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Consumers on health care markets face switching costs for several reasons.
A patient who wants to switch provider after being examined will face
transaction costs, because the patient will need either to be examined
again or somehow transfer their medical records. Switching costs in health
care can thus be viewed as start-up costs for establishing a new patient-
provider relationship. Switching costs are also caused by uncertainty of
the quality (and price) of untested providers. Medical care and dental
care may be defined as experience goods (Nelson, 1970), in the sense
that consumers learns about quality only after consuming the service.
Consumers can therefore be viewed as facing a switching cost that is equal
to what they at most would be willing to pay to be guaranteed that the
services offered by the new provider has the same value to them as their
current provider (Klemperer, 1995).
Finally, there may be what Klemperer (1995) calls psychological costs of
switching, or non-economic brand-loyalty. These kinds of switching costs
relates to what Samuelson and Zeckhauser (1988) calls ''status quo bias''
in decision making, referring to the inclination of sticking to a previous
decision, i.e. the status quo. Samuelson and Zeckhauser (1988) and
Strombom et al. (2002) find evidence of status quo inertia when studying
individual health care plan choices among employees at Harvard University
and University of California respectively.
A standard framework in the theoretical literature on the implications of
consumer switching costs is a two-period model (Gehrig and Stenbacka,
2002; Klemperer, 1987a, 1987b, 1995; Padilla, 1992). Consumers enter
the market and make their purchase in the first period. Once consumers
have chosen a provider, they face switching costs and hence become
locked-in (or at least attached). The main result from these models is that
firms compete fiercely in the first period to attract new customers and
exploit locked-in customers in the second period, by charging higher prices
(Padilla, 1991).
The differing degree of competition across periods gives rise to a pricing
schedule that follows a pattern of introductory offers, sometimes also
referred to as a bargain-then-ripoffs structure.
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The pattern is clearest
when sellers can distinguish between new and old customers (Farrell and
Klemperer, 2007). In the case of health care markets, sellers can clearly
distinguish between customers in different stages, depending on what
services they are purchasing. In a two-period model of switching costs,
a consumer purchasing informative services would be a ''new'' customer.
On the other hand, an individual that has already been examined and is
about to undergo some therapeutic service, is ''locked-in''.
Another result from the core two-period model is that market shares
become valuable and a determinant of future profits, because of locked-in
customers' repeated purchases. The firm's problem is to set prices in the
first period such that total discounted profits are maximized. Hence, the
firm takes both current-period profits and the effect of current-period
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It is shown in Klemperer (1987a) that the effect of switching costs on competition
depends on consumers’ expectations about prices. If consumers have rational
expectations, they will recognize that low prices today will be followed by high
prices tomorrow. Foreseeing this will thus make customers less sensitive to price
cuts or introductory offers. Note that the overall effect of switching costs on
competition is ambiguous, as the tough first-period competition may be offset by
the relaxed competition in the second-period.
