publication . Preprint . 2006

Co-ordination and Lock-in: Competition with Switching Costs and Network Effects

Joseph Farrell; Paul Klemperer;
Open Access
  • Published: 01 Jul 2006
Abstract
Switching costs and network effects bind customers to vendors if products are incompatible, locking customers or even markets in to early choices. Lock-in hinders customers from changing suppliers in response to (predictable or unpredictable) changes in effciency, and gives vendors lucrative ex post market power-over the same buyer in the case of switching costs (or brand loyalty), or over others with network effects. Firms compete ex ante for this ex post power, using penetration pricing, introductory offers, and price wars. Such "competition for the market" or "life-cycle competition" can adequately replace ordinary compatible competition, and can even be fier...
166 references, page 1 of 12

9Schmalensee (1982) and Villas Boas (2006) analyse models of experience goods that show similarities to switching costs models. Hakanes and Peitz (2003) and Doganoglu (2004) model experience goods when there are also learning or transactional switching costs; Doganoglu shows that adding small switching costs to Villas Boas' (2006) model can sometimes reduce price levels. 10For related models in which consumers di er in their \quality" from rms' point of view, and rms are uncertain about consumers they have not supplied and can exploit those they know to be of \high quality", see, for example, Nilssen (2000) and Cohen (2005) on insurance markets and Sharpe (1990) and Zephirin (1994) on bank loan markets. 11Aftermarkets have been much studied since a US Supreme Court decision (ITS v.

Kodak) held that it was conceptually possible for ITS, an independent repair rm, to prove that Kodak had illegally monopolized the aftermarket for servicing Kodak photocopiers: see e.g. Shapiro (1995), Shapiro and Teece (1994), MacKie-Mason and Metzler (1999), and Borenstein, MacKie-Mason, and Netz (1995, 2000). 12If the unadvertised follow-on product is always purchased, it can be interpreted as the \quality" of the advertised product { see Ellison (2005) and Vickers (2003). 13Gabaix and Laibson (2006) analyse this case when only some consumers are rational.

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