Law & Economics Working Papers
"No Contract" is on the rise in many consumer markets. Sellers are luring customers with the assurance that no commitment is required—that the consumer can terminate the service freely at any time, without paying a termination penalty. What explains the increasing prevalence of No Contract? Is it welfare enhancing? We examine the costs and benefits of No Contract, as compared to the lock-in alternative, and conclude that the rise of No Contract is generally desirable, a market response to consumers' growing awareness and understanding of the costs of lock-in. We argue, however, that lock-ins continue to prevail less conspicuously, through loyalty programs that, like termination penalties, punish consumers for switching. Doctrinally, courts scrutinize lock-in contracts as penalty liquidated damages, and reduce these fees when excessive. We show that while courts' skepticism of lock-in is generally justified, the doctrinal method is fundamentally misguided, resulting in inconsistent and welfare-reducing outcomes. In fact, with informed consumer choice disciplining sellers' actions, as evidenced by the rise of No Contract, the need to regulated this type of lock-in contracts is diminishing. Consumers, however, are not as alert when joining loyalty programs, and the distortions arising form such lock-ins are heightened, rather than resolved, by competition. Courts and regulators should be focusing their attention on loyalty programs, not early termination fees.
Oren Bar-Gill & Omri Ben-Shahar, "No Contract?" (Coase-Sandor Institute for Law and Economics Working Paper No. 636, 2013).