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

Firms in information technology (IT) intensive industries rely on IT investments to improve the quality of their products and services. Competing firms in these industries need to consider two opposing effects when they make IT investment decisions. The declining cost and improving performance of IT over time provides the later entrant a potential cost advantage. On the other hand, the first entrant has the potential to build its market share and retain the market share if consumers incur a cost to switch to the later entrant. In this paper, we analyze the investment strategy of an early entrant that expects the later entrant to have a cost advantage. The results show that in a market with a low (high) switching cost, a decline in IT cost reduces (increases) the investment level of the early entrant. In both types of markets, a higher switching cost mitigates the cost advantage of the later entrant. The results suggest that the early entrant should design a product that imposes a high switching cost. We use examples from Internet Service Providers to provide the motivation for the problem and illustrate the model, analysis, and results.