Switching Costs in Vertically Related Markets

Abstract

In the presence of switching costs, firms are ofteninterested in expanding current market shares toexploit their customer base in the future. However, ifthe product is sold by retailers, manufacturers mayface the problem of extracting too much surplus fromthe retailer. If this happens, then the latter has notan incentive to build a subscriber base. This paperwould like to connect two streams in the literature,on switching costs and vertical restraintsrespectively. An upstream–downstream duopoly model ispresented to analyse the mutual incentive for firms toenter into particular trading relationships. Whenswitching costs are high, then integrated structuresare predicted. On the other hand, when lock in effectsare not too relevant, mixed structures withindependent and integrated firms emerge as anequilibrium in growing industries. The results arediscussed with reference to the UK mobiletelecommunications industry.