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Week 5

by: Jacqueline Ho
Jacqueline Ho
GPA 3.6
Economics of Technology and E-Commerce
Simon Board

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About this Document

Week 5 lectures and readings
Economics of Technology and E-Commerce
Simon Board
Class Notes
economics ecommerce technology 106t
25 ?




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This 4 page Class Notes was uploaded by Jacqueline Ho on Saturday October 31, 2015. The Class Notes belongs to Econ 106T at University of California - Los Angeles taught by Simon Board in Fall 2015. Since its upload, it has received 23 views. For similar materials see Economics of Technology and E-Commerce in Economcs at University of California - Los Angeles.

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Date Created: 10/31/15
Week 5 Lecture 1 October 27 Framing o Endowment effect customer sticks with default options I Have control over something feeling of ownership attachment 0 Choice overload don t overwhelm the customer I Likely to buy nothing 0 Reference effects anchoring product positioning Mental accounting people subdivide expenditures eg insurance separate from computers Zero prices are commonplace 0 Money made from ads and complementary goods Online ads highly targeted low fixed costs Week 5 Lecture 2 October 29 Intensity of advertising depends and varies across industries Informed Uninformed f Info pivot Value increased SX Value times SY Single firms can advertise to shift demand like vertical differentiation With many firms ads soften price competition 0 Ads about prices increase price competition Raise users with new demographics or add value to new customers Increase engagement with new features Increase Sunit by increasing quality of ads with better targeting or making them more integral Switching costs and lockin are twosided For buyers 0 Look for introductory offers 0 Increase the exante bargaining power 0 Beware being heldup after committing 0 Be wary of vague words such as quotfairquot and open Competition when Consumers have Switching Costs Klemperer In a market with switching costs SC a firm s current market share is an important determinant of its future profitability 0 Low price to capture market share high price to profit on lockedin customers tradeoff Consumer SC give firms a degree of market power over their repeat purchasers SC can lead to monopoly profits even for noncooperative oligopolists Categories of SC Need for compatibility with existing equipment Transaction costs of switching suppliers Costs of learning to use new brands Uncertainty about quality of untested brands Discount coupons and similar devices Psychological costs of switching Switching costs paid by firms Other related phenomena Switching costs yield monopoly power giving firms market power over existing customers 0 Less likely for monopolists to be satisfied if there re many firms or if market shares are very asymmetric and a firm with little market share has little to lose and much to gain by cutting price SC can explain quotprice wars when new markets open or a new separate group of customers enter or when new firms enter quotlimit overprice produce less than shortrun profitmaximizing output level in order to reduce its customer base and deter entry by its commitment to be more aggressive if entry does occur Discounting reduces importance of the desire to attract new customers relative to desire to exploit current customers Each firm has incentive to price high today to make competitor fatter and less aggressive tomorrow SC raise prices to both new and old customers when firms can t discriminate between them Higher anticipated rates of growth increase relative importance of the future and so reduce prices Increase interest rate also increases current prices because it reduces the marginal present value of an investment in market share Firms cut prices if demand is more elastic new customer boom and increase prices if it is inelastic Prices are higher with identical than with differentiated products Firms with only a single product may be at a disadvantage relative to a quotfullline producer SC tend to reduce competition Public policy should discourage activities that increase SC WNP P PP N Information Rules Ch 5 Recognizing Lockin Idealistic capitalist quotfrictionfree economy with Internet making things easier 0 SC and past decisions prevent frictionfree o Lockin when costs of switching are substantial Compare SC to revenue on a percustomer basis SC are normal not an exception in an information economy SC measure the extent of a customer s lockin to a given supplier Total SC costs customer bears costs new supplier bears 0 When seller has nice margin there s scope for sweeteners to lower total SC 0 Profit a supplier can earn total SC value of other competitive advantages the supplier enjoys Customer lockin is normal in an info economy because info is stored manipulated communicated and require special training Underlying sources of switching costs 1 Contractual commitment to buy from a specific supplier a Beware contracts that guarantee price but not quality 2 Durable purchases a Suppliers avoid minimal lockin time by staggering times or replacing equipment early b Rent or lease to avoid 3 Brandspecific training a SC tends to rise with time b Can imitate existing brands or develop easytolearn product 4 Information and databases a Make backwardcompatible productsequipment b Insist on standardized formats or publish interface specifications 5 Specialized suppliers 6 Search costs 7 Loyalty programs Suppliers and partners also face lockin twosided Information Rules Ch 6 Managing Lockin Strategy for buyers bargain hard for sweeteners or longterm protection and take steps to minimize SC throughout the lockin cycle 0 Don t think only in terms of today s savings 0 Your bargaining position will be weaker once you make sunk supplierspecific investments 0 Emphasize the SC you ll need to incur in selecting a new vendor 0 Delay as a negotiating ploy o Convince supplier you re the type of customer most worthy of a very attractive initial package capable to influencing the purchase decisions other customers will make you ll have high SC later in the lockin cycle 0 Insist supplier sign contract offering you protection throughout lockin cycle I May be worse off with a partial protection if supplier drops quality cuts corners etc I Best protection initial discount and keep options open 0 Convince supplier you can easily switch even if you can t 0 Manage SC before you have any 0 Retain rights to information on relationship to the seller I Keep records or retain the rights to transfer records As a supplier or seller I ll 0 Invest to build an installed base of customers aim for customer entrenchment and leverage with complementary products and sell access to customers to other suppliers 0 Look ahead to the whole lockin cycle Evaluate profitability of each type of prospective customer over the lockin cycle Can value a customer by estimating profit margins on products you ll sell to that customer over time 0 With lockin you d earn no more than a normal rate of return on your investments I Quasiprofits margins earned on sales to the installed base normal return on prior investments Seek both differentiation and cost advantages Assure customer they won t be in your power in the future Don t promise more openness than you re willing to deliver Count on lockin that doesn t materialize Rivals design products to minimize SC Large market share is not equal to lockin Increased SC leads to increased market inertia leads to fewer divergences between historical shares Any buyer expected to become locked into your product is likely locked to a rival already Buyer has incentive to inflate his SC upfront to get a sweetener Buyers with growing needs and growing SC are attractive Can market aggressively to influential buyers to build up an installed base of customers Measure of a buyer s influence total gross margins on sales to other customers that results from convincing this buyer to purchase your product 0 Can exploit complementarities by subsidizing the customer who purchases first and to recoup this investment from subsequent customers of related products I Works only if matching the first customer s brand choice improves performance for second customer 0 can entrench by offering more valueadded information services 0 smaller vendors will find it attractive to link arms with companies selling noncompeting products to offer cumulative discounts if rival can figure out more ways to generate profitable revenue streams from customers they ll likely outbid you to attract that customer complements strategy ups the competition in primary product because of the higher value of an installed base set differential prices to achieve lockin divide customers into an installed base the rival s installed base and new customers 0 price differentiation in form of selective discounts for new customers make yourself easy to find and rivals hard to find control the length of lockin cycle by entering into multiyear contracts with large customers and stagger termination dates on different customers 0 can also control frequency and timing of new versions or upgrades as seller may be happy with relatively shortterm contract if buyers are lockedin for long periods of time o extend contracts before they expire 0000000 00000


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