1. Recognizing Lock-In
Hal R. Varian
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2. Recognizing Lock-In
User’s cost of switching in high-tech industries can be high
Compare
Ford v. GM
Mac v. PC
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3. What’s the Difference? Durable investments in complementary assets
Hardware
Software
Wetware
Supplier wants to lock-in customer
Customer wants to avoid lock-in
Basic principle: Look ahead and reason back
Kierkegaaard: “it is perfectly true, as philosophers say, that life must be understood backwards. But they forget the other proposition, that it must be lived forwards.”
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4. Examples Bell Atlantic and AT&T Computer Associates
5ESS digital switch used proprietary operating system
Large switching costs to change programming
Computer Associates
Legacy software for IBM mainframes
Bell Atlantic: 1995 suit for monopolization
15 year life of switch
Computer Associates: $3.5 billion, behind Microsoft and Oracle
Computer Associates: $432,000 per employee
Microsoft: $422,000 per employee
Oracle: $180,000 per employee
Don’t want to switch OS or applications or vendors.
Peru bought Soviet aircraft at deep discounts
Didn’t buy manuals or spare parts!
Most airlines avoided this mistake.
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5. More examples Windows and Office Others?
Individual switching costs: learning new software
Collective switching costs: exchanging file formats
Others?
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6. Small Switching Costs Matter
Phone number portability
Landlines
Cellphones: history
addresses
Hotmail portability
Forwarding services: ACM, alumni, etc.
Lock-in costs on a per customer basis
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7. Valuing an Installed Base
Customer C switches from A to "same position" w/ B: Total switching costs = C’s costs + B's costs of new customer
Example
Switching ISPs costs customer $50, new ISP $25
New ISP make $100 on customer, switch
New ISP makes $70 on customer, no switch
Special case
Competitive market for commodity product
PV of profit=switching costs
ILEC profits=customer + CLEC switching costs
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8. Profits and Switching Costs In General:
Profits from a customer = total switching costs + quality/cost advantages
In commodity market like telephony, profit per customer = total switching costs per customer
Use of this rule of thumb to..
Decide how much to invest to get lock-in Evaluate a target acquisition
Make product and design decisions that affect switching costs
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9. Examples NYTimes, June 11, 2002 McKinsey Quarterly, March 2002
“Earthlink acquires PeoplePC customers for $80 apiece, half of what the company pays to acquire dialup customers.”
McKinsey Quarterly, March 2002
Estimates sensitivity of checking account customers to bank charges
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10. Classification of Lock-In
Durable purchases and replacement: declines with time
Brand-specific training: rises with time
Information and data: rises with time
Specialized suppliers: may rise
Search costs: learn about alternatives
Loyalty programs: rebuild cumulative usage
Contractual commitments: damages
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11. Durable Purchases After purchase supplies, maintenance
Watch out for multiple pieces of hardware
Supplier will want to stagger vintages
Contract renewal
Technology lock-in v. vendor lock-in
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12. Ink Jet Printers
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13. Brand-specific Training
How much is transferable?
Software
Wetware and retraining costs can be huge
Berkeley Financial System, Izio v Catalyst v Sakai
Competitors want to lower switching costs
Quattro Pro help for Lotus users
MS Word help for WordPerfect users
MSNT and AOL
Wordperfect help in Microsoft World
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14. Information & Databases
Datafiles
Insist on standard formats
Control of data can be valuable
Ameriserve example in fastfood industry
high-labor turnover
supplier manages inventory information
big costs to switching to alternative supplier!
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15. Specialized Suppliers
Advertising, legal, accounting firms
Pentagon
Dual sourcing
Infotech examples
Intel and AMD
Adobe PDF
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16. Search Costs Customer cost in finding new supplier
Supplier costs in finding and servicing new customer
promotion, closing deal, setting up account, credit risks
Example: Credit Cards
$100 million in receivables sells or about $120 million
Market valuation of “loyalty”
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17. Loyalty Programs Constructed by firm
Frequent flyer programs
Frequent coffee programs
Nonlinear reward structure is important to induce switching rather than diversification
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18. Contractual Commitments
“Requirements contract”: Purchase supplies from one supplier
Beware of “evergreen contracts” that renew automatically
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19. Suppliers and Partners
Both sides may be locked in
Railroad spur lines
Customized software
IPOs
Bilateral monopoly problem
Game of Chicken
@home and AT&T
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20. Follow the Lock-in cycle
Brand Selection
Lock-In
Sampling
Entrenchment
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21. Lessons Switching costs are ubiquitous
Customers may be vulnerable to lock-in
Value your installed base
Watch for durable purchases
Be able to identify 7-types of lock-in
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