Do Switching Costs Make Markets Less Competitive?

Abstract

The conventional wisdom in economic theory holds that switching costs make markets less competitive. This paper challenges this claim. We formulate an empirically realistic model of dynamic price competition that allows for differentiated products and imperfect lock-in. We calibrate this model with data from frequently purchased packaged goods markets. These data are ideal in the sense that they have the necessary variation to separately identify switching costs from consumer heterogeneity. Equally important, consumers exhibit inertia in their brand choices, a form of psychological switching cost. This makes our results applicable to the broad range of products that are distinctly identified (i.e. branded) rather than just to those products for which there is a product adoption cost or explicit switching fee. In our simulations, prices are as much as 18 per cent lower with than without switching costs.

Consumer learning and evolution of consumer brand preferences

“…We thank an anonymous reviewer for this insight. 13 We also tried a utility specification where Equation 1 has a last brand purchase dummy to capture any one-lag state dependence effects not related to learning (e.g., switching costs (Dubé et al 2009) or preference inertia (Che et al 2007;Shin et al 2012)). Indeed, Osborne (2011) found that in frequently purchased product categories there are both learning and switching costs.…”

Consumer learning, switching costs, and heterogeneity: A structural examination

“…One way to perform this kind of exercise would be to take the demand systems as given, solve for the market equilibria implied by each model, and compute comparative statics. This sort of exercise has been performed in markets with switching costs in Dubé et al (2008). In this paper, the computation of the market equilibrium is tractable because switching costs are the only source of dynamics, and consumers are not forward-looking (Dubé et al (2008) argue that the problem with forward-looking consumers is similar to the problem with myopic ones, when firms prices follow a Markov process.).…”

“…This sort of exercise has been performed in markets with switching costs in Dubé et al (2008). In this paper, the computation of the market equilibrium is tractable because switching costs are the only source of dynamics, and consumers are not forward-looking (Dubé et al (2008) argue that the problem with forward-looking consumers is similar to the problem with myopic ones, when firms prices follow a Markov process.). Solving the model with forwardlooking consumers who learn their match values for new products is a more difficult task.…”

“…Two of these quantify consumer response to introductory promotional behavior: I compare the impact of short term introductory price discounts on future market shares across all three models, and the impact of introductory informative advertising on market shares in the full model to those of the model without switching costs. Relative to the model with learning and 2 Some product categories where evidence of switching costs have been found are nondiet soft drinks and liquid laundry detergents (Chintagunta 1999), ketchup (Roy et al 1996), margarine, yogurt and peanut butter (Erdem 1996), breakfast cereals (Shum 2004), and orange juice (Dubé et al 2008). In the empirical marketing literature, these types of switching costs are equivalently referred to as habit persistence or inertia.…”

Do frequency reward programs create switching costs? A dynamic structural analysis of demand in a reward program

“…In a two-period reward program model, the switching costs also affect second-period utility and equal the discount provided if the customer repeats the same choice made in the first period (see Caminal and Matutes 1990). The empirical literature on switching costs has also followed this approach by using a single parameter that additively affects the indirect utility in a discrete choice model (see Dube et al 2006, as an example).…”