Digital Business Development & Strategies: Lock-in PDF

Recognizing Lock-In Chapter Five Digital Business Development & Strategies Objectives Identify patterns that arises to lock-ins Measure switching costs Avoid lock-ins Help! Let me out!...

Recognizing Lock-In Chapter Five Digital Business Development & Strategies Objectives Identify patterns that arises to lock-ins Measure switching costs Avoid lock-ins Help! Let me out! 2 Example of lock-in 3 Story of lock-in When the cost of switching from one brand of technology to another are substantial, users face lock-in. This is increased when you invest in durable investments in complementary assets specific to that brand – Toyota vs Honda car (not much difference) – Mac vs PC Customer lock-in is the norm in the information economy. 4 How is IT vulnerable to lock-ins? Switching one component may involve switching all – hardware (Servers, OS, infrastructure, licenses, contracts) – Software (mission critical data in ERP systems) – Training (used to the feature) Cost of Switching__: – Choices for future limited by decisions in the past – Buyers bear costs when they switch from one IT to another Example: Troublesome, incompatible complementary assets __Dynamics__: – Supplier wants to lock-in customer – Customer wants to avoid lock-in – New supplier wants customer to cross the lock-in barrier 5 Mass Market Lock-In Compare switching costs to revenue on a per-customer basis. Switching costs may be low per customer yet critical for strategy Switching cost $100 per customer 1 million customers = $100 million Example: Retaining phone # in SG (before June 2008) Add up these switching costs across your entire installed based (customer currently using your product/service) to value that base. 6 Lock-in & Switching Costs Customers: Protect yourself from lock-in’s adverse effects Supplier: Use lock-in to your advantage when possible Both: You must understand switching costs and be able to anticipate and measure them Basic Rule: look ahead and reason back 7 Valuing an Installed Base of Customers (with switching cost) Can be used by Suppliers for: 1. How much to invest to attract customers Discounts, advertising, R&D 2. Evaluate value of target company whose current base of customers is a major asset. 3. Make decisions affecting customers’ switching cost. Product design Compatibility decisions 8 Valuing an Installed Base of Customers New suppliers can figure out how much to spend to acquire that customer   Cost the Total Switching Cost the NEW CUSTOMER Costs SUPPLIER bears bears Example: Switching cost: Sally changing telco (Red to Green) = $50; cost Green telco $25 to setup If Green telco can expect > $75 revenue out of Sally > Make her Switch! (offer goodies!/compensate) If Green telco can expect < $75 , don’t bother to attract Helps incumbent suppliers price product/service Profit from current customer  Total Switching Costs  Quality/cost advantages Example: Hassle of changing phone number = $100 (customer switching cost) Incumbent telco can earn extra $100 in profit from customer if he/she stays 9 Example What "Orange" telco must do "Red" telco to entice me to switch Currently 1 year contract; Pay the penalty $160 penalty for breaking the Let me keep my cell phone contract $160 number I have a “lucky” number Let me keep my hp or 98884848 provide one of equal value Current hp $200 and less for free than a year old Plan and services must be Plan: 100 minutes talk time, better value 500 SMS = $29 No long queues or disruption of service when switch over 10 Classification of Lock-In 7 Types of Lock-In Switching Costs 1. Contractual commitments Compensatory or liquidated damages 2. Durable purchases Replacement of equipment 3. Brand-specific training Learning a new system 4. Information and databases Converting data to new format 5. Specialize suppliers Funding of new supplier 6. Search cost Combined buyer and seller search costs 7. Loyalty programs Any lost benefits from incumbent supplier 11 Contractual Commitments Variations – Vague protection on Contract Seller can charge “reasonable price” or annual adjustments – Requirements Contract All purchases only from specific supplier – Minimum Order Size Commits to buying certain amount – “Evergreen Contract” Auto renewal before ending date Switching Costs for Buyer – Pay damages on breach of contract 12 Contractual Commitments TIP for Buyer: When Negotiating, think about 1. Non contractible aspects of products / service Example: Quality must not be compromised 2. Switching costs and options after contract end A New supplier may be willing to buy you out of your current contract 13 Durable Purchases Seller earns revenue from “_aftermarket” sales – Example: Photocopier + service contract, printer + cartridges Switching Costs for Buyer – Includes replacing the equipment and complacements – Switching cost declines when Depreciation (lesser useful lifetime) Equipment economic value drops (e.g. rapid change in technology) Secondary market for used equipment exists 14 Durable Purchases Seller Strategy: 1. The supplier Most vulnerable to be replaced towards end of useful lifetime of equipment 2. Prolong lock-in by: Stagger models of equipment sold to customer Induce customer to replace older equipment before “expiry” TIP for Buyer: 1. Rent or lease the equipment 2. Push more transactions into the “fore-market ” E.g. Extended warranty, upfront repair/maintenance contract with the lease 15 Brand-Specific Training Software training is brand-specific (e.g. SAP) – Degree of lock-in depends on how much Training can be transferable Switching Costs for Buyer – Includes direct costs & lost productivity to learn new system with equal proficiency – Tends to increase over time as staff gets familiar with system 16 Brand-Specific Training Seller Strategy: 1. Maintain high switching costs Series of upgrades with enhanced capabilities More investment by buyer in training to learn features 2. To break into new market Imitate existing brands/ make software easy to learn Example: Google (1998) v.s. BaiDu (2000) TIP for Buyer: 1. Request standardized interfaces / protocols Easier to transfer training 2. Buy/switch to something easy to learn 17 Information and Databases Information and Database grow over time – Proprietary format hard to port E.g. SAP data Switching Costs for Buyer – Includes conversion to new format – Increase over time as size of data grows TIP for Buyer: 1. Insist on standard file formats and interfaces Some degree of control 2. Insist vendor publish interface specifications 18 Allow competition from similar products Specialized Suppliers Single supplier of specialized equipment Switching Costs for Buyer – Includes finding of new supplier – Increases over time if difficult to find comparable TIP for Buyer: – Get variety of commitment and options before awarding contract (Example: option to buy x amt at y price) – Dual sourcing Example: IBM, Intel & AMD 19 Search Cost Switching Costs by buyers and sellers to find the “right one” – Buyer: costs in changing habits, time and effort in searching, risks working with new (unknown) supplier – Supplier: promotional costs, closing deal, setting new account, risk with new customer (credit risk) Seller Strategy: – Recoup costs of ‘bad’ customers with penalties E.g.: credit card late payment penalty TIP for Buyer: – If a “good” customer > identify yourself to ask for good rates 20 Loyalty Programs Common & effective – “ Aritifical lock in_” – entirely a construct of firms’ strategies. – Reward repeat purchases from single vendor Example: SQ Frequent flyer, credit card reward points – Easier to administer as companies target promotional efforts based on histroic buying patterns(personalized pricing) Switching Costs – Lost benefits from current vendor (E.g.: reward points expiring) – Need to “re-clock”/earn loyalty points 21 Loyalty Programs Seller Strategy: 1. Offer discounts to offset switching costs E.g. introductory discounts (10,000 points when you sign up) 2. Co-operate with complementary suppliers E.g. Credit card privileges – dinning promo (1-for-1) TIP for Buyer: 1. Calculate the costs you will bear = lost rewards + marginal returns to additional business 2. Negotiate with new supplier to cover such costs 22 Suppliers and Partners face lock-ins too! Companies who wrote software for the Apple computer needed to retool to write software for Windows. As a supplier: – Be alert so that you are not left in a weak bargaining position – Protect your downside by getting customers to commit to buying enough to cover your cost. – Get commitment from partners in rollout dates, product specs and pricing. 23 Lock-In Cycle Customer actively considers another brand or chooses a Brand new_brand Selection Lock-In Sampling Entrenchment 24 Lock-In Cycle Brand Customers actively Selection new product, take advantage of the inducements Lock-In Sampling Entrenchment 25 Lock-In Cycle Brand Selection Lock-In Sampling Customer get used to and develop a Entrenchment preference of brand. May invest in 26 complementary assets Lock-In Cycle Brand Selection Switching becomes too expensive. Lock-In Sampling Entrenchment 27  Managing Lock-In Chapter Six Digital Business Development & Strategies Buyers Be aware & identify lock-in Measure the switching costs Now what? Bargain Hard Brand Selection Minimize Lock-In Switching Sampling costs Entrenchment 29 Lock-In Strategies for Buyers Bargain before lock-in & Keep options open Depict yourself as Bargain for initial Think ahead & be an attractive sweeteners creative customer Seek Protection Keep your options Watch out for from monopolistic open via second creeping lock-in exploitation sourcing 30  Brand Selection phase Bargain BEFORE get locked in Examples of sweeteners: Bargain for initial – Initial discounts_ sweeteners – Extended Warranty – Support in switching from previous system Think ahead (of cycle) as you negotiate – _Service support guarantees___ – Free upgrades _ Think ahead & Emphasize switching cost you need to be creative incur in selecting the vendor. – Retraining, disruption Bargaining position will be weaker once sunk, supplier specific investments are made. 31 Brand Selection phase Convince the vendor that you Depict yourself – Will make substantial follow-on as an attractive purchases customer – Have high switching costs – Are an “ influential ” referral Seek Protection Beware of Contract terms_: from – Vague protection monopolistic – Price commitment contracts. exploitation Sellers retain control over quality of service and response time etc. 32 Once in the lock-in cycle Entrenchment stage: Key switching costs under control Keep your Convince the vendor that you options open via – Can easily switch, low disruption costs second sourcing Switch or partially switch to get better terms in negotiation Buyers beware of creeping lock-in from: Watch out for – Added purchases creeping lock-in – Data stored in proprietary formats – Getting used to features Spot and negotiate for favourable terms using previous 4 strategies 33  Lock-In Strategy For Sellers To build an installed base of customers 3. 1. Leverage Invest Selling complementary products to loyal customers and “selling _” them to other 2. Focus on suppliers. Entrench “trapping_” customer’s investment, 34 commitment Lock-In Strategy For Sellers 1. Invest in an Installed Base (cust with switching cost) Look ahead at whole Lock-in cycle – Analyze profits over time  how much to invest to keep them Fight for new customers – Recoup these cost from profitable sales to lock-in customers – “normal rate of return” Structure Life-Cycle Deal – Offer discount( “ Sweetener ”) for expensive equipment capture revenues in multiyear service contract Attract Buyers with High Switching Costs – Tricky as buyers will ask more “sweeterner” – Worth it as investments will generate “aftermarket” needs Sell to influential customers – Influence measured by gross margin on sales to other customers that results from convincing this buyer to purchase 35 Lock-In Strategy For Sellers 2. Encouraging Customer Entrenchment Entretch by Design – proprietary features in products/services – value-added information services to deepen relationship Loyalty Programs and Cumulative Discounts – Track individual buyers: heavy users, cumulative basis – Volume discounts for incremental purchases, bonus credits – Reward past loyalty only to those who remain loyal – Tie up with companies selling noncompeting products – Charge higher list price to offset costs of awards to loyal customers 36 Lock-In Strategy For Sellers 3. Leveraging Your Installed Base (cust with switching cost) Sell Complementary products – Large collection set attractive terms for primary product Example: iphone/ipod; Xbox & games – Also brings value to customer Selling Access to your installed base – An installed base is valuable asset – even when you don’t have complementary products 37 Lock-In Strategy For Sellers 3. Leveraging Your Installed Base Setting differential prices to achieve lock-ins – Installed-base: Use versioning, E.g. Enhanced functionality/services – Rival’s installed base – Discount to overcome switching cost – New customers – Low willingness to pay. Give selective discounts/ Introductory offers rates for first 90 days or first six months – Anticipate and block arbitrage (pose as new customers) Raise Search Costs – Make yourself easy to find and rivals hard to find – Not easy with availability of Web 38 Lock-In Strategy For Sellers 3. Leveraging Your Installed Base Exploit __first-mover Advantage – Use multiyear contracts – Stagger termination dates on different customer contracts to keep rivals poaching difficult to achieve scale economies – Frequency and timing of new versions and upgrades Control __cycle length_____ – Get customers to extend their contracts before expiry 39 Readings Shapiro, C. & Varian, H.R. (1998). Information Rules: A Strategic guide to the Network Economy. Boston, Mass. : HBS Press. – Chapter 5 – Chapter 6 40