Service providers may attempt to “lock in” customers to prevent them from switching to alternative products, technologies, or suppliers. Customer lock-in involves raising customers’ switching costs to the point that the cost of switching outweighs the potential benefits from switching.
Switching costs may be:
- Transactional, for example the cost of replacing existing equipment and technology in order to move to a different service provider, or
- Contractual, for example penalties for breaking an existing contract with one service provider, in order to switch to a new service provider.
Contractual provisions that increase switching costs are not necessarily anti-competitive. Service providers may use contractual provisions that ensure customer loyalty to recover legitimate underlying costs over a period of time, for example:
- Service providers may incur substantial upfront fixed costs to acquire and serve customers. For example, it is common for mobile service providers to subsidize the cost of mobile handsets and recover the cost of the subsidy through service charges over time,
- Service providers may have incentives to spread non customer-specific fixed costs over as many customers as possible. In order to do this, a service provider may use contractual provisions to ensure customer loyalty and maintain its installed customer base.
Where the customer’s switching cost is less than the present value of the expected revenue from the customer, competing firms may offer to pay the customer’s switching cost. In this case, switching costs are not effective as a means of locking in customers.
RELATED INFORMATION
Remedies for Customer Lock-In