Switching cost and store choice

Switching costs are generally regarded as anticompetitive as firms can raise prices to “locked-in” consumers, at least up to the cost of switching to a lower-priced alternative. However, there is some evidence, both theoretical and empirical, that tends to show the opposite. Namely, suppliers, anticipating the pool of rents potentially available, compete aggressively to acquire non-switching consumers. Moreover, fixed shopping costs and uncertain prices imply that there is a “real option” value embedded in consumers’ shopping behavior, and which must be priced in and compensated if consumers are to switch stores. We argue that retail prices are lower when retailers use programs designed to increase customer retention, or “stickiness.” We test our theory using a panel of household-level, store-choice data. Contrary to the conventional wisdom, we find that loyalty is pro-competitive and leads to lower prices than would otherwise be the case. We also find that approximately 50% of the cumulative loyalty effect is attributable to the existence of a real option due to price uncertainty and that switching costs are substantial and comprise around 12% of the average cost of a basket of groceries.