London, England

25 April 2003

Hosted by Office of Fair Trading

NERA Director Dr. Mark Williams and former NERA Director Dr. Jorge Padilla released a new Office of Fair Trading Research Paper at a seminar organized by the Office of Fair Trading on Friday, 25 April 2003. The report, "Switching Costs," was commissioned from NERA by the OFT and authored by Drs. Padilla and Williams and former NERA Senior Consultant Ciara McSorley.

The report consolidates fifteen years of academic research on switching costs, and presents these in an accessible way to the policy, legal, and academic communities, whilst providing some "signposts" to policy makers on the policy implications of switching costs.

"Switching costs come in many forms and are a pervasive feature of a wide range of markets," said Dr. Padilla. "They can arise because of transactions costs, product compatibility, contracts, uncertainty, or even for psychological reasons. But however they arise, they fundamentally affect the way in which markets operate, and in turn, how policy makers should evaluate those markets."

The report shows how in markets with switching costs, firms tend to adopt "bargain then rip-off pricing," in which prices are driven down for those not already locked in by switching costs, compensating -- in part or in full -- for the higher prices faced once customers are locked in. Firms trade off the incentive to "harvest" locked-in customers, or "sow" market share that will provide future harvesting possibilities.

In addition to reviewing the literature on switching costs, at this OFT presentation Drs. Padilla and Williams also showed "switching costs in practice," giving examples from real-world competition cases such as the 1995 Monopolies and Mergers Commission report on video games and the 2001 Competition Commission report on the proposed Abbey National/Lloyds TSB merger, to demonstrate how switching costs can make a difference in practice.

"Switching costs are not a theoretical curiosity," said Dr. Williams. "The academic literature on switching costs is one of those areas of economics which generates fundamental and radical insights into our understanding of markets, and appropriate competition policy and merger control."

For further information about the report, or to discuss the role of switching costs in competition policy, please contact Dr. Williams using the contact button below.