Where changing supplier is costly, customers stay with an incumbent whose offer is worse, so the incumbent can price above a rival's without losing them.
Klemperer's analysis shows the market splitting into two phases: competition to acquire customers, which can be fierce and unprofitable, and harvesting afterwards. Switching costs include learning, data, contracts, and the risk of the transition itself, and they are frequently created deliberately by the design of the product.
In practice
- A firm quotes a rival 20% cheaper and stays put, because migration would take a year of someone's time.
- A bank keeps customers who would leave if the account number moved with them.
- Standing
- Compare path dependence and lock-in, which describe the same mechanism at the level of standards rather than firms.
- Subject
- Economics & Incentives
- Essay
- The theories behind every argument about money