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

Author

Listed:
  • Thomas Gehrig

    (Universität Freiburg)

  • Rune Stenbacka

    (Swedish School of Economics, Helsinki)

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 %.

Suggested Citation

  • 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.
  • Handle: RePEc:kud:kuieci:2005-09
    as

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    File URL: http://www.econ.ku.dk/cie/dp/dp_2003-2006/2005-09.pdf/
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    References listed on IDEAS

    as
    1. Yongmin Chen, 1997. "Paying Customers to Switch," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 6(4), pages 877-897, December.
    2. Paul Klemperer, 1995. "Competition when Consumers have Switching Costs: An Overview with Applications to Industrial Organization, Macroeconomics, and International Trade," Review of Economic Studies, Oxford University Press, vol. 62(4), pages 515-539.
    3. Dos Santos Ferreira, Rodolphe & Thisse, Jacques-Francois, 1996. "Horizontal and vertical differentiation: The Launhardt model," International Journal of Industrial Organization, Elsevier, pages 485-506.
    4. Drew Fudenberg & Jean Tirole, 2000. "Customer Poaching and Brand Switching," RAND Journal of Economics, The RAND Corporation, pages 634-657.
    5. Gehrig, Thomas, 1996. "Natural oligopoly and customer networks in intermediated markets," International Journal of Industrial Organization, Elsevier, vol. 14(1), pages 101-118.
    6. Irmen, Andreas & Thisse, Jacques-Francois, 1998. "Competition in Multi-characteristics Spaces: Hotelling Was Almost Right," Journal of Economic Theory, Elsevier, pages 76-102.
    7. Avner Shaked & John Sutton, 1982. "Relaxing Price Competition Through Product Differentiation," Review of Economic Studies, Oxford University Press, vol. 49(1), pages 3-13.
    8. Gehrig, Thomas, 1998. "Competing markets," European Economic Review, Elsevier, vol. 42(2), pages 277-310, February.
    9. repec:ulb:ulbeco:2013/1759 is not listed on IDEAS
    10. de Palma, A, et al, 1985. "The Principle of Minimum Differentiation Holds under Sufficient Heterogeneity," Econometrica, Econometric Society, pages 767-781.
    11. Farrell, Joseph & Klemperer, Paul, 2007. "Coordination and Lock-In: Competition with Switching Costs and Network Effects," Handbook of Industrial Organization, Elsevier.
    12. Thomas Gehrig & Rune Stenbacka, 2004. "Differentiation-Induced Switching Costs and Poaching," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 13(4), pages 635-655, December.
    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    quality choice; switching costs; poaching; natural oligopoly;

    JEL classification:

    • D43 - Microeconomics - - Market Structure, Pricing, and Design - - - 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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