Switching Costs in Two-Sided Markets

In many markets, there are switching costs and network effects. Yet the literature generally deals with them separately. This paper bridges the gap by analyzing their interaction (or ‘indirect bargain’) in a dynamic two-sided market. It shows that in the symmetric equilibrium, the classic result that the first-period price is U-shaped in switching costs does not emerge, but instead switching costs always intensify the first-period price competition. Moreover, an increase in switching costs on one side decreases the first-period price on the other side. Policies that ignore these effects may overestimate the extent to which switching costs can reduce welfare.