Recognizing Lock-In
Hal R. Varian
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Recognizing Lock-In
• User’s cost of switching
products/suppliers in tech industries can
be large
• Compare
– Ford v. GM
– Mac v. PC
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What’s the difference?
• Durable investments in complementary
assets
– Hardware
– Software
– Wetware
• Switching one component may involve
switching all
• Supplier wants to lock-in customer
• Customer wants to avoid lock-in
• Basic principle: Look ahead and reason
back
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Examples
• Bell Atlantic and AT&T
– 5ESS digital switch used proprietary
operating system
– Large costs to change programming
– But even larger costs to change HW
• Computer Associates
– Legacy software for IBM mainframes
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More examples
• Windows and Office
– Individual switching costs: learning new
software
– Collective switching costs: file formats for
exchanging work
• Online bill payments
• Other examples…
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Small Switching Costs Matter
• Phone number portability
– Landlines
– Cellphones: history of portability
• Email addresses
– All providers make it hard to switch
– Forwarding services: ACM, alumni, etc.
• Lock-in costs on a per customer basis
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Pricing and switching costs
• With no switching cost
– Highest price you can charge user = cost of next
best alternative
– Alternative could be “go without” or “buy from a
competitor”
• With switching cost
– Highest price you can charge user = cost of next
best alternative + user switching cost
• Examples
– Automobile + parts
– Cell phone + additional services
– Printer + ink
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Impact of competition
• Before choice is made environment may be
very competitive (cell phones)
– Competition leads to low prices
• After choice is made you may have few
alternatives
– Lack of competition leads to high prices
• Smart buyer looks at both the before choice
and after-choice situation
• Smart seller looks at user switching costs as
an asset
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Competition for locked-in
customers
• Competitors can compensate user for
switching
– Earthlink’s EasySwitch
– Word for Wordperfect users
• But competitors may have cost of
acquiring new customers as well
– What matters is user + alternative supplier
switching costs
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Impact of competitor’s
customer switching costs
• Customer C switches from A to "same position"
with supplier B: Total switching costs = C’s
costs + B's costs of new customer
• Example
– Switching ISPs costs customer $50, new ISP $25
– New ISP make $100 on customer, worth
compensating usr
– New ISP makes $70 on customer, not worth
compensating user
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Profits and Switching Costs
• Profits from a customer = total
switching costs + quality advantages
– Why? Because price can exceed supply
cost by amount of user switching costs
– Profit = my price – my supply cost
– Profit = competitor’s price + quality
advantage + switching cost – supply
cost
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Commodity market
• All products are same (e.g., local phone
service)
– Profit per customer = total switching costs per
customer
• Use of this rule of thumb to value your
installed base of customers
– Decide how much to invest to get lock-in
– Evaluate a target acquisition
– Make product and design decisions that affect
switching costs
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Examples
• NYTimes, June 11, 2002
– “Earthlink acquires People PC customers
for $80 apiece, half of what the company
pays to acquire dialup customers.”
• McKinsey Quarterly, March 2002
– Estimates sensitivity of checking account
customers to bank charges
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Types of Switching Costs
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Durable purchases and replacement
Brand-specific training
Information and data
Personalized suppliers
Search costs
Loyalty programs
Contractual commitments
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Durable Purchases
• After purchase supplies, maintenance
– Photocopying machines
• Watch out for multiple pieces of
hardware
– Supplier will want to stagger vintages
– Contract renewal is sensitive time
•
Technology lock-in v. vendor lock-in
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Ink Jet Printers
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Brand-specific Training
• How much is transferable?
• Software
– Wetware and retraining costs can be huge
– Berkeley Financial System, Izio v Catalyst v Sakai
• Competitors want to lower switching costs
– Quattro Pro help for Lotus users
– MS Word help for WordPerfect users
– Earthlink Easy Switch
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Information and Databases
• Datafiles
– Insist on standard formats
• Control of data can be valuable
– Ameriserve example in fast food industry
– high-labor turnover
– supplier manages inventory information
– big costs to switching to alternative
supplier!
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Personalized Suppliers
• Advertising, legal, accounting firms
• Pentagon
– Dual sourcing for tech and strategy
reasons
• Infotech examples
– Intel and AMD chip socket design
– Xerox Interleaf and Adobe
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Search Costs
• Customer cost in finding new supplier
• Supplier costs in finding and servicing new
customer
– promotion, closing deal, setting up account, credit
risks
• Example: Credit Cards
– $100 million in receivables sells or about $120
million
– Market valuation of credit card “loyalty”
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Loyalty Programs
•
Constructed by firm
– Frequent flyer programs
– Frequent coffee programs
• Much easier to do now that most
transactions are computer mediated
• Nonlinear reward structure is important to
induce switching rather than diversification
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Contractual Commitments
• “Requirements contract”: Purchase
supplies from one supplier
• Beware of “evergreen contracts” that
renew automatically
– Magazine subscriptions
– Cell phone renewals – retention specialists
– AOL contract cancelation
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Suppliers and Partners
• Both sides may be locked in
– Railroad spur lines
– Customized software
– IPOs
• Bilateral monopoly problem
– Game of Chicken
– @home and AT&T
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Follow the Lock-in cycle
Brand Selection
Sampling
Lock-In
Entrenchment
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Lessons
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Switching costs are ubiquitous
Customers may be vulnerable to lock-in
Value your installed base
Watch for durable purchases
Be able to identify 7-types of lock-in
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