Lock-In and Switching Costs

• Lock-in hinders customers from changing suppliers in response to changes in efficiency, and gives vendors profitable market power – over the same buyer in the case of switching costs (or brand loyalty), or over others with network effects.
• Switching costs are the costs that a consumer incurs as a result of changing brands, suppliers or products.
• Although most switching costs are monetary in nature, there are also psychological effort and time-based switching costs.

Recognizing Lock-In

• When the costs of switching from one brand of technology to another are substantial, users face lock-in.

• User’s cost of switching products/suppliers in tech industries can be large.
• Compare :- Ford or GM or Toyota ,Mac or Windows or Linux

• Durable investments in complementary assets :- Hardware ,Software ,Netware
• Switching cost and lock-in are found everywhere in information systems
• Supplier wants to lock-in customer
• Customer wants to avoid lock-in
• The way to win in markets with switching costs is neither to avoid lock-in nor to embrace it.

Examples

• Bell Atlantic and AT&T
• In the mid- to late-1980s, Bell Atlantic invested $3 billion in AT&T’s 5ESS (Class 5 telephone electronic switching system) to run its telephone network.
• 5ESS switches employ a proprietary operating system controlled by AT&T.
• AT&T was in the powerful position of having monopoly control over a wide range of enhancements and upgrades to its switches. Toll free: AT&T charged Bell Atlantic $8 million ,Voice Dialing: AT&T charged Bell Atlantic $10 million
• Mass Market Lock-In :-Phone number ,eMail ID ,OS

Valuing a Installed Base Of Customers

Customer Base: The customer base of a company consists of consumers who have purchased that company’s products or services in the past.
Installed Base: The installed customer base are those customers who are currently using a company’s products.
Supplier also bears some costs when it acquires a new customer.
Customer switches from A to “same position” with B :

• Total switching costs = customer costs + B’s costs

Example

• Switching ISPs costs customer 5,000 and new ISP 2,500
• New ISP make 10,000 on customer, switch
• New ISP makes 7,000 on customer, no switch

Classification of Lock-In

1. Durable purchases and replacement
2. Brand-specific training
3. Information and data
4. Specialized suppliers
5. Search costs
6. Loyalty programs
7. Contractual commitments

Durable Purchases

• Purchase of expensive, durable equipment Switching costs depend on depreciation
• Rent/lease vs. buy
• Technology lock-in vs. vendor lock-in

Brand-Specific Training

• Customer is locked-in when considerable additional time and effort would be required to learn a new brand of product.
• Switching costs tend to rise with time, as personnel become more familiar with existing system.
• Beneficial to customer when priority is to standardize equipment by using a single vendor.

  Information and Data

• Datafiles :- Insist on standard formats
• CD –>VD –> Bluray Disk backward compatibility

Specialized Suppliers

• When buyers purchase specialized equipment over a period of time
• Choices today determine needs for tomorrow
• Choosing one supplier will cause dependency
• Comparable alternatives not available
• Examples of Specialized Supplier Situations :- Department of Defense ,NASA

Search Costs

• Transactions cost in finding new supplier
• Also costs borne by new supplier
• Promotion, closing deal, setting up account, credit risk

Loyalty Programs

• Artificial Lock-in thru a companies strategic marketing—technology company or otherwise
• Promotions and incentives to keep a customer loyal to one vendor
• Technology makes it easier to track a consumers buying habits and brand preferences
• Loyalty programs will become more popular in the age of the educated consumer

Contractual Commitments
Contract to buy from specific supplier

• Requirements contract
• Minimum order-size commitment
• Evergreen contract

Switching Costs- damages for breach of contract
Anticipate future switching costs

Suppliers and partners face lock-in, too

Anyone who makes investments that are specific to a particular supplier, customer, or partner is subject to lock-in for the economic lifetime of those investments.

Brand Selection
customer chooses a new brand. Brand choice could mean purchasing a new multimillion dollar switch, buying a videodisk player, purchasing a new software program
Sampling
customer actively uses the new brand and takes advantage of whatever inducements were made to give it a try .Offering powerful sweeteners to attract new customers
Intention :turn into revenue-paying customers

• Use of the new brand
• Not at a contract level
• Customer advantage
• Supplier dangers

Entrenchment
onsumer really gets used to the new brand, develops a preference for that brand over others, and perhaps becomes locked in to that brand

• Complete brand preference
• Complementary investments
• Switching costs begin to rise

Lock-in

• High level of entrenchment
• Switching costs now expensive
• Return to brand selection stage follows

After this, we return to the brand selection point when the customer either switches brands or actively considers alternative brands without selecting them

Managing Lock-In

• Lock-In Strategy for Buyers
• Lock-In Strategy for Sellers
• Investing in an installed base
• Encouraging customer entrenchment
• Leveraging your installed base

Lock-in Strategy for Buyers

Minimize lock-in and avoid monopoly exploitation
Basic strategy for buyers who are anticipating lock-in

• Bargain for initial sweeteners, such as discounts or support for switching from your previous system.
• Don’t be too anxious. Convey the impression that your benefits from switching are small and the costs are large.
• Depict yourself as an attractive customer down the road, because of either your own future purchases or you ability to influence other purchasers.
• Seek protection from monopolistic exploitation down the road, but beware of vague promises offering such protection.
• Keep your options open via second sourcing. Partial switching is a way to gain leverage in negotiation.
• Watch out for creeping lock-in, and retain information about usage records.

Lock-in Strategies for Sellers

Hold your customers and switch from your competitors to you
Basic Strategy for Sellers

• Be prepared to invest to build an installed base through promotions and by offering up-fronts discounts.
• Cultivate influential buyers and buyers with high switching costs.
• Design your products and your pricing to get your customers to invest in your technology, thereby raising their own switching costs.
• Maximize the value of your installed base by selling your customers complementary products and by selling access to your installed base.
• Lengthen and strengthen cycle by encouraging customer entrenchment
• Sell complementary products and/or access to customers
• Claim openness, but don’t deliver
• Leveraging your installed base
• Loyalty programs
• Brand-specific training

Three key principles

The basic strategy for dealing with lock-in should utilize the following three key principles.

1. Investment: Invest in an installed base
2. Entrenchment: encourage customer entrenchment
3. Leverage: Leverage your installed base

1. Investing in an installed base
Evaluate profitability of each type of prospective customer and estimate profit margins on products you will sell to that customer over time

• form an accurate estimate of each customer’s future switching costs to determine expected revenues
• Measure buyers’ influence i.e. if this buyer stimulates other sales through word of mouth

Eg: Iomega

• In 1995, it launched its 100 MB Zip drive(70x floppy disk size).
• Iomega designed its Zip system that accept only Zip disks manufactured by Iomega.
• Loss on sales of Zip System using heavy discounts and promotions.
• Why?: The plan was to build an installed base of Zip-drive users and then earn profits from the sale of Zip disks to these locked-in users.

2. Encouraging customer entrenchment
Build relationship with customers to simultaneously offer them value and induce them to become more and more committed to your products, technology, or service.

• Entrenchment by design/feature
• Loyalty programs
• Cumulative/volume discounts

3. Value of  Installed Base

• Expanding the scope of complimentary products beyond that offered by rivals
• Selling vital customer demographics to marketing companies
• Give customers a good reason to upgrade & make transaction as easy & cheap as possible
• Make yourself easier to find & rivals kept hidden(SEO)
• Push customers to extend contracts before they expire or recommend premature upgrades