Heat Pump Installations & Market Failure

The Heat Pump Market is Broken. Here's How We'll Try To Fix It

Abstract

Markets are uniquely bad at pricing one-time services with asymmetric information factored in, such as heat pump installations. A similar service is infrequent, expensive healthcare services, such as surgeries & pregnancies.

We need to fix this.

This memo considers multiple solutions, including:

1. Pricing. Standard market pricing (think: Mass Save weatherization)

2. Regulations. Educating homeowners on required permits/inspections

3. Transparency. Getting Mass Save or Abode to openly publish contractor prices

4. Transparency. Publishing distributor data on equipment recall/warranty rates

5. Vetting. Deep vetting for bulk deals

Challenges in Pricing One-time (Custom) Services

Consider a knee surgery at a hospital. What’s a good price¹? It’s hard to tell:

From a 2018 WSJ article. Here’s what the hospital found out: “The actual cost? $10,550 at most, including the physicians. The list price was five times that amount.”

Efficient markets operate on easy access to cost & quality information for various players in the market, and markets for one-time custom services have none of that. Here’s a more rigorous comparison:

Heat pumps installations (not equipment), like knee surgeries, suffer from a lack of price transparency & quality data. The result, like healthcare, is price inflation.

No Price Transparency

It’s really easy to price shop for all apples, cars, or haircuts; you can walk into a few grocery stores, look online, or call a few barber shops. You can also just ask your neighbors.

• But you can’t do that for contracting work; your neighbor’s house may be different from yours.

• Even if there’s a website that tells you the average price of something, they typically won’t tell you which contractor offers the best price & quality.

• Prices fluctuate seasonally.

• Getting multiple quotes can be time consuming, and you’ll need to be home.

Minimal Quality Information

It’s also really hard to figure out which contractor is actually good or not. When a salesperson tells you

“you’re paying $20k more, but you’re paying for quality”

Is this true? Or is it just a sales tactic?

Healthcare (and other trades in the commercial space) solves for this by requiring licensure, but the only thing required for MA right now is the standard EPA 608 license. Permits can help, but…

The standard information on a municipal permitting website. How am I supposed to know which permits a contractor is supposed to pull?

• It’s tough to even figure out which permits a heat pump installation requires, because municipal sustainability offices are separate from the inspections offices, and the inspections offices typically publish information for contractors, not consumers.

• AHRI certification doesn’t have that much market presence.

• MeasureQuick doesn’t publish their contractor list.

• Websites such as EnergySage & Angi’s List doesn’t do anything close to an in-person walkthrough of contractor work.

• Reviews have been the standard proxy so far.

We think these factors lead to 3 specific problems in the market, and for policy goals.

Impact & Problems

1. Price inflation at the high end of the market. Consumers may opt for less expensive alternatives, such as furnace replacements, if they can’t find a fair deal.

2. Market for lemons at the lower end of the market. In the absence of rigorous quality standards, low-quality installations may enter the market, leading to a market for lemons. We think this may be countered by word-of-mouth validation about quality, but it would really help if cities or Mass Save enforce permits on every installation.

3. High-pressure sales tactics. I think there are a lot of fair people doing site walkthroughs & doing their jobs. But the lack of a rigorous way to compare cost & quality means that private equity firms are incentivizing salespeople to try to push for sales at all costs, which can lead to poor consumer experiences.

Potential Solutions

We need to tackle all 3 problems. This is an account of what we’re looking into.

Weatherization, with standard pricing set by Mass Save.

1. Solutions for price inflation.

   1. Standard price setting². A good example of this is how Mass Save approaches weatherization: all the prices are standard. It doesn’t mean a contractor can’t charge a price higher than the program price; however, to qualify for incentives, they can’t charge above that price. We know Mass Save is looking into this in limited capacity, and we support those efforts. (Note: standardizing pricing for heat pumps is a lot more difficult, and we are currently developing ever-more sophisticated ways to do that.)

   2. More price transparency. I currently can’t think of any other way to get apples-to-apples price comparisons between contractors besides our open market benchmarks³. Maybe Mass Save or Abode should publish all the contractor quotes they receive, with the contractor names? Maybe contractors can all start publishing pricing menus?

   3. Wholesale pricing/bulk deals. Yes, this is what we organize at Laminar Collective, and what Solarize did back in the day. It’s tough for towns because they typically can’t endorse contractors, but I can’t help but think that multi-town municipal procurement would be so advantageous here. Maybe do this via. CLEAResult / Homeworks?

2. Solutions for market for lemons⁴.

   1. Make permits known & required. Towns should publish an easy 1 pager on all permits required for each type of heat pump installation for homeowners. We are currently compiling this on our end for the Metro West, and will publish when it’s ready.

   2. Publish callback rates from distributors. How often contractors go back to a supply house to get replacement parts for a defective installation (via warranty) is probably one of the clearest quality metrics out there. You can’t fake this. Getting distributors to publish this would be difficult, but also would be incredibly good for distributors who sell to high-quality contractors.

   3. Deep vetting for bulk deals. Can’t do this for the entire market since it’s tough to scale, but possible for a few contractors competing for a big deal.

3. Solutions for high-pressure sales tactics.

   1. Consumers: ask your salesperson how they are paid. Salary? Commission?

   2. Consumers: ask your salesperson how much profit margin the company makes, and if the company is owned by private equity.

   3. Automate the initial sales step. A more difficult way to get around this problem, but potentially something that we’ll see in the next few years.

Finally, one more thing that could be useful is defining contractor categories, and what you can expect out of them. I’ll write about that in another memo.

Conclusion

It’s important for regulators and market players to fix this market so consumers can benefit the most from the billions of dollars that Mass Save is allocating for heat pump rebates. It is equally important to fix this so that there is a functioning market even if Mass Save rebates phase out one day.

We believe we can take steps to do that by enforcing permits, potentially embracing standard market pricing for Mass Save, and publishing more data on contractors & distributors.

This represents our current best understanding of market dynamics. What we do in the coming year will revolve around this.

Cheers,

Kit

P.S. My first job out of college was in healthcare. I was a data scientist on a team tasked with understanding healthcare service pricing, and figuring out how to negotiate better deals based on market benchmarks.

One wild example of US health care pricing, courtesy of NPR & Kaiser Health News.

You don’t need to be a data scientist to know that healthcare pricing in the United States is absolutely bonkers. I didn’t think I’d find another market where pricing was so crazy. But here we are.

1. Here’s the answer from the WSJ article:

For nearly a decade, Gundersen Health System’s hospital in La Crosse, Wis., boosted the price of knee-replacement surgery an average of 3% a year. By 2016, the average list price was more than $50,000, including the surgeon and anesthesiologist.

Yet even as administrators raised the price, they had no real idea what it cost to perform the surgery—the most common for hospitals in the U.S. outside of those related to childbirth. They set a price using a combination of educated guesswork and a canny assessment of market opportunity.

…The actual cost? $10,550 at most, including the physicians. The list price was five times that amount.

Competitive forces are out of whack in health care. Hospitals are often ignorant about their actual costs. Instead, they often increase prices to meet profit targets. Patients, especially those with insurance, often don’t know the price of a procedure and rarely shop around.

2. It’s worth noting that many other countries, and CMS in the US, negotiate to set their healthcare prices!

3. We get minimal funding to do this, by the way.

4. Note: the traditional solution calls for an assessor, like CarFax. Likewise, we’re looking for more rigorous quality data than a Google rating.