switching-costs

Switching Costs And Why They Matter In Business

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

Companies that are able to create high switching costs (either through cost leadership, differentiation, or else) will also be able to create a competitive advantage.

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

The inability to create high switching costs (either through pricing, better and simpler product, brand, or all these) might prevent the company to create a long-term competitive advantage.

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Gennaro Cuofano

Gennaro is the creator of FourWeekMBA which target is to reach over two million business students, executives, and aspiring entrepreneurs in 2020 alone | He is also Head of Business Development for a high-tech startup, which he helped grow at double-digit rate | Gennaro earned an International MBA with emphasis on Corporate Finance and Business Strategy | Visit The FourWeekMBA BizSchool | Or Get in touch with Gennaro here