Regulating Endogenous Customer Switching Costs

Recent concern has arisen with regard to the potential for introducing competition in previously protected sectors as customer switching costs may make entry (and hence, aggressive price competition) difficult to achieve. An excellent example of this arises telecommunications deregulation with regard to the costs customers face in changing phone numbers. Interestingly, in such cases, switching costs can be ameliorated by incumbent action. For telecommunications, technologies exist that port existing phone numbers between networks. Regulators therefore, favour mandating such amelioration of switching costs but issues arise as to the allocation of the costs of implementing such solutions. This paper examines the issues associated with the regulation of customer switching costs. We compare regimes whereby customers as opposed to firms bear amelioration costs and find that while a customers-pay approach assists in facilitating an efficient choice regarding amelioration, incumbents have an incentive to distort those costs upwards under such a regime. Our central result is that a better approach would be to have incumbents bear amelioration costs but encourage the exercise of 'buy back’ options whereby the incumbent pays the switching customer to bear their original cost of switching rather than utilize amelioration technologies. In the case of number portability, this regulatory option is similar to vesting customers with property rights over their existing number that they can sell to their current network.