1 / 25

Recognizing Lock-In

Recognizing Lock-In. Hal R. Varian. Recognizing Lock-In. User’s cost of switching products/suppliers in tech industries can be large Compare Ford v. GM Mac v. PC. What’s the difference?. Durable investments in complementary assets Hardware Software Wetware

mercer
Download Presentation

Recognizing Lock-In

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript


  1. Recognizing Lock-In Hal R. Varian SIMS

  2. Recognizing Lock-In • User’s cost of switching products/suppliers in tech industries can be large • Compare • Ford v. GM • Mac v. PC SIMS

  3. 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 SIMS

  4. 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 SIMS

  5. More examples • Windows and Office • Individual switching costs: learning new software • Collective switching costs: file formats for exchanging work • Online bill payments • Other examples… SIMS

  6. 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 SIMS

  7. 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 SIMS

  8. 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 SIMS

  9. 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 SIMS

  10. 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 SIMS

  11. 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 SIMS

  12. 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 SIMS

  13. 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 SIMS

  14. Types of Switching Costs • Durable purchases and replacement • Brand-specific training • Information and data • Personalized suppliers • Search costs • Loyalty programs • Contractual commitments SIMS

  15. 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 SIMS

  16. Ink Jet Printers SIMS

  17. 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 SIMS

  18. 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! SIMS

  19. 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 SIMS

  20. 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” SIMS

  21. 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 SIMS

  22. 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 SIMS

  23. 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 SIMS

  24. Follow the Lock-in cycle Brand Selection Sampling Lock-In Entrenchment SIMS

  25. Lessons • 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 SIMS

More Related