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Recognizing Lock-In: 

Recognizing Lock-In Carl Shapiro Hal R. Varian

Recognizing Lock-In: 

Recognizing Lock-In Cost of switching Compare Ford v. GM Mac v. PC

What’s the Difference?: 

What’s the Difference? Durable investments in complementary assets Hardware Software Wetware Supplier wants to lock-in customer Customer wants to avoid lock-in Basic principle: Look ahead and reason back

Examples: 

Examples Bell Atlantic and AT&T 5ESS digital switch used proprietary operating system Large switching costs to change switches Computer Associates Aircraft repair and cargo conversion

Small Switching Costs Matter: 

Small Switching Costs Matter Phone number portability Email addresses Hotmail (advertising, portability) ACM, CalTech Look at lockin costs on a per customer basis

Valuing an Installed Base: 

Valuing an Installed Base Customer C switches from A to "same position" w/ B Total switching costs = customer costs + B's costs Example Switching ISPs costs customer $50 new ISP $25 New ISP make $100 on customer, switch New ISP makes $70 on customer, no switch Disruption costs Example: ILECs v CLECs Competitive market Profit=switching costs e.g. ILEC profits=customer + CLEC switching costs

Profits & Switching CostsIn General:: 

Profits & Switching Costs In General: Profits from a customer = total switching costs + quality/cost advantages In commodity market like telephony, profit per customer = total switching costs per customer Use of this rule of thumb How much to invest to get locked-in base Evaluate a target acquisition (e.g., Hotmail) Product and design decisions that affect switching costs

Classification of Lock-In: 

Classification of Lock-In Durable purchases and replacement: declines with time Brand-specific training: rises with time Information and data: rises with time Specialized suppliers: may rise Search costs: learn about alternatives Loyalty programs: rebuild cumulative usage Contractual commitments: damages

Durable Purchases: 

Durable Purchases Aftermarket sales (supplies, maintenance) Depends on (true) depreciation Usually fall with time Watch out for multiple pieces of hardware Supplier will want to stagger vintages Contract renewal Technology lock-in v. vendor lock-in

Brand-specific Training: 

Brand-specific Training How much is transferable? Software Competitors want to lower switching costs Borland and Quattro Pro help Word and WordPerfect help

Information & Databases: 

Information & Databases Datafiles Insist on standard formats

Specialized Suppliers: 

Specialized Suppliers Advertising, legal, accounting firms Pentagon Dual sourcing Intel and AMD Adobe PostScript Java

Search Costs: 

Search Costs Transactions cost in finding new supplier Also costs borne by new supplier Promotion, clsoing deal, setting up account, credit risks Example: Credit Cards $100 million in receivables sells or about $120 million Market valuation of “loyalty”

Loyalty Programs: 

Loyalty Programs Constructed by firm Frequent flyer programs Frequent coffee programs Personalized Pricing Gold status Example: Amazon and Barnes and Noble Amazon Assocates Program v. B&N's Affiliates program Add nonlinearity?

Contractual Commitments: 

Contractual Commitments “Requirements contract”: Purchase supplies from one supplier Beware of “evergreen contracts”

Suppliers and partners: 

Suppliers and partners Railroad spur lines Customized software

Follow the Lock-in cycle: 

Follow the Lock-in cycle Brand Selection Sampling Lock-In Entrenchment

Lessons: 

Lessons Switching costs are ubiquitous Customers may be vulnerable Value your installed base Watch for durable purchases Be able to identify 7-types of lock-in