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, … Show more
“…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.…”
We develop a structural dynamic demand model that examines how brand preferences evolve when consumers are uncertain about product quality and their needs change periodically. We allow for strategic sampling behavior of consumers under quality uncertainty and allow for strategic sampling to increase periodically as consumers' needs change periodically. We differ from previous work on forward-looking consumer Bayesian learning by allowing for 1) spill-over learning effects across different versions of products or products in different product categories that share a brand name and 2) duration-dependence in utility for a specific version of a product or product class to capture systematic periodic changes in consumer utility and migration of consumers across product versions or classes. We also assess the evolution of price elasticities in markets where there is consumer quality uncertainty that diminishes over time as consumers get more experienced. We estimate our model using scanner data for the disposable diapers category and discuss the consumer behavior and managerial implications of our estimation and policy simulation results.
“…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.…”
We develop a structural dynamic demand model that examines how brand preferences evolve when consumers are uncertain about product quality and their needs change periodically. We allow for strategic sampling behavior of consumers under quality uncertainty and allow for strategic sampling to increase periodically as consumers' needs change periodically. We differ from previous work on forward-looking consumer Bayesian learning by allowing for 1) spill-over learning effects across different versions of products or products in different product categories that share a brand name and 2) duration-dependence in utility for a specific version of a product or product class to capture systematic periodic changes in consumer utility and migration of consumers across product versions or classes. We also assess the evolution of price elasticities in markets where there is consumer quality uncertainty that diminishes over time as consumers get more experienced. We estimate our model using scanner data for the disposable diapers category and discuss the consumer behavior and managerial implications of our estimation and policy simulation results.
“…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.).…”
Section: Conclusion and Extensionsmentioning
confidence: 99%
“…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.…”
Section: Conclusion and Extensionsmentioning
confidence: 99%
“…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.…”
“…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).…”
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