Estimating Switching Costs and Oligopolistic Behavior
Posted: 3 Mar 1999
We present an empirical model of firms' strategic behavior in the presence of switching costs. Consumers' transition probabilities embedded in firms strategic interaction are used in a two-stage game to derive structural estimable equations of a first order condition, market-share (demand), and supply equations. The novelty of the model is in its ability to extract information on both the magnitude and significance of switching costs, as well as on consumers' transition probabilities, from conventionally available highly aggregated data which do not contain consumer-specific information. As a matter of illustration, the model is applied to panel data of banks, to estimate the switching costs in the market for bank loans. We find that the point estimate of the average switching cost is 6.6% which is about one half of the market average interest rate on loans, and that over a quarter of the customer's added value is attributed to the lock-in phenomenon generated by this switching cost. More than a third of the average bank's market share is due to its established bank-borrower relationship. The duration of bank-customer relationship implied by the model estimates averages 14 years. The presented technique may be applicable to modelling a wide class of problems where only aggregate data exist.
JEL Classification: L13, G21
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