Strategic IT Investments: The Impact of Switching Cost and Declining IT Cost

Abstract

The declining cost of information technology (IT) over time provides the later entrant in information-intensive industries a cost advantage. On the other hand, the earlier entrant has the potential to build and retain its market share if consumers incur a cost in switching to the later entrant. We investigate the impact of a decline in the IT cost and the switching cost on IT investment strategies of firms. We find that a declining IT cost always hurts the early entrant’s profit. The early entrant may assume an aggressive investment strategy or a defensive investment strategy in response to a decline in the IT cost, depending on whether the switching cost relative to the extent of decline in the IT cost is high or low, respectively. A decline in IT cost also hurts the later entrant’s profit if the switching cost is high. A surprising result is that when the decline in the IT cost is higher than a critical value, a higher switching cost increases consumer surplus. When firms control the switching cost, the early entrant increases its investment in quality and switching cost and maintains its quality and its market-share leadership irrespective of the extent of decline in the IT cost.