Leasing serves as a commitment device that enables IBM to keep prices high. The leasing contracts make it much more costly for IBM to lower its price.

When its machines are on short-term leases, any price reduction must be passed along to all customers, not just the ones who haven’t yet bought. The loss in revenue from the existing customer base may outweigh the increase in new leases. In contrast, when the existing customer base owns its computers, this trade-off does not arise; the customers who already bought the computer at a high price are not eligible for refunds.

Thus leasing is an example of moving in small steps. The steps are the length of the lease. The shorter the lease, the smaller the step. Customers don’t expect IBM to keep its price high when the steps are too big; they will wait for a price reduction and get the same machine a little later at a lower price. But if IBM leases its computers only on short, renewable contracts, then it can credibly maintain high prices, customers have no reason to wait, and IBM earns higher profits.

As college professors and authors, we encounter the same problem closer to home in the market for academic textbooks. If commitment were possible, publishers could raise profits by bringing out new editions of a textbook on a five-year cycle, rather than the more common three-year cycle. Greater longevity would increase the text’s value on the used-book market and consequently the student’s initial willingness to pay when a new edition appears. The problem is that once the used books are out there, the publisher has a strong incentive to undercut this competition by bringing out a new edition. Because everyone expects this to happen, students get a lower price for their used books and thus are less willing to pay for the new editions. The solution for the publisher is the same as for IBM: rent books rather than sell them.