Switching costs in vertically related markets*

In the presence of switching costs, firms are often interested in expanding current market shares to exploit their customer base in the future. However, if the product is sold by retailers, manufacturers may face the problem of extracting too much surplus from the retailer. If this happens, then the latter has not an incentive to build a subscriber base. This paper would like to connect two unrelated streams in the literature, respectively on switching costs and vertical restraints. An upstream-downstream duopoly model is presented to analyse the mutual incentive for firms to enter into particular trading relationships when consumers are repeat-purchasers. When switching costs are high, then integrated structures are predicted. On the other hand, when lock in effects are not too relevant, mixed structures with independent and integrated firms emerge as an equilibrium in growing industries. The results are discussed with reference to the UK mobile telecommunications industry.