Antitrust & Competition Policy Blog

Editor: D. Daniel Sokol
University of Florida
Levin College of Law

Monday, December 14, 2009

Switching Costs in Network Industries

Posted by D. Daniel Sokol

Jiawei Chen (Department of Economics, University of California-Irvine) explains Switching Costs in Network Industries.

ABSTRACT: In network industries, switching costs have two opposite effects on the tendency towards market tipping. First, the fat-cat effect makes the larger firm price less aggressively and lose consumers to the smaller firm. This effect tends to prevent tipping. Second, the network-solidifying effect reinforces network effects by making a network size advantage longer-lasting and hence more valuable, thus intensifying price competition when networks are of comparable size. This effect tends to cause tipping. I find that when switching costs are high, the fat-cat effect dominates and an increase in switching costs can change the market from a tipping equilibrium to a sharing equilibrium. When switching costs are low, the network-solidifying effect dominates and an increase in switching costs can change the market from a sharing equilibrium to a tipping equilibrium. Policy intervention to remove switching costs in network industri! es may substantially reduce the likelihood of market tipping.

http://lawprofessors.typepad.com/antitrustprof_blog/2009/12/switching-costs-in-network-industries.html

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