Automatic-Renewal Contracts with Heterogeneous Consumer Inertia

Johnen, Johannes [UCL]

Automatic contract renewals are a common feature in consumer markets and a frequent concern among policymakers. They can be used to exploit consumer inertia when consumers forgo benefits from switching to better alternatives. I study limited attention as a source for this inertia, and investigate robustness to present bias in extensions. In both cases, I study how firms can use contract renewal to sell to consumers with different degrees of inertia. Monopolists optimally distort automatic-renewal contracts to exploit inertia of consumers. However, the more a monopolist designs contracts to exploit inertia, the higher are the benefits to more sophisticated consumers who take advantage of these offers by not procrastinating. This adverse-selection problem forces monopolists to focus less on exploiting inert consumers, leading to fewer consumer mistakes. Adverse selection can induce monopolists to offer more efficient contracts. I show that adverse selection might not occur with competition, and that competitive firms focus more on exploitation. Competitive firms frequently offer less efficient contracts. Indeed, with limited attention, competition leads to larger renewal prices and more back-loaded pricing. I discuss implications for teaser rates and evaluate recent policies on automatic-renewal contracts in the USA and the UK, such as reminders and increased salience of automatic-renewal features.