Advertisement

Quantitative Marketing and Economics

, Volume 12, Issue 4, pp 379–419 | Cite as

Who pays for switching costs?

  • Guy Arie
  • Paul L. E. Grieco
Article

Abstract

Earlier work characterized pricing with switching costs as a dilemma between a short-term “harvesting” incentive to increase prices versus a long-term “investing” incentive to decrease prices. This paper shows that small switching costs may reduce firm profits and provide short-term incentives to lower rather than raise prices. We provide a simple expression which characterizes the impact of the introduction of switching costs on prices and profits for a general model. We then explore the impact of switching costs in a variety of specific examples which are special cases of our model. We emphasize the importance of a short term “compensating” effect on switching costs. When consumers switch in equilibrium, firms offset the costs of consumers that are switching into the firm. If switching costs are low, this compensating effect of switching costs causes even myopic firms to decrease prices. The incentive to decrease prices is even stronger for forward looking firms.

Keywords

Dynamic oligopoly Switching costs 

JEL Classifications

D43 L13 L14 

References

  1. Beggs, A., & Klemperer, P. (1992). Multi-period competition with switching costs. Econometrica, 60(3), 651–666.CrossRefGoogle Scholar
  2. Biglaiser, G., Cremer, J., Dobos, G. (2013). The value of switching costs. Journal of Economic Theory, 148(3), 935–952.MathSciNetCrossRefGoogle Scholar
  3. Cabral, L.M.B. (2012). Small switching costs lead to lower prices. New York: New York University.Google Scholar
  4. Chen, Y. (1997). Paying customers to switch. Journal of Economics & Management Strategy, 6(4), 877–897.CrossRefGoogle Scholar
  5. Dube, J.-P., Hitsch, G.J., Rossi, P.E. (2009). Do switching costs make markets less competitive. Journal of Marketing Research, 46(5), 435–45.CrossRefGoogle Scholar
  6. Dubé, J.-P., Hitsch, G.J., Rossi, P.E. (2010). State dependence and alternative explanations for consumer inertia. RAND Journal of Economics, 41(3), 417–445.CrossRefGoogle Scholar
  7. Ellickson, B.E., & Pavlidis, P. (2014). Switching costs and market power under umbrella branding. Rochester, New York: Simon School of Business.Google Scholar
  8. Farrell, J., & Shapiro, C. (1988). Dynamic competition with switching costs. The RAND Journal of Economics, 19(1), 123–137.MathSciNetCrossRefGoogle Scholar
  9. Farrell, J., & Klemperer, P. (2007). Coordination and Lock-In: Competition with Switching Costs and Network Effects In Armstrong, M., & Porter, R. (Eds.), Handbook of industrial organization (Vol. 3, pp. 1967–2072): Elsevier. chapter 31.Google Scholar
  10. Garcia, A. (2011). Dynamic price competition, switching costs, and network effects. Charlottesville: University of Virginia.Google Scholar
  11. Hotelling, H. (1929). Stability in competition. Economic Journal, 41–57.Google Scholar
  12. Keane, M.P. (1997). Modeling heterogeneity and state dependence in consumer choice behavior. Journal of Business & Economic Statistics, 15(3), 310–327.MathSciNetGoogle Scholar
  13. Klemperer, P. (1987). The competitiveness of markets with switching costs. The RAND Journal of Economics, 18(1), 138–150.CrossRefGoogle Scholar
  14. Klemperer, P. (1995). Competition when consumers have switching costs: an overview with applications to industrial organization, macroeconomics, and international trade. The Review of Economic Studies, 62(4), 515–539.CrossRefGoogle Scholar
  15. Nilssen, T. (1992). Two kinds of consumer switching costs. The RAND Journal of Economics, 23(4), 579–589.CrossRefGoogle Scholar
  16. Park, M. (2011). The economic impact of wireless number portability. Journal of Industrial Economics, 59(4), 714–745.CrossRefGoogle Scholar
  17. Pearcy, J. (2014). Bargains Followed by Bargains: When Switching Costs Make Markets More Competitive. Bozeman, Montana: Montana State University.Google Scholar
  18. Rhodes, A. (2014). Re-examining the effects of switching costs. Economic Theory, 57(1), 161–194.MathSciNetCrossRefGoogle Scholar
  19. Salop, S.C. (1979). Monopolistic competition with outside goods. The Bell Journal of Economics, 10(1), 141–156.CrossRefGoogle Scholar
  20. Shcherbakov, O. (2010). Measuring consumer switching costs in the television industry: Yale University.Google Scholar
  21. Shin, J., Sudhir, K., Cabral, L.M.B., Dube, J.-P., Hitsch, G.J., Rossi, P.E. (2009). Commentaries and rejoinder to do switching costs make markets less competitive. Journal of Marketing Research, 46(4), 446–552.CrossRefGoogle Scholar
  22. Shy, O. (2002). A quick-and-easy method for estimating switching costs. International Journal of Industrial Organization, 20(1), 71–87.CrossRefGoogle Scholar
  23. Somaini, P., & Einav, L. (2013). A Model of market power in customer markets. Journal of Industrial Economics, 61(4), 938–986.CrossRefGoogle Scholar
  24. Viard, V.B. (2007). Do switching costs make markets more or less competitive? The case of 800-number portability. The RAND Journal of Economics, 38(1), 146–163.CrossRefGoogle Scholar

Copyright information

© Springer Science+Business Media New York 2014

Authors and Affiliations

  1. 1.Simon Graduate School of BusinessUniversity of RochesterRochesterUSA
  2. 2.Department of EconomicsPennsylvania State UniversityUniversity ParkUSA

Personalised recommendations