Reimbursing Consumers' Switching Costs in Network Industries

Jiawei Chen () and Michael Sacks ()
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Jiawei Chen: Department of Economics, University of California, Irvine, 3151 Social Science Plaza, Irvine, CA 92697, USA

No 16-13, Working Papers from NET Institute

Abstract: This paper investigates firms' decisions to reimburse consumers' switching costs in network industries. Prior literature finds that switching costs incentivize firms to harvest their locked-in consumers rather than price aggressively for market dominance, resulting in a lower market concentration. Using a dynamic duopoly model, we show that this result is reversed if firms have the option to reimburse consumers' switching costs. In that case the larger firm offers a bigger reimbursement to switching consumers than the smaller firm does, as an additional instrument to propel itself to market dominance. Consequently, an increase in switching cost increases market concentration. Compared to the case without reimbursements, allowing firms the option to reimburse results in greater consumer welfare despite having a much higher market concentration. Consumers' benefits from a larger network and switching cost reimbursement outweigh the higher price charged by a dominant firm.

Keywords: network goods; price discrimination; reimbursement; switching costs (search for similar items in EconPapers)
JEL-codes: L11 L13 (search for similar items in EconPapers)
Pages: 32 pages
Date: 2016-09
New Economics Papers: this item is included in nep-com and nep-net
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