Enhancing Market Power by Reducing Switching Costs

Abstract

Competing firms often have the possibility to jointly determine the magnitude of consumers’ switching costs. Examples include compatibility decisions and the option of introducing number portability in telecom and banking. We put forward a model where firms jointly decide to reduce switching costs before competing in prices during two periods. We demonstrate that the outcome hinges crucially on how the joint action reduces consumers’ switching costs. In particular, firms will enhance their market power if they implementmeasures that reduce consumers’ switching costs by a lump sum. Conversely, they willpreserve market power by not implementing actions that reduce switching costsproportionally. Hence, when policy makers design consumer protection policies, they should not always adopt a favourable attitude towards efforts by firms to reduce switching costs.switching costs, market power, welfare