The subscription trap and the cost of consumer inertia

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Ananya Bhargava: From streaming services to beauty boxes and meal kits, the subscription model has taken over. Subscriptions promise convenience, personalization, and flexibility. But they also make spending easier to ignore. Small monthly charges add up, free trials quietly turn into long-term commitments, and canceling isn’t always as simple as signing up. For many consumers, what starts as convenience can quickly turn into paying for things they no longer use or need.

I’m joined by Dr. Ben Klopack, an Assistant Professor of Economics at Texas A&M University, whose work explores Industrial Organization and Urban Economics. And in this episode, we’ll explore how features like auto-renewal keep customers locked in, the role of consumer inertia, and the two key forces behind it: inattention and switching costs. We’ll also look at potential policy efforts, like the Federal Trade Commission’s click-to-cancel rule, and what they mean for the future of consumer protection.

Benjamin Klopack: I’m Benjamin Klopack, and I’m an assistant professor at Texas A&M University in the economics department, and I first started working on subscriptions as part of this bigger project, using a large data set composed of credit and debit card transactions for millions of U.S. consumers. We started from observation that this kind of subscription business model is growing rapidly, and there are a variety of explanations for why this is. I think consumers are consuming more digital goods than before, which perhaps lend themselves to be consumed in a subscription model. We focus on a different motivation, which is that, from a firm’s perspective, typically, these subscriptions are billed automatically every month in order for a consumer to not purchase the product, they have to actively go in and cancel the good. There’s a lot of evidence from surveys that consumers are subscribed to many products that they don’t remember or would have liked to cancel but have not. Estimates from these survey studies show that consumers think that they spend, on average, kind of on the order of $80 or $90 per month, and when they check their bill, it’s actually closer to three times that amount. So we thought that, there’s this other motivation for subscriptions, which is that, from the firm’s perspective, consumers that subscribe to a product may continue to purchase it longer than if they were making that decision, kind of actively in each month. 

So we worked on this paper, which uses that big credit and debit card dataset to measure how important this phenomenon is in subscription markets, and oftentimes economists call this inertia. So we wanted to measure inertia in subscription products, and we found its quite large. We focused on consumers who, in our data, in our credit card dataset, they are subscribed to a product, but then in a given month, their credit card is replaced with a card with a new number, because, for example, they’ve lost or their card’s been stolen, or it expires, and so the credit card company sends them a new credit card number. And the interesting thing about that is that in that particular month, let’s say you’re subscribed to Netflix. In that month, you have to go in and renew your subscription to Netflix and enter payment information, and that triggers kind of an active choice, whereas in most months, your Netflix subscription is being renewed in the background, you’re not having to do anything active. And we found that the cancellation rates in the month in which your card is replaced, because it’s lost or stolen or expired, is about four times as high as normal months. So we use that kind of pattern to think about how large is consumer inertia in this market, and what does it tell us about the revenue that subscription services generate because of this consumer inertia.

Bhargava: One thing that I saw recurring when I was researching more about subscriptions and consumer inertia was the term “negative option marketing,” if we could get a standard definition of what negative option marketing is and how it works.

Klopack: Negative option marketing just describes a bunch of situations, which include subscriptions where consumers are basically opted into some sort of consumption. In subscriptions, I’ve opted into renewing my Netflix service next month, unless I make an active choice and tell Netflix I want to cancel and go through the process of logging in and canceling my service. So I think negative option marketing includes both subscriptions, but also some other types of practices, like free trial, where I signed up for something, and then after some period, eventually I continue to be automatically billed.

Bhargava: In your paper, you have defined two major drivers of consumer inertia. There was inattention and switching costs. So could you explain what those mean in simple terms and how they show up in action?

Klopack: So inertia is the pattern that we see consumers when they’re in kind of an auto-renewal type of product, like a subscription that they pay most months and that they cancel relatively infrequently. There are multiple sort of economic models that are consistent with that pattern of inertia. One is inattention. So suppose you subscribe to Netflix and you sort of don’t think about your Netflix subscription very much. Inattention would say that kind of you rarely think about your Netflix subscription. Sometimes you do think about it, you remember that you’re subscribed to Netflix, and it’s really only in those moments that you remember, which is not every kind of month that you even have the opportunity to cancel. That’s sort of what a model of inattention is. 

Switching cost says, you know, you’re subscribed to Netflix every month, but there’s a cost associated with canceling it. I have to go to the website, I have to navigate the menu, figure out how to cancel it. Maybe Netflix is going to ask me if I’m sure I want to cancel it and offer a lower price for three months to get me to remain subscribed, etc. So those are sort of both economic models that are consistent with this pattern of consumer inertia, which is that in our data, what we see is that consumers remain subscribed in most months and cancel disproportionately in months in which they have to re-enter their payment card information.

Bhargava: And you did differentiate between inattention and switching costs when talking about policy. So could you talk a bit about why it’s important to distinguish between the two when we’re forming recommendations on what policy should be implemented?

Klopack: When we think about policy remedies that are proposed in these markets. For example, the FTC proposed a click-to-cancel rule, which would have simplified cancellation procedures. You can think of other potential policy remedies. Suppose that you know subscription services have to allow you to automatically opt out after a certain period, rather than opt in, kind of indefinitely. Suppose that I put a policy that when you sign up for a streaming service, after six months, you’re defaulted into auto-cancellation rather than auto-renewal. So your term of your subscription is six months rather than indefinite. If I’m a consumer that’s inattentive and I have no switching costs, then that might look like a really good policy, because if, after six months I no longer want the subscription, I may be inattentive and forget to cancel it, but this policy is going to default me into canceling and so that may help these inattentive consumers. And if I do want the subscription, it’s easy enough for me to re-sign up for Netflix. If I’m in a switching cost model, then typically there’s a cost associated with canceling the subscription and re-signing up for the subscription. If I auto-default people into cancellation, I may cancel the subscriptions of many people that actually want Netflix. In that case, those policies may impose an additional hassle cost on those consumers, because they have to pay the switching costs.

Bhargava: And some people do worry that certain regulations like this would reduce convenience. How would you respond to that concern?

Klopack: So I think any regulatory solution should keep in mind that one of the reasons I think that we have subscription products is that consumers really value convenience, and so when I turn on my TV and my Netflix subscription is active, and I don’t have to incur the transaction cost of entering my credit card information to do a small transaction, to watch a TV show or movie, that that’s valuable to consumers. And so we should think carefully about the trade-offs of reducing the convenience of subscription products while simultaneously protecting consumers from signing up for a product and then paying for it indefinitely. The click-to-cancel rule proposed by the FTC, which would have simplified cancellation procedures: It’s my understanding is it’s currently on hold for some procedural reasons, but still under consideration. I think that’s a relatively low-cost way to help consumers in certain respects. I think simplifying cancellation is, in general, positive for consumer protection. I don’t think it has a particularly large costs for firms to implement, aside from reducing their revenue from these inertia consumers, who I think we should be protecting. In some markets, you can imagine scope for policies that go a bit further, like if I offer consumers the ability to choose an end date for their subscription or data which they’re defaulted into auto-cancellation rather than auto-renewal at the time of sign up. You can imagine markets in which those policies would provide additional protection without reducing the convenience benefits that consumers receive from subscriptions.

Bhargava: You had mentioned earlier how subscriptions affect people’s awareness of how much they’re actually spending each month. So along those lines, what do you think are going to be the habits moving forward? Do you think there’s going to be more overspending on having subscriptions, and then possibly even overconsumption with things like subscription boxes? 

Klopack: I think one of the challenges of the subscription model, from a consumer perspective, is particularly when the goods I’m consuming are digital, so the Netflix subscription or an Amazon Prime subscription, I may not notice. If I’ve subscribed to Peacock, but I just don’t watch it, my credit card is being billed in the background. If I don’t look carefully at my credit card statement each month, I may completely forget that I’m paying for Peacock, even though I don’t use it very much. Physical products, those things can be a little more salient. If I’m ordering Blue Apron boxes and my Blue Apron food is piling up on my doorstep, that subscription is, in some sense, a little harder to forget about than my Peacock subscription, which is going on in the background. As we consume more and more digital goods, I think we get more and more subscription services that look like Peacock. The survey evidence is fairly strong that many consumers have subscriptions that they have signed up for and do not remember. And so I think the more opportunities we have for this potential for unanticipated spending, or spending on products that consumers don’t use. I think another kind of interesting phenomenon has also been the rise of services to manage subscription spending, things like Truebill or which is acquired by Rocket Money, I believe. Other similar services to help consumers manage their spending, both on subscriptions and other things, as well as tools that have been instituted by credit card issuers, like, for example, Chase allows consumers to see their recurring payments in each month to make it easier to track.

Bhargava: I’d love to hear your thoughts on how you see the subscription economy evolving over the next five to ten years, as consumers become more aware. And maybe regulation potentially increases. 

Klopack: I don’t think we’ll see subscriptions go anywhere as consumers are offered sort of more and more options with respect to subscriptions. I think eventually we can see some pullback, where consumers are being more careful about their subscription spending, being more punishing of firms that do things that are abusive with respect to subscriptions, for example, making it really difficult or costly for consumers to cancel, which has been also an active enforcement area for the FTC. I’ll highlight another paper that’s in this space that I think is interesting and provides some complimentary results to our work. It’s by Miller, Sahni, and Strulov-Shlain, who are economists at Stanford and University of Chicago, I believe. Our paper looks at consumers that are already signed up to a set of subscription services, and what happens to their cancellation rate in the month of their credit card expires. They take an alternate approach, which is they work with a large subscription service directly that I believe is a newspaper, and they run an experiment where they offer consumers both auto-renewing and auto-canceling contracts, and their research question is, to what degree do consumers anticipate the fact that they will remain subscribed longer than they plan to? If consumers really know that they’re inertial – so they know they’re going to get stuck in the subscription – they may be less likely to sign up in the first place. From a firm’s perspective, that’s important, because if I think that part of the benefit of selling my product in a subscription is that I can supercharge my revenue because I get these customers that stay subscribed for a long time. If that also comes at the cost of having fewer customers in the first place, then that’s kind of a counterweight to this temptation to make my product an auto-renewing subscription. And so they find that consumers partially anticipate their inertia, but kind of not fully. And I do this experiment, and I offer consumers auto-canceling versus auto-renewing contracts, they’re more likely to sign up if I give them an auto-canceling contract than an auto-renewing contract. And so that points to some anticipation of this inertia.

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