A Switching Costs Explanation of Tying and Warranties
Competitive markets in which buyers face a cost of switching suppliers can result in an inefficient pricing pattern: sellers initially seek to gain market share with below-cost prices, then later exploit past customers with above-cost prices. This article shows that, rather than simply offer cash discounts initially, sellers can bundle a tied good that is worth more to high-demand buyers. This bundling strategy can efficiently screen out socially undesirable sales to low-demand buyers that a straight cash discount would invite. This theory can explain warranties, which are a kind of tying contract in which aftermarket service is bundled with a durable good. The theory also has application in imperfectly competitive markets, in which sellers for reasons of price discrimination prefer a pricing pattern with high aftermarket prices and low durable-good prices. Finally, the theory has implications for antitrust law in the Kodak setting and antitrust cases involving warranties specifically. (c) 2008 by The University of Chicago. All rights reserved..
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