Information technology in business and society

1. Information technology in business and society Session 24 – Switching Costs and Lock-IN Sean J. taylor

2. Administrativia • G1: Submit group feedback forms • G2: any questions?

3. Another Bundling Example We can charge higher prices, but we get fewer sales. Less correlated The advantage of the bundle decreases with correlation. More correlated

4. Learning objectives • Explain switching costs, technological lock-in and how switching costs lead to technological lock-in. • Understand how switching costs affect industry competition. • Understand the sources of lock-in and switching costs: • durable purchases • brand-specific training • information and databases • contracts • Be able to identify and analyze sources of lock-in for specific products or in specific business contexts. • specialized suppliers • search costs • loyalty programs

5. 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

6. Example: Switching cars versus switching computers? Technology lock-in: Overview • 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?)

7. Examples of Switching Costs/Lock-in?

8. Increasing switching costs… Switching costs & competitiveness Reduces the threat of new entrants Threat of New Entrants Reduces rivalry among existing competitors Main industry Bargaining Power of Suppliers Bargaining Power of Buyers Rivalry Among Existing Competitors Reduces the bargaining power of suppliers over time, due to reducing number of firms in the main industry 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 typicallyreduce competitiveness and increase industry profits

9. Sources of lock-in Type of Lock-In Switching Costs Contractual Commitment Compensatory damages Durable purchases Replacement costs, complementary products Brand-specific learning Interface learning, corporate re-training Information and databases Cost of transfer, re-creation, imperfections Search costs Cost of time, attention, uncertainty Network Effects Lost relationships, lost network value Loyalty programs Lost accumulated benefits

10. Sources of lock-in Type of Lock-In Switching Costs Contractual Commitment Compensatory damages Durable purchases Replacement costs, complementary products Brand-specific learning Interface learning, corporate re-training Information and databases Cost of transfer, re-creation, imperfections Search costs Cost of time, attention, uncertainty Network Effects Lost relationships, lost network value Loyalty programs Lost accumulated benefits

11. Driver of lock-in Pattern of lock-in Supplier strategies • Investments in durable assets • Customer buys expensive hardware (durable asset) • Customer is forced to buy (high-margin) complementary products/services to avoid re-investment in new durable assets • Discount upfront durable products to lock-in the customer • Make money off the upgrades and complementary products/services Durable purchases Examples?

12. Drivers of lock-in Pattern of lock-in Supplier strategies • Learning how to use product (Ticketmaster example) • Training employees (skill set becomes the complementary product) • 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 • 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 Brand-specific training Examples?

13. Drivers of lock-in Patterns of lock-in Supplier strategies • 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) • Customer invests in product • Customer stores/gathers product-specific information with use (increases with time) • Customer stays with existing product to avoid transfer costs • Actively encourage informational investment, offering convenience, cost reductions in return • Build interfaces to your competitors’ products Information and Databases Examples?

14. Drivers of lock-in Pattern of lock-in Supplier strategies • Actually finding new supplier (attention, time, evaluation) • Aversion to uncertainty from unknown alternatives (loss of knowledge gained from experience) • 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 • Pay special attention to first-time customers • Highlight reductions in uncertainty Search Costs Examples?

15. 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

16. Bargain Hard before you become locked in Keep your options open Retain the rights to transfer your information Managing lock-in as a customer • 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. • Second source of supply • Adopt (or require) an open system architecture • Signal by actually partial switching (geographic areas, businesses) • Switching doctors is easier when you have medical records • Switching mechanics is easier when you have maintenance records for your equipment.

17. Attract the right customers Entrench them Leverage your installed base Managing lock-in as a seller • 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 • Design-in gradual ease of use, informational investments • Use web-based loyalty programs actively • Highlight reductions in uncertainty, value from their investments • 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

18. Next Class:Wrap-up and Review