When human nature conflicts with government policy or business strategy, human nature will usually win. From mobile phones to credit cards, customer inertia remains a dominant influence in many markets.
Most readers of this newspaper will regularly receive invitations to apply for a credit card. To tempt them, there will be an introductory offer – 0 per cent interest for six months, reduced rates on balance transfers. And Christmas is peak season for sales of mobile phones – if “sale” is the right word. There is always a selection of “free” handsets and even the fanciest model is available at a price well below its cost of production. Much the same goes for bank accounts. The easiest way for a student to earn money is to open a bank account.
These goods and services are consumed continuously but bought only occasionally. Once you have put a credit card in your wallet, programmed a mobile phone or acquired a cheque book, you use the supplier’s services day in, day out. But you do not monitor the price of these services day in, day out. If you manage your credit card purchases carefully – taking maximum advantage of the free credit periods and regularly changing card – you can borrow thousands for years without paying a penny in interest. But only a sad person would invest the necessary time and energy.
In all these markets introductory prices are low and ongoing prices high. The standard interest rate on credit cards is well above the cost of funds, the cost of making a mobile call is greater than the cost of connection. But these profits are dissipated in marketing expenditures and in introductory incentives.
So, despite the high charges, these markets are not necessarily profitable. A kind of equilibrium emerges in which the expected profit on the continuing service equates to the cost of customer acquisition. And accounts are bought and sold, without the consent of the customers, at prices that value their inertia. Such markets still yield higher profits than average, because first movers – such as Barclaycard and Vodafone – do very well. But you can usually get a better deal from a new entrant. The best strategy for an established company is to keep prices high and let market share erode. Credit card issuers have allowed this to happen; phone companies remain jealous of their market share.
The outcome is not satisfactory for either producers or consumers. Active customers incur the costs – in time and effort – of frequently changing their provider. Passive customers pay more than they need. Producers experience high churn and incur wasteful expenditure on marketing and in setting up customer accounts. From time to time, businesses try to escape the trap of introductory offers and give guaranteed lower prices to old and new customers alike. But promotional incentives always creep back.
What is true of mobile phones, credit cards and bank accounts is also true of mortgages. The way in which loyal customers subsidise fickle switchers is a justified complaint in David Miles’s recent review of the British mortgage market.* But, as he explains, this outcome is the product of competition, rather than a failure of competition. When credit was provided by a cartel of financial institutions, the bank manager would intimidate you, not bribe you. Competition changed the balance of power between producers and consumers.
Prof Miles advocates pricing transparency and few people would argue with that. But knowledge of the structure of prices is not enough. You also need the time and inclination to use that knowledge. Few people enjoy being active shoppers in these markets. Nokia became successful by establishing mobile phones as fashion accessories rather than business tools. But making mortgages glamorous is beyond even the most inspired of marketeers. Until people enjoy filling out applications for credit cards, or amending their standing orders, customer inertia will remain a dominant influence in these markets.
They function as they do because of the way we think about the products sold in them. And, however companies plan or governments regulate, that will continue. When human nature conflicts with government policy or business strategy, human nature will usually win.
* The UK Mortgage Market Interim Report, December 2003