Why Should Monopolies Satisfy Their Customers?

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The importance of customer satisfaction in competitive markets has been well documented in academic research. Satisfied customers bring in higher profits for a firm by increasing demand for the firm’s product or service, reducing customers’ price sensitivity toward the offerings, and reducing related costs. Businesses operating in competitive markets have embraced these findings, and many firms consider improving customer satisfaction a top priority. However, little is known about how customer satisfaction affects the financial performance of firms in monopolistic markets, which are characterized by limited demand potential for firms and limited choice of the product/service providers for customers. Thus, a question remains: should monopolistic markets such as utility firms also invest in customer satisfaction?

To answer this question, Abhi Bhattacharya, Neil A. Morgan, and Lopo L. Rego explored the relationship between customer satisfaction and profits earned by utility firms operating in monopolistic markets. Using customer satisfaction data obtained from the American Customer Satisfaction Index (ACSI) of U.S.-based public utility firms between 2001 and 2017, the authors demonstrate that customer satisfaction is positively related to utility firms’ profits because customer satisfaction helps decrease utility firms’ operating costs incurred by serving their customers. Specifically, utility firms that have higher customer satisfaction benefit from cost savings achieved by addressing fewer customer complaints. Moreover, these firms can more easily implement operational and technological changes, facilitated by increased customer trust and goodwill.

Their study has important implications for utility managers, policy makers, and regulators. The results suggest that utility managers should have a cost-based motivation for tracking and improving customer satisfaction to enhance profitability. For example, for the average utility firm in the sample, a one-unit (on a 100-point ACSI scale) improvement in customer satisfaction is associated with a $29 million reduction in operating costs per year. In addition, the authors show that, considering that improving customer satisfaction is a “win-win” deal for both customers and utility firms, policy makers and regulators could also benefit from placing a greater emphasis on helping utility firms improve customer satisfaction. For example, regulators can encourage utility firms by allowing investments in customer satisfaction to be recoverable and require the collection and reporting of customer satisfaction data. In summary, firms with the luxury of a monopoly can still benefit from the positive impact customer satisfaction in terms of profitability. In addition, the study provides an evidence-based, and monetarily incentivized reason for stakeholders of monopolistic firms to track and invest in improving customer satisfaction for enhanced profitability through its efficiency enhancing benefits.

We reached out to the authors to gain additional insights from their study.

Q: Considering that research at the intersection of relational assets such as customer satisfaction and firm performance in monopolistic markets is in its early stages, can you suggest which other firm performance outcomes could be examined in future research?

A: It is indeed true that the role of satisfaction in monopolies has not previously been examined. In fact, in most satisfaction studies monopolies are deliberately omitted from the sample, as it was considered very unlikely to be of any importance in such markets. We think that investigations of a variety of performance outcomes may be of value in such monopolistic markets. For instance, most utilities are publicly traded and do spend on both marketing and R&D (though it may not necessarily be reported in 10-Ks). Does the stock market value such investments? Further, since customer attrition is minimal, would there be any demand side factors that would lead to greater sales volatility or risk? It might be particularly interesting to look at both customer mindset dependent variables (such as brand value and satisfaction) as well as financial market dependent variables (such as investor returns) when a firm’s monopoly status is under threat or even when competitors start entering the market. For example, firms such as Netflix and Uber enjoyed brief but substantial monopolies in streaming services and ridesharing, respectively, but competitor firms soon entered those markets and disrupted their monopoly status.

Q: As discussed in the article, most public utility firms operate in one state. Given such strong geographic roots, one can expect that community-focused investments made by utility firms are significant drivers of the satisfaction of their local customers in addition to the traditional strategic drivers such as price, quality, and value. What  other factors could potentially drive relational assets of utility firms in monopolistic markets?

A: We agree that corporate social responsibility initiatives and other altruistic community-focused activities could indeed be a source for customer satisfaction in such markets. In energy markets, a commitment to sustainability and healthy environmental practices are typically much appreciated by at least some segments of their customer base. Further, we expect (but do not know yet) that continual innovation and engagement in customer-centric practices would also be key to customer satisfaction. Given our result that satisfaction is indeed important (profitable) for monopoly firms, we would expect such firms to engage in (and benefit from) most activities that firms in normal competitive markets do. In fact, other than trying to prove that a firm’s product offering is superior to a competitor, a lot of utility firms already take many steps to ensure greater customer satisfaction, including streamlining payment interfaces and increasing customer knowledge about sustainable practices through webinars, etc. The interesting wrinkle in monopolistic markets, however, is that all of the benefits to the firm flow via cost savings. Thus, the cost of any drivers of satisfaction that a monopolist invests in will need to be recouped via customer responses that allow them to operate more efficiently.  

Q: Recent research has examined the asymmetric effects of customer satisfaction and customer dissatisfaction and has found that the latter has a stronger impact on firm performance. However, as discussed in your research, customers of utility firms in monopolistic markets either face high switching costs or do not have the option to switch when dissatisfied. Given this, please share your views on whether and how customer dissatisfaction could impact firm profitability differently than customer satisfaction for such firms?

A: In our data, we found satisfaction levels to be generally on the lower side (vs. other industries) for utility firms. We also did not find any evidence for asymmetric effects at the aggregate level. However, the question is interesting. In competitive markets, customers can switch to a competitor, but that is not the case in monopolies. However, sufficient customer dissatisfaction can incur regulatory appeals and consequent reprimands, which might be a threat to monopoly status. Unfortunately, given that we study (mainly) large established utilities we do not find enough variance in the satisfaction–dissatisfaction spectrum to trigger an asymmetry. However, at an individual customer level, it is likely that dissatisfaction creates a greater impact. To an extent, we do find that service failures (whether or not due to natural causes) create a strong dissatisfaction wave and a string of complaints.

Q: Do you expect any difference of cross-sector customer satisfaction returns between firms operating in competitive markets and firms operating in both competitive and monopolistic markets (e.g., utility firms that operate in both)?

A: We controlled for such diversification, and the extent of diversification among utility firms in noncompetitive markets was not substantial. However, in competitive markets both satisfaction pathways (i.e., through increasing revenue and decreasing costs) should be operative. Given this, we would expect returns, on average, to be higher in competitive markets. However, this may vary a great deal depending on the opportunity for operating cost savings from increased satisfaction. For example, this may be greater for firms dealing directly with end-user customers versus those selling indirectly. It may also be larger in service contexts than for physical goods. The whole “efficiency-enhancing” benefits of satisfaction (and in fact all market-based assets) have been largely ignored in empirical research across all types of markets (including competitive ones). For utility firms , which are typically tied up in energy markets, it might not be easy to diversify much in unrelated markets due to a lack of sufficient market knowledge. However, firms such as Google, which enjoys a near monopoly in the search engine market, have diversified successfully and continue to reap gains in multiple arenas.

Q: Your research focused only on residential customers of utility firms because of the availability of data. Do you expect similar effects of customer satisfaction on the profitability of utility firms for their commercial and industrial customers?

A: We focused on residential customers since we only had data on satisfaction from them. However, to the extent that satisfaction is dependent on product quality and/or price, we believe that such a relationship does exist for industrial customers as well. While industrial customers may be more “rational” in decision making, we do know from past literature that satisfaction matters there, too. Hence, we do expect the same relationship to hold across the range of customer types. Depending on the size of the industrial customer, they may also have greater power to cause cost-increasing downsides (appeals to regulators) or cost-saving upsides (co-operation in demand limiter use) for a utility depending on their satisfaction.

Q: Do you think the findings of the current research on public utility firms in highly regulated monopolistic markets apply to other types of monopolistic markets? For example, are the effects similar in monopolies caused by high economic barriers (e.g., economies of scale, technological superiority), or by legal barriers (e.g., intellectual property rights such as patents and copyrights)?

A: This is a great question and really one for future research. There are certainly monopolies of different types, geographic scale, and even extent (i.e., strong market power but not enough to qualify a firm as a monopoly). Then there are duopolies and everything in between. We think (and we ran some preliminary studies in airline markets) that the satisfaction–service cost relationship holds in all service markets, but we do not know a priori how the value of satisfaction changes depending on the type and/or extent of a monopoly. We believe that the satisfaction–revenue pathway may attenuate as the amount of switching costs in a market increase, since the value of customer loyalty becomes lower; however, the satisfaction–cost pathway may remain largely the same.

Additional Author Insights

A striking implication of our study is that a fundamental assumption in regulatory economics—that monopolist and customer incentives are misaligned is incorrect in this unique context (at least it is incorrect in markets with current regulatory regimes in place). This creates a broader salient question as to whether and how customer satisfaction should be incorporated into regulatory controls. We think this could be a potentially significant move forward in designing more effective and efficient regulatory regimes (which are, after all, designed to protect customers).

Read the full article:

Bhattacharya, Abhi, Neil A. Morgan, and Lopo L. Rego (2021), “Customer Satisfaction and Firm Profits in Monopolies: A Study of Utilities,” Journal of Marketing Research, 58 (1), 202–22.