Reimbursing Consumers' Switching Costs in Network and Nonnetwork Industries

ABSTRACT To analyze how firms' policies to reimburse consumer switching costs affect prices, market structure, and welfare, we develop a dynamic duopoly model with network effects, switching costs, and switching cost reimbursement. We find that each firm's reimbursement strategy is nonmonotonic in its installed base. While nonmonotonic, the firm with the greater installed base always reimburses more of the switching cost than its smaller competitor, allowing the firm that obtains an early advantage to dominate the market. Consumers benefit from the reimbursement, while producers only benefit in network industries when network effects are large; otherwise, the reimbursement induces a prisoner's dilemma.