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Who pays for switching costs?

Author

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  • Guy Arie
  • Paul E. Grieco

Abstract

Earlier work characterized pricing with switching costs as a dilemma between a short-term “harvesting” incentive to increase prices versus a long-term “investing” incentive to decrease prices. This paper shows that small switching costs may reduce firm profits and provide short-term incentives to lower rather than raise prices. We provide a simple expression which characterizes the impact of the introduction of switching costs on prices and profits for a general model. We then explore the impact of switching costs in a variety of specific examples which are special cases of our model. We emphasize the importance of a short term “compensating” effect on switching costs. When consumers switch in equilibrium, firms offset the costs of consumers that are switching into the firm. If switching costs are low, this compensating effect of switching costs causes even myopic firms to decrease prices. The incentive to decrease prices is even stronger for forward looking firms. Copyright Springer Science+Business Media New York 2014

Suggested Citation

  • Guy Arie & Paul E. Grieco, 2014. "Who pays for switching costs?," Quantitative Marketing and Economics (QME), Springer, vol. 12(4), pages 379-419, December.
    • Handle: RePEc:kap:qmktec:v:12:y:2014:i:4:p:379-419
    DOI: 10.1007/s11129-014-9151-9
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    References listed on IDEAS

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    Cited by:

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    2. Aljoscha Janssen, 2022. "Price dynamics of Swedish pharmaceuticals," Quantitative Marketing and Economics (QME), Springer, vol. 20(4), pages 313-351, December.
    3. Timothy J. Richards & Jura Liaukonytė, 2023. "Switching cost and store choice," American Journal of Agricultural Economics, John Wiley & Sons, vol. 105(1), pages 195-218, January.
    4. Luisa Dressler & Stefan Weiergraeber, 2023. "Alert the Inert? Switching Costs and Limited Awareness in Retail Electricity Markets," American Economic Journal: Microeconomics, American Economic Association, vol. 15(1), pages 74-116, February.
    5. Jiawei Chen & Michael Sacks, 2016. "Reimbursing Consumers' Switching Costs in Network Industries," Working Papers 16-13, NET Institute.
    6. Wu, Lingli & Deng, Shiming & Jiang, Xuan, 2018. "Sampling and pricing strategy under competition," Omega, Elsevier, vol. 80(C), pages 192-208.
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    8. Pires, Tiago, 2018. "Measuring the effects of search costs on equilibrium prices and profits," International Journal of Industrial Organization, Elsevier, vol. 60(C), pages 179-205.
    9. Jason Pearcy, 2016. "Bargains Followed by Bargains: When Switching Costs Make Markets More Competitive," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 25(4), pages 826-851, December.
    10. Janssen, Aljoscha, 2020. "Price Dynamics of Swedish Pharmaceuticals," Working Paper Series 1325, Research Institute of Industrial Economics.
    11. Ruiz-Aliseda, Francisco, 2016. "When do switching costs make markets more or less competitive?," International Journal of Industrial Organization, Elsevier, vol. 47(C), pages 121-151.
    12. Andrew Rhodes, 2014. "Re-examining the effects of switching costs," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 57(1), pages 161-194, September.
    13. Timothy J. Richards & Bradley J. Rickard, 2021. "Dynamic model of beer pricing and buyouts," Agribusiness, John Wiley & Sons, Ltd., vol. 37(4), pages 685-712, October.
    14. Richards, Timothy J. & Liaukonyte, Jura, 2018. "Switching Cost and Store Choice," 2018 Annual Meeting, August 5-7, Washington, D.C. 274201, Agricultural and Applied Economics Association.
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    More about this item

    Keywords

    Dynamic oligopoly; Switching costs; D43; L13; L14;
    All these keywords.

    JEL classification:

    • D43 - Microeconomics - - Market Structure, Pricing, and Design - - - Oligopoly and Other Forms of Market Imperfection
    • L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets
    • L14 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Transactional Relationships; Contracts and Reputation

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