Competition when Consumers have Switching Costs: An Overview with Applications to Industrial Organization, Macroeconomics, and International Trade

TLDR

Switching costs make a firm’s current market share a key determinant of future profitability. The paper surveys how switching costs shape firms’ pricing, product, and competitive strategies, and argues they explain multi‑product firms and inter‑firm competition. The authors analyze firms’ pricing and product decisions under switching costs by modeling the trade‑off between capturing market share and harvesting profits, considering entry threats, macroeconomic factors, and industry dynamics.

Abstract

We survey recent work on competition in markets in which consumers have costs of switching between competing firms' products. In a market with switching costs (or “brand loyalty”), a firm's current market share is an important determinant of its future profitability. We examine how the firm's choice between setting a low price to capture market share, and setting a high price to harvest profits by exploiting its current locked-in customers, is affected by the threat of new entry, interest rates, exchange rate expectations, the state of the business cycle, etc. We also discuss the causes of switching costs; explain introductory offers and price wars; examine industry profits; and analyse firms' product choices. Moreover, we argue that switching costs between suppliers help explain both the existance of multi-product firms and the nature of competition between such firms.