Edited by Joseph E. Harrington Jr and Yannis Katsoulacos
Chapter 1: Switching Costs and Network Effects in Competition Policy
Jacques Crémer and Gary Biglaiser1 In their traditional definition switching costs refer to real, concrete, ‘hard’ costs that consumers or firms must bear when changing suppliers. There is no switching cost, or very little, when you switch from one baker to another; there is some switching cost when you change the brand of car you are driving as you need to relearn how to program the radio; there are substantial switching costs when a firm changes consumer relationship management (CRM) software. As a consequence, incumbent suppliers have a strategic advantage: they can, within limits, charge a higher price than entrants and ‘keep’ their customers. Network effects refer to the fact that, for some types of goods, individuals or firms prefer to consume the same good as others. Using a social networking site that does not have any other users does not increase one’s utility. Economists have stressed the fact that network effects lead to strategic effects which are very similar to those induced by switching costs. Consumers will hesitate to ‘leave’ an incumbent, even to migrate to an entrant which offers lower prices and/or better quality, as they fear that they will lose the benefits of the network effects. This analogy is so ingrained in the collective wisdom of economists that they sometimes speak of network effects as ‘collective switching costs.’ For instance, in his lectures at Berkeley on ‘Strategic Computing and Communications Technology’2 Hal Varian states ‘network effects lead to substantial collective switching costs and lock-in,’ which...
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