Lock-In and Number Portability

What’s the big deal with number portability? Firms create ways to lock consumers in to their products all the time–loyalty programs such as frequent flyer miles are a common example. In the case of cell phones there are two or three sources of lock-in. The first is the physical phone itself: not all brands of phones work with all providers, so switching can involve the cost of a new phone. A second form of lock-in some cellular companies use is one-year contracts; under the terms of these contracts, if you cancel your service (e.g., switching to another company) then you owe your cellular provider $150 (Sprint PCS does this). The third, and probably the strongest, form of lock-in is the lack of number portability. This is particularly strong for business users, where the costs of changing a phone number include new cards and more importantly, potentially lost sales. Note that contracts and free phones are a type of lock-in that expires (at the end of the contract or when the phone breaks/gets lost/is too obsolete), but the non-portable number is a permanent lock-in.

At the same time, there are many cellular firms and the industry seems fiercely competitive. Yet once you have signed on with a given company, they have some monopoly-like power over you (even though they lacked such power before you signed on). How does this work out for consumers? In lock-in markets, most of the competition for consumers occurs up-front. Basically, consumers anticipate that once they choose a particular firm it will be costly for them to switch. So if customers end up a bit unhappy with the service and they call, the attitude of the company will be along the lines of What are you gonna do? Switch? I don’t think so. Still, the industry is competitive, meaning that firms enter until the profits are driven down to the level where the firms on average earn a normal rate of return on capital.

If each firm has market power over its customers, what drives the profits down? The firms know and the customers know that post-sale service won’t be great, and there’s not much firms can do to credibly committ to excellent post-sale service because everybody knows their consumers are locked-in. They could try to develop a great reputation, but that is costly and takes time, and the temptation to cut back on service, reduce price cuts (due to falling technology costs), or spend less on infrastructure will always be there, because doing those things won’t lead the firm’s customers to leave in mass, as would occur in industries without lock-in. So in markets like these, all the action centers around getting the customer, not keeping the customer, which is somewhat automatic. So the competition plays out in the form of up-front goodies: X months free or other special introductory price plans, a free or heavily subsidized phone, a bunch of frequent flyer miles, and so on.

So consumers still benefit from competition in markets with lock-in, but it comes in a big payment up front to compensate consumers for anticipate future crappy service. This is at least better than monopoly markets, where you get crappy service and no up-front goodies (think of your local phone company), bot over the long run, competition without lock-in is beter. First note that if lock-in did not exist, you would lose all or most of the up front goodies–why would companies give you something valuable to become a customer today when you can costlessly keep the stuff and switch tomorrow? What would you get in exchange for this? Faster price decreases, better-staffed call centers, probably more cell towers, and most importantly in my opinion, faster innovation.

Why faster innovation? When all the competition is up-front, the firms just match each others’ up-front goodies, adding minor twists. The day-to-day pressure that a major innovation by a rival could steal 50% of your customers in a matter of months just is not there in the same way it is in competitive markets without lock-in. So on balance, when lock-in is reduced, firms are neither helped nor harmed as they earn a normal rate of profit either way–they spend less on bribing consumers with up front benefits but prices are lower and/or service quality is higher. Consumers appear to get about the same benefit–less up front and more over time. But with lock-in, most consumers are unhappy most of the time; they are only happy when they are choosing a provider from scratch. Without lock-in, most consumers are happy most of the time, which seems like a good thing. Add in the fact that the dynamic competitive pressures, while they do exist even with lock-in, are much stronger without lock-in. The result would be faster innovation, so the policy scales are tipped well in favor of local number portability. Everything I’ve seen on the subject says that the costs to the companies are minimal, so there really is no compelling reason not to do it.


P.S. If this is true then why are the firms so opposed? It’s mostly due to management risk-aversion.