INFORMATION
TECHNOLOGY IN
BUSINESS AND
SOCIETY
SESSION 24 – SWITCHING COSTS AND LOCK-IN
SEAN J. TAYLOR
ADMINISTRATIVIA
• G1: Submit group feedback forms
• G2: any questions?
Less correlated
More correlated
ANOTHER BUNDLING
EXAMPLE
We can charge higher prices, but
we get fewer sales.
Ex. 1
Alice
Bob
Chris
Rock
$10
$5
$5
Example Rock
Price
Hip Hop
Price
Country Price
Hip hop $5
$10
$0
1
$10
$10
$10
Country $0
$0
$10
2
$10
$5
$10
Ex. 2
Alice
Bob
Chris
3
$10
$5
$0
Rock
$10
$10
$5
Hip hop $5
$5
$0
The advantage of the bundle
decreases with correlation.
Country $0
$0
$10
Ex. 3
Alice
Bob
Rock
$10
Example
Separate
Bundle
Improvement
1
$30
$45
$15
Chris
2
$40
$45
$5
$10
$10
3
$45
$45
$0
Hip hop $5
$5
$5
Country $0
$0
$0
LEARNING OBJECTIVES
1.
Explain switching costs, technological lock-in and how
switching costs lead to technological lock-in.
2.
Understand how switching costs affect industry
competition.
3.
Understand the sources of lock-in and switching costs:
4.
•
durable purchases
•
specialized suppliers
•
brand-specific training
•
search costs
•
information and databases
•
loyalty programs
•
contracts
Be able to identify and analyze sources of lock-in for specific
products or in specific business contexts.
SWITCHING COSTS & LOCK-IN
OVERVIEW
What should you consider when deciding on
switching from PC to Mac?
Switching costs in the Mac-PC example
•
Buying new peripherals (used to be OS-specific)
•
Buying new software (OS-specific)
•
Converting your PC files to Mac-compatible files (file formats used
to be OS-specific)
•
Learning how to use the new OS (OS-specific)
•
Finding a new ‘support group’ or corporate support infrastructure
(OS-specific)
What about when switching from an HP to
Dell PC?
Switching from a HP to a Dell PC
• The cost of switching tends to be minimal
• Microsoft makes more money than HP when one buys an HP PC
Most of the margins seem to go to the part of the
product/system that drives the switching costs
TECHNOLOGY LOCK-IN: OVERVIEW
Example: Switching cars versus switching computers?
Computers
Across brands: PC to Mac
• Buying new peripherals
• Buying new software
• Ensuring that your PC files can be
read by your Mac
• Learning how to use the new OS getting used to the new UI, figuring
out what the mouse does when you
double-click, what the control and
function keys do, how to live with one
mouse button...
• Finding a new ‘support group’
Upgrade: any computer to any other
• Copying files, reinstalling software
• Shortcuts, bookmarks,…
• Getting used to the feel/layout of the
new keyboard
Automobiles
Across brands: Honda to BMW
• Finding a new service shop
• Finding where to get spare parts
• Buying new accessories/toolkit
• Adapting to the new dashboard,
figuring out where all the controls,
switches and levers are
Upgrade: any car to any other
• Getting license plates, registration,
insurance, spending time at DMV/AAA
• Getting used to 'how the car drives'
(maybe this is a little less if you buy a
car of the same brand and model?)
EXAMPLES OF SWITCHING
COSTS/LOCK-IN?
SWITCHING COSTS & COMPETITIVENESS
Increasing switching costs…
Threat of New
Entrants
Reduces the threat
of new entrants
Reduces rivalry among
existing competitors
Main industry
Bargaining Power
of Suppliers
Bargaining Power
of Buyers
Reduces the bargaining
power of suppliers over time,
due to reducing number of
firms in the main industry
Rivalry Among
Existing Competitors
Reduces the bargaining
power of buyers
Threat of Substitute
Products or Services
(generally reduces, but we’re
not going to discuss this force)
High switching costs typically
reduce competitiveness and increase industry profits
SOURCES OF LOCK-IN
Type of Lock-In
Switching Costs
Contractual Commitment
Compensatory damages
Durable purchases
Replacement costs,
complementary products
Interface learning,
corporate re-training
Cost of transfer,
re-creation, imperfections
Cost of time, attention,
uncertainty
Brand-specific learning
Information and databases
Search costs
Network Effects
Lost relationships, lost
network value
Loyalty programs
Lost accumulated benefits
SOURCES OF LOCK-IN
Type of Lock-In
Switching Costs
Contractual Commitment
Compensatory damages
Durable purchases
Replacement costs,
complementary products
Interface learning,
corporate re-training
Cost of transfer,
re-creation, imperfections
Cost of time, attention,
uncertainty
Brand-specific learning
Information and databases
Search costs
Network Effects
Lost relationships, lost
network value
Loyalty programs
Lost accumulated benefits
DURABLE PURCHASES
Driver of lock-in
•
Investments in durable assets
Pattern of lock-in
•
Customer buys expensive hardware (durable asset)
•
Customer is forced to buy (high-margin) complementary
products/services to avoid re-investment in new durable assets
Supplier strategies
•
Discount upfront durable products to lock-in the customer
•
Make money off the upgrades and complementary
products/services
Examples?
BRAND-SPECIFIC TRAINING
Drivers of lock-in
•
Learning how to use product (Ticketmaster example)
•
Training employees (skill set becomes the complementary product)
Pattern of lock-in
•
Customer invests in learning to use product/interface
•
Customer becomes adept at usage (increases with time)
•
Customer sticks with product to avoid re-learning, company
standardizes product to reduce training costs
Supplier strategies
•
Reduce learning barriers to adoption
•
Consciously design-in learning over time. Competitors want to lower
switching costs. Borland and Quattro Pro help for Lotus1-2-3. Word
and WordPerfect help
Examples?
INFORMATION AND DATABASES
Drivers of lock-in
•
Complementarity between HW+SW on one hand vs. Information on the
other.
•
Transferring/porting product-specific information/files/media
(actual transfer, imperfect transfer, re-creation)
Patterns of lock-in
•
Customer invests in product
•
Customer stores/gathers product-specific information with use
(increases with time)
•
Customer stays with existing product to avoid transfer costs
Supplier strategies
•
Actively encourage informational investment, offering convenience,
cost reductions in return
•
Build interfaces to your competitors’ products
Examples?
SEARCH COSTS
Drivers of lock-in
•
Actually finding new supplier (attention, time, evaluation)
•
Aversion to uncertainty from unknown alternatives (loss of
knowledge gained from experience)
Pattern of lock-in
•
Customer invests in finding a supplier
•
Customer evaluates and understands quality of supplier
•
Customer pays premium for current supplier, trading off cost of
search against higher prices
Supplier strategies
•
Pay special attention to first-time customers
•
Highlight reductions in uncertainty
Examples?
LOYALTY PROGRAMS
Constructed by firm
• Frequent flyer programs
• Gold status (airline customer switching tactic)
Personalized Pricing
• Example: Amazon and Barnes and Noble
Referral Program
• Amazon Associates Program vs. B&N's Affiliates program.
• More effective if royalty based on cumulative referrals.
Loyalty programs create 2 kinds of switching costs
• Have 15000 miles and need 25000 miles
• Minimized by switching carriers after encashing in bulk
• Double Miles/Preferential treatment for Gold/Platinum/Silver cards
MANAGING LOCK-IN AS A CUSTOMER
Bargain Hard before you become locked in
•
Don’t fall for sweeteners alone (initial discounts on hardware, extended
warranty instead of a service contract)
•
Bargaining position becomes weaker once you make sunk investments
•
Think ahead to entire lock-in cycle when you negotiate. (TCI, MS and
Java). Convince seller of your switching costs later.
Keep your options open
•
Second source of supply
•
Adopt (or require) an open system architecture
•
Signal by actually partial switching (geographic areas, businesses)
Retain the rights to transfer your information
•
Switching doctors is easier when you have medical records
•
Switching mechanics is easier when you have maintenance records for
your equipment.
MANAGING LOCK-IN AS A SELLER
Attract the right customers
• Right segment, right features/advantages, differentiation
• Isolate and target the buyers with high switching costs
• Look for buyers with a high sphere of influence (connected,
credible)
• Index investment to the lifetime value of the customer
Entrench them
• Design-in gradual ease of use, informational investments
• Use web-based loyalty programs actively
• Highlight reductions in uncertainty, value from their investments
Leverage your installed base
• Up-sell complements, premium services (own/partners)
• Sensibly sell access to your installed base
• Price discriminate with care (yours, your competitors’, nobody’s),
and expect your competitor to do the same
NEXT CLASS:
WRAP-UP AND REVIEW