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

Thomas Gehrig and Rune Stenbacka
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Rune Stenbacka: Swedish School of Economics, Helsinki

No 2005-09, CIE Discussion Papers from University of Copenhagen. Department of Economics. Centre for Industrial Economics

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 %.

Keywords: quality choice; switching costs; poaching; natural oligopoly (search for similar items in EconPapers)
JEL-codes: D43 L15 (search for similar items in EconPapers)
Pages: 26 pages
Date: 2005-10
New Economics Papers: this item is included in nep-com, nep-mic and nep-mkt
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