| Abstract: |
Switching costs and network effects bind customers to vendors if products are
incompatible, locking customers or even markets in to early choices. Lock-in
hinders customers from changing suppliers in response to (predictable or
unpredictable) changes in effciency, and gives vendors lucrative ex post
market power-over the same buyer in the case of switching costs (or brand
loyalty), or over others with network effects. Firms compete ex ante for this
ex post power, using penetration pricing, introductory offers, and price wars.
Such "competition for the market" or "life-cycle competition" can adequately
replace ordinary compatible competition, and can even be fiercer than
compatible competition by weakening differentiation. More often, however,
incompatible competition not only involves direct effciency losses but also
softens competition and magnifies incumbency advantages. With network effects,
established firms have little incentive to offer better deals when buyers’ and
complementors’ expectations hinge on non-effciency factors (especially history
such as past market shares), and although competition between incompatible
networks is initially unstable and sensitive to competitive offers and random
events, it later "tips" to monopoly, after which entry is hard, often even too
hard given incompatibility. And while switching costs can encourage
small-scale entry, they discourage sellers from raiding one another’s existing
customers, and s also discourage more aggressive entry. Because of these
competitive effects, even ineffcient incompatible competition is often more
profitable than compatible competition, especially for dominant rms with
installed-base or expectational advantages. Thus firms probably seek
incompatibility too often. We therefore favor thoughtfully pro-compatibility
public policy. |