Handbook on the Economics and Theory of the Firm
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Handbook on the Economics and Theory of the Firm

Edited by Michael Dietrich and Jackie Krafft

This unique Handbook explores both the economics of the firm and the theory of the firm, two areas which are traditionally treated separately in the literature. On the one hand, the former refers to the structure, organization and boundaries of the firm, while the latter is devoted to the analysis of behaviours and strategies in particular market contexts. The novel concept underpinning this authoritative volume is that these two areas closely interact, and that a framework must be articulated in order to illustrate how linkages can be created.
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Chapter 31: Product Innovation when Consumers have Switching Costs

Evens Salies


Evens Salies 31.1 INTRODUCTION A primary weapon of a capitalist society is the development of new products that firms race to introduce before a competitor comes out with a model that consumers will like much better (Baumol, 2006). Economists have long recognized, however, that in free markets, incentives to innovate will be diluted unless some factors grant innovators a temporary monopoly (Tirole, 1988). Patenting is the most cited factor in the economic literature. This survey concentrates on another factor that confers innovators with firstmover advantage over their competitors, namely consumer switching costs, whereby ‘a consumer makes an investment specific to her current seller, that must be duplicated for any new seller’ (Klemperer, 2008, p. 9). This concept that has been formally introduced in theoretical economics in the seminal journal articles of Von Weizsäcker (1984) and Klemperer (1987),1 can be dated back to Schumpeter ([1942] 1962) who suggested a role of long-period contracts as devices for tying prospective customers to investing firms. Unlike patenting or other price or non-price strategic instruments, temporary monopoly power can arise as a purely demand-side phenomenon when, for example, consumers want to avoid transaction costs (the cost of using the market in the sense of Coase, 1937) or learning how to use another firm’s technology. The effect of consumer switching costs on innovation is controversial, however, and has been largely neglected in the economics of the firm literature, in which the focus on demand inertia is for the case of businessto-business relationships, where buyers...

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