The Influence of Switching Costs on Customer Retention: a Study of the Cell Phone Market in France

ABSTRACT - The behavioral objective of customer satisfaction programs is to increase customer retention rates. In explaining the link between customer satisfaction and loyalty, switching costs play an important role and provide useful insight. If the market is competitive and switching costs are high, only satisfied customers repurchase products and services because of competition, which results in small number of false loyal customers who are dissatisfied but obliged to be loyal. The purposes of this paper are (1) to examine heterogeneity in the customer satisfaction-loyalty link, (2) to identify customer segments with asymmetric levels of satisfaction and loyalty, and (3) to analyze the role of switching costs among different types of the satisfaction-loyalty link. Empirical illustration of our study is based on the cellular phone market in France.



Citation:

Jonathan Lee and Janghyuk Lee (1999) ,"The Influence of Switching Costs on Customer Retention: a Study of the Cell Phone Market in France", in E - European Advances in Consumer Research Volume 4, eds. Bernard Dubois, Tina M. Lowrey, and L. J. Shrum, Marc Vanhuele, Provo, UT : Association for Consumer Research, Pages: 277-283.

European Advances in Consumer Research Volume 4, 1999      Pages 277-283

THE INFLUENCE OF SWITCHING COSTS ON CUSTOMER RETENTION: A STUDY OF THE CELL PHONE MARKET IN FRANCE

Jonathan Lee, University of Pittsburgh, U.S.A.

Janghyuk Lee, Ecole SupTrieure des Sciences Economiques et Commerciales (ESSEC), France

ABSTRACT -

The behavioral objective of customer satisfaction programs is to increase customer retention rates. In explaining the link between customer satisfaction and loyalty, switching costs play an important role and provide useful insight. If the market is competitive and switching costs are high, only satisfied customers repurchase products and services because of competition, which results in small number of false loyal customers who are dissatisfied but obliged to be loyal. The purposes of this paper are (1) to examine heterogeneity in the customer satisfaction-loyalty link, (2) to identify customer segments with asymmetric levels of satisfaction and loyalty, and (3) to analyze the role of switching costs among different types of the satisfaction-loyalty link. Empirical illustration of our study is based on the cellular phone market in France.

INTRODUCTION

As market becomes more competitive, firms are more inclined to maintain their market share through not only cpturing new customers, but also to retain current customers who are recognized much easier and proven to be a more reliable source of economic performance (Fornell and Wernerfelt 1987; Peters 1988; Reichheld and Sasser 1990). To increase current customer’s retention rate, firms focus on the implementation of effective schemes as part of the defensive marketing strategy including customer satisfaction program (Anderson and Sullivan 1993; Rust and Zahorik 1993; Anderson, Fornell, and Lehmann 1994; Jones and Sasser 1995), complaint management (Hirschman 1970; Fornell and Wernerfelt 1987), and loyalty programs (Reichheld 1996; Dowling and Uncles 1997). In developing various customer satisfaction programs, researchers also focused on the management of service quality: developing strategies to meet customer expectations (Parasuraman, Zeithaml, and Berry 1988), and explaining the impact of service quality on profit (Rust, Zahorik, and Keiningham 1995; Zeithaml, Berry, and Parasuraman 1996). They focus mainly on the process in which customers form expectations of service, perceive the performance of delivered service, decide to remain or switch, and the analysis of performance implications.

In explaining the link between customer satisfaction and loyalty, marketing researchers have given little attention to the role of switching cost. Fornell (1992) introduced the switching barrier as an element of loyalty function in addition to customer satisfaction. Recently, Jones and Sasser (1995) mentioned it as one of the factors that determine the competitiveness of market environment. They argue that high switching costs discourage customers to switch from current product vendor or service provider. In the presence of switching costs, ex ante homogeneous products or services, that is, functionally identical services, become ex post heterogeneous (Klemperer 1987). Consequently it may result in the misrepresentation of the satisfaction-loyalty link by creating a group of customers having false loyalty. The purposes of this paper are (1) to examine heterogeneity in the customer satisfaction-loyalty link, (2) to identify customer segments with asymmetric levels of satisfaction and loyalty, and (3) to analyze the role of switching costs among different types of the satisfaction-loyalty link. Empirical illustration of our study is based on the cellular phone market in France.

Empirical illustration of our study is based on the cellular phone market in France. As of April 1999, the number of cell phone users has reached 12.9 million with 22.2% of penetration rate, the market recorded 37% growth rate for a 6-month period. It is of great interest to marketing researchers not only for its rapid growth but also for its implications to customer satisfaction management in the emerging market. The cell phone market inherently presents various types of switching costs including transaction cost and search cost. Therefore, consumers should consider the expected costs of switching in pre-purchase evaluation of services in addition to price and service quality. Given the importance of switching costs, we expect to find various types of consumer satisfaction-loyalty link and explain the variation in terms of the size of switching costs. For example, we can identify a group of dissatisfied-loyal customers with high switching costs or completely satisfied-disloyal customers with low switching costs.

THEORETICAL BACKGROUND

Antecedents and Consequences of Service Quality

During the 1980s, service quality has received much attention as one of the key strategic factors of product differentiation to increase market share and to boost profits (Philips, Chang, and Buzzell 1983; Buzzell and Bradley 1987). Researchers focused on the process in which consumers evaluate service quality. Consumer expectations and perceived performance of services were found to be the main antecedents of measuring service quality. Service quaity measure consists of dimensions such as tangibles, reliability, responsiveness, assurance, and empathy (Parasuraman, Zeithaml, and Berry 1985). Also, the importance of the influence of disconfirmation on service quality, arising from discrepancies between anticipated and perceived performance, was reported (Tse and Wilton 1988; Bolton and Drew 1991; Cronin and Taylor 1992). This process was developed into a dynamic model which traces the way customers form and update their perception of service quality and identifies the consequences of these perceptions on individual-level behavioral intention variables (Boulding, Kalra, Staelin and Zeithaml 1993). Customer retention is thought of as one of the various behavioral consequences of service quality (Steenkamp 1989) since it produces a direct and immediate impact on the market share of firms. The analysis of impacts of service quality on profit (Koska 1990; Rust, Zahorik, and Keiningham 1995; Zeithaml, Berry, and Parasuraman 1996) completed the structure of service quality process from expectations to its financial consequences.

Customer Satisfaction and Loyalty

The behavioral objective of customer satisfaction programs is to increase customer retention rates (Fornell 1992). Recent attempts to understand customer satisfaction formation have produced several important findings. For example, disconfirmation and perceived quality were found to affect customer satisfaction more than expectations (Churchill and Suprenant 1982) and expectancy-disconfirmation (Oliver and DeSarbo 1988; Yi 1990). Anderson and Sullivan (1993) also showed satisfaction as a function of disconfirmation and perceived quality by analyzing Swedish data of customer satisfaction survey. Customer satisfaction program was recognized by managers as a major tool that can increase profit by preventing customers from defection (Reichheld and Sasser 1990). Reichheld (1996) reported the economics of customer loyalty in terms of customer retention, that is, as customer retention rate increases by 5% from the current level, net present value of customer may increase by 35% for software company and by 95% for advertising agency. As a result of consistent high satisfaction level, a long-run reputation effect insulating firms by reducing customers’ price sensitivity (Anderson and Sullivan 1993).

According to Uncles and Laurent (1997), customer loyalty is viewed sometimes as a behavior measure (hard-core loyalty, repeat purchase probability, etc.) and as an attitude (brand preference, commitment, intention-to-buy). As a behavioral measure, customer loyalty was measured as the long-term choice probability (Jeuland 1979; Carpenter and Lehmann 1985; Colombo and Morrison 1989; Dekimpe, Steenkemp, and Mellens 1997), and a minimum differential needed for switching (Raju, Srinivasan, and Lal 1990). Attitudinal approach focused mainly on brand recommendation (Boulding et al. 1993), resistance to superior product (Narayandas 1996), repurchase intention (Cronin and Taylor 1992; Anderson and Sullivan 1993), and price premium to pay (Zeithaml et al. 1996; Narayandas 1996). As for the individual level relationship between satisfaction and loyalty, loyalty between merely satisfied and completely satisfied customers was found to be significantly different in competitive markets such as automobile industry (Jones and Sasser 1995). Narayandas (1996) also confirmed the different degree of loyalty between satisfied and delighted users of personal computing products.

Satisfaction-Loyalty Linkage and Switching Cost

Fornell (1992) argued that the impact of customer satisfaction for repeat business and customer loyalty is not the same for all industries. Different types of customer satisfaction-loyalty links were presented depending on factors such as market regulation, switching cost, brand equity, loyalty program, proprietary technology, and product differentiation at industry level (Jones and Sasser 1995). Hauser, Simester, and Wernerfelt (1994) also pointed out that consumers become less snsitive to satisfaction level as switching cost increases. Jones and Sasser (1995) present a very intuitive classification of satisfaction-loyalty linkage at the individual level. Customers were classified into 4 different groups: loyalist/apostle (high satisfactionBhigh loyalty), defector/ terrorist (low satisfactionBlow loyalty), mercenary (high satisfactionBlow loyalty), and hostage (low satisfactionBhigh loyalty). As in Fornell (1992), switching costs play a crucial role by making it costly for customers to switch to another service provider. The results of Anderson and Sullivan (1993) similarly support the role of switching costs by observing the average satisfaction and retention elasticities for selected firms in 1989. They argue quality elasticity should increase as average satisfaction decreases. For airlines and banking industry, this relationship of average satisfaction and quality elasticity was correctly maintained because customers have to incur switching costs. However, in supermarket, where there exists almost no switching cost, this order was not respected between firms. It means customers’ quality elasticity may depend more on switching cost than on the level of satisfaction. In our context, this is an important finding that shows the impact of switching cost on the satisfaction-loyalty link in a competitive market.

Switching Costs and Market Competition

To uncover segment with false loyalty, we believe a more comprehensive model of the satisfaction-loyalty link is required, which accounts for both switching costs and market competition. If the market is not competitive (in case of monopoly), we may find a large proportion of false loyal customers who are locked-in due to no alternatives (such as local telephone and airlines industries in Jones and Sasser (1995)). If the market is competitive and switching costs are negligible, we may find a large portion of mercenary customers who are satisfied but disloyal because there is no switching cost to incur (such as personal computers, automobiles industries in Jones and Sasser (1995)). If the market is competitive and switching costs exist, only satisfied customers repurchase products and services because of competition, which may result in small number of false loyal customers. This seems to be the case in the cell phone market. Figure 1 describes the typology of satisfaction-loyalty linkage derived from Jones and Sasser (1995) with respect to both market competition and switching costs.

Therefore, the satisfaction-loyalty linkage can be more significant when the market is competitive and switching costs exist. This link can be reinforced by increased consumption of products and services, which in turn further increases switching cost. Controlling for switching costs alone can’t be effective since it basically exploits its locked-in customers with high switching costs. And loyalty programs such as bonus reward, can not be effective without properly structured satisfaction program.

DATA ANALYSIS AND RESULTS

Measurement of Loyalty, Satisfaction, and Switching Cost

Subjects for this study consist of 256 respondents (by personal interview) who are currently subscribing wireless services from various vendors. Using the aforementioned literature, we develop three measures used in this study. To measure customer loyalty, we use a subset of the original measures developed in Narayandas (1996). They are (i) repurchase intent, (ii) resistance to switching to a competitor’s product that is superior to the preferred vendor’s product, and (iii) willingness to recommend preferred vendor’s product to friends and associates. They can be viewed as an attitudinal measure of loyalty (Uncles and Laurent 1997). For customer satisfaction measurement, we selected the reevant attributes based on the performance ratings for cellular phone published by Consumer Reports (Buying Guide 1998). They consist of customer satisfaction with respect to (i) pricing plan, (ii) coverage of the calling area, (iii) clarity of sound, and (iv) precision of billing service. Finally, to operationalize switching costs, we first measure three types of switching costs (transaction, learning, and contractual) following Klemperer (1987). Transaction costs, related to its volume, arise as a customer switches between completely identical brands such as long distance carrier. Learning costs are needed to get familiar with new products or services after switching. And contractual costs arise based on the terms of contract such as the early cancellation fee and the minimum length of subscription. In addition, we incorporate search cost. Search cost was considered as one of the key elements of switching costs for price discrimination in competitive markets (Holmes 1989; Borenstein 1991). Table 1 shows the summary of descriptive statistics of three measures used in this study.

Identifying Consumer Segments

We first examine whether there exist different types of satisfaction-loyalty link and how the level of switching cost varies among them. Using 3 variables (overall satisfaction, repurchase intention and difficulty to switch), we run a K-means cluster analysis that can handle large numbers of cases. Three segments provided an excellent fit, and a separate discriminant analysis using the same variables resulted in 99% classification accuracy into three groups. Table 2 shows the results of cluster analysis and segment classification results.

FIGURE 1

SATISFACTION-LOYALTY LINK RELATED TO MARKET COMPETITION AND SWITCHING COSTS

The results confirm previous findings (Narayandas 1996; Jones and Sasser 1995) that show heterogeneity in the satisfaction-loyalty link. Segment 1 shows low satisfactionBlow loyalty type, which is termed the defector group in Jones and Sasser (1995). Firms need to understand the sources of dissatisfaction and to further develop customer satisfaction measurement program. Consumers in segment 2 are true loyalists who are very satisfied and show strong commitment to repurchase of services. For both segment 1 and segment 2, we find low switching costs. Whereas low switching costs make it easier for dissatisfied customer to defect in segment 1, they are not deemed to be important for loyalists in segment 2. The role of switching cost in the satisfaction-loyalty link is highlighted in segment 3 in which customers show low to medium satisfaction but relatively high loyalty. It can be characterized as forced loyalty due to high switching costs. Customers in segment 3 present a strong latent threat to a company since they will defect quickly if the competitors can provide incentives in terms of switching costs. Finally, we could not identify a group of customers who are completely satisfied but exhibit no loyalty. This so-called mercenary group (Jones and Sasser 1995) emerges as the degree of market competition intensifies. In the next section, we discuss the implications of the relationship between market competition and switching costs.

Segment-level Analysis

A principal component factor analysis was performed as a preliminary step to regression analysis. As shown in Table 4, three loyalty measures loaded on a single factor explaining 62% of the variance. For customer satisfaction, two factors explaining 65% of the variation in the data are found. Factor 1, termed the "price factor," is composed of customer satisfaction regarding pricing and billing service. Factor 2, called the "quality factor," is composed of the service area and sound quality. Similarly, two factors explaining 63% of the variation are found for switching costs. Factor 1, called the "information factor," is composed of search cost and learning cost. Factor 2, termed the "usage factor," is mainly composed of transaction costs that are proportional to the average number of calling hours and the number of contact person. In addition to tw factors of switching costs, we also consider perceived difficulty in switching to account for the intangible aspect of switching.

For each segment identified above, loyalty factor is regressed on the satisfaction scores, switching-cost scores, and perceived difficulty in switching. Table 4 reports the results of segment-level regression.

It is interesting to note that none of the switching cost variables is significant in segment 1, the defector group. If they decide to switch to other providers, switching costs will not be the barrier considering low switching costs in this segment. For customers in segment 2, the quality factor of satisfaction is significant whereas the price factor is not at the 5% significance level. In other words, loyalists who are very satisfied with the current provider are less concerned with the pricing plan and willing to pay a price premium. Also, the significance of usage factor of switching costs shows that they are heavy users of services and therefore incur high transaction costs if they decide to switch. The opposite is the case for segment 3 in which customers show low to medium satisfaction but high loyalty. They are dissatisfied with the service, but the information factor becomes a switching barrier for them. That is, it is time-consuming and costly for them to search for a new vendor. This is also reflected in the significance of perceived difficulty in switching for both segment 2 and segment 3.

DISCUSSION

For the continued success of a firm, it is critical to retain its current customers and maintain loyalty to its brands. Hence the success depends heavily on the well-designed customer satisfaction program. By understanding the role of switching costs in satisfaction-loyalty link, a firm can take advantage of the current structure of switching costs in preventing customers from switching and/or in attracting potential customers by creating high switching costs. As a matter of fact, inducing current customers to consume more products or services does not necessarily guarantee increased loyalty. However, since switching costs are in general proportional to the volume of consumption or the purchase frequency, it indirectly increases switching costs and in turn contributes to customer retention, specifically for mecenary consumer group. As switching costs reach a threshold that can deter switching, a reward program can be implemented to increase the benefits of membership, which results in higher loyalty or the state of inertia loyalty. In sum, management of switching cost can be directed towards both loyal and disloyal customers so that it increases customers’ incentives to repurchase products or services. Also, only loyalty programs accompanied by well-designed satisfaction program can be effective in increasing customer retention.

Finally, Hauser et al. (1994) argue that if customers can be segmented by switching costs, (a) a firm can improve its profits by placing different weights on customers with different levels of satisfaction with different switching costs, and (b) satisfaction receives the highest weight when the absolute values of the switching costs are small. The reason is that as switching costs decrease, it becomes easier for customers to switch. We like to point out that the clustering method used in this study is limited in its use if the primary concern is to find out a threshold of switching cost that can deter customers to switch. Given the managerial implications of switching costs, the further development and application of rigorous statistical approach seem to be a good topic for future research.

TABLE 1

DESCRIPTIVE STATISTICS

TABLE 2

RESULTS OF CLUSTER ANALYSIS AND DISCRIMINANT ANALYSIS

TABLE 3

FACTOR ANALYSIS RESULTS

TABLE 4

SEGMENT-LEVEL REGRESSION RESULTS

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Authors

Jonathan Lee, University of Pittsburgh, U.S.A.
Janghyuk Lee, Ecole SupTrieure des Sciences Economiques et Commerciales (ESSEC), France



Volume

E - European Advances in Consumer Research Volume 4 | 1999



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