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.