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Persuading Consumers to Sign Long-Term Contracts

Companies that focus on driving customer usage and spending see their conversion rates increase.

(originally published by Booz & Company)

Title: Strengthening Customer Relationships: What Factors Influence Customers to Migrate to Contracts? (fee or subscription required)

Authors: Yolanda Polo and F. Javier Sese (both University of Zaragoza)

Publisher: Journal of Service Research, vol. 16, no. 2

Date Published: May 2013

Although contracts have become widely used in recent years, pay-as-you-go consumers still account for a large portion of the customer base in many industries and businesses, including legal services, media, telecommunications, repair and maintenance, and entertainment or professional sports. A 2011 study of U.K. and German mobile phone firms, for example, found that more than half of their customers had a prepaid plan and were not tied to a contract.

That’s a problem for companies, because there’s no question that subscribers are more profitable. On average, they generate 4.5 times more revenue than noncontract customers, according to the study. It stands to reason, then, that a small uptick in the number of customers who sign on the dotted line would lead to a significant increase in revenue for companies—including those in business-to-business contexts such as tech support or consulting. However, despite contracts’ clear value to firms, surprisingly little research has been done on how managers can strengthen their companies’ ties with customers to encourage them to sign long-term deals.

This paper aims to fill the gap by identifying the key factors that lie behind customers’ decisions to transition from pay-as-you-go to contract status. Noting that their findings are applicable to several industries, the authors based their study on cell phone users, in part because of the massive size of the mobile market. Because so many people have more than one cell phone— for personal use and/or business—penetration rates have actually surpassed 100 percent in most developed nations, and the market is still growing. The authors were also drawn to this sector because the contract problem is particularly vexing for telecom operators, who shoulder huge operational costs and face stiff competition for customers, which makes the negative impact of weak and short-term client relationships all the more damaging to their bottom line.

The authors tracked nearly 300 customers, all of whom began as pay-as-you-go clients, of a major mobile communications supplier for four years, gathering user and account data on a monthly basis. About 22 percent of the customers moved to a contract and 78 percent stuck with their pay-as-you-go phone cards, which shows how difficult it can be for firms to secure long-term commitments.

In a series of analyses, the authors found that the first key factor in the decision by customers to make the switch was whether they exceeded their expected usage: Did their usage regularly exceed the amount of credit they loaded on their cards, and, if so, how big was the gap?

The clear implication for telecom companies, and other types of service providers, is that they can increase the likelihood that customers will sign contracts by getting them to use their service more during the pay-as-you-go period.

In the mobile phone market, for example, companies should encourage their pay-as-you-go customers to install social media applications, online games, or other time-consuming programs that would increase their mobile service use. In other industries, offering discounts, promoting free trials, and bundling services with partner firms are all viable strategies. In addition, employed, female, and younger customers all had usage rates that exceeded their own expectations, so these groups should be among the first targeted by marketers, the authors write.

The second factor influencing the decision by customers to switch to a contract was a variation of the first: The more customers paid when not on a contract, the more likely they were to see the benefits of a long-term deal and make the switch. This doesn’t mean, however, that companies should simply raise rates for noncontract clients, the authors write; over the long term, the higher prices would likely drive away potential customers or cause existing ones to leave. Rather, managers hunting for contract contenders should begin by focusing on customers with a history of higher spending. Once they are identified, these customers should be plied with inducements to exercise their bigger spending habits during the noncontract phase. Companies should offer points for frequent usage in a loyalty program, among other incentives.

Last, customers who had had a longer noncontract relationship with the firm showed a higher probability of joining the contract program, the authors found. Thus, retention strategies and effective customer service are crucial. Although keeping long-standing low-end customers happy with good service is important, companies should keep their eye on the real goal: Strengthening these ties to convert them into more profitable contract-based relationships.

The authors stress that these managerial and marketing insights can be applied more generally to other industries. Internet-based phone companies, music streaming websites, file hosting services, and new-media businesses such as online newspapers and magazines are all facing the same challenge. These findings highlight the need for companies to encourage higher usage and spending during the pay-as-you-go phase.

The recommendations also extend to B2B firms, the authors write. For example, companies specializing in consulting, computer-related support, or legal services can team up with complementary firms to give customers easier access and more opportunities to use services.

“Marketing managers should move from the prevailing backward-looking focus toward a forward-looking focus,” the authors write, “in which each customer’s future considerations are monitored and managed proactively.”

Bottom Line:
Companies can lay the groundwork for customers to sign a contract by tracking and influencing their use of the company’s services in the pay-as-you-go phase. Although getting customers to make the switch is tough, it’s worth the effort because it is so profitable. Companies should target customers who have longer relationships with the firm, spend more during the noncontract phase, and have reason to think they will use the service frequently enough to offset the higher costs of a contract.

Author profile:

  1. Matt Palmquist is a freelance journalist based in Oakland, Calif.
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