Higher Profits through Customer Lock‐In

Citation

Paswan, A. (2006), "Higher Profits through Customer Lock‐In", Journal of Consumer Marketing, Vol. 23 No. 2, pp. 114-115. https://doi.org/10.1108/07363760610655050

The starting premise of the book is: Switching costs (any costs associated with changing from one brand to another) significantly drives profits and hence it is crucial to understand the dynamics of switching costs. However, almost immediately (Part I) the book seems to take on a perspective that sounds contrarian to what most consumer satisfaction researchers believe. It brings up memories of arguments in consumer behavior seminars – studying consumers like a fisherman studying fish or a marine biologist studying fish. It argues that the relationship between customer satisfaction (CS), loyalty, profits, and market capitalization; although well researched in academia; is not very well supported by industry data. The author states:

Why, then, do even highly satisfied consumers defect? Why is CS a bad predictor of a buyer's intention to allocate business to a certain supplier? Why do so many customer‐relationship management (CRM) projects fail? Industry observers report CRM project failure rates of 60‐70%, indicating that CRM often fails to improve the profitability of the firm (p. 3).

The author also provides contingency conditions under which customer satisfaction drives customer loyalty, i.e. when the market is competitive, when potential for customer satisfaction exists and the instruments for enhancing customer satisfaction can be protected, and when switching costs play no role in the purchasing process. The book drives home the arguments that instead of bothering about customer satisfaction (calling it a trap) firms should focus on an alternate strategy – create customer switching costs and consequently lock‐in customers, because switching costs increase customer loyalty. The book then goes on to suggest that customer lock‐in through switching costs enhance shareholder value by increasing future cash flows, accelerating cash flows, and reducing volatility of cash flows. The types or instruments of switching costs identified are transaction switching costs (time and effort spent), learning costs, loyalty reward programs, brand‐specific investment (proprietary technology, procedures, site‐ specific investment, personal relationships and emotional bonds), and compatibility (similar to network externalities in the extant marketing literature).

The book makes no bones about its argument:

Management is about achieving profits. More specifically, it is about competitive advantage to achieve above normal profits (p. 29).

Büschken suggests that every firm should try to achieve a large customer base with significant switching costs because it is a resource that cannot be easily and quickly imitated by competitors. The author argues that a significant switching cost and customer lock‐in gives the firm an enormous advantage in terms of near monopoly power and the potential for price discrimination (particularly against old customers). With regards to the resultant ethical dilemma, the book offers several arguments – consumers are rational, markets are efficient, and if price discrimination against old (loyal) customers is wrong, then all other ways of discriminating against any one set of customers is also unethical, and hence “If markets are efficient (and they should be) and customers are rational, then markets with switching costs do not present unique ethical problems” (p. 38).

In Section Two, the author details some of the macro issues associated with switching costs. He argues that market share becomes a key driver of future profits in markets with customer lock‐in, and he discusses the effects of network externalities and complements. Once again, the notion of price discrimination against locked‐in customers is brought in as a positive factor.

In this section, the author takes a look at the effects of switching costs on consumers and offers tips on how to avoid or mitigate lock‐in traps. Consumers could reduce brand‐specific investments through opting for less entrenched brands and performance‐based compensation. Consumers could also insure (provide counterweights to lock‐in) their brand‐specific investments through vendor reputation, mutual lock‐in, contracts, avoiding partial contracts, and dual sourcing. The author does suggest:

Vendors should be prepared to openly discuss with customers the degree of entrenchment that results from adopting their brand. Don't let customers run into traps. They will eventually find out and be dissatisfied, and that may hurt in the long run much more than any price discrimination can compensate (p. 55).

However, somehow one gets the feeling that these tips are provided for firms so that they can prevent consumers from reducing lock in.

Büschken suggests a novel approach to segmenting markets with switching costs because segmentation enables firms to differentiate and differentiation increases profits. First, the market structure should be analyzed using dynamic lock‐in and then locked‐in customers should be analyzed in terms of origin and extent of their switching costs to establish their propensity to switch. In each market with switching costs, there are three segments: new buyers or first timers, users with irrelevant switching costs, and entrenched users with significant switching costs. Then, segment the locked in customers using the criteria of their accessibility and their propensity to switch.

The third section details the instruments for creating switching costs, customer lock‐in, and consequently robust customer loyalty (here Büschken acknowledges that the reverse, i.e. higher loyalty does not mean higher switching cost, is not necessarily true). Some of the instruments purported to result in higher switching costs are brand‐specific learning (case made for idiosyncratic products), contractual lock‐in and associated tradeoff between short term versus long term benefits, loyalty programs (up‐front discounts and back end incentives), technological lock‐in and the role played by innovation, customer‐supplier relationships and personal relationship‐based lock‐ins.

The fourth section examines the implications of switching costs on business strategy. Some of the strategies for customer bases include enhancing brand reputation through symbolic, competitive, and relational actions; deepening customer lock‐ins through upgrades and complements, and cross‐selling. Strategy for entrenched users include unfreezing, moving, and refreezing them. The author argues that:

Pricing is the litmus test of strategy. If customer loyalty is high, a price premium can be commanded (p. 141).

Another implementation strategy is to use new product development to progressively lock‐in customers. However, there is a caveat offered:

Be aware of new product concepts that are targeted at new markets and divert a lot of resources from the customer base (p. 149).

On the supply chain end, the book argues that firms should develop dealer support for lock‐in strategy by providing an additional source for lock‐in such as assortment function and alternate governance mechanisms such as franchising. The idea is to reduce customer uncertainty, and it should have a spillover effect on brand communication as well. The author at this stage cautions that efforts diverted towards increasing customer base may hurt profits. The book suggests that it is crucial to clearly explain the relationship between brand‐specific investment and the added value to customers and to develop a reputation as a reliable source of value enhancing upgrades and complements that safeguard customer interest.

The last section deals with the question, “How do we know that the lock‐in based strategy is working?” Using two outcome dimensions of strategy based on customer lock‐in (i.e. degree of market penetration and the extent of perceived switching costs), a 2 × 2 matrix is offered as a monitoring grid. To assess the influence of the customer lock‐in on customer equity, managers need to look at customer equity drivers anchored in switching costs – acquisition and retention rates and the factors that drive these. Clearly, this requires some reorientation in terms of organizational mindset. Finally, the book closes with some future outlooks which aid and abet customer lock‐in strategy – building and emergence of networks, rise of customer power, increasing importance of the internet, and one‐to‐one marketing.

While a lot of issues dealt with in the book and how‐to tips for managers make sense, the book seems to be one sided, i.e. it primarily focuses on the firm's perspective. The arguments presented are interesting and pragmatic, albeit somewhat contrarian. The stance taken by the author also has future research implications. It would be interesting to test if customer lock‐in is in fact a better predictor of customer loyalty than customer satisfaction, and the conditions under which these relationships (one way and/or the other) hold true? The book, if nothing else, makes one question some of our commonly‐held beliefs about the relationship between customer satisfaction, loyalty, and profits. To that extent it serves a very useful purpose.

Audhesh Paswan

Associate Professor, Department of Marketing and Logistics, COBA, University of North Texas, Denton, Texas, USA