The Australian government has 'subscription traps' in its sights

As I noted in a post last week, firms are increasingly selling subscriptions rather than products because consumer inertia can make them substantially more profitable. Once a customer starts a subscription, they tend not to cancel the subscription as soon as they should, simply because it requires some thought and attention (as well as a little bit of time) to execute a cancellation of the subscription. This 'customer inertia' is a form of switching cost, which locks customers into buying the subscription. However, sellers can easily amp up the switching cost by making it more difficult (and therefore more costly) to cancel. This makes customer lock-in more effective, and can 'trap' customers into their subscription.

In this article in The Conversation last year, Jeannie Marie Paterson (University of Melbourne) provides a couple of examples of 'subscription traps', each of which represents an instance of the firm increasing the switching costs for the consumer:

One example is when consumers sign up for a service quickly and easily online, but can only cancel on the phone (sometimes needing to ring another country)...

Another example, known as “confirm shaming”, involves requiring consumers to click through multiple screens before they can cancel.

Typically, each of those screens has a message asking consumers to reconsider, often reiterating the service’s purported benefits and even offering new discounts on the price not previously available.

When the switching costs are higher for the consumer, the customer lock-in is more effective (it is harder for the consumer to cancel, or switch). The firm can then profit through selling at a higher price, or by selling complementary goods and services to the locked-in consumer.

It is deceptively easy for a consumer to get locked in as well. I'm sure that you will have been offered the first month free on a subscription. That is how the firms get you. Firms often offer subscriptions at a low price initially (or free), then once the consumer is locked in, the firm can raise the price (this is referred to as multi-period pricing).

However, governments are wising up to the 'subscription traps' that Paterson highlights. She notes that:

Making it hard to cancel – commonly called a “subscription trap” – isn’t currently illegal. But now the federal government has announced a plan to ban subscription traps and other hidden fees.

Since then, the policy process in Australia has advanced, with draft legislation released in early 2026 that would impose disclosure, notification, and easy-cancellation requirements on subscription contracts from 1 July 2027, if the legislation is passed.

It is worth noting that banning subscription traps is not the only policy solution here. Anything that reduces the switching costs will likely be effective at reducing customer lock-in. One example that Paterson notes is:

California’s “click to cancel” rules also mean consumers must be able to cancel using the same method of communication they used to subscribe. And businesses must offer consumers information on how to cancel.

So, if signing up for a subscription requires a single click, then cancelling a subscription must also require a single click. That minimises the switching costs, and minimises customer lock-in. Making subscriptions easy to cancel would allow consumers to retain the genuine benefits of subscriptions (including lower transaction costs and fewer service interruptions) while reducing the unnecessary costs from subscriptions they no longer use. Firms may still be able to offer discounts or reminders to retain customers, but the cancellation process should inform consumers rather than obstruct them. Reducing these artificial switching costs is therefore likely to improve consumer welfare overall.

Read more:

• The subscription economy as price discrimination
• The switching costs of online subscriptions
• More on the switching costs of online subscriptions
• Cancelling subscriptions and customer lock-in
• Why do firms increasingly prefer to sell subscriptions, rather than products?

The business economics of The Summer I Turned Pretty

I tell my students that, once they start to understand some economics, they start to notice it everywhere. It's not just a throwaway line. It really is true. As an example, one of my ECONS101 students excitedly shared with me a short example on the business economics of Prime Video's show The Summer I Turned Pretty. That show is not really my cup of tea (I prefer something like The Witcher). However, the pricing strategy that Amazon employed with The Summer I Turned Pretty is quite interesting to tease out. Specifically, when season 3 of The Summer I Turned Pretty was released on Prime Video, Amazon simultaneously released seasons 1 and 2 for free on YouTube. What was Amazon trying to do?

I believe that this was an example of Amazon using customer lock-in to increase the number of subscribers to Prime Video. Customer lock-in occurs when consumers find it difficult to change once they have started purchasing a particular good or service. High switching costs (the cost of switching from one good or service to another, or from one provider to another) are likely to generate customer lock-in, because a high cost of switching can prevent customers from changing to substitute products.

Where are the switching costs here? With a television show, viewers get invested in their favourite characters and in following particular storylines. If a viewer was to watch something else instead, they face a switching cost of missing out on knowing what their favourite characters are doing, or how the storylines that they were following play out. So, once a viewer starts watching a particular television series that they like, they are reluctant to stop. This is the switching cost in action - the viewer is locked into watching that series.

By releasing the first two seasons of The Summer I Turned Pretty for free on YouTube, Amazon is hoping that will attract new viewers, who will become locked into watching it, and then pay for a subscription to Prime Video in order to continue watching season 3. More Prime Video subscribers equals more revenue (and profits) for Amazon. And because very few consumers would be attracted to Prime Video for the first two seasons of this show, making them available for free didn't really have a high opportunity cost for Amazon (and the challenge of cancelling subscription services creates a further degree of lock-in). 

This strategy is essentially a form of multi-period pricing - setting the price low initially (free for the first two seasons), before raising the price once consumers are locked in (since they have to have a paid subscription to watch season 3). This works because locked-in customers have less elastic demand for a product (they are less price sensitive). So, charging a higher price to locked-in customers than to those who are not (yet) locked in is a profit-maximising strategy.

There is a further aspect of this strategy that I find equally interesting. The student I was speaking with noted that some of her friends had waited until the last episodes of The Summer I Turned Pretty were released, before subscribing to Prime Video for one month and binge-watching the whole season and then cancelling their subscription. In contrast, my student was more impatient and watched each episode as it was released. However, that meant paying for three months of Prime Video subscription.

This sounds a lot like price discrimination - charging different prices to different consumers for the same good or service (and where the difference in price doesn't reflect a difference in costs). In this case, super-fans of the show will be impatient and wanting to watch each episode as it is released. They have short time horizons (they want to watch now), so their demand is less elastic. And with less elastic demand, the profit-maximising price is higher. In contrast, casual fans of the show will be more patient, and happy to wait and binge-watch the whole season in a day. They have longer time horizons, so their demand is more elastic. And with more elastic demand, the profit-maximising price is lower.

By releasing one episode a week, Amazon is able to effectively price discriminate for both groups. The impatient fans (with inelastic demand) pay for three months of Prime Video (a higher price), while the patient fans (with more elastic demand) pay for one month (a lower price). Even better, Amazon doesn't even need to be able to tell these fans apart, because the fans make the decision themselves about what price to pay.

Economics is all around us. You just need to keep your eyes open, and you will see it.

[HT: Georgie from my ECONS101 class]

Black Mirror Season 7 illustrates the ultimate version of customer lock-in

[This post contains spoilers. You have been warned.]

I love the TV show Black Mirror. Charlie Brooker (the writer of almost all episodes of the show) is an evil genius. Nearly every episode depicts some dystopian near-future that is just plausible enough to make you both worry, and think. The first episode of the latest (seventh) season, titled Common People, is a perfect illustration of this. It is also a perfect illustration of customer lock-in, albeit at an extreme level. From the Wikipedia description of the episode:

Welder Mike Waters (Chris O'Dowd) and schoolteacher Amanda (Rashida Jones) have been married for three years and are trying to conceive a baby. One day while teaching, Amanda collapses, and doctors discover she has an inoperable brain tumor. Mike is introduced to Gaynor (Tracee Ellis Ross), a representative from tech startup Rivermind Technologies. Gaynor explains that Rivermind can remove the tumor and replace her excised brain tissue with synthetic tissue powered by their servers. While the surgery is free, the couple agree to pay a monthly subscription fee to give Amanda a chance at living a normal life again.

Initially the service seems to help Amanda, but as time passes they find that it has several limitations which can only be bypassed by subscribing to the costlier "Plus" tier, as opposed to their current "Common" tier. Unbeknownst to Amanda, she begins interjecting brief advertisements into her daily speech.

As I describe in my ECONS101 class, customer lock-in occurs when consumers find it difficult to change once they have started purchasing a particular good or service. High switching costs (the cost of switching from one good or service to another, or from one provider to another) are likely to generate customer lock-in, because a high cost of switching can prevent customers from changing to substitute products. High switching costs could also, in some cases, prevent consumers from stopping buying the good or service - that is, the switching cost causes the consumers to keep buying the good even if they would want to stop (if there was no switching cost). This is the case for subscriptions, for example (see here or here or here).

In this case, Rivermind appears to have discovered the ultimate form of customer lock-in. The switching cost that Mike and Amanda face if they try to cancel their Rivermind subscription is that Amanda dies (or becomes comatose - the episode is somewhat unclear on this point). That switching cost is obviously very high and provides a strong incentive for Mike and Amanda to keep their subscription going. They are locked into the subscription, which is quite expensive.

Rivermind doesn't just profit from Mike and Amanda through their subscription. Rivermind also engages in a form of multi-period pricing. Typically, firms engage in multi-period pricing by starting new consumers with a low price, and then raising the price once those consumers are locked in. This is what utility firms are trying to do when they offer a discounted rate for electricity or broadband for new customers (for a limited time!). The price is initially low, and then when the new customers are locked in, the price increases (because the discount ends).

Rivermind's approach is somewhat different to the standard case of multi-period pricing. Instead of directly raising the price of the service that Mike and Amanda receive, Rivermind degrades the quality of that service (by introducing advertising). Rivermind then introduces an advertising-free tier that is more expensive (which Mike and Amanda are invited to 'upgrade' to, even though tit is really just a more expensive price for the service they started with). Rivermind then also introduces more tiers of subscription with greater coverage and more perks (and even higher prices).

The Black Mirror episode focuses on the increasingly desperate ways in which Mike tries to keep the subscription going. However, my takeaway is that it illustrates how firms can lock consumers in with switching costs that are non-monetary, and then profit from those locked in consumers. Thanks Charlie Brooker - now you've given me something else to worry about in the dystopian near-future.

Read more:

• The subscription economy as price discrimination
• The switching costs of online subscriptions
• More on the switching costs of online subscriptions
• Cancelling subscriptions and customer lock-in

Always be a new customer - price discrimination and 'loyalty taxes'

Price discrimination is one of the most pervasive pricing practices that firms use. It involves the seller the seller selling the same product to different consumers for different prices, and where those differences in prices don't reflect differences in cost. Specifically, the seller should charge a higher price to consumers who have less elastic demand (consumers who are less price sensitive, and those who are less likely to go elsewhere), and a lower price to consumers who have more elastic demand (those who are more price sensitive).

Some of the examples seem really perplexing, until you think about them in terms of the price elasticity of demand. For instance, consider the example of Delta Airlines charging a higher price to its frequent fliers than to those who are not frequent fliers (one of my favourite examples to use in my ECONS101 class). That seems to make no sense, until you realise that frequent fliers are less likely to go elsewhere, because they want to keep accumulating air miles. That means that the frequent fliers have less elastic demand than other consumers do, and a price-discriminating airline should be charging them a higher price.

Given how common price discrimination is, I was interested to read this article in The Conversation last month, by Allan Feis (University of Melbourne), about what he refers to as 'loyalty taxes':

A “loyalty tax” occurs when discounts are offered to new customers while longer-term customers pay more. Often this involves increasing premiums at the first and subsequent renewals...

Our research last year showed, on average, customers renewing their insurance policy paid 27% more than new customers. Our most recent data indicates the gap has risen to 34%. This translates to hundreds of dollars for the average home and contents insurance policy.

Loyalty taxes appear to be widespread in Australia. The Australian Competition and Consumer Commission concluded from different pricing inquiries that loyal customers of both banks and energy providers end up paying more. It also demonstrated the price difference for insurance in northern Australian – with one insurer on average charging renewing customers 15-20% more than new customers.

In Britain, regulators have calculated that customers are, by their fifth renewal, paying about 70% more than a new customer. The Competition and Markets Authority estimates the total cost of loyalty taxes in five British markets – mortgage, savings, home insurance, mobile phone contracts and broadband – to be about £4 billion (about A$7 billion) a year.

Translating this British estimate to the equivalent sectors in Australia (taking into account differences in population and GDP), the cost to consumers could be as high as A$3.6 billion, or at least $140 a year per person. This estimate does not include the energy sector, where evidence suggests the practice of charging longstanding customers more is rife.

Loyal customers are, by definition, less likely to go elsewhere. Common sense suggests that companies should look after these customers, especially if the cost of acquiring new customers exceeds the cost of keeping existing customers (apparently, five times as much). However, maybe that heuristic is breaking down, especially if loyal customers are profitable in the short term, because their less elastic demand means that firms can charge them a higher price until they leave.

In my ECONS101 class, we also talk about customer lock-in, where customers find it difficult or costly to change provider once they have started buying from one. The cost might be monetary (such as a contract termination fee), or it could simply be the time and effort required to find a new seller. One way a firm can increase the number of locked-in consumers is to offer a low price initially. Once the consumers are locked in, it makes sense for the firm to raise its price to those consumers. This is referred to as multi-period pricing.

'Loyalty taxes', as described by Feis, cover both of these situations (price discrimination, and multi-period pricing). It is difficult for consumers to avoid the loyalty tax if it arises from multi-period pricing (especially if they are locked in by a contract termination fee), but less costly to avoid price discrimination, if firms are simply charging loyal and long-term customers a higher price.

The take-away message from this for consumers should be: make sure that you regularly change suppliers, for electricity, broadband, insurance, etc. If you're not locked in by a contract, you should be checking for alternatives on a regular basis (and there are government-provided services available to help, like whatsmynumber in the case of electricity providers in New Zealand). If the firms are only giving better deals to new customers, you should be aiming always to be a new customer.

Make sure you get your cocaine loyalty card stamped

In ECONS101, we cover many different pricing strategies. One of my favourites to discuss is customer lock-in and the associated multi-period pricing. This is because I get to use the example of drug dealers, who have been known to give away their highest quality product for free.

To see why, we need to take a step back. In order to lock customers into buying from them (enigmatically called 'customer lock-in'), there needs to be a switching cost - a cost of switching to some other seller. Switching costs might include contract termination fees, for example, but in the case of drug dealers it might be as simple as it being difficult for the buyer to find some other seller (drug dealers can't exactly advertise themselves in the yellow pages, after all). Drug dealing syndicates might reinforce these switching costs by using violence to ensure that rival sellers stay out of their turf, meaning that addicted customers really have no other option but to come to the syndicate to get their fix.

Why give away product for free then? Having established switching costs, you need to find some way to get customers to start buying your product (and then, having started buying from you, the customers find it difficult to switch to some other seller or to stop buying). Some firms give away free samples - this is also why cellular networks are so keen to give you a free or heavily discounted phone. In the case of drug dealers, they give away their product for free. The reason they give away the highest quality product is because it is also the most addictive. There's nothing like having an addicted customer, locked into buying from you because it is too costly for them to switch, if you want to increase your profits.

And one way you increase your profits is using multi-period pricing. Initially you give away the product for free, and then once your customers are locked into buying from you, you can raise the price and reap the profits. In the case of drugs, you can also lower the quality by cutting them with something worthless (after all, if the customers are locked in, they aren't going anywhere else for their fix).

Which brings me to this story from The Telegraph (paywalled, or try this version from the New Zealand Herald):

With its smiling face logo and tempting offer to buy five and get the sixth free, this loyalty card at first appears as innocuous as those offered by any High Street coffee shop or supermarket.

But, it is being handed out to wealthy cocaine users to boost sales and loyalty and reveals just how fierce competition between drug dealers fighting turfs wars for ‘market dominance’ has become...

The card 'scheme' offers stamps for bulk purchases giving the sixth and then 12th wrap of cocaine free, said the source who handed it to the Daily Telegraph.

A wrap of cocaine generally costs between £50 and £80, depending on the quality, the source said, adding that it is understood a network of couriers deliver the drug.

The loyalty card reads: "One freebie for every five stamps you collect!! Love Loyal-T". The smiley face design on the front is evocative of the 1980's acid dance scene.

Given how easy it is to profit from locked-in customers as per my description above, why would cocaine dealers offer a loyalty card? You only profit if your customers are locked into buying from you. If there are many competitors selling the same (or a very similar) product, then you haven't really locked those customers in. This is why drug syndicates try to keep competitors out of their turf.

But say that, for whatever reason, you couldn't keep competitors out of your market. Maybe your competitors are sending drugs into your town from outside and it is difficult to intercept their couriers. Or perhaps your customers have realised that they can get their fix by travelling to the next town, or by navigating to the right site on the dark web. How do you lock those customers in to buying from you? One answer is to offer a loyalty card.

How do loyalty cards generate customer lock-in? Remember, there needs to be a switching cost. In the case of loyalty cards (whether we are talking about coffee cards, cocaine loyalty cards, or even airline miles or Flybuys points), there is a cost of going to an alternative seller - you miss out on a stamp on your loyalty card (which would have taken you one step closer to a free fix). In the case of loyalty cards, the switching cost is small, so the lock-in is fairly weak. But overall, it explains why cocaine dealers would be willing to offer a loyalty card to their customers.

Trustpower takes multi-period pricing a bit too far

Last week in ECON100 we covered pricing strategy. Part of that topic looks at customer lock-in and multi-period pricing. Customer lock-in occurs when customers find it difficult (costly) to change once they have started purchasing a particular good or service. Customers are typically locked in because of high switching costs (literally the costs of switching from one good or service to another). Switching costs might include contract termination fees, but also include other costs such as the cost of searching for an alternative good, and learning how it works, etc. It is these high switching costs that prevent customers from changing to substitute products.

Firms can take advantage of having locked-in customers through multi-period pricing. This occurs when the initial price is low (to attract customers) and then the price is raised once the customers are locked in. Multi-period pricing only increases profits if the customer is locked in - if the customer is free to move to other providers, then when the price is increased they are likely to do so. There are lots of examples of multi-period pricing - one of my favourites is that it is a good explanation for why drug dealers give away free samples of their highest-quality (and most addictive) product.

So, it was interesting to read this article in the New Zealand Herald last week, about the strategy employed by Trustpower:

Trustpower has been hauled through the courts and fined $390,000 for misleading consumers over a campaign for an unlimited broadband deal.

Between March and July last year, Trustpower promoted a $49 a month for 12 months unlimited data broadband plan, under the campaign theme: "Good things happen when power and broadband get together." ...

However, the $49 price was available only to customers who signed up for power and broadband at the same address on a 24-month contract term.

For the last 12 months on the contract the cost jumped to $79 a month and if a customer wished to cancel the contract at any time during the 24-month period they would incur exit fees.

This is a classic example of multi-period pricing, supported by locking customers into a contract through the use of a high termination fee. It is worth noting that the Commerce Commission took issue not with the multi-period pricing strategy itself, but with the way it was marketed - the increased price over the second 12 months of the 24-month contract was buried in the fine print of the advertisements for the deal. If Trustpower had been more up-front about the terms of the deal, it wouldn't have attracted the Commission's attention (but it might not have attracted as many consumers' attention either!).

Cellphones and customer lock-in (literally)

In ECON100 we spend a whole topic looking at pricing strategy, which is a substantial departure from most microeconomics principles courses. Pricing strategy is important because it helps to explain why firms don't typically price at the point where marginal revenue is exactly equal to marginal cost (the point that would maximise profits for a firm selling a single product at a single price). We also look at non-price business strategies that are related to creating and capturing value (in other words, ways of increasing profits).

One of the areas we look at is switching costs and customer lock-in. Switching costs are the costs of switching from one good or service to another. Switching costs might include contract termination fees, but also include other costs such as the cost of searching for an alternative good, and learning how it works, etc. Customer lock-in occurs when customers find it difficult (costly) to change once they have started purchasing a particular good or service. Switching costs typically generate customer lock-in, because a high cost of switching can prevent customers from changing to substitute products.

Which brings me to this opinion piece by Juha Saarinen last month, which makes the case against telcos locking their customers in:

With that in mind, it seems a shame that SIM locking has reared its ugly head again.

This is a feature in GSM networks that allows providers to restrict or lock phones bought from them so that only their SIM cards can be used in them. The idea here is that telcos will "subsidise" phones - or on some plans, include it for no money upfront - but you have to stay on their networks.

Having to pay less upfront for phones is an attractive proposition for many, especially when it comes to expensive smartphones.

However, telcos are not charities and they make up for the cost of the device in usage charges over the time it is locked to their networks. You're not going to save money in other words, and likely lose out over time as better deals and plans come online.

Juha is describing the act of multi-period pricing, a common counterpart to switching costs and customer lock-in (and the reason why we discuss these things in a topic on pricing strategy). Multi-period pricing occurs where the initial price is low (to attract customers) and then the price is raised when the customers are locked in. Multi-period pricing only increases profits if the customer is locked in - if the customer is free to move to other providers, then when the price is increased they are likely to do so. There are lots of examples of multi-period pricing - one of my favourites is that it is a good explanation for why drug dealers give away free samples of their highest-quality (and most addictive) product.

In the case of locked mobile phones, the customer is literally locked in because the phone they are given for free (or heavily discounted) is unable to be used with any other network. The telcos are not dummies - they're doing this because it increases their long-run profits. They take a hit by giving away the handset at below cost, and make up for it through monthly plan charges from a long-term locked-in customer.

If that sounds a bit unfair or anti-competitive to you, then according to Juha you may be right:

You'd think that the Commerce Commission would frown upon telcos again trying to lock in customers with SIM locking to prevent "churn", or moving to other providers with more competitive deals, but no. The regulator has done a one-eighty on SIM locking lately.

"We don't believe SIM locking is anti-competitive. It's analogous to early termination provisions in post-pay contracts," a commission spokesperson told me.

"Customers have choices of buying handsets directly or honour some sort of undertaking if they accept a handset subsidy," the spokesperson added.

Those arguments are both flimsy though. First, a contract between a telco and a person or company doesn't stop customers from moving to other providers.

Sure, you'll have to honour the contract or pay termination fees (which can be exorbitant), but you can use your phone on another network if it's compatible with it.

Let's say Telco A's service in your area is bad but Telco B is good; you need phone service and will bite the bullet and switch providers. With an unlocked phone, you can.

I have to agree with the Commerce Commission here. While on the surface locking customers into a long term relationship sounds anti-competitive or unfair to the customer, the customer is still free to choose not to purchase from the provider offering a locked phone and to go with another provider (even if it means being locked into purchasing from the other provider instead). The only difference is that this mobile phone lock-in is technological rather than contractual. But the customer need not be locked in - they could purchase the phone at full price and not have a locked phone (or be locked into a contract with termination fees) at all. They would then be free to change provider at will.

Another key point is that owning a locked phone doesn't stop customers from moving to other providers - it only stops them taking their phone to another provider. If the customer wants out of their contract and they are willing to pay termination fees, then probably they are willing to purchase a new phone to get out of a locked phone. The $30 cost to unlock the phone (quoted in the article) hardly seems excessively prohibitive alongside the contract termination fees which might be hundreds of dollars, depending on the phone. I don't see the issue here. As for customers who want to change because of poor service in their area, perhaps they should have looked at the quality of service in their area before purchasing the phone, locked or otherwise.

In this last bit I think Juha misses the point:

Large multinational telcos can use their market power to hammer out exclusive deals with phone makers and offer handsets to customers at low initial cost, provided they agree to be locked in over a period of time.

They can also offer network features and services exclusively to locked-in customers - and refuse to connect customers who have bought handsets directly. Telcos may also be tempted to offer plans with more expensive local and roaming rates to customers who bring their own handsets so as to steer them towards locked ones with better deals for calling, texting and data.

So, customers can get phones cheaper as a result of exclusive deals between the telcos and phone makers? The horror! As for telcos offering their locked-in customers features and services not available to those who aren't locked in, this sounds like a good deal for both the customer and the telco. The customer will be made better off (than going with some other provider without a locked phone) provided that the extra features and services are more valuable to the customer than the freedom to change provider. The telco will be made better off because this incentivises more customers to lock themselves into using their service.

Customer lock-in and multi-period pricing are a legitimate tool for increasing profits, and can actually make both the customer (who can get a better phone earlier than if they had saved up for it) as well as the telco better off. Having said all that though, as a customer it pays to think carefully about the total cost of the phone plus the monthly plan charges over the locked in period - is it worth it?