11

3.Understanding barriers to energy efficiency‘....the debate between ‘engineering’ and ‘economic’ approaches to energy efficiency in fact involvesan underlying conflict over economic principles. To resolve this conflict, technology analysts mustacknowledge that empirical findings are meaningful only when linked to a well articulated theoreticalframework. Similarly, economists must recognise that theoretical assertions are meaningful only ifthey stand up to empirical scrutiny.’1

The section develops a systematic classification of barriers to energy efficiency based on acomprehensive review of the literature. The aim is to clearly define each barrier and to describeits mode of operation. This forms a basis for developing suitable measures for each barrier toguide to the empirical research. Here a ‘measure’ is a means of identifying the existence andimportance of the barrier using evidence from case study research.

The taxonomy aims to synthesise ideas from three broad areas of literature: economics;behavioural/psychological theories; and organisational theories. Within this, the economicsliterature has been given the greatest emphasis as the concept of a barrier originates from withinit. The argument developed here is that mainstream economic theory is useful but insufficient tounderstand barriers to energy efficiency. Instead, understanding may be enhanced by introducingideas from more recent developments in economic theory, including organisational economicsand transaction cost economics. Not only do these ideas aid the understanding of barriers, theyalso legitimate a wider scope for policy intervention.

3.1 WHAT IS A BARRIER?

A barrier is a postulated mechanism that inhibits investment in technologies that are both energyefficient and (apparently) economically efficient. To determine the existence of barriersempirically we need to ask (Weber, 1997):

1. What is the barrier? e.g. hidden costs, risk, lack of capital, lack of information,inadequate financial incentives etc.

2. Who or what is it an obstacle to?: e.g. firms, public organisations, departments withinorganisations, individuals.

3. What does it prevent? e.g. purchase of more efficient equipment, retrofitting insulation toa building, establishing a monitoring & targeting scheme.

Hence for the empirical research to be fruitful we need to:

1. Obtain a clear theoretical understanding of the nature of the proposed barrier. This involves aprocess of abstraction, and includes assumptions about the nature of individual rationality (e.g.utility maximising behaviour or routine following), and the relative importance of socialstructures and individual agency.

2. Identify the relevant actor. The primary question is: why do organisations neglect costeffective investments?. But to answer this we must examine the role of individuals anddepartments within the organisation. Equipment suppliers, public agencies and energy servicecompanies (ESCOs) will also play an important role, but the constraints of this project mean

1 Sanstad & Howarth (1994) p 817

12

that these can only be studied to a limited extent. The primary focus will be decision makingwithin energy using organisations.

3. Identify the relevant energy efficient investment. We will seek to understand the generalcontext of energy decision making within an organisation. But within this we will focus onwhy specific technologies have or have not been adopted. A list of relevant technologies willbe developed for each sector based on those most widely recommended in energy efficiencypublications.

This section is concerned primarily with (1) above - identifying the proposed barriers.Identification of the relevant actors and technologies forms part the empirical research withineach country and sector and is described in the individual case study reports. Results of theresearch are summarised in sections 4 to 7.

A review of the literature leads to a broad classification of barriers into three groups: i) neo-classical; ii) behavioural; and iii) organisational. In practice this typology is not exclusive; eachbarrier will have economic, behavioural and organisational aspects (Weber, 1997, p834). Thethree groups form perspectives that highlight particular aspects of a complex situation. One aimof the empirical research is to determine which perspective offers the most plausible account ofwhy investments are not undertaken. Table 3.1 introduces each perspective.

Table 3.1 Perspectives on barriers

Perspective Examples Actors TheoryEconomic imperfect information,

asymmetric information,hidden costs, risk

Individuals &organisations

conceived of asrational & utility

maximising

Neo-classicaleconomics

Behavioural inability to processinformation, form of

information, trust, inertia

Individualsconceived of as

boundedly rationalwith non-financial

motives and a varietyof social influences

Transaction costeconomics,

psychology, decisiontheory

Organisational energy manager lackspower & influence;

organisational culturelead to neglect of

energy/environmentalissues

Organisationsconceived of associal systems

influenced by goals,routines, culture,

power structures etc.

Organisationaltheory

Again, it should be noted that these perspectives overlap. For example, transaction costeconomics combines neo-classical ideas with behavioural theories (bounded rationality) andthrough this derives an explanatory theory for the existence and structure of organisations(Williamson, 1985). Transaction cost economics provides a powerful perspective on the barriersproblem and will be elaborated in more detail in section 3.2.10.

Historically the theory of market barriers has been developed from within an economicperspective, and the contribution of alternative perspectives to the understanding of barriers ismuch less well defined. However, the assumption behind this project is that standard economic

13

theories may not be sufficient to provide an adequate explanation for the efficiency gap.Therefore, other perspectives will need to be explored.

3.1.2 A map of barrier models

As a guide to the following sections, Table 3.2 provides a summary of the barriers identified fromwithin each perspective. Note that values and organisational culture are italicised. In this context,the first refers to environmental values held by individuals, while the second refers toenvironmental values embedded within an organisations’ customs and routines. The assumptionhere is that the existence of environmental commitments can be an important variable inexplaining the take-up of energy efficient technologies. However, the absence of environmentalvalues/culture cannot be strictly characterised as a barrier as efficiency investments are assumedto be cost effective under normal commercial criteria.

14

Table 3.2 A taxonomy of barriers to energy efficiency

Perspective Sub-division Barrier Description CommentsEconomic Rational

behaviourHetrogeneity Technology may not be cost effective in a

particular instanceAn empirical question.

Hidden costs Technology investment entails extra costs orloss of benefits that are not reflected inengineering models.

Examples include overheads for staff,overheads for energy information systems,disruptions, hassle, and inconvenience.

Risk Stringent investment criteria may represent arational response to risk

Energy efficiency investments may be a higherrisk than others, or there may bebusiness/market risk

Access tocapital

Some agents cannot obtain capital to invest. A key issue is the level of gearing of acompany and the expected consequences offurther borrowing

Market ororganisationalfailure

Imperfectinformation

Agents lack sufficient information to makeeconomically efficient decisions.

Information has public good characteristicsand may be undersupplied by markets.

Adverseselection

Agent cannot transmit or discover energyproperties of a good.

A form of asymmetric information in whichtransaction costs prevent the energy efficiencybenefits of a good from being signalled.

Split incentives Agent cannot appropriate benefit ofinvestment - landlord-tenant typerelationships.

Examples included departments not beingaccountable for energy consumption, andequipment purchasers not being accountablefor running costs

Principal-agentrelationships

Principal may impose strict investmentcriteria to compensate for imperfectinformation

Asymmetric information creates incentives forthe agent to maximise his utility to thedetriment of the principal. Principal-agentrelationships are pervasive withinorganisations.

15

Behavioural Boundedrationality

Boundedrationality

Cognitive limitations lead to agentssatisficing rather than optimising and relyingon routines & rules of thumb.

Organisational routines may systematicallyneglect energy efficiency

Well established opposition to mainstreamtradition in economics. Strongly supported byempirical studies of energy decision making.

Routines are an organisational solution tobounded rationality

The humandimension

Form ofinformation

Form of information may be inadequate tostimulate action.

Results from social psychology. Form ofinformation as important as cost.

Credibility andtrust

Agent may not trust source of information Credibility enhanced by interpersonal contacts.

Inertia1 Agents resist change because they arecommitted to what they are doing and justifyinertia by downgrading contrary information.

Derives from theory of cognitive dissonance.

Values2 Lack of environmental awareness leads toneglect of efficiency opportunities

Not barrier but an important explanatoryvariable

Organisationaltheory

Power Agents lack sufficient power within anorganisation to initiate action

Energy manager may lack status and authority

Culture Environmental awareness and energyefficiency play no part in corporate culture.

Not a barrier but an important explanatoryvariable

16

3.2. ECONOMIC APPROACHES TO BARRIERS

3.2.1 Neo-classical behavioural assumptions

Much of the barriers literature is rooted in neo-classical economics. This approach attempts toreconcile the existence of the efficiency gap with the hypothesis that consumers make energyrelated decisions in a fully rational manner. Despite extensive criticism, this approachremains dominant (Sutherland; 1996; Jaffe & Stavins, 1994b).

Neo-classical economics assumes that individuals have stable preferences that they seek tosatisfy through market transactions (Sanstad & Howarth, 1994). The choices consumers makereveals information about these underlying preferences. Hence, the acceptance or rejection ofenergy efficient technologies reflects a rational evaluation of the relevant costs and benefits.While factors such as imperfect information may influence the decision, possibly to thedetriment of energy efficiency, the rationality hypothesis is a core assumption that is notchallenged.

A common criticism of this standpoint is that it represents a unrealistic description of actualbehaviour (Hodgson, 1988). This type of rationality would require individuals to solvecomplex optimisation problems - such as those that fill economics journals! FollowingFriedman (1953), many economists respond to this criticism by arguing that while peoplemay not solve complicated optimisation problems, they behave as if they do. For example:

‘....It is not necessary that people know-how to perform net present value calculations; rather, theymake decisions balancing costs today and costs tomorrow, with those trade offs incorporating theirtrue discount rate.’2

Economic models are therefore argued to provide a good description of observed behaviour.

As pointed out by Hodgson (1988), a central problem with this approach, is that it does notallow for falsification. If empirical results run counter to theoretical predictions, the modelsare adjusted by adding hidden costs, information asymmetries and other factors. This runs therisk of tautology: since agents are rational, failure to invest in energy efficiency must implythe existence of hidden costs or some other factor. Sutherland provides an example of thisline of argument (Sutherland, 1994; Sutherland, 1996).

Despite these limitations, the neo-classical approach provides an essential baseline for anunderstanding of barriers. The following sections outline:

1. the early barriers literature;2. the economists’ recasting of this literature in terms of neo-classical market failures;3. the distinction made by Jaffe & Stavins between ‘true market failures’ and ‘non market

failure market barriers’;

2 Jaffe & Stavins, 1994b, p 810

17

4. the framework used in this project which distinguishes: a) market failures; b)organisational failures; and c) non-failures (rational behavior); and

5. the relationship between barriers and discount rates

The discussion draws heavily on Golove & Eto, (1996) and Jaffe & Stavins (1994b).

3.2.2 Market barriers and market failures

One of the first systematic analyses of the causes of the efficiency gap was by Blumstein et al(1980). They identified a number of features of the energy service market (barriers) that wereclaimed to inhibit investment in energy efficiency. The barriers included:

• misplaced incentives: where two parties engage in transactions where neither party has theincentive to invest in energy efficiency (the classic example is landlords and tenants);

• financing: where low income individuals and small business owners cannot gain access tocapital for efficiency investment;

• market power: where the market for energy efficient equipment is subject to imperfectcompetition;

• regulation: where regulatory control of monopoly energy suppliers leads to pricesdeparting from marginal costs; and

• gold plating: where energy efficiency is coupled with other features of a good and is notavailable separately.

This study was followed by numerous papers which extended the list of proposed barriers.For example, Hirst & Brown (1990) assert that uncertainty in future fuel prices is a marketbarrier, while Warren (1990) cites the use of stringent payback criteria for discretionaryinvestment in industry. Studies such as these attracted strong criticism from neo-classicaleconomists who pointed out that the term ‘market barriers’ is ambiguous and was not beingused in a rigorous fashion (Sutherland, 1996). Many of the proposed market barriers could bebenign characteristics of well functioning markets. For example:

• Capital markets may constrain the availability of capital to low income households, butthis may be because such households are high risk borrowers. The capital market may beworking efficiently, even though it may inhibit energy efficient investment (Sutherland,1996).

• Uncertainty in future fuel prices would lead a risk averse investor to substitute capital orlabour for fuel. Hence such uncertainty should encourage energy efficiency, not act as abarrier (Sutherland, 1996).

• Energy efficient investments may be associated with additional (hidden) costs such asmanagement time, disruption of production etc. These costs may be ignored in bottom upmodels but are nevertheless real. Investors may be making a rational decision not to investin the light of these additional costs.

Such criticisms have been very beneficial in clarifying ideas on barriers and relating these totraditional notions of market failures. The key argument is that public policy should aim toencourage economic efficiency and not energy efficiency alone (Jaffe & Stavins, 1994b;Sutherland, 1996; Golove & Eto, 1996, p 13). Neo-classical economists would assert thatintervention to encourage economic efficiency is only justified when there exists some form

18

of market failure.3 This occurs when the requirements for efficient allocation of resourcesthrough well functioning markets are violated. The basic theorems of welfare economics statethat the allocation of resources will be optimal where:

1. a complete set of markets with well defined property rights exist such that buyers andsellers can exchange assets freely;

2. consumers and producers behave competitively by maximising benefits and minimisingcosts;

3. market prices are known by all consumers and firms; and4. transaction costs are zero.

Violations of these conditions lead to four broad types of market failure:

• incomplete markets• imperfect competition;• imperfect information; and• asymmetric information.

The following four sections briefly introduce these important concepts.

3.2.3 Market failures 1: Incomplete markets

Efficient markets require property rights to be well defined, that is (Tietenberg, 1996, p41):

• comprehensively assigned: all goods are privately or collectively owned with allentitlements known and enforced;

• exclusive: all the benefits and costs from the use of a good accrue to the owner;

• transferable: all property rights must be transferable from one owner to another involuntary exchange; and

• secure: goods are safe from involuntary seizure or encroachment.

Markets fail where property rights are not well defined. Violation of the exclusivity principleleads to externalities. This is where the actions of one economic agent affects the welfare ofothers in a way that is not reflected in market prices, thereby leading to a discrepancy betweenprivate costs and benefits and social costs and benefits. The classic case is unregulatedpollution from a production process.

Private goods are characterised by excludability, where the consumption of the good can beexcluded from others, and rivalry, where consumption of the good reduces the amountavailable for others. Many ‘goods’, notably the services provided by the environment, do nothave these characteristics. This classification of goods is summarised in the following table.

3 Market failure is argued to provide a necessary but not sufficient condition for governmentintervention to improve social welfare. Government intervention may be separately justifiedfor other objectives, such as improved equity.

19

Table 3.3 Private, common, public and toll goods

Rivalry in consumption Non-rivalry in consumption

ExcludablePrivate goodse.g. food, houses

Toll goods,e.g. motorways

Non-excludableCommon goodse.g. fisheries, common grazinglands

Public goods e.g. defence, public health

Public goods are particularly relevant to the barriers debate. Public goods are not depleted byan additional user and it is generally difficult or impossible to exclude people from theirbenefits. As a consequence, public goods are unlikely to be provided by private firms becausethey cannot be priced. Instead, public goods may be provided by the government. Commonlycited examples of public goods are defence, public health, police, fire protection and certaintypes of research. The relevance of this to the barriers debate is that information is consideredto have public good aspects, as described below

3.2.4 Market failures 2: Imperfect competition

Markets need to be competitive if they are to allocate resources efficiently, although therequired degree of competition is an imprecise concept. In conditions of market power, firmsare able to charge prices in excess of marginal costs. Specific examples include monopoly,duopoly and ogliopoly. Such situations are common in the energy supply industry as it hasseveral features (e.g. electricity networks) which can be considered as natural monopolies.The thrust of liberalisation in the energy supply industry is to introduce competition where itis possible and to use economic regulation of private firms where it is not.

3.2.5 Market failures 3: Imperfect information

If the market produces and transmits insufficient information, participants will be unable toundertake all mutually advantageous exchanges. As with competition, the amount ofinformation required for efficiency cannot be precisely established.

We may expect markets to undersupply information because it has public goodcharacteristics. That is, many people may ‘consume’ the same information without reducingits supply. Similarly, it may be difficult to exclude people from the benefits of information.Private firms may be unable or unwilling to supply information because they would be unableto capture all the benefits. This is a common rationale for government intervention.

As Golove and Eto point out, the public good aspect of information is also relevant totechnology adoption:

‘....the information created by the adoption of a new technology by a given firm also has thecharacteristics of a public good. To the extent that this information is known by competitors, therisk associated with the subsequent adoption of this technology may be reduced, yet the valueinherent in this reduced risk cannot be captured by its creator.’4

4 Golove & Eto (1996, p19).

20

Hence, this may provide a rationale for government funded demonstration projects for newtechnologies.

3.2.6 Market failures 4: Asymmetric information

This is a special form of imperfect information where parties to a transaction have access todifferent levels of information. For example, a seller may know more about the quality of agood than the buyer. Similarly, an insuree may know more about her level of precautionarybehaviour than the insurer. Two important consequences of asymmetric information areadverse selection and moral hazard. In addition, the more familiar barrier of split incentivesmay also be interpreted as a consequence of asymmetric information. These important ideasare introduced below.

Adverse selectionAdverse selection exists when one party has private information, before entering into acontract to buy or sell. As a consequence of this, the premium charged may affect theselection of customers who buy or sell (Milgrom & Roberts, 1992, p149). For example, loanapplicants may have private information about their creditworthiness or business prospects.This information is not accessible by lenders, and the applicants have no incentive to discloseit. Raising the interest rate charged to borrowers may only lead to a poorer quality of loanapplicants (Stigilitz & Weiss, 1981). This, in turn, may raise the bank’s costs of lending.

In the above example, the private information is in the hands of the buyer (loan applicant).But it may equally well be in the hands of the seller. The seller may have difficulty incommunicating that information to potential buyers. For example, consumers may be unableto observe the superior quality of a product. They will tend to select goods on the basis ofvisible aspects such as price, and be reluctant to pay the price premium for high qualityproducts. As a result, too little of the high quality product may be sold despite the existence ofan effective demand.

In some cases, low quality products will drive high quality products out of the market. Theclassic demonstration of this was by Ackerlof (1970) who used this model to examine thesecond-hand car market. The quality of a secondhand car is private information to the seller -the buyer has no way of finding out. The more poor quality cars there are on the second-handmarket, the lower the average quality and the lower the price. This will discourage owners ofquality cars from putting them up for sale, thereby driving the average quality and price stilllower. This sort of process could reach an equilibrium in which only the poorest quality carsare traded - i.e. bad drives out good. This is a highly plausible explanation for a commonlyobserved phenomenon - the value of a second-hand car is much less than a new one, evenwhen it is only a couple of months old.

The problem of adverse selection may be overcome through product guarantees (marketsignalling) or through intervention in the form of product standards

Moral hazard and principal-agent relationshipsThe term moral hazard originated in the insurance industry (Pindyk & Rubenfeld, 1998,chapter 17). Insurance companies lack the ability to monitor the actions of policyholders afterthey have issued a policy. But the holder may act in a way to make the insured loss morelikely to occur.

21

The term is now used more widely to describe to any behaviour under a contract that isinefficient (Milgrom & Roberts, 1992, p195). It refers to situations where the actions of oneparty are unobservable to a second party. Since the interest of the two parties may differ, thiscreates an incentive to act in an opportunistic manner to the detriment of the other. Thiscreates economic inefficiency as the costs and benefits of acting differ from the true socialcost. Note that, in contrast to adverse selection, moral hazard refers to opportunisticbehaviour after a contract has been signed.

Moral hazard is usually discussed in the context of principal-agent relationships. Here, theagent is the party who acts (e.g. a worker) and the principal is the party whom the actionaffects (e.g. a employer). The principal’s problem is to ensure that the agent acts to herbenefit, but she lacks complete information - i.e. she cannot evaluate how hard the agent hasworked or whether she has been honest.

There is an extensive literature on moral hazard and principal-agent relationships (Mohlo,1998; Milgrom & Roberts, 1992). This literature began by examining the relationshipbetween managers of companies (the agent) and shareholders (the principal), but has beenextended to a wide range of contexts. Moral hazard can arise both in market relationshipsand within individual organisations. In the latter, it may be addressed through improvedmonitoring of employees and incentive contracts, although the scope for this may vary widelywith context (Milgrom & Roberts, 1992).

The distinction between adverse selection and moral hazard is summed up by Mohlo (1998,p8):

‘ In its pure form, adverse selection is a problem of precontractual opportunism in that thepresence of private information provides people with the opportunity to lie prior to contract takingplace. Moral hazard is a problem of postcontractual opportunism, in that the presence of someunobservable action provides people with an opportunity to cheat after the deal is signed.’

Split incentivesOne of the most familiar barriers to energy efficiency is split incentives. The most commonlycited example is landlords and tenants in the housing market. The landlord of a building maybe unwilling to retrofit an apartment to reduce energy use since the resulting savings wouldbe realised by the tenant. But at the same time tenants will be unwilling to retrofit since theymay move out before benefiting from the cost savings.

This type of problem may also be interpreted as a form of market failure resulting fromasymmetric information (Jaffe & Stavins, 1994b, p 805). One party may have the relevantinformation on the costs and benefits of an energy efficiency investment, but it may bedifficult to convey this to the other party. If there were no information problems, landlordsand tenants would be able to enter into contracts to share the costs and benefits of theinvestment. Hence, landlords could invest in efficiency measures and recover the value of thatinvestment through higher rents. Similarly, in cases where the landlord pays the energy bill,tenants could make the investment and recover the cost through reduced rents. In practice,however, the gains that would be achievable through such arrangements are swamped by thetransaction costs involved. The arrangements that would be needed to make rents reflect thecapitalised value of energy savings would be highly complex.

22

Split incentives may therefore be understood in the more familiar terms of inability toappropriate the benefits of an investment, or alternatively as a manifestation of asymmetricinformation and transaction costs. In either case, the situation can be understood as a truemarket failure in the neo-classical sense, thereby (potentially) legitimating public policyintervention.

3.2.7 The Jaffe-Stavins framework

The market failure framework described above gives a rigorous basis for understandingbarriers to energy efficiency and the rationale for policy intervention. Jaffe & Stavins (1994b)make the following distinction:

• market barriers refer to any factor which explains why technologies which appear costeffective at current prices are not taken up;

• market failures refer to those market barriers which correspond to the instances indicatedabove and which therefore might justify a public policy intervention to improve energyefficiency.

The (contestable) assumption here is that public policy intervention is only justified inconditions of true market failure. By implication, there may be some barriers which are notmarket failures and for which no intervention may be justified. These include somecommonly cited barriers such as hidden costs and the operation of capital markets.

Market failures are pervasive (Sanstad & Howarth, 1994, p 813). Hence, the mere existenceof market failure may not be sufficient to justify intervention; it is also necessary that thebenefits arising from an intervention exceed the cost of implementation (Jaffe & Stavins,1994b, p 808). The latter may include government expenditure, regulatory burdens and lost ofutility from changed product performance.

In addition, there may be market failures that do not explain the energy efficiency gap, butwhich may nevertheless justify public intervention. The obvious example is environmentalexternalities which are currently not reflected in energy prices. While there may be a case forraising energy prices to reflect these externalities, this does not explain the neglect ofinvestments which appear cost effective at current energy prices.

Jaffe and Stavins have used this framework to produce a helpful characterisation of the typesof barrier and the rationale for intervention. This is summarised in Table 3.4 (fulldescriptions of each barrier are given later).

23

Table 3.4 Barriers and market failures

Explains efficiency gap Does not explain efficiency gapBarriers thatare marketfailures

• Public good attributes of information• Positive externalities of technology

adoption• Split incentives in energy service

markets• Adverse selection in energy service• Moral hazard & principal agent

relationships in energy service markets

• Distortions in energy pricing(e.g. departures from marginalcost pricing, cross subsidies,VAT differentials etc.)

• Environmental externalities

Barriers thatare not marketfailures

• Heterogeneity• Hidden costs (e.g. overhead costs,

disruption)• Risk (technical or business)• Access to capital

-

Source: Jaffe & Stavins, 1994b

The Jaffe-Stavins framework provides a helpful characterisation of the potential forimproving energy efficiency. It allows a distinction to be made between (Jaffe & Stavins,1994b, p 808):

• the economists’ potential: achievable by removing market failures;• the technologists’ potential: achievable by the additional removal of ‘non-market failure

market barriers’; and• the hypothetical potential: achievable through the additional elimination of market failures

in fuel and electricity markets, such as departures from marginal cost pricing.

Jaffe & Stavins argue that the 'narrow social optimum', which corresponds solely to theelimination of market failures justified by a cost-benefit test, is likely to be very small. Theneo-classical efficiency gap is therefore much lower than the gap estimated by engineering-economic models This framework is summarised in Figure 3.1.

24

Figure 3.1 Characterisation of energy efficiency potential

Increasingenergyefficiency Hypothetical potential

Eliminate marketfailures in energymarkets

Technologistseconomicpotential

Effect of marketbarriers thatcannot beeliminated atacceptable cost

Eliminate highdiscount rates dueto uncertainty,overcome inertia,ignoreheterogeniety

Economist'seconomicpotential

Truesocialoptimum

Additionalefficiencyjustified byenvironmentalexternalities

Narrowsocialoptimum

Eliminate thosemarket failureswhose eliminationcan pass abenefit/cost test

Eliminatemarket failuresin the market forenergy efficienttechnologies

Source: Jaffe & Stavins, 1994b, p 808

Three important points should be noted about this approach. First, the assumption thatintervention should be confined to the elimination of market failures justified by a cost-benefit test is not universally accepted As with equity, reduced energy use may be considereda political objective requiring intervention, but externality taxes may not be a viable policymechanism. Addressing ‘non-market failure market barriers’ may therefore be justified.

Second, the classification of barriers as market failures or not is still the subject of fiercedebate (Sutherland, 1996; Levine et. al., 1994). Golove & Eto (1996), for example, take abroader view which hinges on the treatment of transaction costs (section 3.2.10). Thisapproach is explicitly rejected by Jaffe & Stavins (1994b, p809). The transaction costapproach gives a greater role for government intervention.

Finally, the relative size of the efficiency gaps in Figure 3.1 an empirical question. Theimportance of different barriers must first be assessed empirically, before judgements can bemade about the legitimacy of intervention. It is this, rather than the rationale for intervention,that is the focus of the BARRIERS project.

3.2.8 The framework used for the BARRIERS project

While the Jaffe-Stavins framework is very useful, it is necessary to modify it for theBARRIERS project. This is because Jaffe & Stavins refer solely to market failures, and theexamples they use are drawn solely from energy service markets. For example, principal-

25

agent relationships are illustrated with the example of house builders acting as agents forhouse buyers. In this sense they are located firmly within the neo-classical tradition in thatthey are reluctant to open up the black box of organisations and to analyse how individualorganisations behave. Instead, they prefer to treat private firms as if they were unitary, profitmaximising actors.

The inadequacy of this tradition in neo-classical theory has spurred the development oforganisational economics and the theory of the firm. This applies traditional and new ideasfrom economic theory to explain the structure and behaviour of organisations. One approach,represented for example by Olson, employs game theory to study organisations and assertsthat ‘...The logic of collective action is such that, in general, rational self-interestedindividuals will not act to achieve their common or group interests’ (Olson, 1971).Organisations must therefore use coercion or the provision of selective incentives.

More recent approaches develop the themes of asymmetric information, moral hazard,principal-agent relationships and transaction costs to explain internal organisation anddecision making (Milgrom & Roberts, 1992; Rowlinson, 1997, chapter 2). Within this, thetransaction cost framework develop by Williamson (1985) has played a central role. AsDeCanio notes:

‘The modern theory of the firm is preoccupied with how transactions costs (rooted in boundedrationality) shape the complex set of contracts and commitments that define the firm. Dealing withproblems of agency, moral hazard, imperfect or asymmetrical information and incentive design arethe substance of the modern managers’ professional life.’ (DeCanio, 1994, p106).

Using these ideas, the Jaffe Stavins framework can be extended to include the concept oforganisational failure. This recognises that many barriers result from internal organisationalstructure, procedures and routines, and from the incentives these place on organisationalmembers. In other words, as a consequence of internal organisational problems theorganisation does not respond to price signals in the manner assumed in neo-classical models.The appropriate response may then be through managerial tools, such as incentive design,rather than through public policy intervention. Using these ideas, we can classify barriers intothree groups:

• market failure: where the barrier can be considered a market failure within the energyservice market, thereby legitimating public policy intervention;

• organisational failure: where the barrier results from organisational structure and policyand may be reduced through managerial tools such as task allocation and incentive design;and

• non-failure: where the organisation is behaving rationally given the risk-adjusted rate ofreturn on an investment in the existing context of energy, capital and ‘hidden’ costs.

Table 3.5 summarises this classification, distinguishing between internal failures withinorganisations and external failures within energy services markets:

26

Table 3.5 Economic barriers: market failure, organisational failure and rational behaviour

Category Particular instanceBarriers that mayrepresent marketfailures

• Public good attributes of information associated with energyefficient technologies

• Positive externalities of adopting energy efficient technologies• Adverse selection in energy services markets• Moral hazard & principal-agent relationships in energy services

markets• Split incentives in energy services markets

Barriers that mayrepresentorganisational failures

• Imperfect information on organisational energy use• Moral hazard & principal-agent relationships within organisations• Split incentives within organisations

Barriers that mayrepresent rationalbehavior

• Heterogeneity• Hidden costs (e.g. overhead costs, disruption)• Risk (technical or business)• Access to capital

Since the focus of the BARRIERS project is public and private organisations, the aboveframework is more useful than that provided by Jaffe & Stavins. It is also relativelyunderdeveloped within the literature. While organisational economics is a well establishedfield, there are very few studies dealing explicitly with energy efficiency. Notable exceptionsinclude the work on agency and control problems by DeCanio (DeCanio, 1993; DeCanio,1994; DeCanio, 1998) and recent contributions by Howarth et al (Howarth et al, 2000;Haddad et al, 1998).

It is important to emphasise that the distinctions in Table 3.5 are blurred and contentious.Furthermore, it is incorrect to assume that organisational failures can be corrected solelythrough organisational change and that, as a consequence, they provide no rationale for publicpolicy intervention. Modern organisational economics argues that problems such asinformation asymmetries, agency relationships and bounded rationality are endemic featuresof any organisation and prevent the profit maximisation assumed by neo-classical economics(DeCanio, 1993; Milgrom & Roberts, 1992). In this context, public policy interventions thathelp organisations overcome these obstacles can be a cost effective way of both improvingeconomic efficiency and achieving wider benefits such as reduced emissions. Howarth et al(2000) illustrate this with a discussion of US programmes for promoting energy efficiency:

‘The Green Lights programme.....aims to introduce credible data on relevant investmentopportunities at a crucial point in a firm’s organisational chart.......The voluntary programmeprovides an alternative route for the flow of information that is free from the suspicion ofmisaligned incentives. In effect, EPA certifies the economic value of products and services withdesirable environmental characteristics, short circuiting the principal-agent problem within firmsby providing effective high quality information at the level of the firm that is most relevant todecision-making.......

.....The same policy mechanism that addresses the agency problem also addresses the split-incentives problem. The decision-making level within the firm’s hierarchy that maximises firm-wide profits for energy efficiency investments is where facilities management and productionbudgets are combined on the same ledger. This may be as high as the office of the chief financialofficer. Without outside intervention, this level of the firm typically would not evaluate lighting

27

retrofit or similar decisions. Such decisions would be left to appropriate divisions, where anegative decision likely would be reached. By focusing attention and providing credible data onproducts and services. Green Lights contributes to the resolution of this organisational failure.’5

3.2.9 Barriers and discount rates

High discount rates are not listed above as a barrier to energy efficiency. This is becauselabelling them as such is an example of faulty economic reasoning. Jaffe and Stavins haveprovided a cogent summary of why this is the case, which is summarised briefly below (Jaffe& Stavins, 1994b, p 806).

Jaffe & Stavins distinguish:

1. the implicit discount rate that organisations appear to be using;2. estimates of the ‘correct’ discount rate that organisations should use;3. the difference between (1) or (2) and other private sector discount rates, notably the rates

used by utilities to evaluate energy supply options; and4. the social discount rate that ought to be applied in evaluating future energy savings when

making public policy decisions.

The observation that organisations have high implicit discount rates when making energyefficiency decisions is merely a restatement of the existence of the efficiency gap. Estimatesof implicit discount rates are derived through an examination of the decisions made and acalculation of the rates that would make those decisions optimal given estimates of capitalcosts and future energy savings. But simply observing that implicit discount rates are hightells us nothing about why they are high. This could either be through organisations applyingnormal discount rates in the context of market failure, or through organisations applying veryhigh discount rates. Hence the high discount rate is not a barrier, but a restatement of thephenomena to be explained.

Similarly, estimates of the correct discount rate amounts to assuming the answer. A claim thatthe ‘correct’ discount rate is much lower than that observed amounts to assuming that allbarriers are true market failures. Similarly, the claim that consumers are already using thecorrect discount rate amounts to assuming that there are no market failures (Sutherland,1996). In neither case is the existence, operation or magnitude of market failuresdemonstrated.

The observation that private discount rates are higher than those used in energy supplyinvestment is open to the same criticism. There may be very good reasons why they arehigher, related to the relative risk of investment. Without further investigation of thesecontextual conditions, the observation tells us little.

Finally, the observation that private discount rates are higher than the social discount rate ispointless. First, no consensus has been achieved on what the social discount rate should be.Second, most other forms of investment are subject to the same argument, implying thatgovernments should intervene everywhere. Hence this observation has little policy relevance.

5 Howarth et al, 2000, p483. Emphasis added.

28

These comments demonstrate that debate over the correct discount rate to use isunproductive. The challenge is to demonstrate the operation of barriers empirically.

3.2.10 Barriers and transaction costs

The framework summarised in Table 3.5 will be used for the BARRIERS project. Asindicated, this represents an extension of mainstream economics by including ideas fromorganisational economics. At this point it should be noted that the dominant theme withinorganisational economics derives from the work of Williamson and goes under the heading oftransaction cost economics (Williamson, 1985). While transaction cost economics will notbe used explicitly within the BARRIERS project, ideas from it have informed much of thepreceding discussion. Both Sanstad & Howarth (1994) and Golove & Eto (1996) have arguedthat transaction cost economics has much to offer in understanding barriers to energyefficiency:

‘While only a subset of the original list of market barriers represent what neo-classical economistsaccept as market failures, others represent a transaction cost economics based sense of marketfailure. We would argue that both neo-classical market failures and transaction cost based failuresrepresent legitimate possible objects of government policies.’ (Golove & Eto, 1996, p 24)

The concept of transaction costs derives originally from the Nobel Prize winning economist,Ronald Coase:

‘.....there are costs of using the pricing mechanism. What the prices are have to be discovered.There are negotiations do the undertaken, contracts have to be drawn up, inspections have to bemade, arrangements have to be made to settle disputes and so on. These costs have come to beknown as transaction costs. Their existence implies that the methods of co-ordination alternative tothe market, which are themselves costly and in various ways imperfect, may nonetheless bepreferable to relying on the pricing mechanism, the only method of co-ordination normallyanalysed by economists.’6

In contrast to neo-classical economics, transaction cost economics starts with the assumptionthat transactions are rarely costless. The structure and organisation of economic institutionsare largely explained by efforts to minimise transaction costs - for example, the choicebetween in-house provision or contracting out by an industrial firm. As Kenneth Arrow hasnoted:

‘...market failure is not absolute, it is better to consider a broader category, that of transactioncosts, which in general impede and in particular cases completely block the formation of markets’7

These costs include:

• costs of gathering, assessing and applying information;• costs of negotiating with potential suppliers, partners and customers;• costs of assuming risk;• costs of reaching decisions; and• costs of reaching and enforcing agreements among parties. 6 R. Coase in his 1991 Nobel Prize Lecture, The Institutional Structure of Production, cited inGolove & Eto 1996, p 22.7 Arrow, 1969, p48

29

Williamson has systematised these ideas to explain what causes transaction costs and whytransactions occur within markets or firms. He achieves this through combining Coase’sinsights with behavioural assumptions that depart somewhat from mainstream economics.The two important behavioural assumptions are:

• bounded rationality: which implies that people make decisions subject to constraints ontheir attention, resources and ability to process information; and

• opportunism: which implies that self interest seeking can take anti-social forms such aslying, stealing and cheating.

Bounded rationality is an important concept which is developed further in section 3.6.1. Theuse of opportunism has already been implied to some extent in the earlier discussions onmoral hazard.

In Williamson’s theory, information costs can be viewed as a subset of transaction costs. Itseems a tautology to assert that transaction costs are ‘normal’ and have no implications forpolicy (Sanstad & Howarth, 1994, p 815). However, this appears to be the line taken by someneo-classical commentators. For example: ‘...Other than with regard to the public gooddimensions of learning, such adoption costs are more aptly described as part of the typicallyunmeasured costs of technology and hence, if anything, constitute a category of non-marketfailure explanation...’. (Jaffe & Stavins, 1994b, p 809). Transaction cost economics thereforerepresents a departure from the mainstream tradition and may legitimate a greater role forpolicy intention.

A very important point is that transaction costs are contingent on the institutional structure.Some structures may lower transaction costs and thereby lead to greater energy efficiency. Forexample, energy services companies may overcome many of the transaction costs faced byenergy using firms.

In a classic paper, Coase (1960) shows that transaction costs may provide a rationale forpolicy measures to internalise externalities when the costs of administration and enforcementare less than the associated benefits. Intervention circumvents transaction costs by avoidingthe costs of information dissemination and bargaining. The important policy question thenbecomes: are there possible interventions or alternative institutional arrangements that canovercome transaction costs at positive net benefit? (Sanstad & Howarth, 1994, p815).

Transaction cost theory has additional elements which will not be developed here. The theoryalso has its drawbacks: for example, transaction costs have proven difficult to measure andthere is a risk that, as within hidden costs, they can become a tautology - invoked to explainany departure from neo-classical predictions. But the important points are:

• transaction costs economics provides a powerful alternative to the mainstream tradition;• transaction cost economics has much to offer in understanding barriers to energy

efficiency;• transaction cost economics poses the important question: ‘how can transactions be

organised to economise on bounded rationality, whilst simultaneously safeguarding against

30

the hazards of opportunism?’ The same question can usefully be applied to developpolicies to encourage energy efficiency.

The following sections discuss the nature and operation of the barriers to energy efficiencyidentified from economic theory, distinguishing between: a) market failures; b) organisationalfailures; and c) rational behaviour (non-failures).

31

3.3 ECONOMIC BARRIERS 1: MARKET FAILURES

The four general types of neo-classical market failure developed earlier were:

• incomplete markets;• imperfect competition;• imperfect information; and• asymmetric information.

Most of the discussion of market failures in energy service markets centres on the last two -imperfect and asymmetric information.

Market failures in the first two categories are important but are less relevant to explaining theefficiency gap (Table 3.4). Environmental externalities represent a form of incompletemarkets, but do not explain the failure to adopt technologies at current prices. Similarly,monopoly energy suppliers may depart from marginal cost pricing but this again doesn’texplain the gap. The discussion below will concentrate on issues of information.

3.3.1 Imperfect information in energy services markets

The importance and policy implications of imperfect information is one of the central issuesin the energy policy debate. The primary claim is that the energy service market produces andtransmits insufficient information about the energy performance of different technologies.This leads consumers to make sub-optimal decisions based on provisional and uncertaininformation, and consequently to underinvest in energy efficiency. Since imperfectinformation is one of the basic market failures recognised by economists, this is claimed toprovide a rationale for policy intervention. The editors of a special edition of Energy Policyon energy efficiency note that: ‘Information problems taking different forms are the principalsource of market failures that account for the “gap” in energy efficiency investments’.(Huntington et al, 1994)

The information we are interested in falls into three broad categories:

• information on current energy consumption;• information on energy-specific investment opportunities; and• information on energy consumption of new buildings and purchased equipment

There are several dimensions to imperfect information. Following Golove & Eto (1996, p 20)we can distinguish:

• Lack of information: Consumers may lack information on the energy performance ofdifferent technologies. As Eyre (1997, p 31) notes: ‘Faced with good information oncapital costs and poor information on operating costs, consumers may rationally andsystematically choose the low capital option’.

• Cost of information: There are costs associated with searching and acquiring informationon the energy performance of technologies. Because of these costs, consumers may actwithout full information.

32

• Accuracy of information: Accurate information may be difficult to obtain, since sellers oftechnologies may have incentives to exaggerate or manipulate performance data Unbiasedinformation may be available from other sources but this may be more costly.

As Hewett (1998, p2.11) notes, the problem of imperfect information is likely to be mostserious when:

1. the product or service is purchased infrequently;2. performance characteristics are difficult to evaluate either before or soon after purchase;

and3. the rate of technology change is rapid relative to the interval between purchases.

All these apply in the case of energy service markets (Hewett, 1998, p2.11). Energyefficiency consists of a wide range of complex products and services, purchased from anequally wide range of firms. Most products (boilers, lighting equipment, insulation etc.) arepurchased infrequently and the technology will have changed substantially since the previouspurchase. Also, customers may have great difficulty in evaluating performance claims. It isvery difficult to evaluate the energy performance of technologies such as control systems,motors and variable speed drives, even after purchase. This is partly a consequence of thelack of information on energy consumption patterns and hence the lack of detailed feedbackon inefficient purchases and behaviours (Hewett, 1998, p2.13). Without low levelsubmetering, all that is available is a monthly energy bill, which makes the operating costs ofindividual technologies fairly invisible. Kempton & Montgomery (1982) have compared theinformation value of the average energy bill to that of receiving a single monthly bill from thegrocery store for ‘food’!

These features are important when we compare the purchase of energy efficiency to that ofenergy supply (e.g. electricity or gas). Here we have a simple, uniform and easy tounderstand product which is purchased from a small number of large, well established andtrusted firms. Purchases are made regularly, market information is widely available and‘performance’ is judged largely on price. In short, the costs of acquiring information onenergy efficiency greatly exceed that for energy supply. Now energy supply and energyefficiency may be understood as different means of delivering energy services (heat, lightetc.). Viewed in this way, the latter is disadvantaged relative to the former. The result islikely to be overconsumption of energy and underconsumption of energy efficiency.

Problems of imperfect information provide a rationale for policy intervention - such asgovernment information schemes. The Energy Efficiency Best Practice Programme (EEBPP)in the UK is a good example. However, the form of intervention is important. Sutherlandargues that appliance labelling schemes are legitimate as they directly address the informationmarket failure. But he argues that not appliance standards are not legitimate since theyprevent some customers from exercising their preferences for low capital cost/high energycost appliances (Sutherland, 1996, p 364).

This argument assumes that intervention should be confined to correcting neo-classicalmarket failures, and only where the benefits outweigh the costs (Jaffe & Stavins, 1994b).However, most commentators acknowledge a wider role for intervention. For example,harmful drugs are not labelled but banned, on the grounds of public safety. The

33

appropriateness of intervention is therefore as much an ideological as empirical issue. Anadditional point is that labelling schemes are widely recognised as being less effective inreducing energy consumption than appliance standards (Robinson, 1991).

While neo-classical arguments suggest that information may be underprovided by the market,they give little guidance on how much information should be provided. Empirical researchmay demonstrate that agents lack information and that this provides an explanation for thefailure to adopt a technology. However, the extent to which this legitimates policyintervention is open to dispute. The case for intervention must therefore be treated as asecond order question. The first priority for empirical research is to determine:

• how much information agents possess;• the reasons why they lack information; and• the effect this has on investment decisions.

3.3.2 Asymmetric information in energy services markets

As described in section 3.2.6, three types of asymmetric information are relevant to marketfailures:

• Adverse selection in energy service markets;• Moral hazard within principal-agent relationships in energy service markets; and• Split incentives (or appropriability) in energy service market.

These are discussed in turn below. Examples of asymmetric information within organisationsare discussed in section 3.4.

Adverse selection in energy services marketsProblems of adverse selection may pervade the energy services market. Take housing as anexample. In a perfect market, the resale value of a house would reflect the discounted valueof energy efficiency investments. But asymmetric information at the point of sale preventsthis. Buyers are unable to recognise the potential energy savings and account for them whenmaking a price offer. Estate agents have greater resources than buyers, but similarly neglectenergy efficiency when valuing a house. Since the operating costs of a house affect the abilityof a borrower to repay the mortgage, they should be reflected in mortgage qualifications.Again, they are not. In all cases, one party (e.g. the builder) may have the relevantinformation, but transaction costs impede the transfer of that information to the potentialpurchaser. The result may be to discourage house builders from constructing energy efficienthouses as they will not be able to capture the additional costs in selling prices.

The same processes are at work in a range of energy services markets. In many cases,producers may be unable to market desirable technologies since consumers are unable toobserve their characteristics prior to sale (Howarth & Sanstad, 1995, p106). For example, theenergy efficiency of commercial buildings depends heavily on the detailed features of heating,ventilation and controls such as Building Energy Management Systems (BEMS). But incomparison to highly visible features such as outward form and aesthetics, the performance ofbuilding services equipment is extremely difficult for the customer to observe. Substitutionof an inefficient or oversized piece of equipment in place of efficient equipment could be

34

relatively easy. In an analogous manner to Akerlof’s second-hand car market, we may havebad (inefficient equipment/buildings) driving out good (efficient equipment/buildings).

The importance of adverse selection will depend on the nature of the good or service. Here, itis important to recognise that the energy services market is highly differentiated (Golove &Eto, 1996, p 28). At one end we have energy supply (kWh) and at the other we have energyefficiency investments, such as insulation. But in between, there are products that use energy(e.g. appliances) and products that affect the use of energy (e.g. building materials). Thesemay be purchased directly, or via intermediaries such as construction firms or maintenancefirms. In these intermediate cases, energy efficiency is a secondary feature of the product orservice and often relatively invisible.

One way of classifying goods is as follows (Hewett, 1998, p 2.14):

• search goods: where quality may be ascertained by searching for information prior topurchase;

• experience goods: where consumers cannot determine quality prior to purchase and mustrely on learning from experience after the purchase; and

• credence goods: where consumers cannot ascertain quality even when they have hadexperience with their purchase.

Goods that have energy labels may fall in the category of search goods with regard to energyefficiency. But, as Hewett (1998, p 2.14) points out, most energy efficiency products andservices are credence goods. Inadequate submetering together with complicating factors suchas changes in weather or production output will mean that the energy performance of newlypurchased equipment cannot be observed, even after purchase. In this context, the purchasingdecision is heavily influenced by the perceived trustworthiness of the seller. Absence of trustwill create problems. Credence goods such as energy efficiency will therefore be particularlyvulnerable to adverse selection (Hewett, 1998, p 2.14)

Moral hazard and principal-agent relationships in energy services marketsPrincipal agent relationships are more relevant to barriers within organisations than to thewider energy services market (section 3.4). But some features of the energy services marketmay be interpreted in these terms. For example, construction companies may be interpreted asacting as agents for the client. The latter may either be the ultimate occupier of the buildingor a speculative developer. The construction company may have incentives to take actionswhich are different from what the principal would prefer - notably to cut corners on energyefficiency to maximise profits. This is possible because the agents’ actions are largelyunobservable by the principal. In a similar manner, subcontractors to the main constructioncompany may also have incentives to maximise profits by, for example, putting in cheaperand less efficient components. In complex projects such as buildings, these actions mayeasily undermine energy efficiency.

Split incentives (appropriability) in energy services marketsThe appropriability, or split incentives, barrier has been recognised for many years and isclearly of major importance. The key issue is: What’s in it for me?

35

As described in section 3.2.6, the classic example is landlord-tenant relationships. Here, thelandlord of a building may be unwilling to retrofit an apartment to reduce energy use since theresulting savings would be realised by the tenant. But at the same time tenants will beunwilling to retrofit since they may move out before benefiting from the cost savings.

Most literature on split incentives has focused on the household sector. But landlord-tenantproblems also arise in the public, commercial and industrial sectors through the leasing ofbuildings. This barrier is particularly important in commercial buildings as the leasing ofoffice space is very common. In many leases, tenants simply pay a fixed pro rata share of thebuilding’s energy bill. This means the savings generated by one tenant’s investment wouldaccrue to all other tenants as well, diluting the investment incentive. The problem could beovercome through sub-metering, but this appears relatively rare. As in the housing market,transaction costs will prevent the benefits of such investments from being shared.

36

3.4 ECONOMIC BARRIERS 2: ORGANISATIONAL FAILURES

Organisational failures fall into two broad categories:

• Principal-agent relationships within organisations• Split incentives & appropriability within organisations

These are discussed below.

3.4.1 Moral hazard and principal-agent relationships within organisations

Barriers within organisations are exemplified by the use of stringent payback periods forenergy efficiency investments. It is common to observe both: a) the use of payback rates inpreference to discounted cash flow analysis; and b) the use of very stringent payback criteria(<2 years) which are significantly greater than firm’s cost of capital (DeCanio, 1994). Theseobservations run counter to the recommendations of neo-classical economics which are thatfirms should proceed with all investments whose risk-adjusted rates of return exceed thefirm’s cost of capital. The fact that departures from this recommendation are the normdemands explanation. Principal-agent relationships within the organisation may provide suchan explanation.

As indicated in section 3.2.6, principal-agent relationships exist where the interests of oneactor, the principal, depends on the action of another actor, the agent. The agency problemarises when the principal tries to ensure that the agent behaves in ways that are consistentwith the principal’s interests. The relationship between shareholders/owners and a firmsmanagers takes this form but, more fundamentally, agency relationships are pervasive withinfirms. In hierarchical structures, one person may be both a principal and agent at the sametime for different functions. Similarly, one person may have more than one principal.

The objectives of the principal and agent are assumed to diverge. To ensure her interests arebeing met, the principal may strictly monitor the agent, and/or create an appropriate incentivestructure (Rowlinson, 1997, p31).

Principal-agent relationships represent a form of asymmetric information. Principals (e.g. theowner) cannot observe either the true quality of decision making or the true profitability ofprojects. They will be unfamiliar with the specific local conditions in which the agent makesher decisions and there are transaction costs entailed in transmitting the relevant information.This creates the risk that profits are dissipated into ‘managerial slack’ - defined as the excessof resources over the minimum required for the task (DeCanio, 1993, p 909). One method ofreducing this slack is to set the hurdle rate for investment projects to be substantially abovethe cost of capital to ensure that only highly profitable investments are undertaken (Antle &Eppen, 1985; Statman, 1984). Under certain assumptions this allows the principal to controlmoral hazard at lower cost (DeCanio, 1993, p 909). Furthermore, we would expect the hurdlerate to be higher for small investments, since the transaction costs of determining theprofitability of the investment represent a greater portion of the expected savings. Energyefficiency investments typically fall into this category of small, cost saving investments.

37

Several formal models have been developed to demonstrate this outcome (Narayanan, 1985;Chaney, 1989). But, as DeCanio notes:

‘...the underlying idea....is that the owner’s general problem of acquiring information andexercising control leads to second-best expedients that may maximise profits subject toorganisational constraints but are not first-best solutions that would optimise the allocation ofresources..’(DeCanio, 1983, p 910).

The primary second best expedient is the use of high hurdle rates (short payback periods) forenergy efficiency investments. But the widely observe practice of capital rationing (Ross,1986) may also be explained in these terms. Here, managers reduce the funds available forsmall, cost saving projects to reduce the risk that, in the absence of effective monitoring,resources will be misallocated.

3.4.2 Split incentives & appropriability within organisations

A second asymmetric information barrier is split incentives, analogous to landlord tenantrelationships (DeCanio, 1983, p 908).

It is often the case that managers remain in their post for relatively short periods of time(DeCanio, 1993, p 908). In large companies, there may even be a policy of job rotation. Buta manager who is in a post for only 2-3 years has no incentive to initiate investments thathave a longer payback period. The incentive structure is therefore skewed towards projectswith rapid returns - although these may prove inferior to others if a full discounted cash flowanalysis were performed. As with landlords and tenants, problems of information andcommunication prevent the incentive structure from being modified. Statman & Sepe point toa related issue in that, even without job rotation, management incentive structures aretypically biased towards short term performance (Statman & Sepe, 1985).

The use of submetering and cost centres is also a crucial issue. It is necessary to ask, what arethe personal incentives for investing in energy saving? The greatest incentive would be if thedivisional managers were responsible for their own energy costs and could directly benefitfrom any savings. If cost savings are recouped elsewhere then this incentive is diluted. Tointroduce such accountability, it may be necessary to submeter energy use by individual costcentres. Alternatively, accountability could be centralised with the energy management staffwith individual posts made self funding from the savings from efficiency improvements. Theappropriate solution will depend very much on the size and structure of the organisation andon the proportion of total costs accounted for by energy (this will determine the strength ofthe incentive). Complex issues of accountability may be expected to arise in largerorganisations.

Very similar issues arise in equipment purchasing. The purchaser may have a strong incentiveto minimise the capital costs of the purchase, but may not be accountable for running costs.Alternatively, maintenance staff may have strong incentives to minimise capital costs and/orto get failed equipment working again as soon as possible, but may have no incentive tominimise running costs. Again we see how complex issues of accountability and splitincentives could arise.

38

3.5 ECONOMIC BARRIERS 3: RATIONAL BEHAVIOUR

The third category of economic barriers refers to factors which cannot be classified as eithermarket or organisational failures. Here, the barriers are real features of the decision-makingenvironment, albeit ones which are difficult to incorporate in engineering-economic models.By not making a particular energy efficiency investment, an organisation may be actingrationally given this broader decision-making context. For example, if an energy efficienttechnology does not perform as well under certain criteria than an inefficient alternative, thenthe organisation may be rational in rejecting it. Hence, these type of barriers do not justifyany form of government intervention.

The three main barriers in this group are hetrogeneity, hidden costs and risk. Problems withaccess to capital may also be included here, although this category is more contentious.These barriers are discussed in turn below.

3.5.1 Heterogeneity

The heterogeneity argument is straightforward (Jaffe & Stavins, 1994b, p 805; Golove & Eto,1996, pp 13-14). The estimates of cost effectiveness for a particular technology are based onthe characteristics of an average user within a particular class. For example, small scale CHPmay be demonstrated to be cost effective for medium sized sites in the brewing industry. Butwithin this definition of a class of users, there may be wide variation in actual characteristics.In the case of CHP, profitability depends on high annual utilisation and typically requires atleast two-shift, 6 days/week working patterns. While this may be the norm in a particularsector, it may not apply in all cases. Hence, for a subset of the population with low annualoperating hours, CHP will not be profitable.

The size of this subset will depend on the distribution of characteristics within a population.In some cases it could be large. If engineering economic models do not reflect this variation,they will overstate the opportunities for a particular technology in a particular sector.

Whether heterogeneity can provide an explanation for the efficiency gap is an empiricalquestion. It cannot be settled in the abstract. Since the issue is the distribution ofcharacteristics within a population, it is most obviously addressed through survey work.However, case study analysis may be able to eliminate heterogeneity as an explanation for thefailure to adopt a technology in a particular instance.

3.5.2 Hidden costs

Hidden costs represent the most important argument against the ‘efficiency gap’ hypothesis.The claim is that engineering-economic studies fail to account for either the reduction inbenefits associated with energy efficient technologies or the additional costs associated withthem (Nichols, 1994). As a consequence, the studies overestimate efficiency potential.

Three broad categories of hidden costs can be identified:

• general overhead costs of energy management;• costs specific to a technology investment; and

39

• loss of benefits associated with an efficient technology.

Possible elements of each type of cost are indicated in the following table.

Table 3.6 Possible components of hidden costs

Category ExampleGeneraloverhead costsof energymanagement

• costs of employing specialist people (e.g. energy manager)• costs of energy information systems (including: gathering of energy

consumption data; maintaining sub metering systems; analysing data andcorrecting for influencing factors; identifying faults; etc.);

• cost of energy auditing;Costs involvedin individualtechnologydecisions

• cost of i) identifying opportunities; ii) detailed investigation and design; iii)formal investment appraisal;

• cost of formal procedures for seeking approval of capital expenditures;• cost of specification and tendering for capital works to manufacturers and

contractors• cost of disruptions and inconvenience;• additional staff costs for maintenance;• costs for replacement, early retirement, or retraining of staff;

Loss ofbenefits inindividualtechnologydecisions

• problems with safety, noise, working conditions, extra maintenance, reliability,service quality etc. (e.g. lighting levels).

The relevant empirical questions for hidden costs are:

• what is the magnitude of the hidden costs associated with an energy efficient investment(an cardinal approach)?

• are their instances where the hidden costs associated with an energy efficient technologyare comparable with those of an inefficient technology, but where the latter are stillpredominantly chosen (a ordinal approach)?

Both questions may be tested empirically, but the research design must be comprehensive toensure that all factors are taken into account. Unfortunately, there are relatively few examplesin the literature. One example of an cardinal approach is the 1994 study by Hein & Blok. Thisfound the search and information costs of a range of energy efficiency investments to formbetween 3% and 8% of the total investment cost.

Levine et al (1994) provide a much cited example of a ordinal approach. They studied anumber of energy efficient technologies that were: i) commercially available; ii) identical toinefficient technologies in the quality of service provided; iii) highly cost effective; and iv)apparently free of any hidden costs. Despite this, inefficient technologies with a somewhatlower capital cost were generally preferred. The technologies studied included ballasts incommercial fluorescent lights, residential refrigerators and standby power in colourtelevisions.

The salary overhead costs of energy management are of particular importance. For example,the UK EEBPP recommends that a sum equivalent to 5% of an organisation’s annual energy

40

expenditure be reserved for energy efficiency investment. For a site with a £1m bill, thiswould equal £50k. But the salary costs for a full-time energy manager may be £30k, or 60%of the annual investment budget. In this context, stringent payback criteria for investmentprojects may be justified as a means to recover the salary overhead costs. But is it reasonableto load all of the salary overheads onto investment projects? Much of energy managementmay be seen as an essential overhead, including with tasks such as negotiating with energysuppliers and overseeing maintenance. The question of what proportion of overheads shouldbe recovered through investment projects is difficult to answer and may vary betweenorganisations.

The inclusion of information costs as a hidden cost leads to an overlap with true marketfailures. The argument is that there are costs entailed in, for example: identifying theinvestment opportunity; identifying the options available; identifying the energy performanceof different technologies; verifying the quality of information; assessing the reliability ofequipment suppliers, and so on. These costs may easily be neglected in standard engineering-economic models. But is the difficulty and cost of obtaining information a consequence of afailure in the market for information, or is the market working efficiently? The empiricalstarting point is the same - identifying whether information costs exist - but interpretation ofthe results is contentious.

3.5.3 Risk

Both high discount rates for energy efficiency investments and the rejection of particularenergy efficient technologies may represent a rational response to risk. For example, if thereis some doubt that a business will survive over the next three years, stringent investmentcriteria may be entirely appropriate.

We may distinguish three broad categories of risk:

• External risk: e.g.• overall economic trends (e.g. recession);• expected reductions in fuel and electricity prices8;• political changes and government policy;

• Business risk: e.g.• sectoral economic trends;• individual business economic trends;• financing risk (reaction of capital markets to increases in borrowing);

• Technical risk: e.g.• technical performance of individual technologies• unreliability

Risk therefore has many dimensions. Furthermore, its importance can be expected to varywith the individual country, sector, business and technology and to change over time. Riskmay be difficult to evaluate objectively and while perceptions of risk may inhibit investment,this does not mean that those perceptions are rational. All these factors make risk particularlydifficult to incorporate within engineering-economic models. 8 This could only justify stringent investment criteria for energy efficiency projects if therewas confidence that the direction of energy price changes would be downwards.

41

For the purposes of empirical, case study research the key questions are:

• What are the perceptions of risk in each area?• How has this influenced investment criteria and investment decisions?• What is the impact of risk on energy efficiency investment, as against other forms of

investment?

The last is important. It is necessary to distinguish the overall impact of risk on businessinvestment from the particular impact on energy efficiency investment. Is risk perceived tobe higher for the latter?

Technical risk will be specific to particular technologies. Many of the technologiesrecommended in energy efficiency literature are well proven and apparently low risk. Thismakes it unlikely that technical risk will provide a rational reason for rejection, but there maybe site specific reasons.

Some economists argue that discounted cash-flow models are theoretically inadequate forstudying energy efficiency investments and must be supplanted by more sophisticatedtechniques that take account of risk and uncertainty (Hassett & Metcalf, 1993; Metcalf, 1994;Sutherland, 1991). These models tend to predict higher discount rates and suggest that thisrepresents a rational response to risk. As with other neo-classical approaches, the argumentassumes that economic agents make optimising decisions. Furthermore, the suggested modelsimply highly sophisticated decision making techniques which generally seem implausible tonon economists (Howarth & Sanstad, 1993, p105).

Sutherland (1991) applies the Capital Asset Pricing Model to efficiency investments andconcludes that investors will require higher returns from assets whose yields are uncertain andwhere it is not possible to diversify risks. But Stoft (1993) has shown that Sutherland’s modelexplains only a small risk premium. Also, Howarth & Sanstad (1995) have argued thatuncertainty over the benefits of energy efficiency does not imply that such investmentsincrease overall risk.

Hasset & Metcalf (1993) and Johnson (1994) present a similar argument to Sutherland. Theydevelop a model which suggests that given: a) fuel and capital price uncertainty; and b) theirreversibility of efficiency investments; the rates of return for efficiency investments shouldbe higher than conventional investment models predict. One reason for this is that there is anopportunity cost in acting today, rather than delaying the decision and resolving someuncertainties. The full cost of investment should therefore include the cost of foreclosing suchoptions (Pindyck, 1991).

Again, Howarth & Sanstad et al (1995) have strongly criticised this model. They note that themodel:

• fails to account (by some distance) for the observed high discount rates;• ignores the costs involved in delaying decisions (e.g. the loss of services if an appliance is

not replaced); and• assumes that consumers are fully informed about the characteristics of technologies.

42

Hence, the argument that high discount rates can be considered a rational response to risk forall types of efficiency investment does not seem plausible. The quantitative predictions of themodels fail on their own terms, quite apart from the implausibility of the behaviouralassumptions. However, external, business or technical risk may be a relevant and importantfactor in individual circumstances.

3.5.4 Access to capital

Many consumers (particularly low income households but also some SMEs) have access tocapital only at costs well above the average rate of return on capital in the economy. Thisprevents energy efficiency projects with a high rate of return from being undertaken. Accessto capital is therefore a commonly cited barrier to efficiency investments (Hirst & Brown,1990; Eyre, 1997).

The neo-classical response to this argument is that while inability to access capital mayconstitute a barrier, it need not imply a failure in capital markets. In a perfect market, capitalis allocated to projects with the highest risk adjusted rate of return. Sutherland (1996) andothers argue that groups such as low income households are high risk borrowers. Hence themarket is working efficiently in restricting capital to such groups.

As with hidden costs, this observation is important but runs the risk of becoming a tautology.Are all low income consumers high risk? Some evidence suggests not. For example, theGramreen bank in Bangladesh has lent micro-credit to very poor people for many years andhas never had a default (Righter, 1998). If this is the case, then imperfections in capitalmarkets may impede economic efficiency and thereby justify intervention.

Golove and Eto (1996, p22) argue that this barrier can better be understood as an informationproblem. There is a cost entailed in investigating the credit worthiness of small firms &individuals (i.e. acquiring the necessary information). This may be sufficiently high todiminish the economic viability of such loans. Historical evidence may suggest that theprobability of a default increases for smaller firms. While the risk could be investigated in aparticular instance, the cost of acquiring information will be large because of the largenumber of potential clients.

Another aspect of the capital availability problem relates specifically to the public sector (andhence to higher education in our project). In the public sector, access to capital is frequentlydirectly rationed by government with the aim of controlling public borrowing. Theassumption is that private sector investment is more productive and that excessive publicexpenditure will damage economic objectives (Eyre, 1997, p 33). But such a ruling preventsassessment of the cost effectiveness of individual projects and hence inhibits economicinvestment.

Within private sector firms, restrictions on capital are often self imposed. Here firms seem tobe reluctant to borrow money to finance low risk energy efficiency projects with rates ofreturn that significantly exceed their weighted average cost of capital (WACC). There are twodimensions to this problem. First, there is a restriction on overall borrowing. Second,available finance is allocated to projects according a priority list and energy efficiencytypically comes bottom of the list. But are such restrictions rational?

43

Capital constraints may be self imposed through concerns about the risk of increased gearing.Gearing refers to the ratio of loan finance to equity and there is a voluminous theoretical andempirical literature on the effect of gearing on a firm’s cost of capital (Mclaney, 1994, ch.11)9. The key observation here is that loan finance carries risk in that it imposes obligationsboth to meet annual interest charges and to repay the principal. In contrast to share dividends,these are fixed obligations and are not at the firm’s discretion. High levels of gearing (loanfinance) expose the firm to the risk that it will not be able to meet its payment obligationsshould it experience a downturn in business.

The lenders have the legal right to enforce payment of the interest and repayment of thecapital, using the assets of the company as security. In contrast, ordinary shareholders do nothave rights to enforce the payment of a dividend. This situation means that high levels ofgearing exposes the shareholders to greater risk as all the firm’s profits could be eaten up inthe repayment of lenders. As result, shareholders will demand higher returns ascompensation. Furthermore, high levels of gearing also expose the lenders to greater risk as,should the firm go out of business, the asset value may be insufficient to pay off theoutstanding loans. Hence, lenders too will demand higher interest payments on loans.

The net result of this is that high levels of gearing increase risk and raise a firm’s cost ofcapital. That is, the cost of obtaining additional capital (effective interest rate) may exceed theaverage cost of the existing debt/equity mix (Ross, 1986). Management will therefore restrictthe level of gearing to a level they feel comfortable with. Whether this is rational in any onecase depends upon the current level of gearing, judgements about how the financial marketwill respond to any increase in gearing, and judgements about the future business situation -including movements in exchange and interest rates. Since most efficiency investmentsinvolve relatively small sums of money, these should have very little impact on the level ofgearing for the firm as a whole (particularly for the larger companies). But borrowingrequirements and ‘financing risk’ are likely to be assessed for the firm as a whole, and not forindividual investments. The effect would be to restrict to overall capital budget forinvestment, including that for energy efficiency.

These considerations suggest that it is particularly difficult to assess whether self imposedrestrictions on borrowing represent a rational response to financing risk. The answer will varywith the circumstances. If it is, then access to capital becomes a risk issue rather than aproblem with capital markets. If not, then restrictions on borrowing can be considered as anorganisational failure, rather than rational behavior.

9 The key article in this field is Miller & Modigliani (1958), which challenged the traditionalview of the effect of gearing. This was the starting point for much of the subsequent debate.

44

3.6. BEHAVIOURAL APPROACHES TO BARRIERS

The neo-classical barriers outlined in the previous three sections would impede economicefficiency even with fully rational agents - that is, with utility maximising consumers andprofit maximising firms. But despite its dominance in economic models, the rationalityhypothesis is widely criticised as a poor representation of actual behaviour (Hodgson, 1998).In the energy literature, a wide range of empirical research has demonstrated that assumptionsof economic rationality on the part of energy users are fundamentally flawed (Katzev &Johnson, 1987). For example, Kempton & Montgomery demonstrate that energy consumerssystematically deviate from cost minimising behaviour even when motivated to make carefuldecisions (Kempton & Montgomery, 1983). As Sanstad & Howarth note, ‘...while consumersoften lack complete information about the energy decisions they must make, they moreimportantly lack expertise in processing and applying the information that is available tothem’ (Sanstad & Howarth, 1994, p 816).

The implication of this is that neo-classical analyses of barriers will be insufficient to explainthe efficiency gap. Concepts from behavioural perspectives must also be employed. Thefollowing sections discuss two such approaches. Section 3.6.1 introduces an alternativeconception of rational behavior, known as bounded rationality, which emphasises agents’constraints on time, attention and the ability to process information. Section 3.6.2 summarisessome additional insights that have emerged from psychological studies of energy decisionmaking, focusing on the form of information, credibility and trust, inertia and values. Thedifference between the two approaches is that bounded rationality is considered by someeconomists to be amenable to modelling using modifications to the standard tools ofoptimisation theory (Howarth & Andersson, 1993). Bounded rationality has also beenincorporated into several alternatives to mainstream economics, including evolutionaryeconomics and transaction cost economics (section 3.2.10). In contrast, researchers in the‘human dimensions’ tradition consider economic concepts to be insufficient for analysing andunderstanding energy related behaviour (Stern, 1986; Shove, 1995).

3.6.1 Bounded rationality

The concept of bounded rationality was first introduced by Herbert Simon in the 1950’s andhas been highly influential (Simon, 1955; Simon 1959). The primary assumption is thatbehavioural models should be descriptively accurate, in contrast to the ‘as if’ approachdefended by Friedman (Friedman, 1953). Simon draws a distinction between substantive andprocedural rationality where:

• Substantive rationality implies that agents make decisions in the manner prescribed byformal optimisation models - or that their choices are consistent with the predictions ofsuch models.

• Procedural rationality implies that people make decisions subject to constraints on theirattention, resources and ability to process information - and hence that their choices arelikely to differ significantly from the predictions of optimisation models.

Procedural rationality has two important implications. First, individuals and companies willtend to make satisfactory decisions rather than expend time and effort searching for the

45

optimum decision. This process is termed satisficing rather than maximising. As March &Simon note:

‘Most human decision making, whether individual or organisational, is concerned with thediscovery and selection of satisfactory alternatives; only in exceptional cases is it concerned withthe discovery and selection of optimal alternatives. To optimise requires processes several ordersof magnitude more complex than those required to satisfice.’ (March & Simon, 1958, p 171).

Second, individuals and organisations are rational in the sense that decisions are goaldirected. But constraints on time, attention, resources and the ability to process informationlead to optimising analyses being replaced by imprecise routines and rules of thumb. Meansare found to economise on scarce cognitive resources. In organisations, this could meanfocusing on core activities, such as the primary production process, rather than peripheralissues such as energy use. Decision making is also divided up between specialists, withabstract global objectives being replaced with tangible sub-goals whose achievement can bemeasured.

These basic ideas have been extensively developed. For example, they provide a centraltheme of evolutionary economics, an emerging discipline which mounts a substantialchallenge to the neo-classical mainstream (Dosi & Nelson, 1994; Nelson & Winter, 1982).Evolutionary economics emphasises the:

‘...general occurrence of various rule-guided behaviours, often taking the form of relativelyinvariant routines whose origin is shaped by the learning history of the agent, their pre-existingknowledge and, most likely, their value system and prejudices........the behavioural foundations ofevolutionary theories rest on learning processes involving imperfect adaptation and mistake riddendiscoveries.’ (Dosi & Nelson, 1994, p 159).

Empirical studies of energy decisions overwhelmingly support the hypothesis of boundedrationality. For example, the provision of accurate information on costs and benefits does notnecessarily improve the quality of decision making. In a survey of energy informationprogrammes, Robinson (1991) concludes that ‘... it is clear that, with the exception of somelabelling programmes, energy information programmes on their own have not to date resultedin significant energy savings’.

An example of the importance of routines is given by Almeida’s study of the French marketfor energy efficient motors (de Almeida, 1998). In the general absence of neo-classical marketfailures, consumers consistently chose inefficient motors. Almeida argues that this resultsfrom the use of cognitively efficient rules of thumb. For example, when small end-users hadto buy motors in an emergency, the only parameters they considered were delivery time andprice. The rule of thumb was to buy the same type and brand as the failed motor from thenearest retailer. Similarly, maintenance departments in large firms evaluated motors only interms of maintenance costs and reliability. Almeida’s work demonstrates the importance ofanalysing specific technology decisions. The extent and importance of bounded rationalitywill vary with the decision - for example between emergency replacement, routinereplacement and new requirement.

Three important conclusions follow from this. First, bounded rationality may be consideredas an additional barrier that does not fit into conventional economic models (Sanstad &Howarth, 1994). Some commentators term this barrier a market failure. For example, Eyre

46

notes that: ‘...There is a market failure to the extent that consumers do not attempt tomaximise their utility or producers their profits.’ (Eyre, 1997, p36). The benchmark for thisjudgement is substantive rationality. As Sanstad & Howarth note: ‘...individuals and firms donot always behave according to the logic of economic rationality but they should.’ (Sanstad &Howarth, 1994, p 179).

Second, real world departures from the substantive rationality assumed in most engineering-economic models can account for a proportion of the efficiency gap. How large a proportionis a (difficult) empirical question. It is not possible to determine, a-priori, the relativeimportance of neo-classical barriers and bounded rationality. Studies of energy decisionmaking in practice are required. However, it is very unlikely that the relative importance ofbounded rationality can be established with any precision.

Third, the existence of bounded rationality may also undermine intervention programmesdesigned to improve energy efficiency. If agents lack the ability to use information, there islittle point in providing more information. This point is important as it directly contradictsSutherland’s argument, noted in section 3.2.2, that intervention should be directed atcorrecting imperfect information, rather than bypassing decision making by imposingperformance standards. While standards may offend a strict neo-classical economist, theymay be more likely to work in practice.

Routines as a solution to bounded rationalitySimon’s original work was focused on organisations and he saw the division of labour withinorganisations as a means of economising on bounded rationality (Simon, 1957). Regular andpredictable patterns of behaviour in organisations may be understood as the result of routinesrather than rational choice (Dosi & Nelson, 1997; Nelson & Winter, 1982). The importanceof rules and routines depends upon the organisational structure (section 3.7.1), but rulefollowing is pervasive. Most decisions are the consequence of applying a set of rules to asituation, rather than a systematic analysis of alternatives. As Stern notes: ‘Organisationsgenerally solve problems and respond to environmental demands by applying existingroutines rather than developing new ones.’ (Stern, 1984, p109).

Payback rules represent one type of routine (Stern, 1984, p 109). Their attraction, from abounded rationality perspective, is that they are simple, easy to communicate and intuitive.They economise on managerial effort in examining investment proposals across widelydifferent operations.

Capital budgeting procedures represent a second type of rule, used in delegating the authorityto spend money. Typically, the primary concern when evaluating an investment opportunity iswhether there is money in the budget, rather than what is the rate of return (Stern, 1984, p110). Expenditure that exceeds the budget (breaks the rule) require administrative approval, apotentially complex and lengthy process that discourages attempts to do so. Routinestherefore facilitate information handling, but can be inflexible.

Other types of rule include operation, safety and maintenance procedures, relationships withparticular suppliers, design criteria, equipment replacement routines and so on. They mayeither be formally specified in written procedures or embedded in social practices. Routinesare a means of allocating attention. Energy efficiency opportunities will receive little attentionif they do not form part of standard routines and operating procedures.

47

Routines can become entrenched. For example, Fawkes & Jacques observed that brewerspreferred to use an inefficient design of pump because it was ‘easy to clean’:

‘...Only after extensive tests and persuasive efforts did the brewers admit that it was just as easy toclean the more efficient pump...... the brewers exhibited an almost fanatical unwillingness to evenconsider change.’(Fawkes & Jacques, 1987, p 564).

The implications of this are that energy must form part of organisational goals, proceduresand routines if cost saving opportunities are to be recognised.

3.6.2 The human dimension

The second approach in the behavioural literature derives from social psychology rather thaneconomics and has paid particular attention to improving the effectiveness of energyefficiency programmes (Stern, 1986; Katzev & Johnson, 1987). Many of these programmesdate from the 1973 oil crisis, and the range of psychological literature seems to have declinedin the 1980s as these programmes have declined (Lutzenhiser, 1993, p253). One of thepioneers in the field, Paul Stern, has argued for a renewal of this area of research, and thismay indeed happen as energy efficiency is increasingly linked to global environmentalconcerns (Stern, 1992).

There are two problems with this literature from our perspective. First it is not framed interms of discrete barriers, but instead makes more general psychological observations aboutthe process of energy decision making. Second, it is overwhelmingly dominated by studies ofhousehold energy consumption, with very few studies of organisations. Nevertheless, someuseful insights can be drawn.

The primary aim of this literature is to derive realistic descriptions of how individuals andorganisations make decisions about energy use. Stern likens much economic analysis to theproverbial drunkard, who searches for his lost keys under the lamp post because that is wherethe light is (Stern, 1986). He notes:

‘... models used for energy policy analysis systematically ignore a range of behavioural factors thatcan have a major influence on the success or failure of policy choices. The reliance on conceptsdrawn from the economic theory of consumer behaviour draws attention away from importantinfluences on energy demand, creating blind spots for analysts and policymakers.’10

People do not respond to price signals in the way assumed in energy models. The followingobservations are typical (Stern, 1986):

• Economists assume people respond to marginal prices, but in practice they are more likelyto respond to average prices or total costs.

• Demand is not a smooth function of price. People respond more to rapid change since thestimulus is more noticeable.

• People generally require a higher rate of return for smaller investments.

10 Stern, 1986.

48

Similar points are made by Hewett (1998, p 2.16) who notes that the mental shortcuts used toeconomise on bounded rationality lead not simply to ‘limitedly rational’ decisions but tosystematically biased or erroneous decisions. Quoting Piattelli-Palmarini (1994), she termsthese cognitive illusions.

A systematic alternative to economic theories of rationality has been developed by Kahnmannand Tversky (1979). Termed ‘prospect theory’, this notes that

• people treat gains differently from losses and hence undervalue opportunity costs;• outcomes received with certainty are weighted more than those with uncertain outcomes;

and• choices depend strongly on how a decision is framed, that is, on the reference point.

These and similar observations lead to three concepts from the psychological literature thatmay be framed as barriers:

• form of information;• credibility and trust;• inertia

A further concept, values, is also discussed below. This does not strictly represent a barrier,but is likely to be an important variable in explaining energy decision making.

Form of informationThe costs of acquiring and verifying information have already been discussed. But thebehavioural literature emphasises that there is more to information than cost. This isdemonstrated by US evaluations of energy efficiency programmes which demonstrate thatpeople ignore useful information even when it is costless (Kempton, et al, 1984, n19). AsStern notes: ‘... the cost of searching does not seem to be the main reason people are illinformed. The effectiveness of information depends on more than its availability andcontent.’ (Stern, 1994). In other words, the form of information is crucial.

Such a point is obvious to social psychologists and marketing departments, but also hasimportant implications for energy efficiency policy. Five elements of information in particularare important:

• Information should be specific and personalised. e.g. individual energy audits will be moreeffective than general information on cost saving opportunities.

• Information should be vivid. For example, a US study showed that people who viewed avideo about implementing domestic energy saving measures were significantly more likelyto cut energy use than those who received the information in writing (Winett et al., 1982,n24). Similarly, demonstration of tangible success with a technology is likely to have farmore persuasive power than a sales pitch - hence the emphasis in government informationprogrammes on technology demonstration schemes.

• Information should be clear and simple.• Information should be available close in time to the relevant decision.• Feedback should be given on the beneficial consequences of previous energy decisions if

subsequent efficiency measures are to be encouraged (Seligman et al, 1981)

49

Some of the above observations could be interpreted as the operation of bounded rationality.For example, poorly presented information requires more cognitive effort to assimilate andhence is more easily ignored. Absence of information in a suitable, easy to assimilate formcould be considered a barrier to energy efficiency.

Of particular importance is the implications such observations have for the design of energyefficiency programmes. The empirical studies of residential energy decision making suggestthat people’s responses to information are complex: ‘Human learning processes and theeffective coupling of energy information to incentives are complex topics that remain poorlyunderstood in the energy conservation area.’ (Lutzenheiser, 1993, p 255). This is particularlythe case with the operation of feedback: ‘... despite the large number of informationexperiments reported to date, the area remains murky.’(Lutzenheiser, 1993, p 256). Technicalstaff in organisations should adopt a more sophisticated approach to information acquisition,but the same broad points apply.

While such issues are important, they can only be addressed to a limited extent in the currentproject.

Credibility and trustA further dimension of information is the credibility of the source (Stern, 1994, p43)..Credibility involves a combination of expertise and trustworthiness. One possible explanationfor why people pass up information that is both useful and free is that they do not trust thesource.

A classic study by Craig & McCann (1978) illustrates this point. One thousand New Yorkhouseholds were sent a pamphlet describing how to save energy. Half the householdsreceived the mailing from the local electric utility, and the other half from the state regulatoryagency. The following month, households that had received pamphlets from the agency usedabout 8% less electricity than those that had received the identical pamphlets from the utility.

Similar results were found by Stern et al (1987) from a marketing experiment. Solicitationsfor an energy efficiency programme were made on three different letterheads: the utilitycompany’s; a joint utility-county government letterhead; and the county government’s alone.The last received a significantly better response.

Perceptions of credibility will depend on a variety of factors including: the nature of thesource (e.g. private, governmental, charity or pressure group); past experience with thesource; the nature of interactions with the source; recommendations from colleagues; andrecommendations/impressions from a wide range of contacts within professional and socialnetworks. Of these, it is clear that interpersonal contacts and recommendations count forsignificantly more than labels, pamphlets and paper qualifications (Stern, 1994, p 67). Inreviewing a range of studies that support this observation, Stern (1994, p 67-68) offers thefollowing explanations:

• Uncertainty, lack of knowledge and lack of trust in particular information sources allenhance the value of personal recommendations from known individuals.

• Direct exposure to the adoption of a technology by another individual/firm acts as a‘vicarious experiment’ or trial.

50

• Information from close associates is salient - it stands out from the mass of availableinformation and attracts attention.

Most of these contacts are made through existing professional and social networks whichtherefore play a fundamental role in transmitting information and establishing trust. Forexample, US domestic energy efficiency programmes achieved greater success whenimplemented through existing community groups which had established credibility throughextensive personal contacts. In the organisational context, networks organised through tradeassociations are likely to be similarly effective.

As with form of information, these issues can only be addressed to a limited extent in thisproject. But they do point to some important, policy relevant, questions. E.g. What are thesources of information currently available? What level of trust is placed in each of thesesources? What are the reasons for that judgement of credibility? How may trust ininformation sources be improved?

InertiaInertia has been cited as a barrier in the literature, but dismissed by neo-classical economistsas not falling within a market failure framework (Sutherland, 1996). However, insights fromthe behavioural literature suggest that inertia may be a relevant explanatory variable for thenon adoption of an energy efficient technology.

The findings of prospect theory are relevant here. First, we have the observation that gains aretreated differently from losses. This means that opportunity costs are undervalued (Hewett,1998, p 2.17). Organisations will consider themselves ‘endowed’ with their existingbuildings, equipment and energy bill. Foregone energy savings will be considered anopportunity cost, while the investment costs of energy efficient equipment will be an out-of-pocket cost:

‘[A] certain degree of inertia is introduced into the consumer choice process since goods that areincluded in the individual’s endowment will be more highly valued than those not held in theendowment ... This follows because removing a good from the endowment creates a loss whileadding the same good (to an endowment without it) generates a gain.’11

Similarly, potential energy savings are uncertain, while continuing with the existing‘endowment’ will give predictable outcomes. Since outcomes that are known with certaintywill be given greater weighting than those that are uncertain, this will reinforce the tendencyto inertia.

A third factor is the desire to minimise regret (Hewett, 1998,p 2.17):

‘Action and decisions require a greater justification than inaction, than failing to decided ... Ourmental economy has a built in economy for action. If our actions do not pan out, or cause a loss, weregret having acted. If, instead, we do not act, if we leave things as they are, and our investmentdoes not pan out, or we lose, we still suffer regret but the regret is lesser.’ 12

11 Thaler (1991, p 8), quoted in Hewett (1998, p 2.17)12 Piatelli-Palmarini, 1994, p 27-28, quoted in Hewett (1998, p 2.17)

51

All three factors may cause individuals and organisations to favour the status quo, incontradiction of the predictions of neo-classical economics. Rather similar conclusionsfollow from a separate behavioural theory known as cognitive dissonance (Stern, 1994, p 69).This makes the following observations

• people tend to rationalise previous decisions, emphasising the positive aspects of thedecision and the negative aspects of the unchosen alternative;

• this tendency is greater for difficult, costly or irreversible decisions;• people remember the plausible arguments for their own position and forget the plausible

arguments opposing their position;• once someone makes a small commitment in a given direction, that person is more likely

to make a subsequent larger commitment.

Hence people resist change because they are committed to what they are doing, and theyjustify that inertia by the downgrading of contrary information.

The above observations are generic - inertia may prevent the take-up of a wide range ofopportunities, not simply those related to energy efficiency. But the important point is theeffect of inertia on energy efficiency investment relative to that on purchasing energy as acommodity. This is analogous to the effect of imperfect information on energy efficiencyinvestment (section 3.3.1). In both cases, we would expect there to be a bias against energyefficiency and in favour of energy purchasing. Inertia matters more for energy efficiencybecause it involves investing in hardware with uncertain outcomes and because it represents adeparture from the status quo. Since energy efficiency and energy purchasing providealternative means of delivering the same energy services, this may be economicallyinefficient.

These insights have two potential consequences for energy efficiency. First, inertia may helpexplain the neglect of cost effective efficiency opportunities. Second, the positive resultsfrom efficiency investments may create a momentum leading to greater savings in the future.

ValuesIn one sense, personal values and norms are irrelevant to the ‘efficiency gap’. In specifyingthe existence of a gap, the motivation for investment is assumed to be economic: barrierhypotheses purport to explain why an apparently cost effective investment does not go ahead.

But in reality, economic considerations provide only one element of a decision. Theenvironmental impact of energy use has motivated energy efficiency for many years, and therecognition of global climate change has made it more relevant than ever. Values aretherefore a relevant explanatory variable in explaining the adoption or non-adoption of energyefficient technologies.

We can distinguish between personal values and corporate values, where the latter areembedded in the wider organisational culture. Issues of organisational culture are discussedfurther in section 3.7.3. The personal values of influential individuals such as topmanagement are undoubtedly relevant, since it is often such a product champion that initiatesaction on energy efficiency. Value may play a role in sensitising an individual or organisationto cost effective opportunities to save energy that may otherwise go unnoticed. A related

52

dimension to this is the visibility of energy efficiency performance, and the impact of this onthe public profile (image) of the organisation.

Household studies demonstrate that the relative importance of values in energy relateddecisions depend on the cost and difficulty of the efficiency measure. For example (Stern et al1982) found that personal norms were a reliable predictor of low cost domestic energyconservation measures, but showed a weak relationship to major household investments.

Hence, while the absence of relevant environmental values does not constitute a barrier in theclassic sense, the importance of values should nevertheless be explored. If this were not done,we would miss an important dimension of energy decision making.

Conclusions on the human dimensionWe can conclude that, despite the dominance of studies on residential energy use, the ‘humandimensions’ literature does offer some useful insights that can be incorporated within abarriers model. Furthermore, there is considerable scope for using these ideas in studies oforganisations and in developing policy recommendations. In a survey of the literature,Lutzenhiser notes that:

‘The available research, and the literature on organisational behaviour, suggests that a simplerational model of energy use and conservation decision making applies no better to organisationsthan it does in the residential sector. A significant amount of useful research would also seempossible in this area’ (Lutzenhiser, 1993, p 276)

However, treatment of these issues as separate from imperfect information, boundedrationality and other concepts creates practical difficulties. For example, providing easilyassimilated information from a trusted source can be seen as a means of economising onbounded rationality. Similarly, individual and organisational routines may neglect energyefficiency, but is this a consequence of bounded rationality or inertia? Again, we note that theconcepts are not discrete variables but perspectives which highlight particular aspects of acomplex situation. The research task is to identify which concepts provide the bestexplanation of observed behaviour and then to draw out the implications of this for energyefficiency policy.

53

3.7. ORGANISATIONAL THEORY APPROACHES TO BARRIERS

Organisational theory approaches to barriers are the least well developed of the threeperspectives and what follows is necessarily tentative.

A broad distinction can be made between organisational theory and organisationaleconomics (Rawlinson, 1997). The latter was described in previous sections and representsan application of a small number of relatively precise economic ideas to explaining thestructure and operation of organisations. In contrast, the discipline of organisational theory isnotoriously diverse and eclectic. Ideas are borrowed from a wide range of disciplines andemployed as metaphors to explain different facets of organisational behaviour. The chapterheadings of the book Images of Organisation (Morgan, 1985) give a flavour of the field:

• Mechanisation takes command: organisations as machines• Nature intervenes: organisations as organisms• Towards self-organisation: organisations as brains• Creating social reality: organisations as cultures• Interests, conflict and power: organisations as political systems• Unfolding logics of change: organisation as flux and transformation• The ugly face: organisations as instruments of domination.

While there is a wealth of literature on the behaviour of organisations13, there are very fewstudies dealing explicitly with energy efficiency. A notable exceptions is Cebon’s 1992 studyof US universities (Cebon, 1992). Research in environmental management has borrowedextensively from the organisational literature (Welford, 1997), but energy policy research haslargely neglected it. This is unfortunate, as even a cursory examination suggests that it mayhave a lot to offer. An illustration of this is that ideas from organisational theory have beentaken up in promotional best practice literature published by government agencies (EEO,1995).

Within the constraints of this project, only a very limited portion of this work can be used.We select three concepts from the organisational theory literature that seem particularlyrelevant to energy efficiency. These are:

• organisational structure;• power; and• organisational culture.

3.7.1 Organisational structure

Organisational structure provides a primary focus of organisational theory. While we cannotformulate structure as a barrier to energy efficiency, it is clear that organisational structurewill constrain the range of viable opportunities for improved energy efficiency (Cebon,

13 For good overviews see Hatch (1997) and Morgan, (1985).

54

1992). The reasons for this can be related both to bounded rationality and power relations(discussed below). Hence, while structure is not a causal mechanism, it provides an importantframework for understanding the operation of barrier mechanisms.

A tradition in organisational theory known as contingency theory emphasises that there is noone best way of organising (Burrell & Morgan, 1979). The appropriate structure will dependupon both the nature of the task and the demands of the environment. Management must beconcerned with achieving a good fit between organisation, task and environment. Differentapproaches to management may be necessary to perform different tasks within the sameorganisation and different types of organisation may be appropriate in different environments.

An early study by Burns & Stalker (1961) established the distinction between mechanistic andorganic approaches to organisation. Table 3.7 uses examples taken from Burns & Stalker’soriginal paper to emphasise how different tasks and environments lead to correspondingdifferences in the organisation of work, the nature of authority, the form of communicationssystem and the nature of employee commitment. Burns & Stalker argue that there is acontinuum of organisational forms ranging from mechanistic to organic, and that moreflexible forms are required to deal with changing environments.

Subsequent work by Lawrence & Lorsch (1967) refined this approach by showing thatorganisation styles may differ within organisations, as subunits perform different tasks andface different environments. For example, the organisational structure appropriate for aproduction task may be entirely inappropriate for a R&D lab. In relatively stableenvironments, conventional bureaucratic modes of organisation such as hierarchy, rules andso on may work quite well. In more turbulent environments, they need to be replaced byother modes, such as the use of multidisciplinary project teams. Matrix forms of organisationrepresent a compromise between the two - combining a functional, departmental structurewith a project-team structure (Galbraith, 1971).

55

Table 3.7 Burns & Stalker’s typology of organisational structures

Rayon Mill Switchgear firm Radio & Television firm Electronics FirmNature ofenvironment

Relatively stable:technological and marketconditions well understood

Moderate rate of change: expandingmarket coupled with opportunities forimproved products

High degree of change:dynamic technological andmarket conditions withpredictable rate of novelty

High unpredictable: rapid technologicaladvance and boundless marketopportunities

Nature of taskfacing the firm

Efficient production ofstandard product

Efficient production and sale of basicproduct, subject to modificationaccording to customer requirements

Efficient design, production,and marketing of new productsin highly competitiveenvironment

Exploitation of rapid technical changethrough innovation and exploration ofnew market situations

Organisation ofwork

Clearly defined jobs arrangein hierarchical pattern

Rough division of job responsibilitiesaccording to a functional andhierarchical pattern, modified to meetcontingencies. No stable division offunctions

Consistent blurring oforganisational positions; everysection of managementconcerned with the focal task ofcompetitive selling

Deliberate attempt to avoid specifyingindividual tasks; jobs defined by theindividuals concerned through interactionwith others

Nature ofauthority

Clearly defined and vested informal position in hierarchy;seniority important

Not clearly defined but following thehierarchy except in speciallyconvened committees and meetings

Limits of authority andresponsibility not defined;authority vested in people withability to solve problems athand

Pattern of authority informal andconstantly changing as roles becomeredefined with changing circumstances;vested in individuals with appropriateskills and abilities

Communicationsystem

According to pattern specifiedin various rules andregulations; mainly vertical

According to rules and conventions,but supplemented by regular systemof committees and meetings. Juniorstaff free to consult with topmanagement group

Frequent meetings in a contextof constant consultation acrossall levels and parts of the firm

Completely free and informal; the processof communication was unending andcentral to the concept of organisation

Nature ofemployeecommitment

Commitment toresponsibilities associatedwith their own particular jobs;loyalty and obedienceimportant

Commitment to own job butrecognising the need for flexibility indealing with contingencies arisingfrom the total situation

Commitment to demands ofown functional positionsreconciled with wider demandsfor co-operation and flexibleinterpretation of function

Full commitment to the central tasksfacing the concern as a whole and anability to deal with considerable stressand uncertainty

MECHANISTIC ORGANICSource: Based on Burns and Stalker (1961)

56

Cebons’s 1992 paper represents a valuable case study on how organisational structure at twouniversities influenced the type of energy efficiency technologies that were adopted. Oneuniversity was administratively uniform with its different parties sharing centralisedresources. The second was much more decentralised, with faculties managing their ownbudgets. Cebon examined the implementation of two very different technologies - compactfluorescents and building energy management systems (BEMS).

The centralised university successfully implemented BEMS and similar technologies whichwere complex, expensive, technical and did not require significant interactions with users.The decentralised university, in contrast, was very late in implementing BEMS but was muchmore successful with compact fluorescents and comparable technologies which were cheap,simple and involved the active participation of users.

Cebon emphasises that organisational structure acts as a filter on technology choices. Theproposed causal mechanisms for this are: i) information limitations; and ii) power andresources. In the case of information, the Estates department in the centralised universitycould assess technical information and implement technical solutions, but lacked importantcontextual information such as the needs of users. The reverse was true for the decentraliseduniversity. This restricted the options available to each. More generally we can note thatstructure will influence:

• flows of information within and outside organisations;• asymmetries of information, including principal-agent relationships and the scope for

moral hazard; and• the capacity to acquire and analyse information within individual departments.

The organisational structure in Cebon’s universities corresponded to the mechanistic structurein Burns & Stalker’s typology, and we may expect this type of structure to be more prone tosuch informational problems. The organic structures characteristic of new high technologyindustries tend to have highly skilled workers, lower status hierarchies, bettercommunications and a more problem solving focus. This may act to reduce some of theinformational barriers to energy efficiency. But equally, we must remember Lawrence &Lorsch’s point about internal differentiation. If energy responsibilities are located inmaintenance or Estates departments with limited communication with other groups, somebarriers are likely to remain.

Cebon’s general point is that an actor will only be able to implement the subset of energyconservation technologies compatible with their access to information, and their extent ofaccess will depend on the organisational structure (Cebon, 1992, p 808). Similarly, they willonly be able to implement the subset of technologies compatible with their level of powerwithin the organisation, since they need the co-operation and support of other groups. Thepower dimension is discussed next.

3.7.2 Power

Viewing the organisation as a political system focuses attention on the power relationshipsinherent in organisational structures and on the ability of individuals or departments to

57

influence decisions. The relationship of this to the barriers debate hinges on the poweravailable to those actors responsible for energy efficiency.

This perspective on organisations borrows ideas from political science. Organisations areviewed as: ‘...networks of people with divergent interests who gather together for the sake ofexpediency’ (Morgan, 1985, p 154). Divergent interests lead to multiple goals and structuraldivisions foster conflict. Hierarchical structures in particular lead to competition for limitedresources. Power is the medium through which conflicts of interests get resolved. Powerinfluences who gets what, when and how. It can take a variety of forms, including (Morgan,1985, p 158):

• Formal authority: Typically associated with an agent’s position in the organisationalstructure.

• Control of scarce resources: Such as skills, raw materials, particular technologies and,most importantly, money. Most organisational politics surrounds the process of budgetingand allocation of finance. Power rests in controlling resources on which an organisation isdependent.

• Structure: The size and status of a group or department within an organisation provides anindication of its power. Of particular importance is the degree of centralisation ordecentralisation.

• Information & knowledge: Information is a key resource, which can influence thedefinition of organisational situations and create patterns of dependency.

The important question from the barriers perspective is: How much power is available to theactors responsible for implementing energy efficiency?. In particular, What is their statuswithin the hierarchy? How much control do they have over key resources? Do they have therequired information?

Responsibility for energy matters is typically assigned to engineering or maintenancedepartments that have a relatively low status within an organisation. Top management oftenview energy as a peripheral issue, of limited importance to the strategic direction of theorganisation. Energy is often one of several responsibilities assigned to a single, low statusindividual. Lacking power, funds and management support, the scope for effective action iscircumscribed. In addition, the best people will not be attracted to energy management if thecompensation and prestige are less than the rewards of other positions.

The role of a product champion is also relevant to the power dimension. Product championsacquire a degree of power through their charisma and drive and win top management supportthrough demonstrable success. But, product champions may have an uphill task inovercoming barriers created by divisional structures. DeCanio (1994) reports the blockage ofpromising energy efficiency retrofits because of ‘turf battles’ between different divisions.Similarly, Cebon demonstrates that while decentralisation increases power over individualswithin a unit, it decreases power across organisational boundaries.

3.7.3 Culture

The concept of organisational culture is analogous to the personal values discussed in section3.6.2. That is, while culture cannot be framed as a barrier, it may nevertheless be a relevant

58

variable in explaining the adoption of energy efficient technologies. The notion of culturetakes us further from economics and into sociology and anthropology. Culture is broadlydefined as the mix of knowledge, ideology, values, norms, laws and day-to-day rituals thatcharacterise a social group (Hatch, 1997, chapter 7). Values are the principles and standardsheld to have worth, while norms are unwritten rules of behaviour. As Hatch notes:

‘The essence of a culture is its core of basic assumptions and established beliefs. This core reachesoutward through the values and behavioural norms that are recognised, responded to andmaintained by members of the culture. The values and norms, in turn, influence the choices andother actions taken by cultural members.’14

Organisations may be viewed as mini-societies that have their own distinctive patterns ofculture and subculture (Morgan, 1985, p121). Organisations may be composed of many anddifferent value systems that create a range of competing sub-cultures. Despite this,management theorists look to a uniform corporate culture as the ‘normative glue’ that holdsan organisation together (Morgan, 1985, p135).

A consistent feature of the literature on organisational culture is the crucial role played by topmanagement in shaping the values that guide an organisation (Morgan, 1985, p126; Gladwin,1992). Morgan describes the widely different cultures prevailing in Hewlett Packard and ITTand links these to the personal style of their chief executives. He argues that: ‘the attitudesand visions of top corporate staff tend to have a significant impact on the ethos and meaningsystem that pervades the whole organisation’ (Morgan, 1985, p126). Similarly, Schein arguesthat: ‘...the unique and essential function of leadership is the manipulation of culture.’(Schein, 1985).

The relevance of this to the barriers debate is that the place of energy efficiency andenvironmental values within an organisation’s culture should have a major impact on theadoption of energy efficient technologies. This recognition is implicit in the strategy ofagencies responsible for promoting energy efficiency, who place much emphasis onmanipulating ‘soft’ cultural factors; for example, encouraging the adoption of a corporateenergy policy and marketing the benefits of energy management throughout an organisation(EEO, 1995; HEFC, 1996). The UK Energy Efficiency Office recommends targeting theenergy management strategy to the prevailing organisational culture, where the latter ischaracterised as in Table 3.8.

14 Hatch, 1997, p 135

59

Table 3.8 Energy Efficiency Office characterisation of organisational culture

Dimension Entrepreneurial Team Hierarchical MarketDistinguishingfeatures

Innovation &growth

Participation &co-operation

Structure &control

Productivity &achievement

Focus Anywhere outside Staff oriented Team oriented Towardscompetitors

Planning Very short term Long term Medium term Short termRisk High risk Uncertainty Certainty PredictabilityLeadership Charismatic Unobtrusive &

supportiveConservative &

rule based Managerial &decentralised

Accountability Personal contact Meetings Formal systemsof

representation

Throughperformance

Decisionmaking

Rapid & open tochange

Consensusseeking

Search foroptimality

Rapid & final

Structure Flexible Collaborative Rigid Cost centresMotivators Variety & risk Collaboration Predictability

& security Achievement

& targetsSource: Based on EEO, 1995Note: This table combines both cultural and structural dimensions.

Similarly, Gladwin’s recommendations for building the sustainable corporation include: i)inspiring a shared vision of the corporation as environmentally sustainable; and ii) creating anorganisational culture that guides and supports sustainable corporate behaviour (Gladwin,1992). If factors such as these are the levers for encouraging energy efficiency and improvedenvironmental performance, then they should also be relevant in explaining differences intechnology adoption between organisations. Culture is therefore a relevant variable, albeit onethat defies precise definition.

3.8 A SUMMARY OF POTENTIAL BARRIERS

Table 3.9 brings the discussion of the previous sections together. It sets out the taxonomy of15 barriers to energy efficiency developed for the BARRIERS project and summarises theclaim that is being made in each case. This framework provides the basis for the empiricalresearch. The aim is to test each claim through case studies of individual organisations.

In conducting the empirical research it was found that the distinctions between these barrierscould not always be sustained. Thus, in the case study results reported in sections 4 to 6 aslightly simplified taxonomy is used. This reduces the number of barriers to 12 by:

• combining values with organisational culture;• combining bounded rationality with inertia; and• combining form of information with credibility & trust.

The results of the case studies are discussed using this reduced list of 12 barriers.

60

Table 3.9 A taxonomy of barriers to energy efficiency

Perspective Sub-division

Barrier Claim

Economic Non marketfailure

Hetrogeneity While a particular technology or measure may be cost effective on average, it may not be so in all cases. This mayexplain the non-adoption of some technologies at some of the institutions studied.

Hidden costs Engineering-economic analyses fail to account for either the reduction in benefits associated with energy efficienttechnologies, or the additional costs associated with them. As a consequence, the studies tend to overestimateefficiency potential. Examples of hidden costs include overhead costs for management, disruption, inconvenience, staffreplacement and training, and the costs associated with gathering, analysing and applying information..

Access tocapital

If an organisation has insufficient capital through either internal funds or borrowing, energy efficient investments maybe prevented from going ahead. In the public sector, additional borrowing may be inhibited by public sector rules. Inthe private sector, companies may be reluctant borrow due to concerns about the risk of increased gearing. Whereinternal funds are available, other priorities may take precedence, thereby also preventing the energy efficientinvestment.

Risk The short paybacks required for energy efficiency investments may represent a rational response to risk. This could bebecause efficiency investments represent a higher technical or financial risk than other types of investment, or thatbusiness and market uncertainty encourages short time horizons

Economic Marketfailure

Imperfectinformation

Lack of information may lead to cost effective energy efficiency opportunities being missed. This may be considered amarket failure in that information has public good aspects, which make it likely that it will be under supplied bymarkets. Furthermore, unlike energy supply, energy efficiency consists of a wide range of complex technologies andservices, which are purchased infrequently and for which it is difficult to determine their quality either before or afterpurchase. As a consequence, the transaction costs for obtaining and processing information on energy efficiency arehigher than for energy supply. Overconsumption of energy may be the result

Splitincentives

Energy efficiency opportunities are likely to be foregone if the party cannot appropriate the benefits of that investment.For example, individual departments in an organisation may not be accountable for their energy use and therefore haveno incentive to improve efficiency

Adverseselection

Suppliers know more about the energy performance of a good than purchasers. The latter face difficulties in bothobtaining information prior to purchase and verifying performance subsequent to purchase. As a result, purchasers willtend to select goods on the basis of visible aspects such as price, and be reluctant to pay the price premium for highefficiency products. In some cases, inefficient products will drive efficient products out of the market

Principal-agentrelationships

Principal-agent relationships occur when the interests of one party (the principal) depend on the actions of another (theagent). This type of relationship is pervasive in hierarchical firms. It is characterised by information asymmetry, sincethe principal lacks detailed information about the activities and performance of the agent - and in particular about themerits of individual investment projects proposed by the agent. Such monitoring and control problems can leadprincipals to require stringent investment criteria to ensure that only unambiguously high value projects are undertaken

61

Perspective Sub-division

Barrier Claim

Behavioural Boundedrationality

Boundedrationality

Actors do not make optimising decisions in the manner assumed in standard economic models. Instead, constraints ontime, attention, and the ability to process information leads to reliance on imprecise routines and rules of thumb.These economise on scarce cognitive resources. A consequence of this type of decision-making is that that actors maynot maximise utility, even when given good information and appropriate incentives. Hence, bounded rationality maybe considered as an additional barrier that does not fit into conventional economic models.

The humandimension

Form ofinformation

The cost of acquiring information is only one aspect of decision-making. Research demonstrates that the form ofinformation is critical. To be effective, information must be specific, personalised, vivid, simple and available closein time to the relevant decision.

Credibilityand trust

Also critical is the credibility of the source and the trust placed in the source.. Trust is particularly encouraged throughinterpersonal contacts. If these factors are absent from information on energy efficiency, inefficient choices will bemade

Inertia Agents resist change because they are committed to what they are doing and justify inertia by downgrading contraryinformation. Individuals also treat gains differently from losses, thereby undervaluing opportunity costs; give greaterweighting to certain outcomes than uncertain; and have a strong desire to minimise regret. All these factors causeindividuals to favour the status quo. Inertia creates a bias against energy efficiency since (unlike energy purchasing)this involves investing in hardware with uncertain outcomes and represents a departure from the status quo.

Values Energy efficiency has clear environmental benefits. Individuals motivated by environmental values may thereforegive a higher priority to efficiency improvements than those that are not. Efficiency improvements are most likely tobe successful if ‘championed’ by a key individual within top management. Hence, the environmental values of keyindividuals is a relevant variable in explaining organisational performance on energy efficiency.

Organisationtheory

Power Organisations can be viewed as political systems, characterised by conflicts between groups with divergent interests.The influence of a particular group depends upon its formal authority, the control it has of scarce resources(particularly finance) and its access to information. It is commonly the case that energy management has a relativelylow status and is viewed as a peripheral issue by top management. Lacking power, funds and management support, thescope for effective action may be circumscribed. This may constitute an organisational barrier to efficiencyimprovement

Culture Organisations may encourage efficiency investment by developing a culture (values, norms and routines) thatemphasises environmental improvement. This is more likely to be successful if ‘championed’ by a key individualwithin top management. Hence, organisational culture is a relevant variable in explaining organisationalperformance on energy efficiency.

62

3.9 FROM BARRIERS TO POLICY

The primary aim of the empirical research is to obtain evidence for the operation ofdifferent types of barrier in different contexts. But we also wish to developconclusions that are relevant to energy efficiency policy. The assumption here is thatthe nature and operation of the identified barriers will be relevant to: i) the rationalefor policy intervention to improve energy efficiency; ii) the scope for policyintervention; and iii) the particular choice of policy instrument. For example, clearevidence of a lack of accessible and trustworthy information within a sector wouldpoint to the need for public information programmes. Similarly, evidence that hiddencosts provided the primary reason for non-investment would suggest that policyintervention was not justified on the grounds of market failure alone.

The taxonomy identifies barriers to energy efficiency within energy service markets,as well as barriers within individual organisations. This suggests that the results willbe relevant both to public policy and to internal organisational policy. Policy relevantconclusions may therefore be developed at three levels:

• the organisational level: within individual organisations;• the sector level: via sector associations and other bodies;• the national level: establishing the national policy context for energy efficiency.

Conclusions at the national level will also be relevant to the development of EUpolicy.

The primary unit of analysis is energy management within organisations and the bulkof the research effort is directed towards identifying the operation of various barriers.As a result, the project cannot provide detailed policy recommendations. Instead thepolicy relevant conclusions are indicative only.

The ideas discussed in this section can provide useful pointers for the design of policyinstruments. In particular, policy should have the general objective of minimising thetransaction costs of improving energy efficiency - both for individuals andorganisations. The key elements of this are:

• economising on bounded rationality: allowing actors to make efficient choiceswithout requiring extensive effort in gathering and analysing information;

• aligning incentives: ensuring, as far as possible, that incentives of different groupsare complementary and act in the direction of improved efficiency; and

• safeguarding against opportunism: ensuring, as far as possible, that asymmetricinformation does not encourage decisions or actions that undermine efficiency.