Theory to Practice

Getting out of the trap: the conversion funnel business model

The context

In many industries, companies use a business model characterized by a conversion funnel: the aim is to offer inexpensive, basic products to attract customers, lock them in, and then sell them items that are more advanced and higher priced. We assume that companies develop conversion funnel business models when switching costs are high. (By switching costs, we mean the cost the customer incurs to transition to a different product or service.) 


The extant literature on strategic management and industrial organization holds that switching costs are a lever of power capable of driving trends in prices and profits for companies on the market. In fact, switching costs can produce a lock-in effect on customers, which works to the advantage of incumbents and stifles competition. It follows then that actions intended to curb switching costs would tend to increase competition and decrease the profits of individual companies. 


Thanks to switching costs, companies gain market power when they introduce more advanced versions of their products or services. But at the same time, they’re ramping up the competition with the basic version of their own products. In other words, by creating a link between the prices of the two versions, the conversion funnel business model shifts the epicenter of the competition towards the market for basic products. 

The research

In our article, we assert that by reducing switching costs, the conversion funnel can become destabilized, generating a rise in prices and profits for the sector. This result runs counter to conventional wisdom in strategy research.  


The mobile telecommunications sector provides us with fascinating testing ground to verify our predictions. Most major mobile telecom companies offer both prepaid and postpaid services. Prepaid services are relatively affordable, and appeal to cost-conscious customers who want to try a mobile plan; postpaid services tend to be more expensive, and adapt to customer needs as they evolve over time. Companies typically offer prepaid services to attract new customers, and then try lock them in, with the ultimate goal of converting them to more profitable postpaid services. This process reflects a conversion funnel business model.  


In the late 1990s, countries around the world began implementing mobile number portability (MNP). This policy allowed customers to switch service providers while keeping their mobile number, which substantially reduced switching costs. 

We developed a stylized model to provide to structure our ideas and to generate hypotheses, which we then tested using a difference-in-differences methodology with staggered treatment. We collected data on mobile telecommunications operators around the world from 2000 to 2017. Our results align with our predictions: after the implementation of MNP, the price of prepaid services increased, while the price of postpaid services remained more or less unchanged.  


What’s more, the price rise on the prepaid service leads to a shift towards the purchase of postpaid services. The resulting change in the customer composition (with more of them opting for postpaid services) and the uptick in prices in the prepaid segment translate into higher profits for companies. In addition, we find that when customer switching costs are eliminated, the effect on prices is stronger in markets specialized in advanced versions, where companies have high market power. (This is probably due to high differentiation.)

Conclusions and takeaways

In this article, we’ve shown how changes in a sector that alleviate friction in the customer purchasing journey, surprisingly, can also prove advantageous for companies. In fact, in our study on the telecommunications market, when mobile number portability was introduced, we find evidence that this move boosted the profitability of mobile operators due to a change in their business models. 


When switching costs are high, companies adopt a funnel-shaped business model designed to convert customers from basic products to advanced ones. Although this is advantageous for individual companies, when strategic interactions are factored in, we see that widespread use of this model drives down average prices, and depletes the profitability of the market as a whole. In contrast, a reduction in customer switching costs destabilizes this funnel and decouples product pricing decisions. Counterintuitively, this leads to higher prices and bigger profits across the industry. From this, we conclude that eliminating switching costs can be advantageous for companies, as it breaks away from the conversion funnel approach and redistributes competition between prepaid and postpaid options. 


Thanks to our research, new insights have emerged on the strategies that companies adopt in the face of market friction. Several studies have shown how switching costs incurred by customers contribute to improving the performance of firms by escalating their market power over captive customers. However, when we factor in strategic interactions, the picture becomes more complex. In fact, we’ve observed that business models interact in non-trivial ways with changes in switching costs, showing that company profitability augments when frictions and constraints on competitiveness diminish. In all likelihood, our findings can be extended to other industries too where companies adopt a funnel business model to attract new customers, offering them an affordable basic product in the hopes that they will later upgrade to a more expensive, advanced version.