Out of the trap: customer switching costs, conversion funnel, and industry profitability

Do lower switching costs reduce industry profitability? While established strategy frameworks predict a drop in prices and profitability following reductions in switching costs, we provide a counterexample in which firms’ business model interacts in unexpected ways with switching costs. Across many industries, firms employ a conversion funnel business model to attract customers with affordable products, generate lock-in, and later encourage them to convert to more advanced and profitable products. We argue that a sudden reduction in switching costs disrupts this conversion funnel, which eventually can increase industrywide prices and profitability. We develop a stylized model to formalize our ideas and provide evidence in support of the predictions, using a difference-in-differences methodology with staggered treatment for a large, global sample of mobile telecommunications operators.