What are Switching Costs? Classification and Examples

“Action without study is fatal. Study without action is futile”

-Mary Ritter

 

Every manager can learn about Switching costs and why they are important. But for companies the real aim is to understand how these costs can be useful for their brands. 

 

It is easy to find out multiple ways to increase the features and benefits of the products. Even for ROI there is a fixed formula. But what product managers often fail to consider is the cost component. 

 

The cost composition of every product comprises multiple types of costs.  But one of the significant portions is related to Switching costs. In this blog, we will dive into the meaning and types of Switching Costs.

 

Also Read | Cost of Production

 

What are Switching Costs?

 

When a consumer shifts from one product to another he incurs a certain cost. This cost comprises of- the time taken, efforts involved, emotional as well as the monetary element. 

 

All these elements are given a single name which is “Switching cost” also called “Adoption cost”. Therefore, when you switch to a different brand you need to pay all these costs.  The less the switching cost, the easier it is for consumers to shift. 

 

Now let us learn more about the elements of switching costs that we read above. Companies point of view, they can use each of these to prevent customers from switching. From the customer's perspective, these elements will decide whether he will switch to a competitor product or not. Here are the elements:

 

1. Emotional Value

 

Companies build a relationship with their suppliers. It is difficult to change suppliers because of the emotional connection as finding new ones will entail building a new relationship altogether. 

 

From a customer's perspective, if they are using a product from many years they will have an emotional value with it. Therefore, it will be difficult to switch from such products.

 

2. Time Taken

 

Switching from brand to brand is a time taking process. Consumers usually face a lot of time issues and prevent switching. We can take a simple example- 

 

Imagine waiting over a call to open your bank account and then filing up the paperwork but on the other hand another bank offers quick online service. Obviously you will prefer the latter one and will not shift to the former one in any case because of the time involved.

 

3. Monetary Cost

 

When shifting to another brand, many companies impose an exit fee. This fee can be in the form of administration fee, exiting fee etc. 

 

It is not a compulsion to charge exit fees but companies do so in order to prevent their customers from leaving. Customers also feel that instead of paying extra charges to switch they should tag along with the same brand.

 

4. Efforts/Convenience

 

Companies usually have multiple outlets and stores in various regions across the country and in fact the world. This offers ease to the consumers as they can simply visit the store and buy the product. 

 

Now if the same is done by the competitor and at less prices then consumers will definitely shift. The only possible option is to open more stores so customers can reach easily. 

 

If a brand with higher cost has a nearby store then in most cases people will choose it over the less costly one. Reason being convenience to purchase.

 

Here is an example-  There are plenty of people that refuse to switch from Android OS to Apple and vice versa. A study done by CIRP showed that only 9% of people were ready to shift to IOS and around 12% to Android. The main reason was the switching cost being very high. 

 

 

Switching Costs are broken into two categories- 

 

• High 

 

Companies tend to keep their switching costs high. High costs do not allow the consumer to shift easily. Brands that have low competition or very less or no substitutes products always have a high switching cost. 

 

An example can be INTU, it provides bookkeeping and accounting services to its users. Their users have to invest a lot of time and effort in learning the whole process and certain costs are also involved while learning. 

 

Therefore, the users feel very satisfied here and it is difficult for them to shift to another such service provider. In short, INTU has a high switching cost.

 

• Low

 

Low Switching costs are completely the opposite. Brands having high competition and multiple substitute products have very low switching costs. An example can be artificial jewelry and apparel brands. 

 

There are so many similar brands with unique collections that people shift very easily. In fact, it is not a tedious task to go from one store to another and compare the prices. 

 

Moreover, after the advent of E-commerce platforms, customers are easily shifting because of discounts, low prices, free deliveries and much more.

 

Thus, it is evident that companies with high switching costs tend to be a lot more successful than the others. Brands formulate such strategies that will increase the switching costs so customers are trapped and satisfied at the same time.

 

Also Read | Churn Rate

 

 

Examples of Switching Cost

 

Let us suppose there is a Company XYZ and it wants to change its car supplier. The company needs 50 cars for employees so they can commute from home to work and vice versa. The current supplier charges them $10,000 per month and the new supplier has agreed on $8000 a month. 

 

In this case, there are multiple switching costs involved. The present cars are more comfortable and maintained. But the same cannot be said for the new car supplier right now. Employees will have psychological switching costs in this case.

 

The new car supplier has to be directed to make him understand the routes and areas. Now, this will be time consuming. Therefore, Time switching cost is also involved.

 

Company cannot change the supplier without doing any background checks or previous works done provided by the vendor. It means operational switching costs will also be incurred. So what should the company do in this case? Should the car supplier be changed?

 

Looking at all the switching costs incurred, it will be best if the company retains the present car supplier. The reason is pretty clear. In order to save $2000 a month the company cannot bear to incur such high switching costs.

 

Let us take another example related to High Switching costs. Not many are aware of the Apple Ecosystem. It was a reward scheme started by Apple. Ecosystem was based on an idea that if a user has multiple Apple products and services then he will get rewards. 

 

For example- Buying an iPhone, Airpods, Macbook and Apple smart watch etc. The more Apple gadgets you have the more rewards you get. This meant that Apple created a whole system in which it increased the switching cost of its brand by a great deal. 

 

Also Read | Market Psychology

 

Classification of Switching Costs

 

All types of Switching costs are placed under 3 headings. The heads are:

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Classification of Switching Costs

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1. Financial Costs

 

Financial Switching Costs are in the form of monetary costs incurred by the person who switches. Proper cost benefit analysis must be performed to analyze whether incurring financial switching costs are worth it or not.

 

Here are some examples:

 

• Contract Based

 

If a company is in a multiple year contract with a supplier then switching to a different supplier would mean paying a certain contract pre-cancellation fee. This fee is usually mentioned in the contractual agreement.

 

• Fees and Penalties

 

There are many incidents wherein fees and penalties are imposed on a person. Just like redeeming debentures or bonds earlier than the stipulated time will have a certain fee. 

 

• Operational Costs

 

If a company switches from one vendor to another then during the transitional phase the production will be lower and the revenues will be affected directly. Thus, operational costs are also a big part of financial switching costs.

 

 

2. Procedural Costs

 

Procedural Switching costs are related to costs related to evaluation of alternative products and services in the market, setting up costs, training fees and other kinds of skill development courses. 

 

Here are some examples:

 

• Learning Curve

 

Learning curve related cost means the time taken to learn new skills or techniques after switching to a new product/service. This process is also time taking and requires fees and other costs. Multiple times people have felt demotivated because of learning all over again.

 

• Setting up Costs

 

When you handle new equipment or machinery you need to spend money on their setup. Certain equipment needs specialists and the cost incurred on it is procedural switching costs.

 

• Opportunity Costs

 

Sometimes after switching customers want to go back to the initial choice. This causes loss of a lot of time, thus leading to opportunity cost of lost time.

 

 

3. Relational Costs

 

Relational Switching costs are incurred when a long relationship between a company and vendor or between a company and its loyal customer ends. Customers lose incentives, perks and companies also lose their trusted vendors as well as loyal users. 

 

Here are some examples:

 

• Perks and Incentives

 

When an old and loyal customer switches, the company loses a part of its goodwill as preferred other products. Likewise, the customer also loses his loyalty perks and incentives he got as an old customer of the company.

 

• Compatibility

 

If a customer prefers to mix two or more services from different brands together then the overall compatibility is reduced. Similarly if a company prefers multiple vendors then also this mixture will reduce the overall compatibility. The best example is: Apple Ecosystem.

 

• Migration of Data

 

There are many platforms that store user data after one becomes a user. Migrating such sensitive information is both time taking and unethical hence, not allowed.

 

Also Read | Implicit and Explicit Cost

 

Everyone is a user and with so many options in the market just think how many times we face situations where the switching costs are low or high. For every company these costs play a huge role in determining the overall cost. Analyzing such costs will help a firm deal with competition and improve the customer retention.