Switching costs and Network effects

Question 1

First Mover Advantage

Answer 1

• Innovation with potential monopoly (e.g. due to patent protection, critical mass)
• amplified by switching costs and network effects

Question 2

Reason (1) to create switching costs

Answer 2

high Customer Acquisition Costs

Question 3

Switching costs examples (3)

Answer 3

1. Operating system (software investments)
2. Airlines: loyalty programs
3. Admin costs, number portability

Question 4

Types of switching costs (3)

Answer 4

1. direct
2. relationship-specific
3. product related

Question 5

Direct switching costs

Answer 5

Contract penalties, search costs for replacement, possible issues with new supplier

Question 6

Relationship-specific switching costs (3)

Answer 6

• Learning costs,
• loss of loyalty points,
• psychological

Question 7

Product-related switching costs (2)

Answer 7

• complementary goods

- training costs

Question 8

Increasing switching costs (7)

Answer 8

• Loyalty programs
• long-term contracts
• complementary products
• specific software/data formats
• specific interfaces
• good service
• externalities (family plans, etc.)

Question 9

Decreasing switching costs (4)

Answer 9

• open standards for data
• complementary goods
• dual-sourcing
• negotiate price reduction in anticipation of switching costs

Question 10

Network effects (definition)

Answer 10

Value of products increases incrementally for each customer with each additional customer (positive consumption externalities)

Question 11

Characteristics of network industries

Answer 11

• Critical mass/network size
• complementarity, compatability, standards (no co-existence)
• switching costs
• asymmetric / concentrated market structures
• significant economies of scale

Question 12

Direct network effects

Answer 12

Goods utility incerases with each additional user (exponential growth w/ Metcalfe’s law)

Question 13

Indirect network effects

Answer 13

Goods utility depends on number of additional users AND complementary goods

Question 14

Diffusion in network industries

Answer 14

Follows S-shaped curve, more pronounced than in regular industries

Question 15

Critical mass (definition)

Answer 15

Combination of installed basd, network effects and price at which diffusion becomes self-sustaining

Question 16

Complementarity, compatibility, standards

Answer 16

network goods with INdirect network effects must be consumed together (CDs, VHS, etc.) -> require complements, standards

Winner takes it all

Question 17

Strategies in Network effects (4)

Answer 17

1. raise attention (e.g. reputation)
2. downsize potential risks (reduce lock-in risk)
3. know target market (e.g. influential early adopters)
4. strategic pricing (e.g. skimming, penetration pricing)

Question 18

Customer Value - when will they switch?

Answer 18

Customers will switch suppliers when the NPV of the cost of switching is lower than the NPV of the utility of switching