Do Switching Costs Make Markets More or Less Competitive?: The Case of 800-Number Portability

Abstract

Do switching costs reduce or intensify price competition in markets where firms charge the same price to old and new consumers? The answer is theoretically ambiguous because a firm prefers to charge a higher price to previous purchasers who are "locked-in" and a lower price to unattached consumers who offer higher future profitability.

800-number portability provides empirical evidence to determine whether switching costs reduce or intensify price competition under a single price regime. Before portability, a customer had to change toll-free numbers in order to change service providers. In May 1993, 800-numbers became portable, under a regulatory regime that precluded price discrimination between old and new consumers.

I test how AT&T and MCI adjusted their toll-free services prices in response to portability. I find that the firms reduced prices with portability, implying that the elimination of switching costs due to portability made the market more competitive. Thus, despite rapid growth in toll-free services, the firms' incentives to charge a higher price to "locked-in" consumers exceeded their incentive to capture new consumers. Prices on larger contracts dropped more post-portability than those on smaller contracts, consistent with greater "lock-in" for larger users. I also find evidence that price changes after portability's announcement but before implementation are consistent with rational expectations assumptions of theoretical switching costs models.

Keywords: switching costs, lock-in, number portability, telecommunications

JEL Classification: L13, L96, D43