The conventional wisdom in economic theory holds that switching costs make markets less competitive; that is, prices in equilibrium with switching costs will be higher than prices in the same market with zero switching costs. The models in which this finding has been established typically feature high levels of switching costs. In particular, it is often assumed that there is perfect “lock-in” (i.e., when a consumer adopts a product, he or she will not switch to another competing product). The authors challenge this claim using a computational theory exercise that uses switching costs calibrated from panel data on consumer purchases.
The authors formulate an empirically realistic model of dynamic price competition that allows for differentiated products and imperfect lock-in. They calibrate this model with data from frequently purchased packaged goods markets. These data are ideal in the sense that they have the necessary variation to identify switching costs separately from consumer heterogeneity. Equally important, consumers exhibit inertia in their brand choices, a form of psychological switching cost. This makes the results applicable to the broad range of products that are distinctly identified (i.e., branded) rather than just to products for which there is a product adoption cost or an explicit switching fee. In the simulations, prices are as much as 18% lower with than without switching costs. What is most important to emphasize is that price increases are not observed with switching costs, as much of the theoretical literature would predict. Not only do the authors use the observed level of switching costs calibrated with consumer data, but they also scale this up to a level four times that which they estimate. Even at this very high level of switching costs (on the order of magnitude of the purchase price), increases in equilibrium price are not observed.
Biography
Jean-Pierre Dubé is Sigmund E. Edelstone Professor of Marketing in the Graduate School of Business at the University of Chicago, where he has been a faculty member since 2000. His research applies economic models of empirical industrial organization to study marketing problems. His current areas of research include the competitive dynamics associated with pricing and advertising, the impact of consumer switching costs on pricing, price discrimination, industrial market structure for branded goods, and Internet marketing. He is an area editor for Marketing Science and serves on the editorial boards of Quantitative Marketing and Economics, Product and Operations Management, and Recherche et Application en Marketing. He has also served as a reviewer for several journals in marketing and economics. He has published several articles in Journal of Marketing Research, Management Science, Marketing Science, Marketing Letters, and Quantitative Marketing and Economics.
Günter J. Hitsch is Associate Professor of Marketing in the Graduate School of Business at the University of Chicago. He holds a BA from the University of Vienna and a PhD in Economics from Yale University. Much of his research is concerned with dynamic decision problems and dynamic competition in marketing and industrial organization. His recent and ongoing work addresses optimal product launches, advertising scheduling over time, dynamic pricing and price competition under brand loyalty and switching costs, and pricing in markets with indirect network effects. He is the winner of the 2007 Frank M. Bass Dissertation Paper Award for his dissertation “An Empirical Model of Optimal Dynamic Product Launch and Exit Under Demand Uncertainty” (Marketing Science, Vol. 25, No. 1, 2006).
Peter E. Rossi is Joseph T. and Bernice S. Lewis Professor of Marketing and Statistics in the Graduate School of Business at the University of Chicago. He received his PhD from the University of Chicago and his BA from Oberlin College. He has published widely in marketing, economics, statistics, and econometrics in outlets such as Quantitative Marketing and Economics, Marketing Science, Journal of Marketing Research, American Economic Review, Journal of the American Statistical Association, Econometrica, Journal of Political Economy, Journal of Econometrics, Biometrika, Journal of Business and Economic Statistics, and Journal of Economic Theory. His areas of research interest include pricing and promotion, target marketing, direct marketing, micromarketing, limited dependent variable models, and Bayesian statistical methods. A fellow of the American Statistical Association and Journal of Econometrics, he is founding editor of Quantitative Marketing and Economics and past associate editor of Journal of the American Statistical Association, Journal of Econometrics, and Journal of Business and Economic Statistics.
Journal Marketing Research, Volume 46, Number 4, August 2009
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