One Way To Draw More Customers: Lock Out Others

Companies can increase demand and sales by intentionally turning away some buyers

Based on the research of Raghunath Rao

Why would a company that wants to make as much money as possible deliberately exclude potential customers?

It happens all the time, says Raghunath Rao, chair of the Department of Marketing and the Arthur James Douglass Centennial Professor in Entrepreneurship and Small Business at Texas McCombs. Companies sell expensive bottles of wine at prices that only a few can afford. Others produce items in limited amounts to generate publicity and increase interest from fans.

In new research, Rao provides evidence for a similar but distinct practice: demand lockout. He demonstrates how pushing away one group of customers can ultimately increase profits.

“On the face of it, it doesn’t seem like a rational thing to do,” he says. “If somebody is willing to pay us money, why are we saying we don’t want you to buy from us?”

The key underlying rationale, Rao said, is an economic and marketing concept known as signaling. It’s a mechanism that allows companies to convey the quality of their products when consumers are skeptical about it.

When traditional signals such as brand, price, and advertising aren’t helping — because competing products have similar features and prices — excluding customers can send another kind of signal, says Rao: that a product or service is special or different from others in the marketplace.

Lockout at the Movies

Rao’s research paper, written with Andreas Kraft of the University of Chicago, examines a pop-culture example of demand lockout: R-rated movies. Why do studios seek R ratings, knowing they reduce the overall audience by preventing younger moviegoers from seeing them?

One obvious answer was that many movies do not have a choice. The core theme might be violent or sexual in nature.

However, in many cases, studios do have a choice. By adding certain scenes and dialogue, they can draw an R rating, for mature audiences, from the Motion Picture Association. By cutting certain material, they can earn PG-13, for wider audiences.

That offers a way to differentiate a film in the marketplace, Rao says. By releasing it as R, a studio signals that it may be more realistic in terms of violence or sexuality. Among some filmgoers, that can sell more tickets.

He also reasoned that the better the film, the more of a boost it might get from an R rating. Positive critics’ reviews and word-of-mouth could offset ticket sales lost by excluding families.

To test their theory, Rao and Kraft used machine learning algorithms to analyze subtitles in tens of thousands of movies. These algorithms rated on a scale from 0 to 1 each film’s level of inappropriateness for young viewers. The higher the rating, the less appropriate the movie.

They focused on 1,502 movies on the borderline between PG-13, for a wider audience, or R, for mature audiences. Each had comparable levels of inappropriateness, averaging about 0.7, meaning that editing choices could tip them toward either rating.

The researchers also looked at the first five weeks of box-office receipts for each film to assess how ratings might affect revenues.

They found indicators that R ratings did indeed send signals to potential audiences.

• Regarding quality, movies with better overall critics’ reviews were more likely to be rated R.
• Regarding revenue, R-rated films with high ratings by viewers brought in more money than comparable PG-13 films did.

An R rating boosted revenue only for high-quality films, Rao notes. For lower-quality films, it didn’t increase sales.

Rating Helped Make a Hit

The upshot is that an R rating can help an exceptional film attract an audience, he says. “A high-quality movie produced by a nonmajor studio with relatively few reviews benefits particularly from this signaling.”

He cites the 2006 Academy Award winner “Little Miss Sunshine,” which was centered around a child but had adult themes. With different editing, he says, it could have been rated PG-13. By seeking an R rating, the studio and director were able to lean more into its thematic material. Made for $8 million, it earned $101 million worldwide.

While Rao’s findings show the value of demand lockout in cinema, he says the theory also can be applied to other areas. For example, the streaming audio service Spotify built interest early on by offering free accounts by invitation only.

His findings might also help explain why some activist CEOs exclude some customers by being vocal about their political leanings. By making their politics clear, he explains, they may attract new customers.

“There’s just all kinds of places where it has surprising implications,” Rao says. “Managers need to consider the signaling effects of serving specific segments or refusing to serve certain segments. We show that locking out potential demand can convince consumers of a product’s quality.”

“Signaling Quality via Demand Lockout” is published in Quantitative Marketing and Economics.

Story by Omar L. Gallaga