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Market-Based Solutions to Vital Economic Issues
Research
Sep 1, 2014

The Strategic Implications of Switching Costs under Customized Pricing

Abstract

We analyze how consumer switching costs affect firm pricing and profits under competition. In our model, duopolists who implement customized pricing compete over two periods. Departing from the literature and reflecting the notion of consumers as limited processors of information in cluttered environments, we assume that consumers may or may not engage in price comparisons every period—this depends on the price offered by the firm they can potentially switch to. When the offered price—the bait—is sufficiently low, consumers engage in price comparisons and choose a firm to patronize. In contrast to existing findings, we first demonstrate that switching costs may reduce even single-period profits. We then demarcate conditions under which total (two-period) firm profits increase or decrease with switching costs or are independent of such costs. Finally, we study how strategic consumers affect profits. In the literature, such forward-looking consumers are wary of being baited by a low price only to be locked-in later by high switching costs. Therefore, price sensitivity is lower when consumers are strategic—this increases firm profits. In contrast, we demonstrate that firm profits can reduce when consumers are strategic. Our findings shed light on how competing firms should manage switching costs under customized pricing.

Citation

Chen, Y., Bhardwaj, P., & Balasubramanian, S. (2014). The strategic implications of switching costs under customized pricing. Customer Needs and Solutions, 1(3), 188-199. 10.1007/s40547-014-0016-x


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