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Negative Option Contracts and Consumer Switching Costs

Phillips, Owen R.
A negative option contract is an agreement by which a buyer accepts a flow of goods from a vendor until the buyer notifies the vendor otherwise. In the finance literature [10], a negative option contract would probably be referred to as a negative call option. The contract gives the holder the right to refuse buying the good or service, but the holder does not have the exercise this right. The trade literature argues that negative option contracts were pioneered by the Book-of-the-Month Club more than 60 years ago [2]. Book Club members agree to accept, with the right of refusal, a selected book every month until they opt of the Club. A similar method of marketing is common in the recording industry through tape and compact disk clubs. It is estimated that 10 million consumers in the U.S. belong to a negative option club of some sort [8]. These contracts are legally binding in all states if the consumer signs an agreement that starts the flow of deliveries. Book, recording, and video clubs have thrived with the added feature of “prenotification” for the next unit of delivery. This itself is a negative option. Just before the next delivery the consumer is given the option to refuse the good, usually by mailing a postcard. If the vendor is not notified, delivery is forthcoming. Prenotification gives the consumer control over the bundle of goods ultimately received. Consumers can self-select components of the bundle and the bundle size.
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