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Recognizing Lock-In

Recognizing Lock-In. Cost of switchingCompare Ford v. GM Mac v. PC. What's the Difference?. Durable investments in complementary assets Hardware Software WetwareSupplier wants to lock-in customerCustomer wants to avoid lock-inBasic principle: Look ahead and reason back. Examples. Bell Atlantic and AT

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Recognizing Lock-In

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    1. Recognizing Lock-In Carl Shapiro Hal R. Varian

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

    3. 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 Kierkegaaard: “it is perfectly true, as philosophers say, that life must be understood backwards. But they forget the other proposition, that it must be lived forwards.” Kierkegaaard: “it is perfectly true, as philosophers say, that life must be understood backwards. But they forget the other proposition, that it must be lived forwards.”

    4. 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 Bell Atlantic: 1995 suit for monopolization 15 year life of switch Computer Associates: $3.5 billion, behind Microsoft and Oracle Computer Associates: $432,000 per employee Microsoft: $422,000 per employee Oracle: $180,000 per employee Don’t want to switch OS or applications or vendors. Peru bought Soviet aircraft at deep discounts Didn’t buy manuals or spare parts! Most airlines avoided this mistake.Bell Atlantic: 1995 suit for monopolization 15 year life of switch Computer Associates: $3.5 billion, behind Microsoft and Oracle Computer Associates: $432,000 per employee Microsoft: $422,000 per employee Oracle: $180,000 per employee Don’t want to switch OS or applications or vendors. Peru bought Soviet aircraft at deep discounts Didn’t buy manuals or spare parts! Most airlines avoided this mistake.

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

    6. 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

    7. 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

    8. 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

    9. 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

    10. Brand-specific Training How much is transferable? Software Competitors want to lower switching costs Borland and Quattro Pro help Word and WordPerfect help Wordperfect help in Microsoft WorldWordperfect help in Microsoft World

    11. Information & Databases Datafiles Insist on standard formats

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

    13. 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”

    14. 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?

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

    16. Suppliers and partners Railroad spur lines Customized software

    17. Follow the Lock-in cycle Selects brand: comparison Sampling phase: try the product Entrenchment: makes the durable investments Lock-in: costly to changeSelects brand: comparison Sampling phase: try the product Entrenchment: makes the durable investments Lock-in: costly to change

    18. 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

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