Recognizing Lock-In Jan Damsgaard Dept. of Informatics Copenhagen Business School This presentation is based on chapter five, pp in Shapiro and Varian (1998): Information Rules: A Strategic Guide to the Network Economy Boston, MA: Harvard Business School Press

EBUSSJan Damsgaard, Recognizing Lock-In u Costs of switching –LP to CD to DVD –36 millimeter film to APS (Advanced Photo System) –VHS to DVD u Compare –Switching from Ford to VW –Switching from Mac to PC –Switching from CD to DVD

EBUSSJan Damsgaard, Outline u What are switching costs u Examples of switching costs u Valuing the installed base u Classification of lock-in u The lock-in cycle u Lessons This presentation is based on chapter five, pp in Shapiro and Varian (1999): Information Rules: A Strategic Guide to the Network Economy Boston, MA: Harvard Business School Press

EBUSSJan Damsgaard, What are Switching Costs? u Costs of switching from one system to another u Due to durable investments in complementary assets – Hardware – Software u In general –Suppliers want to lock-in customer –Customers want to avoid lock-in u Basic principle: Look ahead and reason back

EBUSSJan Damsgaard, Examples u IBM’s OS/2 operating systems for students u Penetration pricing –Mobile phones only USD 1 + a one year subscription to certain infrastructure –Cable TV (low cost to join, high running costs) u Provision of complementary products/services –Cheap modems to increase fixed net traffic

EBUSSJan Damsgaard, Your examples u How did you switch from LP to CD? or haven’t you? What was your strategy? u Provide some examples where you feel/felt locked-in to some brand or system or infrastructure u Have you changed ISP or Telephone operator? On what ground did you base your decision? u What Internet services do you feel locked into? u Identify lock-ins’ of society

EBUSSJan Damsgaard, Switching Costs Matter u Accumulated switching costs –Phone number portability – addresses –Hotmail (advertising) –ACM (professional associations) –and many e-commerce sites u Look at lock-in costs on a per customer basis

EBUSSJan Damsgaard, Valuing an Installed Base u Customer C switches from A to "same position" w/ B –Total switching costs = customer costs + B's costs u Example –Provide sweetener t free minutes (higher market value than actual costs) –Hand in competitor’s product to get a discount t Any razor to get Phillips razor at favorable price –Give up the use of competitors’ products to get a discount t The Finnish beer industry (contract) t Coca Cola at Aalborg University (conditions) u Disruption costs

EBUSSJan Damsgaard, Profits & Switching Costs u In General use of this rule of thumb –How much to invest to get a locked-in base t Harvest of switching costs –Evaluate a target acquisition t Buy or steal –Product and design decisions that affect switching costs t Compatibility and migration paths

EBUSSJan Damsgaard, Classification of Lock-In u Contractual commitments u Durable purchases and replacement u Brand-specific training u Information and data u Specialized suppliers u Search costs u Loyalty programs

EBUSSJan Damsgaard, Contractual Commitments u Commitment to source from one supplier u Types of contracts –Evergreen contracts that automatic renews t Book clubs –Requirement contract –Minimum order-size commitment u Switching costs after the contract terminates

EBUSSJan Damsgaard, Durable Purchases u Buying hardware implies the need for software u Aftermarket sales (supplies, maintenance) –ZIP drives and ZIP disks, car market u Usually falls with time u Upgrades as aftermarket service u The difference between technology lock-in versus vendor lock-in

EBUSSJan Damsgaard, Brand-specific Training u Purchase of brand products often requires specific training to use them –SAP systems, FrontPage, WordPerfect, and standard PCs u Competitors want to lower switching costs –Word and WordPerfect help

EBUSSJan Damsgaard, Information & Databases u Examples –CD players and CD disks –Address book software –Usage of home-made macros –Customization u As the library grows so does the lock-in u Minimizing the lock-in –Insist on standard and/or open source formats

EBUSSJan Damsgaard, Specialized Suppliers u Companies that typically offer specialized services –Advertising, legal, accounting firms u R & D increases dependency –Pentagon –Banks selling of key IT system to competitor u Strategy of dual sourcing –IBM, Intel and AMD

EBUSSJan Damsgaard, Search Costs u Transactions cost in finding new supplier –lock-in by habit u Also costs borne by new supplier –Promotion, closing deal, setting up account, credit risks u Example –Looking for satisficing and not optimal solutions u Market valuation of “loyalty” or “laziness”

EBUSSJan Damsgaard, Loyalty Programs u Constructed by sellers –Frequent flyer programs –Frequent user programs u Coordinated programs –Air mileage for car renting u Personalized pricing –Gold, Silver, and Blue Status u Cumulative pay-offs, pyramid-programs

EBUSSJan Damsgaard, Your examples u Provide at least one example of each of the seven types of lock-in –How was it established? –Could it have been avoided? –Can it be sustained? –Can competitors break the lock-in?

EBUSSJan Damsgaard, Suppliers and partners u Anyone that makes investments that are specific to a particular supplier, customer or partner is subject to lock-in for the economic lifetime of the investment –Railroad lines to service a specific customer –Customized software

EBUSSJan Damsgaard, Follow the Lock-in cycle Brand Selection Sampling Lock-In Entrenchment

EBUSSJan Damsgaard, Lessons u Switching costs and lock-in are ubiquitous in the information economy u The installed base is extremely valuable in the information economy u Your choices are limited by the decisions of the past. Path dependency u Be able to identify the 7-types of lock-in

EBUSSJan Damsgaard, MICROSOFT PUTS HAILSTORM ASIDE u Microsoft's My Services, formerly called Hailstorm, has been put on hold due to lack of support from potential partners. The service, part of Microsoft's.Net initiative, was designed to act as a central repository for consumers' personal data. Partner corporations would have access to that data, eliminating the need for users to establish separate profiles for each company. According to reports, despite initial interest in the program from firms including American Express and Expedia, no major partners agreed to implement the service. Experts said that decisions not to use the My Services application are generally based on a distaste for sharing consumer information rather than on lack of trust in the technology. NewsFactor Network, 11 April 2002