DP4996 Two at the Top: Quality Differentiation in Markets with Switching Costs
Author(s): | Thomas Gehrig, Rune Stenbacka |
Publication Date: | April 2005 |
Keyword(s): | natural oligopoly, poaching, quality choice, switching costs |
JEL(s): | D43, L15 |
Programme Areas: | Industrial Organization |
Link to this Page: | cepr.org/active/publications/discussion_papers/dp.php?dpno=4996 |
We explore the effects of switching costs on the subgame perfect quality decisions of oligopolists with repeated price competition. We establish a strong strategic quality premium. We show that competition for the establishment of customer relationships will eliminate low-quality firms in period 1 and that low-quality firms can survive only based on poaching profits. The equilibrium configuration is characterized by an agglomeration of two providers of top-quality as soon as switching cost heterogeneity is sufficiently significant. We demonstrate a finiteness property, according to which the two top-quality firms dominate the market with a joint market share exceeding 50%.