Supplier Surfing: Competition and Consumer Behavior in Subscription Markets

The common marketing practice of offering subscribers enticements to switch suppliers is explored. It is shown that this type of price discrimination is the natural mode of competition in subscription markets such as long distance telephony and banking and that it prevails even when the industry in question is fully competitive and all firms earn zero economic profit. In addition, while price discrimination in monopolistic markets generally enhances efficiency, the type of price discrimination here undermines it because subscribers are induced to spend time and effort changing suppliers. A multi-period model in which each consumer's cost of switching varies randomly over time is studied. In equilibrium, firms set prices that do not depend on market shares or time, and consumers follow a reservation-cost rule which leads them to switch suppliers in 'slack' periods and not to switch in 'busy' ones. Subscription markets are shown to be fully competitive only when three or more firms serve the industry. In this case, the price offered to switchers is actually below cost, while non-switchers pay a premium. A firm, thus, earns positive rent on its base of current customers, but zero expected profit on each new subscriber it attracts. When firms can track consumer behavior over time, an individual may change suppliers in order to establish a reputation as a switcher, thereby securing better future price offers.