Switching Costs, Network Effects, and Buyer Behavior in IT Markets

This research examines how local network effects contribute to the costs of switching vendors, and how such effects differ according to the organization of the IT function. Our results indicate that the costs to ensure compatibility among local area network devices is a major source of switching costs in the markets for routers and switches, and that switching costs increase with the size of a buyer’s installed base. Moreover, we show that when IT purchase decisions are decentralized, the effect of IT vendor choice on other units within the same firm are discounted. We also study how changes in network architecture lower switching costs by reducing the importance of prior complementary investments in learning and configuration on vendor choice. While we show that the introduction of switches may have temporarily reduced switching costs for router buyers investing in switches, the costs of switching vendors remains significant. We thank Rajiv Banker, Mark Doms, Avi Goldfarb, Shane Greenstein, Lorin Hitt, Mike Mazzeo, Sandy Slaughter, Michael Smith, and seminar participants at Carnegie Mellon, Singapore Management University, Temple University, the University of California-San Diego, the University of Minnesota, and the 2002 International Conference on Information Systems for helpful comments and suggestions. Tim Ward and Harry Georgopolous provided helpful technical expertise on computer networking equipment. We thank the General Motors Strategy Center and the NET (Networks, Electronic Commerce, and Telecommunications) Institute for financial support, and Harte Hanks Market Intelligence for providing essential data. All errors are our own.