Recognizing Lock-In Tonia Graves Valentina Neblitt

2 Introduction Why it is important to recognize lock-in  Buyers bear the costs  Look ahead to make better decisions Some Vocabulary  Durable investments  Complementary assets  Switching costs  Lock-in

3 Bell Atlantic’s Stakes In mid to late 1980s, Bell Atlantic invests $3 billion in AT&T digital switches to run its telephone network AT&T’s switches employ a proprietary operating system

4 Bell Atlantic: Problems Encountered When Bell Atlantic wants to add a new capability or connect these switches to a new piece of peripheral hardware, it is dependent on AT&T for upgrades and developing interfaces  Recognizing telephone numbers beginning with 888 as toll-free

5 AT&T’s Stakes Their switches were a valuable asset and generated a nice stream of revenue Aftermarket software upgrades accounted for 30%-40% of its switch-related revenue Used control over proprietary interfaces to prevent others from offering compatible equipment that might compete with AT&T’s offerings

6 Bell Atlantic: Actions & Justification Sued AT&T for monopolization Put up with AT&T for a long time because the switches …  Have a useful lifetime of 15 years or more  Are costly to remove and reinstall  Were bought and paid for and worth much less used

7 Mass Market Lock-In Small switching costs matter  Phone number portability  addresses  Hotmail (advertising, portability) Look at lock-in costs on a per customer basis

8 Switching Costs Switching costs are the norm, not the exception, in the information economy. Protect yourself from lock-in’s adverse effects Use lock-in to your advantage when possible You must understand switching costs and be able to anticipate and measure them

9 Valuing an Installed Base of Customers Companies need to estimate their revenue stream from a new customer to figure out how much to spend to acquire that customer The total cost of switching = costs the customer bears + costs the new supplier bears Profits from a customer = total switching costs + quality/cost advantages

10 Cellular Service Example Sprint PCS  Currently have a one year contract; penalty for breaking the contract $150  Length of service: 4 years  Current phone $200 and less than a year old  Plan: 500 minutes anytime, N/W minutes unlimited = $40 For T-mobile to convince me to switch  Pay the penalty $150  Let me keep my cell phone number  Let me keep my cell phone or provide one of equal value for free  Plan and services must be a better value

11 Classification of Lock-In Contractual commitments Durable purchases Brand-specific training Information databases Specialized suppliers Search costs Loyalty programs

12 Contractual Form Requirements contract Minimum order-size Evergreen contract

13 Durable Purchases One of the most common and important patterns of lock-in: after the initial purchase is made, the customer “must/might” buy follow-on products that work with the durable equipment Aftermarket sales:  iPod

14 iPod Bose® Sound Dock $300 Griffin SmartDeck $30 Griffin PowerPod $15 Griffin iSqueeze $10 Griffin iTrip $50 Apple® USB Power Adapter $30 iPod $300

15 iPod Aftermarket Purchase Totals: $435 Your Enjoyment: Priceless

16 Brand-Specific Training Concepts  How much is transferable?  Switching costs rise over time  Lock-in can outlive equipment  A considerable amount of time and effort is required to learn to work with a new product Examples  WordPerfect/Word, /Calendaring system .NET, Oracle

17 Information & Databases Concepts  Data conversion costs usually increase over time  Use standardized formats and interfaces Examples  Quicken  VHS  DVD

18 Specialized Suppliers Switching depends on the ability of new suppliers to offer comparable equipment or service in the future.  Hybrid cars Dual Sourcing-benefits the customer. Maintain a variety of options and opinions.  Nuclear submarines: two providers (Newport News, VA – Northrop Grumman and Groton, CT – Electric Boat)

19 Search Costs Time spent on resource discovery is a switching cost “Friction” is reduced, but not eliminated Customers can make better decisions with the Internet, but not perfect Examples  New employee  New car Bargaining point: lower churn rate makes customer appear attractive

20 Loyalty Programs Concepts  Real or artificial?  Switching may result customer forfeiting earned credits  Switching may result in increased supplier switching costs (if they match the patrons forfeited credits) Examples  Marriott Rewards  Frequent Flyer miles  Subway Sub Club

21 Integrated Library System (ILS) Cons of Switching  Wetware  Downtime or interrupted access  Loss of user support group, annual conferences  Early retirements, seeking another job  Search costs  Learning curve  Possible loss of data Pros of Switching  From command line to graphical user interface  Addition of web client  Training/Service contract  Improved searching capabilities  More robust and powerful  Changing to the leader in ILSs Price range: six figures + yearly costs (additional records/storage/modules) Staff: 75 (1 staff member dedicated) Customers: students, staff, faculty, community, consortium

22 A supplier can also be a customer but a customer is not always a supplier Mutual lock-in  Federal government agrees provide 67% of all its publications (print & electronic). In return, ODU agrees to provide staffing, preservation and access for the publications. Suppliers & Partners & Lock-In Supplier Customer Supplier Supplier/Customer Supplier

23 The Lock-In Cycle Brand Selection Sampling Lock-In Entrenchment

24 Lessons Switching costs are the norm in information industries. As a customer, failure to understand switching costs will leave you vulnerable to opportunistic behavior by your suppliers. As a supplier, switching costs are the key valuing your installed base. Lock-in arises in one industry after another according to certain identifiable patterns. Suppliers & partners face lock-in as well. The essence of lock-in is that your choices in the future will be limited by your investments today.