Having exclusive sales or distribution rights to a new product may sound like a good deal. New research shows, however, that exclusivity can reduce profits, especially if the firm does not have locked-in loyal customers, because it eliminates the potential for greater word-of-mouth marketing.
In 1995, Japanese telecommunications giant NTT agreed to distribute a new product featuring new technology, but rejected the offer of exclusivity to the Japanese market. Going against the conventional wisdom that the less competition the better, NTT actually wanted more competition. The reason: the product was unfamiliar and untested; as a result, the more customers bought the product, even under a different brand, the more the product would be accepted in the market — and thus the more of NTT’s brand of the product would be sold. In short, cross-brand world-of-mouth would be more profitable in the long run for NTT than exclusivity.
When AT&T was offered at least temporary exclusivity as the U.S. provider for Apple’s early iPhone, its reaction followed the conventional wisdom: it jumped at the chance to keep out competitors.
Which decision was the correct one? To explore this issue of product exclusivity and cross-brand word-of-mouth (WOM), Renana Peres from Hebrew University of Jerusalem and Christophe Van den Bulte from the Wharton School conducted a simulation study manipulating a number of different factors that would be relevant to the results, including:
The researchers expanded on the results of the simulation with a mathematical analysis that explored issues such as price-sensitivity and sales volume.
According to the results, both NTT and AT&T made the right decision because of the differences in the level of customer loyalty or customer lock-in. The research shows that whether or not temporary exclusivity is profitable depends to a large extent on the firm’s level of locked-in customers. Because NTT had a high-level of locked-in customers, the word-of-mouth from the sale of competitor products benefited NTT. Once its customers heard about the new product, they turned to their telecommunications company of choice — NTT — to buy the product. AT&T had a much lower level of loyal customers, and as a result, WOM would have probably benefitted their competitors. There would be no trade-off in profitability through the ‘social contagion’ of word-of-mouth.
Even in markets with strong within-brand word-of-mouth (i.e. everyone’s talking about a specific brand, not the product category), it is sometimes better to forego temporary exclusivity. This is especially true for price-sensitive customers. For example, when a second firm finally enters a market for a product that had previously been sold exclusively by another firm, the second firm has to dramatically lower prices to make inroads into the market — a step that inevitably lowers prices for the entire market.
Exclusivity, in sum, is not an automatic benefit. The structure of the market, the type of product (e.g. does it involve a new technology unfamiliar to customers?), and the price-sensitivity of customers are some of the major factors that must considered before any decision is made to accept, or forego, exclusivity.
The research offers clear, applicable lessons for decision-makers in a number of different situations.
If you’re launching a new product, consider letting competitors enter the market. The research shows that, counterintuitively, you can increase your profits by letting competitors in on the action. Any resulting loss of market share will be compensated by the increased or accelerated demand for the product, depending on your level of customer lock-in.
If you’re a distributor, don’t automatically seek temporary product exclusivity. Instead, as with product manufacturers, consider the potential impact of cross-brand word-of-mouth on the product’s success. It should also be noted that different types of products are going to benefit differently from word-of-mouth. For example, a radically new product or technology needs word-of-mouth to overcome the hesitation of customers to take a risk on the product. Word-of-mouth is less important for low-risk products in mature industries, and therefore exclusivity is desirable.
Don’t let benchmarking fool you. The concept behind cross-brand word-of-mouth is that the rising tide lifts all boats. Measuring your financial performance against competitors might hide the profits lost because exclusivity tamped down word-of-mouth marketing.
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