The Competitiveness of Markets with Switching Costs

Abstract

This article examines a two-period differentiated-products duopoly which consumers are partially locked in by switching costs that they face the second period. While these switching costs naturally make demand more inelastic the second period, they also do so the first period, because consumers recognize that a firm with a higher market share charges a higher price the second period and hence is a less attractive supplier to which to be attached. Prices are lower the first period than subsequently, because firms compete for market share that is valuable later. But prices may be higher both periods than they would be a market without switching costs.