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Switching Costs: Definition – Explanation – Impact

What Are Switching Costs?

Switching CostsSwitching costs are the barriers encountered when changing brands, services, or vendors. They include financial, effort, and time-based costs.  Switching costs generally refer to what a consumer incurs as a result of changing brands, suppliers, or products. The most obvious switching costs are monetary in nature.  However, there are also psychological, adjustment, effort, and time-based switching costs.

The cost of switching can influence a customer’s purchase decisions. Customers tend to repeat purchases from the same firm if switching costs are high.  However, they may select a rival if switching costs are low. Due to taxes and differing prices for items or services, For example, consumers may incur switching costs when purchasing from a different store.  These extra costs can be in the form of fees or different price points for accessories and services.

Switching Costs – A Closer Look

Switching costs often refer to the financial impact of making a change.  However, they also might take the form of substantial time and effort required to change suppliers.  For example, the risk of disrupting regular business operations during a transition period, expensive cancellation costs, or the inability to source comparable replacement items or services. Successful businesses generally strive to deter customers from moving to a competitor’s product, brand, or services. One way to do this is by imposing high switching costs that are not obvious at the start of the business relationship.  Sellers initially seek to gain market share with below‐cost prices, then later exploit past customers with above‐cost prices. For example, warranties are a kind of tying contract in which aftermarket service is bundled with the initial purchase of a durable good.

Consider the many cellular phone carriers that charge exorbitant cancellation fees.  Their objective is that the costs of switching to another carrier will deter customers from doing so. However, recent offers by numerous cell phone carriers compensate customers for cancellation fees.  This strategy makes such switching costs much less punitive. Nevertheless, switching costs are the foundations of a company’s competitive advantage and pricing power. As a result, firms strive to make switching costs as high as possible for their customers.  This allows them to lock customers in and even raise prices every year.  There is less worry that their customers will find better alternatives with similar characteristics or similar prices.

Switching Costs – Why They Matter

Switching costs are significant.  They allow retailers and service providers to preserve revenues while increasing brand recognition. High switching costs make customers less inclined to leave or switch to a rival.  As a result, sales may remain stable or steadily increase. High switching costs may also indicate that items or services are more distinctive than rivals.  In turn, this may further pique potential new customers’ curiosity and raise awareness of your company’s brand.

Cost Impact

The expenses of switching might be significant or negligible. However, the higher the cost of switching, the less likely a person is to change brands, goods, services, or suppliers. In other words, the higher the cost to change, the less value the consumer derives from moving to a different brand, product, service, or provider. Switching costs are classified into two types: low-cost switching and high-cost switching. The price difference is mostly determined by the simplicity of transfer as well as the availability of comparable items from the competition.

Low Switching Cost

Companies with low switching costs generally provide products or services that are similar.  As a result, it is easier for competitors to reproduce the same customer experience at comparable pricing. For example, consumers have relatively low switching costs when it comes to apparel.  It is a simple matter to locate clothes, discover discounts, and compare prices by strolling from one store to another. The growth of Internet shops and rapid shipping has made it even easier for people to shop for clothing online.  Online suppliers allow customers to shop in the comfort of their own homes across many online platforms.

High Switching Cost

Companies that create unique products, have few substitutes and require significant effort to perfect their use enjoy significant switching costs. Consider Intuit Inc., which provides a variety of bookkeeping software solutions to its users. Few consumers are ready to transition away from QuickBooks.  This is because learning to utilize it requires substantial time, effort, and experience. Further, many of Intuit’s programs are interconnected, providing customers with extra capabilities and benefits.  Few firms can equal the scope and use of Intuit’s offerings. Small companies are the key purchasers of Intuit’s bookkeeping solutions.  Many would not consider risking operational interruptions or financial miscalculations if they abandon Intuit’s software. These variables result in high switching costs allowing the business to charge premium rates for its goods.

Common Switching Costs

Companies can utilize a number of strategies to dissuade customers from jumping ship and moving to a rival. The following are examples of common ones:

  • Accessibility – A corporation may have many locations for its stores or products, making it easier for people to purchase its items. Customers may prefer to stick with the higher-cost goods because it is more convenient if a rival provides cheaper items but is further away and difficult to reach.
  • Loyalty & Familiarity – Many businesses continue with their present suppliers because of the emotional cost of finding a new source and forming a new connection.  Getting to know new people is expensive. It’s comparable to why someone could opt to stay in one job rather than go for another that pays a slightly better compensation. Because the individual knows their supervisor and their coworkers, the emotional cost of switching may be too high.
  • Termination Fees – Many firms demand termination fees for customers who discontinue services. These expenses may not even be necessary or justified.  However, a corporation can still add them on with the intention of making it difficult for a consumer to leave. A corporation can disguise these costs in a number of ways.  For example, administrative fees for canceling an account.
  • Time is Money – Customers generally avoid switching from one brand to another if it takes too long. For example, if a person has to wait a long time on the phone to talk with customer service to shut an account.  Or, then fill out paperwork and write a letter to close an account in writing.  Ultimately, they may decide that the time and frustration required are just not worth it.

Up Next: What Is In-House Financing?

In-house financingIn-house financing occurs when a company offers a loan to a client in order for them to acquire its goods or services. In-house financing reduces the firm’s dependency on the banking sector to provide monies to the client in order for the transaction to be completed.

With in-house financing, the seller assumes the risk of a loan.  In exchange, the seller is free to choose who is qualified and what conditions to give. Conversely, working with third-party financial institutions may entail unreasonable standards for borrowers to complete. Different lenders may have lengthy application processes as well. In-house financing occurs when a company utilizes its own capital to make loans to clients. This streamlines the process whereby customers can easily acquire the specific items or services supplied.

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