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Two at the Top: Quality Differentiation in Markets with Switching Costs

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Author Info
Gehrig, Thomas
Stenbacka, Rune

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Abstract

We explore the effects of switching costs on the subgame perfect quality decisions of oligopolists with repeated price competition. We establish a strong strategic quality premium. We show that competition for the establishment of customer relationships will eliminate low-quality firms in period 1 and that low-quality firms can survive only based on poaching profits. The equilibrium configuration is characterized by an agglomeration of two providers of top-quality as soon as switching cost heterogeneity is sufficiently significant. We demonstrate a finiteness property, according to which the two top-quality firms dominate the market with a joint market share exceeding 50%.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 4996.

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Date of creation: Apr 2005
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Handle: RePEc:cpr:ceprdp:4996

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Related research
Keywords: natural oligopoly; poaching; quality choice; switching costs;

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Find related papers by JEL classification:
D43 - Microeconomics - - Market Structure and Pricing - - - Oligopoly and Other Forms of Market Imperfection
L15 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Information and Product Quality

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Klemperer, Paul, 1995. "Competition When Consumers Have Switching Costs: An Overview with Applications to Industrial Organization, Macroeconomics, and International Trade," Review of Economic Studies, Blackwell Publishing, vol. 62(4), pages 515-39, October. [Downloadable!] (restricted)
  2. Gehrig, Thomas, 1998. "Competing markets," European Economic Review, Elsevier, vol. 42(2), pages 277-310, February. [Downloadable!] (restricted)
  3. Paul Klemperer, 1987. "The Competitiveness of Markets with Switching Costs," RAND Journal of Economics, The RAND Corporation, vol. 18(1), pages 138-150, Spring. [Downloadable!] (restricted)
  4. Yongmin Chen, 1997. "Paying Customers to Switch," Journal of Economics & Management Strategy, Blackwell Publishing, vol. 6(4), pages 877-897, December. [Downloadable!] (restricted)
  5. Taylor, Curtis R., 2000. "Supplier Surfing: Competition and Consumer Behavior in Subscription Markets," Working Papers 00-12, Duke University, Department of Economics. [Downloadable!]
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  6. Thomas Gehrig & Rune Stenbacka, 2004. "Differentiation-Induced Switching Costs and Poaching," Journal of Economics & Management Strategy, Blackwell Publishing, vol. 13(4), pages 635-655, December. [Downloadable!] (restricted)
  7. Farrell, Joseph & Klemperer, Paul, 2006. "Coordination and Lock-In: Competition with Switching Costs and Network Effects," CEPR Discussion Papers 5798, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  8. Gehrig, Thomas & Stenbacka, Rune, 2005. "Two at the Top: Quality Differentiation in Markets with Switching Costs," CEPR Discussion Papers 4996, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  9. de Palma, A, et al, 1985. "The Principle of Minimum Differentiation Holds under Sufficient Heterogeneity," Econometrica, Econometric Society, vol. 53(4), pages 767-81, July. [Downloadable!] (restricted)
  10. Irmen, Andreas & Thisse, Jacques-Francois, 1998. "Competition in Multi-characteristics Spaces: Hotelling Was Almost Right," Journal of Economic Theory, Elsevier, vol. 78(1), pages 76-102, January. [Downloadable!] (restricted)
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  11. Drew Fudenberg & Jean Tirole, 2000. "Customer Poaching and Brand Switching," RAND Journal of Economics, The RAND Corporation, vol. 31(4), pages 634-657, Winter.
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  12. Gehrig, Thomas, 1996. "Natural oligopoly and customer networks in intermediated markets," International Journal of Industrial Organization, Elsevier, vol. 14(1), pages 101-118. [Downloadable!] (restricted)
  13. Shaked, Avner & Sutton, John, 1982. "Relaxing Price Competition through Product Differentiation," Review of Economic Studies, Blackwell Publishing, vol. 49(1), pages 3-13, January. [Downloadable!] (restricted)
  14. Dos Santos Ferreira, Rodolphe & Thisse, Jacques-Francois, 1996. "Horizontal and vertical differentiation: The Launhardt model," International Journal of Industrial Organization, Elsevier, vol. 14(4), pages 485-506, June. [Downloadable!] (restricted)
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(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Crespi, John M. & Marette, Stéphan, 2006. "Quality and Competition: An Empirical Analysis across Industries," Staff General Research Papers 12555, Iowa State University, Department of Economics. [Downloadable!]
    Other versions:
  2. Thomas Gehrig & Rune Stenbacka, 2005. "Two at the Top: Quality Differentiation in Markets with Switching Costs," CIE Discussion Papers 2005-09, University of Copenhagen. Department of Economics. Centre for Industrial Economics. [Downloadable!]
    Other versions:
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