentage of the price of the DEG, though the acceptable
percentage may well vary with the product.

(ii) However prices are set, we would in broad terms expect that,
in a competitive market, prices would tend over time to come intoline
with underlying costs plus the margin necessary to ensure
continuation of the business, including sufficient returns to
shareholders and other investors. If there is insufficient
competitive pressure to achieve this, such that most or all prices
are above this level, then those price levels may distort competition
and may tend to result in too limited a demand for such services in
relation to the optimal level which fully competitive conditions
would generate. (iii) In this connection we are considering at what
level of disaggregation a comparison of prices and costs, or
assessment of profitability of EWs, should be made. The most
disaggregated level would be at the individual DEG product level, eg
specific models of a particular manufacturer's range of washing
machines. The next level up would aggregate all models of a
particular manufacturer's washing machines in specified price bands.
Still higher levels of aggregation would put together all models of a
particular manufacturer's washing machine; or all manufacturers'
washing machines in separate price bands. Either might be aggregated
further to include all white goods. (iv) In practice, few if any,
point of sale providers appear to price extended warranties at a more
disaggregated level than product type and price band, primarily
because more disaggregated data on reliability or repair cost are not
available when new models are launched. It has also been put to us
that past data on the reliability of particular manufacturers can be
a poor guide to the reliability of their latest models. This suggests
that it is not sensible to examine price-cost relationships at any
more disaggregated a level than the product categories and price
bands that such providers themselves use. Even here there are likely
to be issues of cost allocation that could make such an assessment
difficult. (v) We also note, however, that some insurers providing
EW services to a number of different manufacturers do have data on
the different reliability and repair costs associated with different
manufacturers; that the variations appear sizeable and sustained; and
that this does lead to differential pricing of different
manufacturers' EWs in the light of these differences in anticipated
costs. We may therefore wish to utilise data available at the level
of individual manufacturers' DEGs. (vi) The alternative to
disaggregated analysis is for us to assume a substantial amount of
averaging, across different products, manufacturers and price bands,
and look at the price-cost relationship across all EWs supplied by
each provider. Whichever level is adopted, however, the issue is
essentially the same; whether prices are excessive in the sense that
they are, over a period, significantly above the level necessary to
cover costs and adequately reward investors. If so, they would be
above the level which full competition would generate, and would
themselves distort the competitive process. (vii) The Commission's
usual approach to profitability is to consider return on capital
employed and we will therefore seek to calculate return on capital
employed in the EW business for those parties that represent a
substantial share of the supply of EWs. The return on capital
employed will be compared with the firms' cost of capital. The
Commission's preferred approach to cost of capital is currently the
Capital Asset Pricing Model. (viii) In this connection, it should be
noted that an individual manufacturer's EW should, in competitive
conditions, tend to reflect any superior or inferior reliability
and/or cost of repair, which its products exhibit. This in turn could
provide useful information to consumers as to the likely reliability
of different manufacturers' products and so enhance competition.
Provision of such information could be restricted if, as a result of
point of sale advantage, EWs were predominantly sold by retailers who
did not distinguish between different manufacturers in any particular
product category.

D. Restricting information Information available to consumers at the
point of sale about alternative EW offerings may be restricted.

(i) Information is generally available at the point of sale about the
main specifications of the DEGs available and their price. It appears
that, in contrast there is very little, if any, information provided
to consumers at the point of sale to enable them to evaluate EWs
offered by the manufacturer or their related insurer prior to
purchase of the DEG. This reflects the fact that in relation to the
specific purchase, any information on those alternative providers of
EWs is typically either inside the packaging of the DEG or only
supplied if a registration card is sent off. In either case, the
information is not readily available at the point of sale prior to
purchase. This may therefore restrict or distort competition.

(ii) We are therefore examining the extent of such in-store
information, and whether it is adequate for consumers to make
properly informed decisions. It is, of course, quite understandable
that a retailer may not wish to, or be expected to, offer full
information on a product which is in direct competition with its own
EW (though this does to some extent happen in relation to DEGs
themselves, given that manufacturers' products compete with some
retailers' own brands; and we may wish to explore this difference).
But competition may still be restricted or distorted if the failure
to sell, or to inform customers about alternative EWs mean that
retailers have to some degree foreclosed access to customers of EWs
for other providers.

(iii) These restrictions or distortions of competition may occur as
the result of failure by retailers to provide relevant information.
Further such effects could occur if manufacturers take steps to
promote their EWs, for example through adding stickers to their
packaging with information about their EWs and providing fuller
information inside the package, but retailers offset this by removing
such information or seeking to ensure that manufacturers with whom
they deal do not include such material. The existence and, if so, the
extent of any such practice is therefore an additional issue for
investigation.

(iv) This in turn raises the possibility that competition will be
restricted if manufacturers are either dissuaded from seeking to
promote their EWs at the point of sale, or at all, as a result of
either indications, or a concern that such activity may have some
bearing on their efforts to obtain retailers' shelf space.

E. Selling practices Retailers may engage in selling practices such
as providing misleading information or excessive selling pressure
designed to increase the sales of EWs sold at point of sale of the
DEGs.

(i) Unless a consumer has decided in advance to buy a particular DEG
product, and has broadly decided the price, and has then taken the
opportunity to research alternative providers of EWs, their terms and
prices, then at the point of sale the consumer will have little, if
any, directly useful information on alternatives to the retailer's
EWs offered.

(ii) If consumers generally purchase EWs at the point of sale, but
do not have full information at that point on alternatives, the
question of whether the retailer's EW, typically the sole EW being
offered at that point, is "good value" in itself (ie leaving aside
whether a lower priced equivalent or a preferable EW specification
might be available later) may become more important than otherwise.

(iii) However, information on likely reliability, potential repair
costs, probability of theft or accidental damage, and so on, may not
be available. If so, consumers may be more susceptible than otherwise
to any statements made by sales staff at the point of sale. This may
be limited to the provision of only such information as is known to
be accurate, or more generally information in line with best practice
codes of conduct; however, in some cases it may consist of
over-enthusiastic selling of EWs, unintentional exaggeration of their
benefits, attempts to exaggerate the potential risks, dangers and
costs of failing to purchase an EW, or other types of pressure
selling. In practice, the borderline between some of these practices
may be very imprecise. However, if substantiated, the latter
categories of conduct could distort or restrict competition.

Benefits of any monopoly identified 3.17 Following section 49 (2) of
FTA, the terms of reference require us to investigate in favour of
what person or persons any monopoly situation exists. The companies
engaging in the conduct listed above, who may thus be monopolists,
may also benefit from that monopoly in so far as it enables them to
increase revenues from EWs through either higher sales volumes or
higher prices, or a combination of these. They may be in a position
to take steps to exploit the monopoly as listed below. They may not
be the only companies that benefit from the monopoly. For example,
others who sell EWs may follow the prices set by the monopolists.

Steps, acts and omissions to exploit or maintain a monopoly situation
3.18 Following section 49 (2) of FTA, the terms of reference also
require us to investigate: whether any steps (by way of uncompetitive
practices or otherwise) are being taken by that person or persons for
the purpose of exploiting or maintaining the monopoly situation and,
if so, by what uncompetitive practices or in what other way; whether
any action or omission on the part of that person or persons is
attributable to the existence of that monopoly situation and, if so,
what action or omission and in what way it is so attributable.

3.19 In the event that some or all of the courses of conduct
described above are found to constitute one or more monopolies, a
number of them may also have the effect of exploiting or maintaining
the monopoly.

3.20 Of the possible uncompetitive practices listed above, A, B and D
may, individually or together, make it difficult for manufacturers or
others without access to point of sale advantage to offer alternative
combinations of cover and time period which may in principle be
attractive to consumers. In addition, it may be more difficult as a
result for manufacturers to offer two-year guarantees, which might
impinge on the attractiveness of a paid-for EW, if information on
this is difficult or impossible to obtain at the point of sale. There
also appears to be little, if any, scope for such provision to be
reflected in the price of DEGs, given the absence of information on
such aspects of a DEG at the point of sale; but with no adjustment of
the price of the DEG to reflect the greater cost to the manufacturer
of a two year guarantee, there is potentially a significant
disincentive to offer longer guarantees. In addition, E above could
serve to maintain a monopoly by reducing the scope for manufacturers
and others to obtain some element of point of sale advantage.

3.21 Furthermore, it may be that if consumers had more information
at the point of sale about relevant statutory rights; alternative
providers of EWs; reliability, durability and repair costs of
products, as well as the incidence of accidental damage or theft;
then this might to some extent reduce any point of sale advantage
available to retailers and hence lessen the scope for the various
courses of conduct described to restrict, prevent or distort
competition. If so, to the extent that retailers do not provide such
information this may constitute an omission, which helps to maintain
a monopoly. In examining this we will also wish to consider whether
any such omission may reflect the cost and/or practicality of such
information being made available at the point of sale. Whether any
such omission serves to maintain a monopoly is also likely to depend
on the extent to which such information is available elsewhere and,
if so, whether consumers have ready access to it.

3.22 C above may act to exploit a monopoly created by one or more of
the courses of conduct, in that it would generate profits above the
level obtainable from EWs in fully competitive conditions; this might
then enable price competition for DEG business to continue at a
consequent level of profit contribution which would by itself be too
low to be sustainable.

3.23 It may also be that firms, if members of a monopoly resulting
from the courses of conduct described, may exploit the monopoly in
other ways. Possibilities include:

F. Unfair terms Terms or conditions may be specified that are not
fair to consumers and would not be sustainable in fully competitive
conditions. Possible examples are: the termination of EW cover
following a claim; disproportionately small repayment on cancellation
in relation to the cost of EWs; applying depreciation rates, or using
reconditioned products for replacement in a way which was not
sufficiently highlighted and therefore expected by some consumers. A
further practice, which we understand may have been largely
discontinued, has been offering cash back to consumers for making no
claim during the life of the EW, but with conditions that mean many
consumers in practice fail to meet the terms. We will consider
evidence for such conduct, whether any such conduct persists and, if
so, on what scale.

G Uninsured cover EWs may be offered in the form of uninsured
service agreements rather than via insurance contracts in order to
obtain the advantage of preferential tax treatment. Such agreements
may provide consumers with a lower level of protection in the event
of insolvency. Many EW providers have established ring- fenced trust
funds to mitigate this risk. We will consider the extent to which, if
at all, these arrangements fall short of providing in practice the
degree of protection afforded by insurance schemes.

The Public Interest 3.24 Following section 49 (2) of FTA, the terms
of reference of the inquiry ask "Do any facts found by the Commission
in pursuance of this investigation operate, or may they be expected
to operate, against the public interest?" In considering the
competition issues, it appears to us that it could be against the
public interest if the following facts were found to be the case.

1) there may be lack of choice for consumers; (see practices A and B)
If there is lack of choice between EWs from different providers, or
lack of flexibility in the packages offered at point of sale,
consumers may not be able to obtain the specific cover that meets
their needs. They may not, for example be able to take alternative
bundles of cover, or for alternative time periods, or to take a
'pay-each-year' option at the point of sale. Consumers may also be
effectively locked in by having contracted and paid for the EW in
circumstances in which they were not in a position adequately to
consider alternatives. They may find it difficult to cancel in order
to switch provider. In assessing this, account needs to be taken of
the extent to which flexibility is in fact provided, and the
advantages of a relatively standard EW product, as well as the extent
to which it requires consumers to take more than they want.

2) there may be excessive prices; (see practice C) Whether or not
consumers perceive that what they are buying is good value for money,
it is a matter of public interest if lack of effective competition
means that they are paying more than they would otherwise. In
assessing this, account needs to be taken of costs, how they relate
to different elements of EW provision, and how prices are set.

3) there may be distortion to competition to sell DEGs ; (see
practice C) If there is scope to make profits in excess of
competitive levels on EWs, the issue arises as to the broader impact.
Shareholders may gain but, if so, this does not appear to raise any
additional competition issues. If, however, the result is lower
prices than otherwise in other competitive areas of business such as
DEG retailing, then this may cause further distortions or
restrictions on competition in these other areas. An excessive profit
contribution from EWs could permit a level of profit contribution on
DEGs that would otherwise be unsustainably low. This could mean that
retailers with significant EW business could successfully seek to
undercut other DEG retailers who did not have this advantage. This
could progressively reduce the latter's market share, even if their
DEG offering at a competitive price were as good as, or perhaps even
better than the alternative; or it could force price-matching on DEGs
from those retailers who lack the benefit of the greater profit
contribution from EWs, thereby threatening their longer term
viability. In either case competition in the wider DEG retailing
market could be distorted or restricted. This could be against the
public interest if it tended to reduce consumer choice between
retailers. It might keep down prices of DEGs, although account would
need to be taken of whether this was at the expense of those buying
EWs, and whether those buying EWs tended to be concentrated in
particular socio-economic groups.

4) information may be insufficient or not readily available; (see
practice D) (a) on alternative EWs available, their terms and
conditions; (b) on the relevant risk factors, primarily likelihood of
a fault, accidental damage or theft, and likely costs of repair or
replacement in the absence of an EW; (c) on statutory rights; It
could be against the public interest if consumers are effectively
prevented or hindered from knowing whether or not it is in their best
interest to buy the EW on offer, or to buy one at all, through lack
of information at the point of sale of the related DEG. In assessing
this, account needs to be taken of the type of information that might
be reasonably made available, and its likely accuracy and relevance.

5) there may be insufficient competition in the provision of EWs at
point of sale; (see practices A and D) There may be very limited
scope for alternative providers to obtain or challenge a point of
sale advantage. It could be against the public interest if, for
example, consumers are hindered or prevented from making a reasoned
and informed choice about which EW to buy because alternative EWs are
not made available, particularly at point of sale. The point of sale
is likely to be the time when it is natural and most convenient for a
consumer to consider an EW, and when, as a result, most consumers do
in fact purchase EWs. If manufacturers' (or others') EWs were
presented as clear alternatives at the point of sale, this could
provide a real choice for consumers. For example, manufacturers might
be in a position to offer EWs on terms that reflected actual risks
related to the reliability of different manufacturers' DEGs. In
assessing this account needs to be taken of commercial relationships
between retailers and manufacturers, and of what is reasonable and
practicable in the retail environment.

6) there may be excessive pressures on consumers to buy EWs; (see
practice E) Clearly it is a matter of public interest if there are
found to be unreasonable sales pressures. The point of sale context,
with the potential for bargaining over credit and DEG prices, may
affect sales behaviour in relation to EWs. Sales targets and
commissions to staff may be a factor.

7) consumers may be subject to unfair terms; (see practice F) If
terms such as those indicated under practice F above persist, this
could be against the public interest, depending on factors such as
the precise effects of such terms, the extent to which consumers are
aware of the terms at the time of purchase, and what scope they have
to purchase EWs without such terms.

8) there may be inadequate protection under non-insured schemes (see
practice G) Many (though not all) EW providers have moved from
insured to non-insured schemes in response to tax changes. This has
had the effect of removing the cover that consumers would have had in
the event of insolvency of the EW provider. In assessing whether this
is against the public interest, factors to consider include the
extent of risk, given that some EW providers have become insolvent,
any benefits to the consumer under the new arrangements, and the
extent to which trust funds provide adequate protection to consumers
with non- insured EWs.



TABLE 1 - SUPPLIERS OF REFERENCE SERVICES 9
ANNEX 1 RETAILERS MANUFACTURERS INSURERS
Apollo 2000 Limited
Apple Computer (UK)Limited
AXA Insurance UK plc
Argos Limited
Beko (UK) Limited
AON Warranty Group Limited
Bennetts (Retail) Limited
Belling Appliances Limited
Cassidy Davis Insurance Services Ltd
Box Clever Technology Limited
BSH Home Appliances Limited
Cornhill Insurance plc
British Sky Broadcasting Limited
Crosslee plc
Domestic & General Group plc
Carphone Warehouse Group plc
Dell Computer Corporation Limited
Hitachi Credit Insurance Corp Ltd
Comet Group plc
Dyson Limited
Landmark Insurance Company Limited
Co-operative Group Limited
Electrolux plc
Norwich Union Insurance Limited
Dabs.com plc
Fisher & Paykel Appliances Limited
Pinnacle Insurance plc
Dixons Group plc
Fujitsu Siemens Computers Limited
Royal & Sun Alliance Insurance plc
Grattan plc & Freemans plc
General Domestic Appliances Limited
Warranty Direct Ltd
Jessops Limited
Hewlett-Packard Limited
John Lewis plc
Hoover Limited

UTILITIES
Littlewoods Retail Limited
IBM United Kingdom Limited
Centrica plc
MFI UK Limited
JVC (U.K.)Limited
Npower Gas Limited
Miller Brothers Group Limited
Kenwood Appliances plc
South Staffordshire Group plc
N Brown Group plc
LEC Refrigeration plc
Southern & Scottish Energy plc
Orange Retail Limited
LG Electronics U.K. Ltd
Phones 4u Limited
Miele Company Limited

BANKS & CREDIT CARDS
Powerhouse Retail Limited
NEC (UK) Ltd
Barclaycard (Barclays Bankplc)
Redcats (UK) plc
Panasonic U.K. Limited
Royal Bank of Scotland Group plc
Richer Sounds plc
Philips Electronics UK Limited
Thomson Multimedia Sales UK Limited
Samsung Electronics (UK) Limited
Vodafone Limited Sanyo Industries (U.K.) Limited
Sharp Electronics (U.K.) Limited
Smeg (UK) Limited
Sony (U.K.) Limited
Time Technology Group Limited
Toshiba Information Systems UK Ltd
Whirlpool (UK) Limited


ANNEX 1 TABLE 2 This table lists the companies currently identified
as providing EWs at the point of sale of the relevant DEGs, and
having more than 1% of the supply of the reference services. These,
together with others who provide EWs at the point of sale and are
listed in Table 1, may be involved in a monopoly situation. (See
notes on next page) Company Value of EWs sold 10 ('000) No of EWs
sold11 ('000)
Dixons Group plc
Appliance Serviceplan Ltd
Cornhill Insurance plc
Comet Group plc
Landmark Insurance Company Ltd
Powerhouse Retail Ltd
Pinnacle Insurance plc
Argos Limited
First Home Services Ltd (Pinnacle Insurance plc)
Cornhill Insurance plc
Littlewoods Retail Ltd
ESP Limited (Pinnacle Insurance plc)
MFI UK Ltd
London General Insurance Company Ltd

Total for those listed above (in respect of EWs provided at point of
sale) 415,000 6,100 Total supply of EWs at point of sale Not yet
calculated Not yet calculated Total supply of EWs12 800,000 15,000

1. The companies listed in Table 2 are providers of EWs at the point
of sale of the relevant DEG (including mail order and telephone
sales). The groups of companies listed have currently been identified
as providing more than 1% of the total supply of EWs in each case,
through the relevant retailer's point of sale. (See paragraphs 3.7
for an explanation of the way in which the providers of EWs are
grouped).

2. Other companies also provide EWs at the point of sale of
the relevant DEGs, and it is possible that the Commission may
conclude that some or all of them are also complex monopolists. These
include the other retailers listed in Table 1 of this Annex, and
retailers with small shares of the supply of EWs. Some of these are
members of the Radio, Electrical and Television Retailers'
Association (Retra) and provide EWs supplied by Retra Insurance
Services Ltd, a subsidiary company of Retra. Many smaller retailers
provide EWs which are supplied by insurance companies; in particular
Domestic and General and Cornhill. If some or all of these are
included in the "point of sale" complex monopoly group the total
share of supply of this group will be greater than the amounts
currently given in Table 2. This letter is being addressed to all the
companies which the Commission has so far individually identified as
those which may fall into this category and to other interested
parties. It is also being published. Comments are invited from any
company that may be affected. Inclusion in a complex monopoly does
not imply any adverse findings relating to any of the companies
concerned.

3. The remaining part of the total supply of EWs is made
up of renewals, and provision of EWs other than at the point of sale
of the relevant DEG; eg manufacturers' EWs and direct sales to
consumers by insurers and credit card companies.

4. Confidential figures in columns 2 and 3 have been excised. Sales
to businesses are excluded.

ANNEX 2 INFORMATION ON MARKET AND ECONOMIC ISSUES

1. This Annex contains further material and evidence relevant to the
market and economic issues described in part 2 of the issues letter,
and where applicable paragraphs are cross-referenced to part 2. Some
of the material is also relevant to part 3 of the issues letter, the
possible monopoly situations.

Where EWs are sold - rates of purchase

2. Paragraph 2.12 - The NOP survey showed one in three of those
who had bought an electrical product for over 50 from a shop in the past
twelve months had purchased at least one of the items with EW cover.
82% of those with an EW had obtained it from the same retailer that sold
them the electrical appliance. 4% had obtained it from the manufacturer
and 4% from an insurer. 2 % had credit card cover and 1% had cover from
the bank. Although retailers are not always able to quantify separately
the proportion of their EW sales which are related to DEGs purchased
from a different DEG retailer, they all believe this to account for a
very small proportion of their total EW sales.

3. Paragraph 2.13 - For some categories of DEG, the rate of sale of
EWs is higher than in others, particularly for higher priced DEGs.
Evidence provided by retailers shows that the rate of sale of EWs in
retail stores can be over 30% for product categories such as
camcorders, washing machines and washer dryers, whereas EW sales on
microwaves and video cassette recorders may be 10% or lower. The NOP
survey found that a greater proportion of those who had purchased a
DEG in the last 12 months had taken an EW where the DEG was more
expensive, the rate of take up being over 40% for products over 300,
compared to 25% for products under 100, and 27% for those between
100 and 200.

4. Paragraph 2.13 - Evidence from retailers also shows that within a
particular product category, consumers are more likely to purchase an
EW if they are purchasing a higher priced model. Retailers have also
suggested that consumers purchase EWs for higher priced DEGs because
the proportionate cost of the EW tends to be lower and the cost of
replacing such an item may be prohibitive, whereas some cheap models
may be regarded as 'disposable'. Also, if a consumer greatly values a
particular DEG (eg their lifestyle means a washing machine or TV is
an essential item), they will be more likely both to go for an
expensive model (with more features, quality and perhaps greater
perceived reliability) and purchase an EW to assure its continuing
availability.

Market definition

5. Paragraph 2.17 - Evidence to date suggests that
it is fairly easy for suppliers to move between offering different
types of EW policy (such as the usual single appliance policies,
multi-appliance policies, and replacement only policies), ie there is
close supply-side substitutability. Parties have indicated that
supply-side substitution between these different products is easy as
they are essentially the same product, can be sold in the same way
and can be sourced from the insurance market or other suppliers in
the same way. Multi- appliance policies, at the simplest level, can
be created by bundling together single-appliance EWs. Survey evidence
suggests that consumers are unaware of the difference between
insurance-backed and service-contract schemes. The terms and features
offered by insurance-backed and service-contract EWs are usually very
similar. All suppliers who expressed a view stated that there would
be very close substitutability between these products in the eyes of
consumers. The OFT Report on the Consumer Survey about Extended
Warranties (July 2002) reported only 14 % of consumers considered
there was a difference between the two types of extended warranty
after they had been prompted that there were two different types. Of
these, only a very small proportion correctly understood what these
differences were.

6. Paragraph 2.19 - In the case of PCs and similar high-technology
digital equipment, most problems experienced by consumers will not
arise from mechanical and electrical failure, but will result from
software problems, the effects of combining different DEGs that are
required to interact (such as a PC and its peripherals, or a TV,
satellite or digital TV receiver, home cinema system, DVD and video
and camcorder), or the customer's inability to follow complex or
incomplete instructions. Distinguishing between hardware faults and
other problems may be difficult. For consumers, it is irrelevant
whether a problem arises from hardware, software or connectivity
problems; they merely require the problem to be fixed. Therefore, in
order to provide a satisfactory service, EW providers may need to
offer an advice service, such as a helpline staffed by trained
engineers. One retailer told us it managed to fix 86% of reported PC
faults either over the phone or by e-mailing software fixes rather
than having to arrange a physical repair. However, such a helpline
service can represent a significant investment in facilities and
staff training that would not be required for EWs without such a
service.

7. Paragraph 2.24 - The major retailers have told us that their
business strategies are based on attracting customers by offering
both DEGs and add-on products such as finance and EWs. The retailers
said that when shopping for DEGs, consumers weigh up their options
carefully and this can take several weeks. During this period they
investigate products and brands, undertake price comparisons and
select the retailer from whom they wish to make the purchase.
However, once the product is selected, price becomes the most
important factor. Thus pricing in the DEG market is intensely
competitive. Retailers argue that consumers will evaluate all aspects
of a retailer's offer before deciding on where to make their
purchase, including aspects of after-sales service and the
competitiveness of the EW offering. However, retailers note that the
major factor is pricing on the DEG. They say the interaction of EWs
and DEGs with consumer purchasing behaviour provides a constraint on
their business conduct and the relative margins that can be achieved
on differing aspects of their business.

8. Paragraph 2.26 - The NOP survey broadly indicated that consumers
rarely perceived EWs and DEGs as a package. Regarding sales
practices, only 9% of respondents to whom an EW was mentioned
reported that they were offered a 'package' price of EW and DEG
together. 9% of respondents said they were offered a discount or some
other advantageous financial arrangement subject to the take-up of an
EW (17% among EW users). Overall, 93% of consumers who obtained an EW
from the retailer said it was clear how much the EW would cost on top
of the price of the DEG, in which case there is scope to consider and
buy them separately.

Point of sale advantage

9. Paragraph 2.28 - The major retailers have accepted that they have, to
some extent, a point of sale advantage. One acknowledged that the price
sensitivity of consumers to EW prices is less than for DEG prices. EWs
are harder to compare (because terms differ) and tend to be seen as a
complementary add-on to the DEG by many customers, therefore it
acknowledged that a point of sale advantage exists for DEG retailers.
However, another argued it could not seek to exploit any such advantage
as, in common with other reputable retailers, it had no incentive to 'entrap'
customers into contracts that they would subsequently wish to cancel. It
also argued that many consumers were aware of alternative EW offers
and of those customers who purchased EWs, many had actively considered
the purchase of an EW before entering the store. However, it is possible
that this could amount to no more than an intention to buy an EW at
the point of sale.

10. Paragraph 2.29 - The boundaries of the relevant market (or
markets) for EWs can be determined through the use of the 'small but
significant non-transitory increase in prices' or SSNIP test. The
test defines the economic market as the minimum number of products or
services and the minimum geographical area in which a hypothetical
profit-maximising firm that was the only seller of these products and
services (ie a hypothetical monopolist) could profitably impose at
least a small but significant and permanent increase in price from
the competitive level. The test is applied by taking the smallest
possible market, and asking whether the monopolist could profitably
impose a small (say 5%) price increase. If enough consumers would
switch to another product to make the price rise unprofitable, then
those products should be considered as part of the relevant market.
The test would then be repeated. The point of reference needs to be
competitive price levels. If prices were greater than this level,
they may have already been raised to the point where further
increases would not be profitable. Then alternative products would
appear relatively cheaper and so more attractive as substitutes, and
the true market would be drawn too broadly.

11. In order to apply the SSNIP test precisely one needs observations
of how consumers' demand for, and suppliers' supply of the product or
service responds to changes in prices from the competitive level. In
practice, these are rarely available. Therefore we rely on evidence
which allows these effects to be inferred, such as surveys of
consumer awareness of substitutes, their willingness to search for
information on alternative offers, how consumers say they might react
to price changes from current levels, their observed switching
behaviour, evidence of competitive interaction in pricing between
different suppliers, whether supplier behaviour indicates they regard
other products as substitutes, and so on.

12. Paragraph 2.31 - Evidence received from different EW providers
suggests that there are few if any significant advertising campaigns
aimed at consumers. It has been put to us that when advertising
campaigns have been undertaken, these have had very little success in
increasing sales. We have been told by one of the parties that
several attempts at advertising EWs have generated a poor level of
consumer interest.

Price Setting

13. Paragraph 2.40 - Retailers' evidence on their EW
price setting processes suggests that some are wholly or primarily
influenced by competitor pricing levels. They price at market levels
or try to match or beat their key competitors. However, any price
matching promises tend not to apply to EWs as terms and conditions
often differ between different providers. One retailer has told us it
would price match on a DEG, or DEG and EW together, but not an EW on
its own. Those suppliers who tracked and responded to competitor
pricing acknowledged that sometimes they could end up selling some
EWs at a loss, but they sought to avoid such situations. Where EW
providers match market prices, it leaves open the question as to how
market prices are determined. Other retailers base their pricing on
sales rates achieved, forecast claims and repair costs, and they will
also respond to changes in the prices of the DEGs to which they
relate. In some product categories, EWs may be priced according to
the price of the DEGs to which they relate; for example EW prices
will be higher for a DEG between 200 and 300 than for a DEG below
200, and there may be a higher priced EW for DEGs over 300, and so
on. We were told this policy may arise to allow for the higher cost
of replacing more expensive DEGs, because there may be more features
in the product that could fail, or they are more complex and so more
expensive to repair, and also so that the price of the EW relative to
the DEG does not deviate too far from usual levels (see paragraph
15).

14. Retailers do not usually break down their pricing analysis by
model or manufacturer. They have said that there are no
forward-looking data available on reliability, claim rates and repair
costs for particular models and manufacturers which would allow them
to do this, and it would be too confusing for staff and consumers to
have a variety of EW prices for similar DEGs. Where there are
significant differences in the claims ratios according to the type of
technology in a product, different prices may be charged. For
example, frost- free fridge-freezers may have different EW prices
from standard fridge-freezers, and EW prices of digital camcorders
may be different from those of analogue camcorders. Where a new
category of DEGs is introduced, there will be no claims history
available and no market price to match. In such cases EW providers
may base EW pricing on the best available forecasts of product
reliability from technical sources, or experience in other countries
where the products may already have been launched.

15. Paragraph 2.41 - Some retailers said that the ratio of DEG and EW
prices could have a significant impact on sales-rates. Some retailers
have approximate targets for the ratio of EW to DEG prices. One
insurer told us that consumers are highly sensitive to the EW:DEG
price ratio, and they will dispense with EWs once the ratio is
excessive - it gave the example of VCRs where EW sales have reduced
dramatically as the product price has declined. It said that new
technology, highly complex or household critical products may have
higher sustainable EW:DEG price ratios as customers have a greater
propensity to protect their investment .

16. Paragraph 2.43 - Insurance companies have told us that, in
setting the prices of EWs that they sell direct, they would be aware
of pricing in the market and seek to remain competitive. However,
they appear in general to attach more weight than retailers to the
need for all product categories to cover forecast claims costs and to
ensure an adequate return. Where EWs are distributed through
retailers acting as sales agents, a target margin may also be added
for the retailer to retain. Pricing of multi-appliance policies is
more difficult, as claim costs will depend on the mix of products
that consumers choose to cover. Costs are therefore calculated based
on experience; pricing may be guided by a target margin over costs
for the insurer. Insurers have also noted that administration costs
tend to be lower for renewals and so a lower mark up is required,
although because the product is older and there is potentially an
element of adverse selection in which consumers choose to renew,
forecast costs will be higher. Insurers do not generally break down
costs by model type or manufacturer, as they, or their retail agents,
would find it difficult to reflect these in pricing lists; they say
it would create too many options and confuse consumers. Where
insurers are providing EWs to one or more manufacturers, they can
base forecast costs, and therefore charges, on the claims history of
each individual manufacturer alone.

17. Paragraph 2.47 - It is possible, therefore, that rather than
being constrained by those of competitors, retail prices are limited
by the amount that consumers are willing to pay. Consumers always
have the option not to purchase an EW. As noted above, EW providers
may perceive that demand is sensitive to price increases from current
levels. As noted in part 2 of this letter, a major reason for the
fact that the great majority of DEG sales are not covered by EWs is
because consumers perceive prices as too high. The Commission is
investigating whether prices have profitably been increased from a
competitive level already.

18. Paragraph 2.52 - Evidence received from retailers and insurers
indicates that there are a wide variety of gross margins on EWs for
different DEG product categories. These seem to have become accepted
in the EW industry as normal pricing. We asked some retailers to
provide EW gross margins on each of their DEG categories, calculated
as retail price minus risk premium, tax and administration charges
(no allowance was made for any other variable costs or allocated
overheads). Typically, such gross margins varied from around zero
(and were occasionally negative for EWs covering particular price
bands for certain DEGs) to over 80%, although the number of product
categories towards the extremes of the distribution were low. It
appears that different retailers have a similar pattern of
distribution of margins. One major retailer acknowledged that there
was wide variation in the gross margin by product, and stated that
this resulted from the fact that it largely set prices by reference
to its competitors' pricing.

Barriers to entry and exit

19. Paragraph 2.58 - There is limited evidence that the number of
independent repair organisations has fallen rapidly in recent years.
One manufacturer estimated that the number of authorised service
centres had fallen from around 800 three or four years ago, to around
450 operating now. We will consider whether this may impede the
ability of a new entrant to the supply of EWs to establish a repair network.

20. Paragraph 2.60 - We have found that consumers are not usually
active in shopping around and comparing prices for EWs, whereas
retailers have indicated that many consumers are active in shopping
around for DEGs. One retailer's response summarises the typical views
expressed: "A consumer buys an electrical product only once every
eight months on average. For major purchases the frequency is, on
average, every fifteen months. It is usually a highly important
purchase and is both planned and considered, since few other
purchases, other than cars, houses and holidays, have such large
ticket values. Consumers typically seek to educate themselves on the
different products on offer, search for the lowest price available,
and, for some, gain added reassurance through the proposition of
strong after-sales support and service... Price comparison is made
easier by the fact that most electrical products are directly
comparable between retail chains, and on the internet. This leads to
especially price-sensitive behaviour by consumers looking to make an
electrical purchase."

Retailer relations with manufacturers

21. Paragraph 2.64 - Although many manufacturers offer EWs, there has
been little evidence received to suggest that they actively advertise the
existence of their EWs prior to sale. Some manufacturers have indicated
they are passive in their approach to the market, they do not see EWs
as their core business, and one said it made no efforts to monitor competitors'
behaviour in this area. Manufacturers told the OFT that there were
difficulties in competing with retailers, as they did not want to
compete against their own customers who might see EWs as their
domain; the same views have been expressed to us. One manufacturer
argued that sales targets and incentivisation distorts the sales of
DEGs as it encourages retailer sales staff to sell low-cost,
less-reliable DEGs with an EW rather than a higher-priced,
more-reliable DEG without an EW or with a free or cheaper
manufacturer's EW.



ANNEX 3 INFORMATION ON COMPETITION AND PUBLIC INTEREST ISSUES

1. This Annex contains further material and evidence relevant to the
competition and public interest issues listed in Part 3 of the issues
letter: A Restricting choice B Contracting in advance C Setting
prices above competitive levels D Restricting information E Selling
practices F Unfair terms G Uninsured cover

2. The material and evidence is also relevant to the market and
economic issues described in part 2 of the issues letter.

A. Restricting choice Choice and coverage of EWs and reasons for
buying them

3. The Commission has received very little evidence to
date that any retailers sell EWs other than those they provide
themselves.

4. Most retailers' EWs, as well as those of some insurers and
manufacturers, offer cover beyond mechanical breakdown, for
accidental damage and frozen food loss. Some EW policies provide
cover against theft. When offered, these benefits cannot be taken out
separately from the mechanical breakdown cover.

5. When asked whether they were aware of these benefits that might be
included in their own EWs, only 33% of consumers spontaneously said
that they were covered for accidental damage, and 12% for theft
(however, only 52% said they were covered against mechanical
breakdown, and 20% for parts and labour costs). Most consumers (92%)
have home contents insurance policies. Of those with home insurance,
85% thought this covered their electrical appliance for theft, while
72% said their appliance was covered for accidental damage.

6.Commission analysis of the NOP survey results found that 3% of
consumers said that a reason why they took out an EW was to obtain
accidental damage or theft cover. According to a survey presented by
one company, 10% of consumers spontaneously mentioned protection
against accidental damage as a reason for purchasing EWs. When
consumers in the NOP survey were prompted for their valuation of the
different EW benefits, mechanical breakdown was top of the ranking,
accidental damage was ranked fifth, theft ninth and frozen food loss
appeared at the bottom.

7. The NOP survey also showed that some consumers value the
convenience of an EW that covers them for all eventualities.
Convenience of arranging repairs and peace of mind were among the
main reasons for taking an EW. Peace of mind was also the most
important reason for EW take-up in the survey presented by one of the
companies. This is likely to be enhanced where an EW covers a wide
variety of risks.

8. However, some respondents to the NOP survey would prefer being
able to buy extended cover for different risks separately, as this
would be better tailored to the DEG that they had purchased, and
could be cheaper.

Incidence of claims

9. Over all EW claims, for the financial year 2001, data from major EW
suppliers indicates that mechanical and electrical failures account for
around 75% to 95% of the value of all claims, accidental damage
anything from under 2% to around 15%, and frozen food loss 1% to 2%.
Where theft cover is included it accounts for approximately 10% of
claims. We are investigating the considerable variability in claims
profiles for different EW suppliers. We will also consider whether the
claims profile is significantly different for products such as PCs and
mobile phones, and if so, whether they are sufficiently different that this
might indicate that such products could be in different economic markets.

10. Data provided by some of the parties show that there are
virtually no claims other than for mechanical failure in some product
categories, whilst in others such as mobiles, claims for accidental
damage and theft can be much more significant. One EW provider told
us that it does not offer these additional benefits together with
cover against mechanical failure as it believes they are largely
superfluous to the product offering.

Periods of cover

11. Retailers typically offer lengths of EW cover of three and five years
from the date of purchase. Some retailers may also offer cover for other
periods, such as two or four years. However, Commission analysis of the
NOP survey results shows that more than half of consumers (56%) who
purchased an EW from theretailer that sold them the DEG claim not to
have chosen the length of cover themselves but say it was pre-specified.
Insurers selling direct to consumers and manufacturers offer EWs for
different periods including three and five years, or longer, but also annual
renewal policies.

12. The NOP survey showed that although consumers would see benefits
from shorter term EWs being available, they also believed that
signing up for a three or five year policy was likely to be cheaper
than one-year renewable policies, that it represents a fixed/known
cost and provided them with the reassurance that the electrical
product is covered for the relevant term.

Consumer search behaviour

13. Some evidence indicated that many consumers would not actively
search for alternative EW providers even in response to an increase in
EW prices. The NOP survey asked consumers what would they do if,
hypothetically, EW prices increased by around 10%. Out of those who
had taken an EW from the same retailer as sold them the electrical
appliance, two in three (64%) would still have taken cover from the same
retailer if the price of cover at that retailer had gone up by 10%, whilst 23%
would not have bought an EW, and only 11% would have 'looked actively
for EWs from other providers'. However, of those that would look actively
for EWs from other providers, 33% would still have taken an EW from a
retailer if the price increase had occurred at all retailers

B. Contracting in advance Original guarantees and EWs

14. The manufacturer's guarantee covers consumers for the cost of repair
due to mechanical failure, normally during the first year after purchase,
although some manufacturers offer a two-year or longer guarantee on
some product categories. In the OFT survey, all consumers expected
manufacturers of large electrical appliances such as colour TVs or
dishwashers to provide a guarantee. 60% expected the manufacturer's
guarantee to last for one year, and almost all the rest expected it
to last longer than one year. Almost two in five (39%) consumers in
the NOP Survey thought they could only take out an EW when they
bought an electrical product, or within one month from purchasing the
appliance (8%).

15. EWs are usually paid for when the policy is taken out, with the
obvious exception of free EWs, and of contracts where there is a
credit package with a monthly repayment schedule. (Some insurance
company warranties are paid for by monthly direct debit.) During the
first year many claims would be covered under the Sale of Goods Act,
so the benefits of the warranty are higher thereafter. However,
providers have emphasised to us that there are features of their
warranties from which a consumer could benefit in the first year.
These features may include cover for accidental damage, help-line
support, faster call-out times for service engineers and loan of
appliances.

Cancelling and cooling off

16. Cooling off periods vary considerably.EWs sold by retailers offer
cooling off periods that vary between 14 and 30 days, and we have
been told that these are in line with the cooling off periods for insurance
contracts in other markets. However it has also been pointed out that
the retailer's cancellation period may have expired by the time the
consumer is aware of the manufacturer's offer. One party has put it to us
that if retailers' limited cancellation periods were to be extended then
more customers would have the ability to shop around for competing
offers from either the manufacturer or a direct insurance provider. Some
non-retail competitors can make consumers aware of their EW offers
through their regular customer contacts, e.g. utility companies
through their monthly bills.

17. In practice few consumers seem to search for alternatives during
the cooling-off period (even if they are aware that such alternatives
exist). According to the NOP survey, 18% of respondents regretted
having purchased their EW, but less than 2% considered cancelling it.

18. It appears that there could be a number of psychological barriers
that mean a consumer will find it difficult or be reluctant to cancel
an EW contract and take out a new one elsewhere. First, they must be
aware that they have a right to cancel the contract. Second, they
must know of, and be able to identify a suitable alternative
provider. Third, they must contact the point of sale provider to
cancel their existing cover. Fourth, they must admit to themselves
that they had made a mistake in their first choice of EW provider.
Fifth, there may be a financial cost in seeking a refund (see
paragraph 19).

19. Our current understanding is that for most EWs, if a consumer
were to cancel the policy after the cooling-off period, then there
would be no refund due for the unexpired period, except by special
dispensation in unusual circumstances. However, at least one
non-point of sale provider said it would refund the entire fee if the
consumer wishes to cancel the policy before expiry of the
manufacturer's guarantee provided no claims have been made; in its
annual plans (i.e. plans taken after expiry of the manufacturer's
guarantee) this provider would offer a pro-rata refund for the
unexpired period of the policy as long as there have been no claims
on it.

C. Setting prices above competitive levels Cost reflective pricing

20. The OFT maintained that EW pricing appeared not to be cost
reflective, after examining data available to it on average repair
costs and noting that a standard fee is charged for EWs for goods of
the same general type within the same broad price banding despite
differing failure rates of electrical goods.

21. Several retailers have told us that pricing at the level of brand
or model would not be feasible due to variations in the reliability
of a manufacturer's models, the fact that reliability varies over
time and the need for large sample sizes to project claims. They also
argue that price banding is easier for consumers and ensures that EW
prices are attractive, given consumers' sensitivity to the EW price
in relation to the DEG price. A retailer has told us that EW
penetration rates seem lower for product categories where the EW:DEG
ratio is higher. At the same time, we have been told that although
the level of EW prices is strongly influenced by market conditions,
prices must be above the cost of the insurance premiums associated
with each EW to avoid negative margins.

22. From some information received, it nevertheless appears that the
amount payable by retailers to insurers to cover risks relates to
whole appliance categories or subdivisions that do not necessarily
match the retail pricing structure. Also, it has been put to us by an
insurer that when underwriting an agent's scheme, the amounts payable
to cover insured risks are set on overall appliance performance. In
this way, risks may be more than covered by the amounts payable on
higher performing appliances but not on the lower performing ones
within a product category. This may allows an EW to be offered on
higher risk products.

Comparability

23. Within each appliance category, there are wide variations between
EW prices charged by different providers. Some retailers have told us
that they would not necessarily wish to match a competitor's EW price,
given the fact that the benefits attached to some EWs may not be the
same, which makes them not directly comparable with others.

24. It seems that there is a wide variation in retailers' mark up of
EWs between different types of appliance. Our preliminary analysis of
information from retailers shows that the five year EW gross margin
across different appliance categories can vary from 0% to over 80%
(or can even be negative). On the other hand, a retailer has put to
us that variations in margins are a result of its market driven
approach to setting EW prices. It argued that it does not set EW
prices on a cost-plus basis but to ensure competitiveness against
other EWs and that a correspondence is maintained between EW prices
and the prices of the DEGs to which they relate. It has also been put
to us that differences in retailer's margins may partly be due to the
fact that the 'risk groups' (the categorisations of DEGs used to
assess the costs of covering risks) and the retail pricing structure
for EWs (based on particular types of DEG and price bands for the
DEG) are not identical.

25. We also note that there are price differentials between EWs
offered by different providers. We have been told that price
differentials may be due to different levels of cover, or variations
in the product ranges stocked across retailers. On the other hand, it
appears from a preliminary analysis that claims under certain
elements of EW cover within particular product categories represent a
low proportion of total claims (see Annex 3 paragraph 9).

Pricing factors

26. Our preliminary analysis confirms that EW pricing
is not based uniquely on costs. Factors that often appear to be more
important in price setting than costs include: comparisons with
competitors (including non-retail competitors and manufacturers), the
price of the related DEG, the need for margins on EWs to be positive,
sales targets, and tracking of the number of EWs sold compared to the
number of DEGs sold in each category.

27. Our analysis to date suggests that for policies sold directly to
consumers, competitors' prices are the main criteria in setting
price.

28. For policies sold via an agent, the price charged by the insurer
to the retailer appears to be a function of the risk of product
failure and the expected cost of repair. The final retail price
charged by large retailers (ie the retail margin added as well as the
premium paid to the insurer) appears largely to be based on what
competitors are doing. Some small retailers may more closely follow
insurers' recommendation by charging prices that add a standard
margin on the risk premium.

Profitability

29. Our preliminary analysis of the questionnaire responses suggests
that electrical retailers do make considerable profits on the sale of EWs.
Profitability in terms of returns on sales after allocation of indirect costs
ranges around the 20% to 50% level, or assuming no allocation of indirect
costs, around the 40% to 75% level.

30. In the case of at least one insurance company, it appears that
profitability of the EW business may be lower than for its other
insurance activities.

31. Information analysed to date suggests that retailers may be using
the profits from the sale of EWs to lower the price of DEGs below
what they would otherwise have been. At least one retailer has stated
in its response that the best strategy is to offer the lowest
possible DEG price along with a high quality service, to maximise
overall profitability levels.

D. Restricting information Awareness of alternatives

32. Consumers appear to give less thought to planning the purchase of an
EW than a DEG, and we have found that many consumers seem to have
little or no awareness of where EWs could be purchased other than at DEG
retailers. The NOP survey showed that three in five purchasers of
major DEGs (i.e. priced at 50 or more) recall salespersons
mentioning EWs but only 4% of these consumers recalled salespersons
mentioning alternative EW providers. NOP reported that the
preliminary shopping around for a DEG does not include information
gathering about EWs, either because information is not available or
because it is not a priority at this stage. Consumers in the NOP
focus groups believed that if they could not buy EWs at point of
sale, then they would forget unless they were reminded of them. Some
respondents thought sourcing alternative providers would be 'time
consuming and inconvenient'.

33. Three in five EW purchasers had not planned to buy EWs before
entering the shop (compared with 41% in the OFT consumer survey) and
we found based on the NOP data that very few (about 3%) of these had
considered suppliers other than the retailer where they bought the
DEGs. Half of EW purchasers who considered alternative providers had
considered another retailer. Less than 4% of all EW purchasers were
able to make comparisons of price and EW features. A survey submitted
by one of the parties showed that 8% of EW purchasers considered
alternatives for their EW before purchasing it in store.

34. Consumer surveys indicate that the levels of awareness of
different types of EW provider are different at the spontaneous and
prompted levels13. In our consumer survey, only one in two
respondents were spontaneously able to identify any type of supplier.
Those most often associated with EWs were retailers (30% of
respondents) and insurers (22%). Manufacturers were only identified
by 7% of respondents, and credit card companies, banks etc by 2%.
Note that some respondents identified more than one type of provider.
At the prompted level awareness was much higher. 92% identified
retailers as providers of EWs, 81% insurance companies and 79%
manufacturers. 54% were aware of credit card companies and 35% of
banks' extended cover .

35. It is possible that consumers did not understand, or were led by,
the prompted questions - many EW holders could not spontaneously
name any type of EW provider, and the prompted figure for awareness
of banks' EWs seems very high given the very limited availability of such
cover. Also 50% of respondents agreed that finance companies were a
source of EWs when this is not normally the case. As a comparison, the
OFT Consumer Survey found,before prompting, 7 out of 10 respondents
mentioned retailers as a source of EWs, and only 1 in 4 mentioned
manufacturers and 1 in 7 mentioned insurers. After prompting, 9 in 10
mentioned retailers,two-thirds manufacturers, and half insurers.

36. Retailers do not generally accept that consumers were unaware of
alternative EW providers. They have argued that consumers have access
to information about the different providers of EWs, as well as their
cost and terms. Sources of such information include DEG retailers,
providers of EWs who market directly to customers, consumer bodies
and the media; information is provided to consumers by various
methods including advertising, direct mail, the internet, material
provided at points of sale or at other points of contact with the
customer. They have also stated that most consumers will have had
experience in the market, and many will have purchased EWs from other
sources. They have also argued that the cooling-off period allows
consumers the chance to shop around. They also said that while some
consumers may not be aware of alternatives, provided sufficient
numbers were aware of and could compare alternative providers then
this would exert competitive pressure on pricing.

Information at point of sale

37. Information on EWs from other providers such as insurers or
manufacturers is not available at point of sale. The NOP survey
found that information about other providers of EWs was offered in
only 4% of cases where the sales person mentioned EWs. Retailers
have told us that they do not train their staff on the terms and prices
of manufacturers' EWs.

38. Manufacturers do not place information on their EWs on the
appliance for retail display. Any documentation would either be
available in the appliance box (which consumers will only see when
they open the package at home) or through mail shots upon return of
the guarantee card contained within the appliance package. Some
manufacturers have told us that they cannot compete directly with
retailers as they do not have access to the consumer at point of
sale.

39. We have been told that it is not common for manufacturers to
place material about their warranties on packaging or display
equipment, but where they do place material such as stickers on
equipment, we understand that the retailer may decide to remove these
from display stock. This is apparently not limited to extended
warranty publicity; the retailer wishes to control the appearance of
the shop floor. Historically, there may have been some instances
where appliance registration cards may have been removed from
packaging but manufacturers and retailers have told us that this is
not a common occurrence today.

40. It has also been indicated that some retailers may be unwilling
to allow retail pricing to reflect longer inclusive manufacturer
guarantee periods (by refusing to accept increases in manufacturers'
prices necessary to meet the extra cost of the longer guarantees).

41. Some manufacturers have told us that they are not more active in
the sale of EWs as they do not wish to compete with their customers'
EWs. For example, a PC manufacturer told us that a retailer had
indicated to it that it regarded information about the manufacturer's
own EW in the packaging of its appliances as unhelpful to consumers.
Similarly, retailers have argued that they do not offer other
providers' EWs as they regard EWs as an integral part of their
service rather than as a separate product. But we note that some
retailers have started to sell EWs not associated with the sale of a
DEG through direct mail, telephone and their repair services.

42. Different parties including retailers and insurers have expressed
their belief that most consumers prefer to buy EWs when they purchase
the DEG. Some have also argued that this is because consumers'
primary focus is the choice of the DEG, not the EW. The NOP survey
showed that most consumers believe that if they could not buy EWs at
point of sale, then they would forget unless they were reminded of
them. It also showed that, according to some consumers, finding
alternative providers would be 'time consuming and inconvenient'.

Take-up of alternatives

43. From the information gathered so far, it appears that the rate of return
of manufacturers' registration cards is low, varying from 1.8% to 20%.
Also, the consequential take-up rates for insurer or manufacturer EWs
out of total mailings are low. A retailer who also mails customers who
do not purchase EWs in store has said that it selects the products for
its mailing programme where historic take-up rates show that this is
economically viable when compared with more general marketing costs.

E. Selling practices The BRC Code

44. Retailers told us that sales staff are trained to follow the British
Retail Consortium (BRC) guidelines on sales practices14, and that
written information on EW prices and conditions is available. In its
July 2002 report, the OFT stated that the mystery shopper exercise
which it commissioned demonstrated poor compliance with the BRC
Code of Conduct. For example, three quarters of stores did not display
signs referring to the price of EWs and more than half of stores did not
display clearly visible leaflets or signs about EWs. The larger retailers
have indicated to us that they are taking measures to ensure all their
branches fully comply with the Code. However, the BRC is not seeking
approval for the Code under the OFT's codes regime, and the BRC says
it has no powers to discipline its members or force compliance with
the Code.

Statutory rights

45. Consumers appear to be widely unaware of their
statutory rights under the Sale of Goods Act. According to the NOP
survey, 65% of consumers thought they could only be compensated for a
failure with their product for a period of one year after purchase or
less. 13% mentioned a period longer than a year and 22% did not know.
A separate DTI consumer survey has shown that there is relatively low
awareness of what is a "reasonable time" in which to return goods,
with over half being ill-informed or simply not knowing. 43%
correctly stated they could return a faulty television 18 months
after purchase, while 34% did not think this was correct and one in
four (28%) did not know. The DTI survey showed that availability of
warranties and guarantees added to consumers' confusion over what was
a reasonable length of time - they assumed they were not entitled to
anything once the guarantee period had expired. The availability of
guarantees also appeared to contribute to consumer confusion, with
many assuming that they had no rights once a guarantee had expired.
Two in three consumers (62%) in the NOP survey would still take out
an EW despite the protection available under their legal rights,
given the need to show inherent fault at the time of purchase.

46.Although some retailers have told us that they train their sales
staff on the Sale of Goods Act, there seem to be no leaflets on it
available in store. Some retailers believe there is substantial
confusion over consumers' statutory rights due to what they see as
the general and imprecise nature of the Act.

Information in store

47. It seems that written information is not
always available when EWs are mentioned to consumers in store.
According to the NOP survey, less than half (45%) of those consumers
to whom the salesperson mentioned an EW had been given any written
information available about the EW, or noticed that it was available,
before they had to decide about it. Of those, 59% said after reading
the information it was clear what they would be covered for and 11%
said it was not clear. 28% did not read the information. Of those
consumers who recall EWs being mentioned to them at point of sale,
four out of five were either completely clear (39%) about the terms
of the EW or clear to some extent (41%) whilst one in ten were not
clear at all.

48. The NOP survey showed that over one third of purchasers of major
DEGs were advised by sales persons to take out an EW. Of those who
were so advised, one in ten were also advised that the EW was good
value for money. Over half were not completely clear about the terms
of the EW cover based on what the salesperson had told them, and
similarly three in five were not completely convinced by what had been
said. Information on repair costs

49. Evidence received indicates that there is great variability in the
reliability, and also in average repair costs, of different brands
and models of DEG. However, the patterns of average levels of
reliability for different manufacturers can change over time.
Information on historic levels of reliability and average repair
costs by brand and model is not generally made available to consumers
by retailers and manufacturers. Some retailers claim to advertise
their standard repair charges in store, and one insurer's website
provides details of approximate costs of repair.

50. The OFT found that sales staff may emphasise problems of
reliability and repair costs when seeking to sell an EW. According to
the NOP survey, consumers recalled that in 10% of cases where the
salesperson mentioned EWs they indicated how likely the product was
to break down, but in only 2% of cases they said that the product was
very or quite likely to break down (compared to 6% where it was
described as very unlikely or quite unlikely to break down).
Retailers pointed out that it would be impossible to give reliability
data for particular models as this would not be established for a
couple of years after launch, by which time the model is likely to
have been replaced or updated. Reliability data based on a
manufacturer's overall record could also be misleading as relative
reliability changes over time and there is great variability between
models.

51. The Consumers Association has surveyed its members to determine
their experience of average DEG failure rates and the average costs
of repairs. The OFT undertook a similar study. Some companies have
provided evidence which suggests the incidence and cost of repairs
have been understated in such surveys. Evidence provided by both
retailers and insurers of actual claim rates under EW schemes (and
based on much greater numbers of consumers), show claim rates for EW
holders to be much higher than the failure rates found in these
surveys would suggest. The companies also provided details of the
cost of repairs. Despite purchasing repair services in bulk and
providing guaranteed work flows to repair organisations, the cost per
job tends to be in excess of what the surveys report to be the
average cost of a repair for an individual consumer.

52. Some parties have suggested that past reliability is not a good
indicator of future breakdown due to changes in product design, the
constant introduction of new models and the variability in
manufacturers' reliability over time. Also, manufacturers regard
reliability as highly sensitive information.

53. Providers of EWs have told us that no information is generally
provided at point of sale on product reliability and repair costs.
Providing such information was not practicable as the risk of
breakdown depended on a number of factors, many of which were
specific to the individual consumer. In addition, it has been
suggested that historic product reliability is no guide to future
reliability. One retailer told us that it was mindful that if such
information were provided, it could be criticised for using scare
tactics to sell EWs.

54. We found one retailer which advertises its standard repair charge
in store and through call centers, and of one insurer which provides
information about approximate costs of repair on its website. In
neither case is this information widely advertised.

55. Retailers have told us that consumers largely draw on their own
experience to assess product reliability and cost of repair and that
consumers are generally well informed about the risks and possible
costs of repairs, partly based on experience of owning other DEGs,
and partly from information that is available in the public domain
such as newspaper and magazine articles. In the NOP Survey consumers
expected 19% of products on average to break down in the first five
years (note however that responses varied widely below and above the
average). The average perceived cost of repair was 76.

Selling practices

56. According to the NOP survey one in three
consumers (36%) were advised by the salesperson to take out an EW. In
the survey, NOP also found that some retailers (namely Currys, Comet,
Powerhouse, Dixons and PC World15) were significantly more likely to
have advised the consumer to take an EW than the average (54%, 52%,
44%, 55% and 50% of cases respectively as compared to an average of
36%). However, only 1% of those consumers who did not take an EW said
they decided not to do so due to sales staff pressure. In the OFT
mystery shopping exercise 7.4% of consumers felt retail staff put
them under pressure to take out an EW. According to the OFT consumer
survey, 9% of consumers claimed staff put them under pressure to take
out an EW. These figures rose to 24% for Dixons and 21% for Comet.

57. The Consumers' Association has suggested that retail sales staff
have been pressured to promote warranty products, and are being given
incentives to give inaccurate information to ensure this happens. The
Association also thought there was some evidence that pressure
selling of EWs had declined since summer 2002, although it had not
disappeared altogether.

58. We currently understand that different retailers pay varying
rates of commission to their sales staff for EW sales. One has told
us it pays no commission; other major DEG retailers report that
commissions on EW sales could account, for an average salesperson,
for between 1% and 11% of their total remuneration depending on the
retailer, rising to between 3.5% and 14.6% respectively for a top
performing sales person at the same retailers. One retailer told us
that it believed commission payments do not give disproportionate
incentives to its staff to pressure sell extended warranties. We were
told that although sales staff are given incentives to make sales,
the rate of incentives is usually no greater for EWs than for any
other product or service.

59. We have seen examples of sales training material used by
retailers. Staff are encouraged to seek to make sales, for example by
focusing discussion of an EW on areas where a consumer may be
concerned: for example where a customer has young children, sales
staff may be trained to stress access to rapid repairs for an
essential item such as a washing machine, or may stress the risk of
accidental damage for a video recorder or television.

60. Some large retailers told us that they do not believe their sales
staff use undue pressure in the sales process. Their staff training,
store management processes, and complaints handling procedures are
intended to ensure that selling techniques follow good practice. One
retailer told us that in its experience, undue pressure upon
customers to purchase an extended warranty simply had the
counter-productive effect that the customer would change to another
retailer for the next purchase.

Bundling and discounting

61. Discounts appear to be available on
combined purchases of a DEG and an EW. Although relating to the EW
they may be applied to the DEG. Retailers' offers may be framed in
some cases as to encourage the take up of an EW with the related DEG.
According to the NOP survey, in 9% of cases where the sales person
had mentioned EWs, the EW was described as part of the product price
(11% of cases where the consumer actually took an EW). In 4% of cases
it was presented as part of the finance costs. 9% of consumers to
whom an EW was mentioned were offered discounts or financial
arrangements such as store credit conditional upon the take-up of an
EW with the appliance. We found from the NOP data that among the
reasons given by consumers for taking up EWs, 2% mentioned the
discount dependent on the take up of an EW and 2% the availability of
a credit deal. 10% of consumers in the OFT survey claimed to have
taken an EW because it was part of a package/special deal. Take up of
EWs was higher when the EW and DEG were purchased on credit.
Discounts seem to be higher on packages that contain an EW than those
without it. According to some suppliers, free credit periods may be
extended if an EW is taken.

62. Evidence provided by retailers suggests that average discounts
granted on purchase prices are greater where a consumer purchases an
EW and a DEG compared to where they purchase a DEG alone. One
retailer indicated the average rate of discount was 2% higher where
an EW was purchased. However, it noted that part of this was because
discounts were offered on discontinued or soiled stock and customers
might be more inclined to take an EW for such goods. Another retailer
recorded a difference of over 3.5% in average discount. As in this
case discounts were given on only a quarter of all sales, where a
discount is negotiated, the absolute difference in the rate of
discount is proportionately greater. We were also told that discount
rates are higher on average where the purchase is on credit. The
retailers told us that while offering discounts conditional on EW
sales was not their policy, there would be an incentive on staff to
secure sales, and one said in its case this would be greater where
the sale included higher margin products such as EWs.

F. Unfair terms

63. For some policies, if an item is replaced then
cover is then terminated. We understand that in this situation some
providers would pay the warranty-holder a refund of part of the EW
cost proportionate to the time remaining on the policy, whilst other
providers would not pay any refund. However, at least one supplier
offers continuous cover, where the remaining period of cover under
the EW is transferred to cover the replacement product. It has been
put to us that the policy period being advertised should reflect the
period of cover, irrespective of the claims experience on the policy.

64. In Autumn 2000, the Financial Ombudsman Service ruled on a
complaint received about a Comet extended warranty refund offer,
described as 'Make a claim or your money back'. The warranty holder
had not complied with the terms for claiming the refund, and the
Ombudsman considered that 'small print' procedural requirements such
as these terms were inappropriate and might well be considered unfair
contract terms. Comet subsequently rescinded its cashback scheme. So
far as we know, very few retailers still operate similar schemes.

65. The OFT suggested that policies that assumed depreciation in the
value of goods, so that after a certain period of time the electrical
appliance is assumed to be worth significantly less than its original
cost, might be considered to be unfair. Some policies limit overall
liability of the provider to the original purchase price or the
current value, whichever is lower. Where a depreciation rule is
applied, then the overall liability is subsequently reduced.

66. In practice, we understand that for most EWs, if a consumer's
product needed to be replaced, the warranty provider would provide a
voucher for a monetary amount that would allow the consumer to buy a
comparable new product. In many cases, customers would receive an
enhanced specification of the product compared with that of the item
being replaced because the original specification might no longer be
available. In some cases, particularly for older products, this may
mean that the value of the replacement product is below that the
original purchase value, but it may nonetheless be a superior
product.

G. Uninsured cover

67. There have been examples of company failures
that have led to purchasers of EWs losing their cover. Our
preliminary review of the questionnaire responses suggests that a
high percentage of retailers are now operating uninsured service
agreements. While most of the larger retailers have told us that
their agreements are backed by independent trust funds, some smaller
operators may be offering less financial security.

68. Where an EW is backed by an insurance company, the insurer will
be FSA regulated and so required to maintain reserves likely to
ensure solvency, but should it fail the consumer will have the
benefit of an FSA compensation scheme. Uninsured service contracts
are not subject to the same regulation. However many providers of
such schemes have arranged ring-fenced reserves to protect the
interests of their EW customers in the event of insolvency. There
have been cases where other providers have taken over obligations
where an EW provider has failed. During early 2002 Dixons Group
provided EWs to 400,000 former Tempo customers through arrangements
entered into with the Administrators of the failed business and
various of its credit providers.



ANNEX 4 RELEVANT STATUTORY PROVISIONS AND TERMS OF REFERENCE

Fair Trading Act 1973

Section 7: Monopoly situation in relation to supply of services

(1) For the purposes of this Act a monopoly situation shall be taken
to exist in relation to the supply of services of any description in
the following cases, that is to say, if - (a) the supply of services
of that description in the United Kingdom is, to the extent of at
least one-quarter, supply by one and the same person, or supply for
one and the same person, or (b) the supply of services of that
description in the United Kingdom is, to the extent of at least
one-quarter, supply by members of one and the same group of
interconnected bodies corporate, or supply for members of one and the
same group of interconnected bodies corporate, or (c) the supply of
services of that description in the United Kingdom is, to the extent
of at least one-quarter, supply by members of one and the same group
consisting of two or more such persons as are mentioned in
sub-section (2) of this section, or supply for members of one and the
same group consisting of two or more such persons, or (d) one or more
agreements are in operation, the result or collective result of which
is that services of that description are not supplied in the United
Kingdom at all.

(2) The two or more persons referred to in sub-section (c) of thissection,
in relation to services of any description, are any two or
more persons (not being a group of interconnected bodies corporate)
who whether voluntarily or not, and whether by agreement or not, so
conduct their respective affairs as in any way to prevent, restrict
or distort competition in connection with the supply of services of
that description, whether or not they themselves are affected by the
competition, and whether the competition is between persons
interested as persons by whom, or as persons for whom, services are
supplied.

(3) In the application of this section for the purposes of a monopoly
reference, the Commission, or the person or persons making the
reference, may, to such extent as the Commission, or that person or
those persons, think appropriate in the circumstances, treat services
as supplied in the United Kingdom if the person supplying the
services -has a place of business in the United Kingdom, or -controls
the relevant activities from the United Kingdom, or -being a body
corporate, is incorporated under the law of Great Britain or of
Northern Ireland, and may do so whether or not those services would
otherwise be regarded as supplied in the United Kingdom.

Inquiry Terms of Reference

Extended Warranties

The Director General of Fair Trading in exercise of his powers under
sections 47(1), 49(1) and 50 (1) of the Fair Trading Act 1973 (the
Act) hereby refers to the Competition Commission the matter of the
existence or possible existence of a monopoly situation in relation
to the supply of extended warranties for domestic electrical goods
within the United Kingdom.

The Commission shall investigate and report on the questions whether
a monopoly situation exists and, if so:

(a) by virtue of which of the provisions of sections 6 to 8 of the
said Act that monopoly situation is to be taken to exist;
(b) in favour of what person or persons that monopoly situation exists;
(c)whether any steps (by way of uncompetitive practices or otherwise)
are being taken by that person or persons for the purpose of
exploiting or maintaining the monopoly situation and, if so, by what
uncompetitive practices or in what other way;
(d) whether any action or omission on the part of that person or persons
is attributable to the existence of that monopoly situation and, if so, what
action or omission and in what way it is so attributable; and,
(e) whether any facts found by the Commission in pursuance of their
investigations under the preceding provisions of this paragraph operate
or may be expected to operate against the public interest.

For the purposes of this reference:

'extended warranty'

means a contract, whether backed by insurance or otherwise, which
covers consumers within the meaning of section 137 of the Act for the
cost of any repairs or replacements that may become necessary within
a specified period beyond that covered by a manufacturer's,
retailer's, or importer's guarantee, and includes both contracts that
provide cover during the period of the manufacturer's, retailer's, or
importer's guarantee, and contracts where cover commences after this
period, and

'domestic electrical goods'

are products designed to be connected to an electricity supply or
powered by batteries, and on which extended warranties are offered to
consumers within the meaning of section 137 of the Act.

The Commission shall report on this reference within a period of 12
months from the date hereof.

Director General of Fair Trading 2 July 2002

ANNEX 5 TAX ARRANGEMENTS
Insurance Premium Tax and Value Added Tax

1.Insurance products are exempt from Value Added Tax (VAT). Insurance
Premium Tax (IPT) was introduced in October 1994 on certain insurance
products, including insured EWs, at a single rate of 2.5%. This was
raised to 4%% in 1997. At the same time a higher rate of 17.5% was
introduced (the same rate as for VAT) for EWs sold by retailers as
well as certain other products. The lower IPT rate remained for EWs
sold directly to consumers (and all EWs on mobile phones); the rate
was increased to 5% in 1999. Unlike most VAT, IPT is not recoverable.
VAT is not recoverable on costs associated with insured EWs (such as
repair costs).

2. Uninsured EWs (or service contracts) are not insurance products and
therefore attract output VAT at 17.5%. No IPT is levied. Companies that
supply these contracts can recover the input VAT incurred on their
business costs by offset against output VAT levied and a net figure
paid to/recovered from HM Customs & Excise.

3. Before the IPT rate increase to 17.5% it was advantageous
to retailers to supply insurance backed rather than service
contracts. This advantage disappeared when IPT was raised to 17.5%
and was replaced by the disadvantage that no input VAT could be
reclaimed.

4. Some "hybrid" EWs include elements of insured and
uninsured cover, for example with cover against the need for repair
provided through a service contract and cover against theft through
insurance. Controlled Foreign Companies

5. A Controlled Foreign Company (CFC) is a company that is; * resident
outside the UK * controlled by persons resident in the UK * subject to
a lower level of tax in the jurisdiction in which it is resident (lower than the
rate at which it would be taxed in the UK - (2002/03: small company
rate 19%, and large company rate 30%).

Current legislation

6. Under Corporation Tax Self Assessment (CTSA), all UK companies
must, in their annual Corporation Tax return, list all CFCs in which
they have an interest and self assess the Corporation Tax due on any
eligible profits arising within them.

7. A company is deemed to have an interest in a CFC if * it holds a
25% interest in the company and * the company has a minimum profit
before tax of 50,000.

8. Where a UK resident company has an interest in a CFC, the profits
of the CFC are taxed in the UK to the extent that they would have been
assessable to UK tax if the CFC had been a UK resident company
(subject to any eligible double tax relief). That is, the profits
which would have been assessable to tax are included within the
Corporation Tax computation for the UK parent and the amount already
paid in tax in the territory in which the CFC is resident is deducted
from the balance due to avoid any double taxation on the same
profits. For example, if a CFC pays tax on its chargeable profits at
10% in a foreign jurisdiction then, assuming the parent company pays
tax at 30%, a further 20% would be due to the UK Revenue.

9. Under current legislation certain activities of CFCs are deemed to be
"exempt activities" and any profits arising on these fall outside the
scope of UK Corporation Tax, despite the fact that had the company
been a UK resident it would have been assessable to Corporation Tax.
Some DEG retailers have been able to avoid paying UK tax on the
extended warranty activities of their CFCs by ensuring that less than
50% of the premium income of these CFCs derives from connected or
associated parties, thus qualifying for the exempt activities
provision. This is achieved in one of two ways. Either the consumer
contracts for the EW with the retailer which insures the transaction
with an unconnected insurer, which in turn reinsures with a captive
insurance company in the same group as the retailer; or the consumer
contracts with the captive insurer rather than with the retailer.

Changes in legislation

10. In his pre-budget report on 27 November 2002 the Chancellor
announced certain changes in legislation. These are aimed at taxing
those profits arising from the EW business of retailers in the UK
which have previously structured their operations to take advantage
of the exemptions described above, such that in future profits
arising from such EW business will be chargeable to UK Corporation
Tax provided that more than 50% of the profits on such activities
arise from UK residents (ie UK resident companies or individuals).
This change in the legislation ensures that both primary insurance
and reinsurance through captive insurance companies is now within the
charge to UK Corporation Tax. These changes are not retrospective and
apply only to accounting periods beginning on or after 27 November
2002.

11. The additional Corporation Tax due as a result of this change
will become payable in the UK by the parent company of the CFC and
will be the difference between the amount which would have been
payable in the UK had the captive insurance company been a UK
resident company and the amount which has already been paid in the
jurisdiction in which it is currently resident (thus avoiding any
double taxation on the same profits).


1 In some cases an importer or local subsidiary may represent a
manufacturer in the UK. Where we use the term 'manufacturer' this
should be taken to include cases where the DEG or EW under
consideration is actually supplied by an importer or another company
acting on behalf of the manufacturer.

2 Existing statutory protection currently provides only for compensation
and not for a right to repair. However, the EC Directive on Consumer
Goods and Associated Guarantees is likely to establish a right to
repair or replacement when it is implemented in the UK; it will also
shift the burden of proof from the consumer in establishing that a fault
existed at the time of purchase, to the retailer who will have to establish
that there was no pre-existing fault. This is likely to be in March 2003.

3 The term 'service contract' does not imply that there is any
programme of regular servicing included in the EW - very few EWs of
any type include such terms.

4 However, there may also be advantages to the consumer from paying
for an EW in advance. Advance payment may reduce the size of risk
premium an insurer will charge to a retailer, or may lower the expected
costs of claims the supplier of a service contract EW may face, and
hence the retail price to the consumer might be lower (see paragraph
2.45 for the reasons for this). Payment in advance will also preclude
inflationary increases in premiums, and will protect the consumer from
being penalised for claims as may happen under annually renewable
policies.

5 Some EWs have included terms which allow consumers to claim back
the cost of the EW when it expires if they have not made a claim. In
practice consumers have usually had to meet tight deadlines for
registering for the offer when they buy the EW, and for claiming the
money at the expiry of the EW. Consequently successful claim rates
have usually been low. Most providers have now withdrawn such
cash-back policies.

6 When a failed DEG is beyond economic repair, providers may
replace it with an equivalent model, or provider a monetary contribution.
Some EW providers may pay less than the purchase price of the DEG,
to reflect the fact that the product will have depreciated, the consumer will
have benefited from part of the useful life of the product, and to
guard against any deliberate sabotage of DEGs by policy-holders as
the EW nears the end of its term. Whether any such depreciation
clauses are applied, and the rates employed, can vary between
providers.

7 The Herfindahl-Hirschmann Index is a measure of market
concentration, calculated by summing the squares of the percentage
market shares of all companies in the market. To put this value in
perspective, the US Competition Authorities issues guidelines in 1992
for assessing mergers which suggest that a Herfindahl value of up to
1,000 indicates a market which is unconcentrated and so a merger
would be unlikely to cause concern, whereas a figure over 1800 would
indicate a concentrated market where a merger would be likely to
raise strong concerns. Moderate concentration, between 1000 and 1800,
would need to be assessed on a case-by-case basis.

8 As companies' accounting years vary, this is based on information
supplied to the Commission in respect of whichever accounting year
includes 25 December 2001.

9 Those currently identified. Not included in the above list are small
retailers (approximately 3,000) which will account for small shares of
supply of EWs. Also not included are some large companies who
account for small shares of supply.

10 Figures for those companies listed are for EWs sold at point of sale
of the DEGs (ie excluding renewals and other non-point of sale
provision of EWs).

11 All EWs sold by the relevant companies at point of sale. Includes
free EWs.

12 The sum of the supply of all EWs whether or not at point of sale of
the DEGs. This is taken from information supplied to date with an
addition of 50m. to cover estimates of information not received.

13 By spontaneous, we mean that respondents were asked whether they
could name types of companies that provide EWs. For prompted
responses, they were then read a list of types of company and asked
which ones supplied EWs.

14 We were told that the BRC Best Practice Code sets out "minimum
standards of good practice [to] be observed when promoting and selling
EWs", and it explicitly states "those selling extended warranties and
warranty providers will take steps and have a policy to prevent undue
pressure to purchase being applied at the point of sale."

15 It should be noted that sample sizes for Powerhouse, Dixons and
PC World are small so the results should be regarded with caution.



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