WP-037: Sébastien Houde, "Bunching with the Stars: How Firms Respond to Environmental Certification" (July 2018)

In this new E2e working paper, faculty affiliate Sebastien Houde shows how firms respond to ENERGY STAR (ES), a voluntary certification program for energy-efficient products. The paper shows that firms are highly strategic in their product line and pricing decisions.

Firms offer products that bunch at the certification requirement, differentiate certified products in energy and non-energy dimensions, and charge a price premium on certified products. In the US refrigerator market, the magnitude of the price premium corresponds exactly to the average willingness to pay consumers have for certified products. This suggests that firms have the ability to extract most of the consumer surplus associated with certified products.

The fact that the size of the ES price premium is of the same magnitude as the private benefits associated with ES-certified models has several implications for the design and evaluation of the program. First and foremost, consumers might not benefit as much from the program relative to the firms. Second, this also has implication for the pass-through and the impact of a certification fee. The Trump administration has proposed recently to stop funding the ES program, which should instead rely on a certification fee that firms would pay to use the ES label. Given that appliance manufacturers and retailers are able to systemically maintain a price premium on ES-certified products, this suggests that a certification fee should be borne almost entirely by consumers. A costly certification would then lead to an increase in the prices of certified products, which would lower their adoption and lead to an increase in externality costs associated with energy consumption. Under various scenarios regarding the magnitude of the certification fee, however, the market and environmental impacts of such a fee could be minimal and could easily cover the cost associated with running the overall ES program.

The conclusions from this study hinges on the fact that in some markets manufacturers of energy-efficient technologies have the ability to price discriminate. The existence and size of the ES premium should then vary widely among the more than 60 product categories covered by the program, thus extrapolating the present results should be done with caution. Nonetheless, this study highlights the importance of accounting for firms’ strategic behaviors in designing and evaluating the ENERGY STAR program.