How Do Switching Costs Affect Market Concentration and Prices in Network Industries?

I investigate the effects of switching costs on the market outcome in network industries using a dynamic duopoly model of price competition in the presence of an outside option. I find that the role of switching costs depends on network effects and the outside option. Without a viable outside option, high switching costs can neutralize the tendency towards high market concentration associated with network effects, but with a viable outside option, switching costs increase market concentration. Furthermore, switching costs lower prices if network effects are modest and there exists a viable outside option, but generally raise prices otherwise.     

What types of switching costs to create under behavior-based price discrimination?

We study firms' incentives to create switching costs using a four-period model consisting of two consecutive price-competing stages intervened by options to create switching costs early (before price competition) and late (during price competition). Acknowledging that many real/social switching costs need to be created early while many contractual/pecuniary switching costs are set up late during the competition, we show that firms are better off minimizing real/social switching costs while maximizing contractual/pecuniary switching costs. The results highlight the importance of timing of creation that is embedded in different types of switching costs. We also show that switching costs can actually benefit consumers when firms practice behavior-based price discrimination because consumers can enjoy benefits of deep price discounts without the hassle of actually switching. Therefore, an observed lack of consumer switching should not be immediately interpreted as lack of competition in markets where both switching costs and behavior-based pricing exist.     

Do switching costs mediate the relationship between entry timing and performance?

The purpose of this paper is to test the effectiveness of switching costs as an isolating mechanism in the context of the first‐mover advantage theory. Whereas both the literature on switching costs and on pioneering propose this as a mechanism through which firms could obtain sustainable competitive advantage, other authors offer a rationale for thinking that this is not the case. We test our hypotheses in the context of the European mobile telecommunications industry. This is a sector that has been characterized by high rates of growth in the number of subscribers, which could reduce the effectiveness of switching costs from being effective as an isolating mechanism. Our results show that switching costs are an important tool through which first‐mover advantages materialize. Copyright © 2011 John Wiley & Sons, Ltd.     

Predicting Household Switching Behavior and Switching Costs at Depository Institutions

This paper uses new survey data to investigate the covariates of self-reported switching costs and switching behavior by deposit account holders. Factors affecting geographic mobility appear to be most important in explaining the duration of deposit relationships. Both younger and older respondents are more likely than others to be at their first bank ever, suggesting a cohort effect in deposit relationships. Households reporting switching costs, net of the benefits from switching, are less likely than others to have stayed with a bank for prices or customer service, suggesting that switching costs may decrease price sensitivity. Switching costs appear more severe for households with high income or education and for households with very low income or minority ethnicity. These findings imply that banking markets characterized by such households may present greater entry costs for new firms.     

When do switching costs make markets more or less competitive?

In a two-period duopoly setting in which switching costs are the only reason why products may be perceived as differentiated, we provide necessary and sufficient conditions for switching costs to lead to higher prices in the first period as well as to higher overall profitability. We show that this happens if and only if switching costs are not too large. We present the only treatment up to date of how switching costs (and only switching costs) affect competition based on the assumption that switching costs differ across consumers, which allows us to illustrate the undesired byproduct of assuming that products exhibit substantial horizontal differentiation. Not only do we draw implications for the classical literature on competition with switching costs, but also for the more recent one that rests upon such an assumption too.     

CUSTOMER POACHING AND ADVERTISING*

This paper is a first look at the dynamic effects of customer poaching in homogeneous product markets, where firms need to invest in advertising to generate awareness. When a firm is able to recognize customers with different purchasing histories, it may send them targeted advertisements with different prices. It is shown that only the firm which advertises the highest price in the first period will engage in price discrimination, a practice that clearly benefits the discriminating firm. This poaching gives rise to ‘the race for discrimination effect,’ through which price discrimination may act actually to soften price competition rather than intensify it. As a result, all firms may become better off, even when only one of them can engage in price discrimination. This paper offers a first attempt to evaluate the effects of price discrimination on the efficiency properties of advertising. In markets with low or no advertising costs, allowing firms to price discriminate leads them to provide too little advertising, which is not good for consumers and overall welfare. Only in markets with high advertising costs, might firms overadvertise. Regarding the welfare effects, price discrimination is generally bad for welfare and consumer surplus, though good for firms.     

Technological Incompatibility, Endogenous Switching Costs and Lock-in

Systems are goods comprising of durables that are sequentially updated with complements. With sequential purchases, if suppliers produce incompatible brands, consumers who upgrade systems with complements of a different brand must replace the durables they own. Thus, the price of these durables is an endogenous switching cost. The paper deals with the concern that firms may use incompatibility to create consumer's switching costs to reduce competition in aftermarkets. However, it shows that, with homogenous durables, and small costs of reaching compatibility, endogenous switching costs increase intertemporal price competition to the extent that producers prefer to have compatible technologies.     

ENDOGENOUS COSTS AND PRICE‐COST MARGINS: AN APPLICATION TO THE EUROPEAN AIRLINE INDUSTRY*

This paper allows for endogenous costs in the estimation of price cost margins. In particular, we estimate price‐cost margins when firms bargain over wages. We extent the standard two‐equation set‐up (demand and first‐order condition in the product market) to include a third equation, which is derived from bargaining over wages. In this way, price‐cost margins are determined by wages and vice versa. We implement the model using data for eight European airlines from 1976–1994, and show that the treatment of endogenous costs has important implications for the measurement of price‐cost margins and the assessment of market power. Our main result is that observed prices in Europe are virtually identical to monopoly prices, even though observed margins are consistent with Nash behavior. Apparently, costs had been inflated to the point that the European consumers were faced with a de facto monopoly prices.     

The Economic Impact of Wireless Number Portability

This paper examines the price response of wireless carriers to the introduction of number portability in the U.S. I find that wireless prices decreased in response to number portability, but not uniformly across plans. Average prices for the plans with the fewest minutes decreased by only $0.19/month (0.97%), but average prices for medium and high‐volume plans decreased by $3.64/month (4.84%) and $10.29/month (6.81%), respectively. The results suggest that higher‐volume users in the wireless market benefited more from the policy‐induced reduction in switching costs.     

ON THE VALUE OF A LARGE CUSTOMER BASE IN MARKETS WITH SWITCHING COSTS*

It is usually acknowledged that firms benefit from a large customer base in markets with switching costs. However, Klemperer [1995] argues that this may not be true if an increase in the size of a firm's customer base induces fierce price competition, making the firm worse off. This paper shows that such an outcome can be obtained under standard assumptions, such as homogeneous goods and uniformly distributed switching costs. In the model, firms have very limited incentives to fight for market shares, and the notion that switching costs make markets less competitive is stronger than previously shown.     

The bonding effects of relationship value and switching costs in industrial buyer–seller relationships: An investigation into role differences

Despite the established importance of buyer–seller relationships in B-to-B markets, research to determine the differential effects that keep suppliers and customers in a relationship has been scarce. Referring to transaction cost analysis, this study investigates how switching costs and relationship value as perceived by each side unfold their bonding forces in such a relationship. Based on a large scale survey administered in Germany, Korea, New Zealand, and Argentina among marketing/sales and purchasing managers the study shows that relationship value has a stronger impact on intentions for relationship enhancement, search for alternatives and switch intention than switching costs for both buyers and sellers. Only with regard to relational tolerance and only for buyers do switching costs play a greater role than relationship value. Furthermore, buyers base their future relationship intentions more on the current state of the relationship than suppliers. Our results suggest that role differences must be taken into account when studying institutional arrangements in B-to-B markets.     

Interstate Long Distance Rates: Search Costs,Switching Costs,and Market Power

A number of authors have argued that the divestiture of AT & T did not reduce the rates of long distance telephone companies as often believed. However, the literature has offered few explanations as to why competition has not lowered rates. This study argues that rates have failed to fall due to the importance of search and switching costs in the industry. Using a panel data set of rates for the three largest long distance carriers, stretching from 1984 to 1993, a reduced form equation is specified to empirically test for the influence of search and switching costs on the price cost margin of the three carriers. The results illustrate that both search and switching costs have provided long distance carriers with market power.     

House Prices and Rents: Microevidence from a Matched Data Set in Central London

I analyze a real estate agency's proprietary dataset containing tens of thousands of housing sale and rental transactions in Central London during the 2006–2012 period. I isolate 1,922 properties that were both sold and rented out within six months and measure their rent‐price ratios. I find that rent‐price ratios are lower for bigger and more central units. These stylized facts are consistent with the user cost formula and reflect differences in maintenance costs, vacancy rates, growth expectations and risk premia.     

Customer capabilities,switching costs,and bank performance

Customers develop switching costs when they invest time and effort to develop capabilities required to optimally use a given product. Such capabilities are likely to be firm specific and cannot be transferred perfectly to competitors' product offerings. Customers who face switching costs are likely to remain with the same firm and consume complementary products that meet their needs. Thus, firms can achieve competitive advantage by exploiting customers' switching costs. In this paper, we hypothesize that the extent to which firms can benefit from customers' switching costs is contingent upon the firms' internal cross‐selling capabilities. We use online banking data to test our hypotheses and find that customers' switching costs contribute to banks' profitability only in the presence of high levels of internal cross‐selling capabilities. Copyright © 2012 John Wiley & Sons, Ltd.     

The Economics of Style: Measuring the Price Effect of Neo‐Traditional Architecture in Housing

Vintage effects have received considerable attention from economists in the context of house prices. Although strongly related, the impact of architectural building styles on prices has not been studied yet. Using a cross‐sectional hedonic price analysis including building styles of recently developed homes in the Netherlands we find a significant price premium for housing with neo‐traditional architecture. Extensive intervention by local authorities on the supply side of the housing market seems the most probable explanation of this effect. The decreasing price premium over time reflects the impact of supply restrictions on price, but also indicates that style does matter.     

Best Practices for New Product Pricing: Impact on Market Performance and Price Level under Different Conditions

To date, research on new product pricing has predominantly been approached as a choice between market skimming and penetration pricing. Despite calls for research that addresses other complexities in new product pricing, empirical research responding to these calls remains scarce. This paper examines three managerial price‐setting practices for new products, i.e., value‐informed, competition‐informed, and cost‐informed pricing. By engaging in these practices, managers can develop and compare quantifications in order to attain an introduction price for the product. The authors draw on consumer price perception literature, Monroe's pricing discretion model, and numerical cognition literature to develop hypotheses about the impact of price‐setting practices on new product market performance and price level. By studying the effects on market performance and price level, the paper provides insights that may help explain the growth of new products and address the problems of underpricing. The hypotheses are tested in a management survey of 144 production and service companies. The results indicate which pricing practices are superior for the achievement of either higher market performance or higher prices in specific product and market conditions. Whereas value‐informed pricing has an unambiguous positive impact on relative price level and market performance, the results also suggest that in many cases engaging in value‐informed pricing is not enough. The effects of cost‐informed and competition‐informed pricing may differ depending upon the objective (market performance or higher prices), product conditions (product advantage and relative product costs), and market condition (competitive intensity). Engaging in inappropriate pricing practices leads to a decline in new product performance. Moreover, bad pricing practices make the positive effect of product advantage on the outcome variables disappear. The latter finding suggests that companies can jeopardize their efforts and investments in the new product development process if they engage in the wrong price‐setting practices. The findings imply that managers should consider different factors in new product pricing. First, when launching a new product, they should determine their explicit pricing objective, either stressing market performance or a higher price level. To determine the most appropriate pricing practices, however, they should next assess their situation in terms of product advantage, relative product costs, and competitive intensity. Together with the pricing objective, these conditions determine the best pricing practice. On a higher level, the findings imply that companies should invest in knowledge development in order to engage in the appropriate pricing practices for each product launch.     

Economic Efficiency and Political Capture in Public Service Contracts

We consider contracts for public transport services between a public authority and a transport operator. We build a structural endogenous switching model where the contract choice results from the combined effects of the incentivization scheme aimed at monitoring the operator's efficiency and the political agenda followed by the regulator to account for the voice of private interests. Our results support theoretical predictions as they suggest that cost‐plus contracts entail a higher cost for society than fixed‐price contracts but allow the public authority to leave a rent to a subset of individuals. Accounting for transfers to interest groups in welfare computations reduces the welfare gap between cost‐plus and fixed‐price regimes.     

Green Noise or Green Value? Measuring the Effects of Environmental Certification on Office Values

This study investigates the price effects of environmental certification on commercial real estate assets. It is argued that there are likely to be three main drivers of price differences between certified and noncertified buildings. These are additional occupier benefits, lower holding costs for investors and a lower risk premium. Drawing upon the CoStar database of U.S. commercial real estate assets, hedonic regression analysis is used to measure the effect of certification on both rent and price. The results suggest that, compared to buildings in the same submarkets, eco‐certified buildings have both a rental and sale price premium.