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Lock In _ Switching Cost


									      Lock In & Switching Cost
Internet trade is going to reduce transaction costs and
  will therefore lead to a frictionless economy

Nevertheless, implementing the required ICT may
  incur enormous costs and new dependencies

Cost of changing standard/technology are called
  switching costs
Not wanting to switch because of high switching
  costs is called lock in
        Examples of Lock In
• Cobol programs in the year 2000 (ad the
  freel lance cobol programmners)
  (language/development environment)
• Mac users (brand)
• Word perfect users (brand)
• House owners when the prices of real
  estated go down
             Bell Atlantic
• 85-90: invested 3 billion USD in AT&T
  5ESS digital switches (mainframes)
• The 5ESS switches use a special (and by
  patents protected) operating system which
  is build, maintained and marketed by
• Every time Bell wants to extend the
  network, they have to call moeten ze AT&T
• Every time Bell wants new functionality,
  they have to call AT&T
       Bell Atlantic continued
• Bell Atlantic paid around 100 miljoen USD
  yearly for upgrades et cetera
• In 1995 Bell went to court, accusing AT&T
  of ‘monopolizing’.

Bell is ‘locked in’ because of the enormous
 switching costs.

Where are you Locked In?
    The value of Lock In
Switching costs don’t have to be high
to make a fortune out of them. 1
million users with a switching costs
of 100 euro as locked in as 1 user of
100 million euro.

Example: phone number portability
The value of switching costs
The customer is not the only one who
incurs switching costs. The vending
party incurs them as well. Total
switching costs are the costs of both
parties together.

It is possible to reduce the total
switching costs: free call minutes by
mobile operators.
   Costs of the vending party are
      important in marketing
• How many free call minutes do you have to
  offer new customers, and what does that cost
  the vending party ?
• How much should microsoft offer to lotus
  notes users, and what does it cost them?

These costs can be compared to the customer
 value of the offer
1. In a competitive markt, offers will be such
   that per customer, the switching cost equal
   expected profit of that customer for the
2. Profit per customer = switching costs
     + differentiation (e.g. brand mark up)
3. It is important to now your customer value,
4. It is important to keep switching cost low
              Forms of Lock in
• Contracts                • Fines and
• Sustainable equipment    • Replacement cost

• Brand/product specific   • Cost of learning/loss
  training                   of productivity

• Information/databases    • Conversion
      Forms of Lock in (cont.)
• Custom made        • Re-development

• Search cost        • Cost of finding a good

• Customer loyalty   • Airmiles, discounts…
   Other forms of lock in
• Vendor lock in (only 1 customer)

• 2 sided lock in (1 op 1 contracts,
custom made solutions)

•partner lock in (sony - philips)
           Lock in…. is by choice!
                    Supplier/product selection

                                           Initial fase (use switch
Getting locked in                          offers)

                        Getting used

                    with consequences
          Dealing with Lock in
The great fortunes of the information age lie in
the hands of companies that have succesfully
established proprietary architectures that are used
by a large installed base of locked in customers.

And many of the biggest headaches of the
information age are visited upon companies that
are locked into information systems that are
inferior, orphaned, or monopolistically supplied.
Managing Lock In & Switching
          Purchasing strategy
•Make switching costs explicit (as high as you
can!) and us them in the negotiations

•Negiotiate before you are locked in and other
options are still realistic

• Negotiate the possibility to talk/deal with other
vendors as well
      Vervolg inkoopstrategie
• Show that you have potential follow up
• Ask for open systems
• Switch
• Try to renegotiate while switching costs go
           Selling strategies
• Invest in a locked in customer base
  (installed base). No investment no
• Lock customers. Design your products
  such that customer lock in is progressive
• Leverage: Act with locked customers so
  that they become as profitable for you as
 Exampls of investment
1995, Iomega introduced the zip drive
(100 mb instead of 1.44)
drive only works with zip-compatible
disk produced by Iomega.
Plan: create a huge installed base of
zipdrive owners and get rich by
selling disks
           Invest in Lock In
• Alle expected profit of locked customers
  can be used to pay back the loans of the

• In a competitive market this implies that the
  average investment cost per customer
  equals the expected profit

• Getting more profit, requires differentiation
        First mover advantage
By being the first with a huge installed base,
 you can become cost leader. This attracts
 new customers et cetera: Winner takes all.

Afterwards you can use the installed base to
 start offering other products. See Microsoft
 or Amazon. Or UPC. (and perhaps earn
 back your investments)
              Installed base
• Don’t invest in installed bases which can’t
  be locked

• Installed base =/= customer base

• Switching cost may depend on the size of
  the installed base
     Locking customers
Internet has realized its claim to
‘frictionless’ and hence low switching
costs. It is not easy to lock in
customers on the internet.

Hence the enormous efforts for
personalization and customer loyalty.
Vendors aim for ‘stickyness’.
An installed base has value

An installed base may contain
valuable demografic information.

The addresses and information can be
sold (beware of privacy)

Access to the installed base can be
       Pricing revisited
Versioning can be switching cost

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