Some goods or services are sold in a ‘secondary’ market; that is, they are ancillary to, or complementary with, products sold in a ‘primary’ market. Everyday examples are consumables such as razor blades or toner cartridges for laser printers, but also add-on products such as extended warranties, payment protection insurance (PPI), overdraft charges on personal current accounts, or payments for baggage on budget airlines. In these situations, firms offering both the primary and the secondary product may sometimes appear to charge high prices in the secondary market. This may happen if customers do not place great emphasis on the secondary product (for example, razor blade) price when purchasing the primary product (for example, razor) and yet face a cost of switching to other providers of secondary products once they have purchased a primary product. That is, if they are partially or completely locked-in to a particular supplier. As a result of high secondary market prices, firms’ profits in secondary markets may also appear high. However, firms may have an incentive to charge low prices for the primary product, in order to attract customers and thus sell more secondary products. Therefore firms’ profits in primary markets may appear low. This pattern of low primary (for example, p rinters) and high secondary (for example, cartridges) prices and profits has typically been termed by the Competition Commission and the Office of Fair Trading (OFT) a ‘waterbed effect’.
The Economics of Secondary Product Markets