Why Mandatory Service Contracts Are Bad For Business
Customer retention and loyalty is in the vocabulary of every company, and one of the main objectives of most. But it seems that entire industries, in particular telecoms for mobile phone service and cable and internet service providers, have a very misguided understanding of what customer retention means and instead insist on locking customers into lengthy contracts which effectively amounts to nothing more than customer detention.
While there are different strategies for customer retention throughout the customer experience lifecycle to prevent defection, generally it involves ensuring customer satisfaction by providing quality products and services. And the general idea of loyalty is that the customers are so satisfied with the quality of the products and services provided that they continue buying from the company. There is also a general belief that customers who are not only satisfied but also delighted will go beyond loyalty and become advocates, actively promoting the company.
Mandatory service contracts go fundamentally against this principle. The very proposition of these is that customers have to stay with the company regardless of satisfaction. While contract terms widely vary between companies who engage in this practice, one thing most have in common is the glaring absence of any promise or guarantee of satisfaction. In fact, they are more often than not a guarantee of poor service.
And it is not so much about the technical aspects of service such as coverage, poor signal and reception or dropped calls, but about the poor problem resolution, long wait for customer service, confusing bills and hidden fees, home installations or repair appointments not honored, which are all too common stories.
Mandatory service contracts may actually be the cause of poor customer experience. First, consumers want the freedom to decide. They want to be able to try before committing and want the ability to opt-out. Just see the number of articles giving advice on how to break service contracts, such as this Wikihow entry. There is something suspicious if a company insists in locking customers in a contract. And this sets the stage for the rest of the customer relationship; it predisposes customers to be more critical and less patient, because they are detained.
Secondly, mandatory service contracts may actually result in the company being less willing to provide good service and address customers’ issues promptly. After all, if they know customers can`t leave, they have that much less incentive to do so.
Companies who engage in this practice of mandatory service contracts enter a vicious circle. Customers distrust them and want service contracts even less, which motivates the companies to over-promise and use dubious sales tactics in order to get customers to sign up or renew their contracts. This also means increased acquisition costs.
While some do provide monthly payment or pay-as-you-go options (like pre-paid cell phone minutes), these are considerably more expensive compared to the contract rate. Why would the out-of-contract rates be so expensive? Because with contracts, the cost of customer acquisition is spread over a certain number of months, allowing decreasing rate over time. This suggests these companies very well know customers are likely to defect because of poor service, so they simply pass on the cost of acquisition back to the customers in the first transaction. For the same reasons, fewer still provide trial or opt-out periods that would allow customers to judge of the quality of service before committing.
And with prices steadily falling, you can see another reason why these providers insist on locking customers at a fixed rate for a long time. Any way you put it, the plans are designed to squeeze the most out of the customers.
It’s not only a coincidence that telecoms and cable and Internet service providers are among the most passionately disliked companies of any industry. Verizon quickly scrapped their idea of charging customers a $2 “convenience charge” after an uproar that saw thousands of angry comments in social media. Nice try.
Incidentally these industries also consistently figure on top of the list of those that receive the most complaints with the Better Business Bureau (BBB) in the US and the equivalent in many other countries. They are also among the industries with the lowest average Net Promoter Score (NPS).
Mobile phone and cable and Internet service providers are not the only ones to engage is this practice. Many gyms for example force service contracts. And many request upfront payment. Unfair cancellation terms have led in some case to court rulings, as in 2011 Ashbourne gym case in the UK.
Breaking the mandatory service contract vicious circle would improve the overall customer experience across those industries as it would force providers to earn retention through satisfaction, rather than by robbing customers of their free will. In turn this would start a more virtuous circle of customer retention: satisfied customers become loyal, commit for longer periods and may actually become advocates, which in turn would decrease acquisition cost and allow yet more customer experience improvements.
It would take one new comer to emerge and provide an excellent customer experience, with clear and simple pricing schemes, without contract, to capture much of the market. Unfortunately in most markets these industries are run by monopolies and oligopolies that are not very willing to change, so customers don’t have much of a choice. Smaller players just cannot offer the same coverage, data speeds or price the large few can.
So it will take government regulations or a brave large provider to have a complete change in corporate philosophy and lead the way. Only then will the others follow suit and start trying to treat customers with some respect. But most customers will see their move as disingenuous and too late, giving the advantage to the first mover. It may take a long time to happen. But I’ll gladly switch my service to the first provider who changes its definition of retention to a satisfaction-based one.
Tagged: | Customer Experience, Customer Service, Service Contracts, Service Providers, Telecoms
David Jacques is Founder and Principal Consultant of Customer input Ltd and a pioneer in the field of Customer Experience Management. He has created the first Framework that brings together cohesively every aspect of Customer Experience Management. He is also passionate about having an in-depth understanding customer values to create emotionally-engaging customer experiences not only at individual interactions but also seamlessly between them.
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David,
Very interesting angle to this topic that you raise. the challenge is that this issue is really complex (more complex than it appears on the surface) and is multi-dimensional.
In terms of complexity, the first place to start is with the methods for valuation of these companies. These contracts are one of the keys to prediction the volitilty and risk of future cash flows of the company – the foundation by which equity prices are modeled. If these companies had no contracts, the methods by which those cash flows would be analyze would have to completely change. So, I’m not sugguesting this should be a justification. But, it just is what it is, at least with public companies in this space.
Of course there are other examples of similar financial relationships that have similar roots. As example, auto leasing. Monthly car lease payments are based on three factors. The down payment, the interest and residual value compared to what the dealer believes he’ll be able to resell it for. All that addes up to the determination that the financing company needs to get ten thousand dollars over three years on that twenty thousand dollar car in order to make the desired profit. Same thing applies in telecom and media carriers. The company has invested in infrastructure and needs to know how much of that fixed cost will each subscriber absorb, then on top of that is the carrier’s profit.
So, I get it in terms of that angle. But, I’m not a CFO. So, from the customer’s point of view, you are spot on! (you were waiting for me to get to that part, weren’t you?). I’m not going to restate what you’ve already laid out nicely.
What I’m going to suggest is a path to get from point A to point B.
First, I have to respectfully disagree with your solution you propose in your last paragraph. At least in the USA, all we need is another government agency muddying the waters and driving even more costs into the system that will ultimately be passed on to the consumer. No. I don’t think government intervention is the answer. On your second suggestion, I do think the market is where the solution will come from. I think it will take actually more likely come from an upstart provider that not only has a different philosophy. But, also one that is able to quantify customer service as a retention driver and use that as a substitue in the valuation/cash flow risk model as opposed to the NPV of a locked in contract.
Thanks for the post and for allowing me to comment.
Hi Barry, thanks for the great feedback. Very informative. It’s good to see it from a company perspective.
While valuation without service contracts could be a challenge, other subscription-based industries are able to do it. It could be the very source of the issues. And that is a problem and cost that is passed on to the consumer. What I find interesting is that if this is done for the sake of valuation, then investment in companies who engage in that practice becomes an ethical concern. Perhaps eventually customer experience and fair treatment of customers will become more of a criteria for investment than it is now. I believe this adds another layer of complexity. Just a wild thought.
You’re right about some justification for wanting service contracts. For example, telecoms often give away handsets, or give them at a highly subsidized price. Service contract ensures that the cost will be recouped over time. So the car example fits here. But these companies insist on service contracts even without any hardware involved. If it was only about recouping hardware costs, there could be break clauses and a pro-rate charge (hardware only) for cancellation.
Government regulation is only a thought, but wouldn’t necessarily be on whether mandatory contracts are allowable in these industries. It could simply be regulations on contract clauses allowing customers to have fair choice of opting-out. Yearly there are thousands of complains through the BBB and other similar organizations, and these companies end up breaking the contracts in and outside of court. Since this happens anyway, perhaps it would save everyone time (and legal costs from both the government and companies) if the ability to break contracts was simply regulated.
I agree though that most likely the changes will happen from the market. And for these industries and others, like banking, I always say it will take just one first company who comes and starts to provide significant customer experience improvements for all the other companies to play catch-up. This is true for any type of industry, product or service. A bit simplistic example, but look at all the electronics companies now trying to make their own touch-screen smartphone, and tablets, after they saw Apple’s first phone product took a huge chunk of the market with one single model.
There are plenty of explanations for the status quo and complacency. But I believe the customer experience competitive imperative will break it. It’s a challenge but the rewards are great for the first mover.
By the way, I love your http://custservicestories.blogspot.com/ posts.