Switching costs consist of the costs incurred by customers to change a product or service toward another similar product and service. In some cases, switching costs can be monetary (perhaps, improving a cheaper product), but in many other cases, those are based on the effort and perception that it takes to move from a brand to another.
Why switching costs matter
When launching a new product on the market, it’s critical to look at existing alternatives, as your solution might work, only if it is convenient (either in times of money, effort, or else) for existing customers.
Indeed, for customers to change brand, and use your product there will be an element of friction, defined as switching cost.
Switching costs go beyond price and money
Let’s imagine a simple example.
You use Google as a primary search engine, and Google Chrome as a browser. With Google and Chrome, you get a set of advantages and products (for instance, the Chrome extensions marketplace enables you to download any app to do anything within your browser).
Even if those serivces are free it’s still very hard to switch to any other search engien or browser, as the effort it takes to get used to a new combination of search engien, browser, extensions and so forth is too “expensive” psychologically to take the leap.
Building up moats
A higher friction fro customers to change toward a new product or service might help the company to “lock them in.” Yet, this strategy to be successful it also needs to offer a great customer experience across the several products.
Thnk for instance the case of Microsoft Office that bundles up its products to create a lock-in experience for users to prevent them to switch (together with Office, customers also get other services that go from email to company’s chat like Microsoft Teams).
This closed environment might make it harder for users to switch to a new brand. Yet, the experience can be also frustrating and limiting if those products don’t work extremely well.
Monetary switching costs
A lower price can help as switching costs in those categories where products and services are more commoditized, therefore, the price will have a higher impact and importance on customers’ behaviors.
A lower price will also be more attractive. In those cases, building up switching costs become harder as the
Imagine the case of the gas station selling gasoline. If it is able to offer a lower price compared to the gas station half a mile away, consumers will prefer it, as it might not make much of a difference were to fuel the vehicle, if not the price.
Non-monetary switching costs
Other non-monetary switching costs can be classified in several ways. Some key switching costs require:
- Effort: it might take the time or mental energy to move from a product to another. Think of the case to change the software that costs less, and yet it’s more complicated to use, therefore requiring more time and effort to learn. The user might still stick with the other more expensive software if that perceived as more comfortable to use.
- Perception: other switching costs are more related to perception. Let’s take two cases:
- Branding and status quo: imagine you can buy a pair of shoes from a less known brand, which costs less. Who is passionate about shoes knows that those are fashion statements, not just things to cover your feet. Therefore, the more recognized brand or the brand that is more in line with the perception of the individual will be the preferred one, independently from price (or at least price is less critical).
- Branding and reliability: imagine the case of a person buying a laptop from a known brand vs. an unknown brand. At the same time, the unknown brand’s laptop might be cheaper, more performant, and overall better. The customer might not switch to it as she/he fears it won’t be reliable.
- Offering an alternative: think of the case of DuckDuckGo, a search engine prioritizing on privacy. Even if that might not be as good as Google, it will still be the preferred choice for those switching to it due to privacy. And those people will stick around.
Low vs. high switching costs
- Understanding Switching Costs:
- Switching costs refer to the barriers that customers face when they consider changing from one brand or product to another.
- These costs can be monetary or non-monetary and involve factors beyond just the price.
- Importance of Switching Costs:
- When introducing a new product, it’s crucial to consider existing alternatives and how convenient it is for customers to switch.
- Switching costs create friction and make it less likely for customers to switch to a new brand.
- Non-Monetary Switching Costs:
- Non-monetary switching costs include effort and perception-based factors.
- Effort: Customers might hesitate to switch to a product that requires more time and energy to learn and adapt to.
- Perception: Branding, status quo, and reliability influence customers’ decisions.
- Branding and Status Quo: Recognizable and well-regarded brands can have an advantage even if their products cost more.
- Branding and Reliability: Customers might stick to a known brand due to concerns about the reliability of alternatives.
- Creating High Switching Costs:
- Companies that successfully create high switching costs can build competitive advantages.
- High switching costs can be achieved through cost leadership, differentiation, or other means.
- An example is Microsoft Office, which offers a suite of interconnected products, creating a lock-in experience for users.
- Low vs. High Switching Costs:
- The inability to establish high switching costs might hinder a company’s ability to maintain a long-term competitive advantage.
- In certain cases where products are commoditized, a lower price can influence customer behavior.
- Examples of Switching Costs:
- Example of Effort: Changing to software that is cheaper but more complex to use might deter customers from switching.
- Example of Perception: Customers might choose a more recognized brand or a brand that aligns with their perception, regardless of price.
- Example of Reliability: Even if a lesser-known brand offers better features, customers might stick to a familiar brand due to reliability concerns.
- Example of Offering an Alternative: DuckDuckGo, a search engine prioritizing privacy, can attract users who value privacy even if it’s not as feature-rich as competitors.
- Creating Competitive Advantage:
- Building high switching costs is a way to create a competitive advantage.
- However, the experience across products must be excellent for this strategy to be successful.
This framework has been thought for any type of business model, be it digital or not. It’s a framework to start mind mapping the key components of your business or how it might look as it grows. Here, as usual, what matters is not the framework itself (let’s prevent to fall trap of the Maslow’s Hammer), what matters is to have a framework that enables you to hold the key components of your business in your mind, and execute fast to prevent running the business on too many untested assumptions, especially about what customers really want. Any framework that helps us test fast, it’s welcomed in our business strategy.
This framework is well suited for all these cases where technology plays a key role in enhancing the value proposition for the users and customers. In short, when the company you’re building, analyzing, or looking at is a tech or platform business model, the template below is perfect for the job.
This framework is well suited to analyze and understand blockchain-based business models. Here, the underlying blockchain protocol, and the token economics behind it play a key role in aligning incentives and also in creating disincentives for the community of developers, individual contributors, entrepreneurs, and investors that enable the whole business model. The blockchain-based model is similar to a platform-based business model, but with an important twist, decentralization should be the key element enabling both decision-making and how incentives are distributed across the network.
Connected Business Concepts
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