Do Customers Learn from Experience?

New research suggests that a specific type of customer experience can systematically lead to worse, not better, choices by consumers.

Most evidence from economic theory suggests that experienced consumers make better choices. Even when we display the behavioural biases that lead us to less optimal economic outcomes, studies show that experience can ameliorate these initial biases and steer us back towards better choices. But does this principle hold true of all experiences?

A new study by Itai Ater from Tel Aviv University in Israel and <link people vardit-schwartz-landsman>Vardit Landsman from Erasmus University provides novel evidence that a specific type of customer experience – namely, that of making overage payments – can systemically lead to worse, rather than better, economic outcomes for customers.

The study, published in Management Science, investigated whether customers choosing three-part tariff plans offered by a commercial bank improved upon their initial non-optimal choice after gaining experience of the plans.

Three-part tariff plans consist of a fixed fee, an included allowance and a positive marginal price for additional usage beyond this allowance termed an 'overage payment'. Examples of these plans include mobile phone, internet, car leasing and banking subscription plans.

Analysing a panel of 70,000 fee-based checking accounts covering thirty months, the researchers documented that – consistent with previous studies – most customers' initial choice was not optimal. Customers revealed a bias for plans that entailed higher fixed monthly payments than those that would minimise their costs yet involved overage payments.

More interesting still was the outcomes of customers' switching decisions. Customers who exceeded their monthly allowance and paid overage fees switched to plans with larger allowances leading to larger monthly payments then prior to switching – in contrast to those who had not experienced overage payments and whose choice of plan reduced their overall costs.

Why? The researchers suggest that customers appear particularly sensitive to the specific experience of paying overage fees – a sensitivity they term 'overage aversion'. A plausible explanation for this phenomenon is that consumers attribute different levels of disutility to expected “within budget” payments than to unexpected payments. The study estimates that customers’ disutility from a payment of $1 in overage payments equals roughly that of $3.5 in fixed monthly payments.

The findings from this study provide insights regarding the substantial revenue to be gained by companies from offering three-part tariff plans, and contribute to future debates on the impact of cellular carriers notifying subscribers as they near their allowance limit.

• Download Do customers learn from experience from Management Science.