DISCUSSION OF: MICHAEL WATERSONS SWITCHING AND SWITCHING COSTS

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DISCUSSION OF MICHAEL WATERSONS SWITCHING AND
SWITCHING COSTS

• Eric van Damme
• CentER and TILEC
• Tilburg University
• ENCORE, The Hague, April 13

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CONTENTS

• General remarks
• A digression
• Switching costs
• Welfare consequences
• Conclusion

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GENERAL

• If consumers are not able, or not willing to reap
  the benefits of competition, market
  liberalisation may fail
• It cannot be assumed that consumers will
  automatically discipline the supply side
• No switching because
• no information
• perceived too costly
• it is assumed that the market will work, hence,
  no need to switch
• Switching, but in the wrong direction to a less
  attractive offer
• Consumer activism, of the right type, is
  essential to make market liberalisation into a
  success
• In market liberalisation, the focus cannot be
  just on the supply side

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GENERAL (2)

• If the consumer side does not behave as is
  assumed in the standard economic textbook model,
  then market liberalisation may lead to more
  market power of suppliers, higher prices and a
  lower consumer surplus
• Michael Waterson has presented this (theoretical)
  message before
• But then seems insufficiently taken into account
• After his empirical work with Giulietti and
  Waddams, the message is now taken much more
  seriously
• As evidenced, for example, by recent work of CPB

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DIGRESSIONINTERACTION SUPPLY/DEMAND

• Entry barriers
• Entry assistance or not?
• Discussion paper of DG Comp on Article 82
• Entry barriers
• Sunk costs Yes
• Scale economies
• Bain Yes
• Stigler Not
• Recent literature
• The question cannot be answered without looking
  at the demand side of the market

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SWITCHING COSTS

• Switching is an investment that is associated
  with various types of costs
• Search costs
• To become informed
• Decision costs
• Thinking about what to do
• Transaction costs
• To actually make the switch
• Error costs
• Making the wrong choice

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SEARCH COSTS

• The Goolsbee example
• Internet reduces search costs
• But consumers heterogeneous
• Some informed, some uninformed
• May be more profitable to milk the uninformed
• Distributional consequences
• No Bertrand competition
• Price dispersion

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DECISION COSTS

• Making decisions involves effort, it is not for
  free
• We might have better things to do
• Neglected in standard economic models

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TRANSACTION COSTS

• Perceived or real?
• If consumers believe the market will work, then
  there is no reason to incur the transaction
  costs, hence, no switching and the market will
  not work

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ERROR COSTS

• The costs of making mistakes
• Switching and then realising that a mistake was
  made is more painful than not having made a
  decision
• Cannot be neglected
• Energy UK
• Pensions Sweden
• Solution paternalism?

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WELFARE CONSEQUENCESRETAIL COMPETITION ENERGY

• (For UK GWW)
• For NL CPB
• Incumbents can keep prices 75 above those of
  entrants, then 30 switches and 70 stays
• Optimistic scenario
• all suppliers p mc
• Consumer surplus increases by 280 million
• Realistic scenario
• Entrants pe mc
• Incumbents (profit maximizing) pi pe 75
• Consumer surplus falls by 88 million

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WELFARE CONSEQUENCES

• In many cases, the net benefits of a new product
  that largely replaces an old one for consumers
  will be small, particularly if demand rather
  inelastic.
• How do we know whether new products that satisfy
  needs better will not be forthcoming? They may
  indeed be. The point is that we have not
  conceived of them yet.
• Inevitably, introducing choice where there has
  been none before is somewhat of a leap in the
  dark, because certain of the benefits only arise
  if firms find new ways of doing old things.

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CONCLUSION

• Good that consumers are in the picture
• There may be too much switching, or too little
• Not conclude too quickly that switching costs
  should be reduced
• Transaction costs are only part of the switching
  costs
• Not conclude too quickly from negative cost
  benefit test in the short run that overall
  liberalisation is not worthwhile
• Will there be new products?
• When?