Recognizing Lock-In Jan Damsgaard Dept. of Informatics Copenhagen Business School This presentation...

Recognizing Lock-In

Jan DamsgaardDept. of Informatics

Copenhagen Business Schoolhttp://www.cbs.dk/staff/damsgaard/

This presentation is based on chapter five, pp. 103 - 134 in Shapiro and Varian (1998): Information Rules: A Strategic Guide to the Network Economy Boston, MA: Harvard Business School Press

EBUSS Jan Damsgaard, 2004 2

Recognizing Lock-In Costs of switching

– LP to CD to DVD– 36 millimeter film to APS (Advanced Photo System)

– VHS to DVD Compare

– Switching from Ford to VW– Switching from Mac to PC– Switching from CD to DVD


Outline

What are switching costs Examples of switching costs Valuing the installed base Classification of lock-in The lock-in cycle Lessons

This presentation is based on chapter five, pp. 103 - 134 in Shapiro and Varian (1999): Information Rules: A Strategic Guide to the Network Economy Boston, MA: Harvard Business School Press


What are Switching Costs? Costs of switching from one system to another Due to durable investments in complementary assets

– Hardware– Software

In general– Suppliers want to lock-in customer

– Customers want to avoid lock-in

Basic principle: Look ahead and reason back


Examples

IBM’s OS/2 operating systems for students Penetration pricing

– Mobile phones only USD 1 + a one year subscription to certain infrastructure

– Cable TV (low cost to join, high running costs) Provision of complementary products/services

– Cheap modems to increase fixed net traffic


Your examples How did you switch from LP to CD? or haven’t

you? What was your strategy? Provide some examples where you feel/felt

locked-in to some brand or system or infrastructure

Have you changed ISP or Telephone operator? On what ground did you base your decision?

What Internet services do you feel locked into? Identify lock-ins’ of society


Switching Costs Matter

Accumulated switching costs– Phone number portability– Email addresses– Hotmail (advertising)– ACM (professional associations)– and many e-commerce sites

Look at lock-in costs on a per customer basis


Valuing an Installed Base Customer C switches from A to "same position" w/ B

– Total switching costs = customer costs + B's costs Example

– Provide sweetener free minutes (higher market value than actual costs)

– Hand in competitor’s product to get a discount Any razor to get Phillips razor at favorable price

– Give up the use of competitors’ products to get a discount The Finnish beer industry (contract) Coca Cola at Aalborg University (conditions)

Disruption costs


Profits & Switching Costs In General use of this rule of thumb

– How much to invest to get a locked-in baseHarvest of switching costs

– Evaluate a target acquisitionBuy or steal

– Product and design decisions that affect switching costs

Compatibility and migration paths


Classification of Lock-In Contractual commitments Durable purchases and replacement Brand-specific training Information and data Specialized suppliers Search costs Loyalty programs


Contractual Commitments

Commitment to source from one supplier Types of contracts

– Evergreen contracts that automatic renews Book clubs

– Requirement contract– Minimum order-size commitment

Switching costs after the contract terminates


Durable Purchases

Buying hardware implies the need for software Aftermarket sales (supplies, maintenance)

– ZIP drives and ZIP disks, car market Usually falls with time Upgrades as aftermarket service The difference between technology lock-in

versus vendor lock-in


Brand-specific Training

Purchase of brand products often requires specific training to use them– SAP systems, FrontPage, WordPerfect, and standard

PCs

Competitors want to lower switching costs– Word and WordPerfect help


Information & Databases Examples

– CD players and CD disks– Address book software– Usage of home-made macros– Customization

As the library grows so does the lock-in Minimizing the lock-in

– Insist on standard and/or open source formats


Specialized Suppliers Companies that typically offer specialized

services– Advertising, legal, accounting firms

R & D increases dependency – Pentagon– Banks selling of key IT system to competitor

Strategy of dual sourcing– IBM, Intel and AMD


Search Costs Transactions cost in finding new supplier

– lock-in by habit Also costs borne by new supplier

– Promotion, closing deal, setting up account, credit risks

Example– Looking for satisficing and not optimal solutions

Market valuation of “loyalty” or “laziness”


Loyalty Programs Constructed by sellers

– Frequent flyer programs– Frequent user programs

Coordinated programs– Air mileage for car renting

Personalized pricing– Gold, Silver, and Blue Status

Cumulative pay-offs, pyramid-programs


Your examples

Provide at least one example of each of the seven types of lock-in– How was it established?– Could it have been avoided?– Can it be sustained?– Can competitors break the lock-in?


Suppliers and partners

Anyone that makes investments that are specific to a particular supplier, customer or partner is subject to lock-in for the economic lifetime of the investment– Railroad lines to service a specific customer– Customized software


Follow the Lock-in cycle

Brand Selection

SamplingLock-In

Entrenchment


Lessons Switching costs and lock-in are

ubiquitous in the information economy The installed base is extremely valuable

in the information economy Your choices are limited by the decisions

of the past. Path dependency Be able to identify the 7-types of lock-in


MICROSOFT PUTS HAILSTORM ASIDE Microsoft's My Services, formerly called Hailstorm, has

been put on hold due to lack of support from potential partners. The service, part of Microsoft's .Net initiative, was designed to act as a central repository for consumers' personal data. Partner corporations would have access to that data, eliminating the need for users to establish separate profiles for each company. According to reports, despite initial interest in the program from firms including American Express and Expedia, no major partners agreed to implement the service. Experts said that decisions not to use the My Services application are generally based on a distaste for sharing consumer information rather than on lack of trust in the technology. NewsFactor Network, 11 April 2002

Recognizing Lock-In Jan Damsgaard Dept. of Informatics Copenhagen Business School This presentation...

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