Switching costs are another one of those terms that get thrown around a lot but it’s very difficult to get clear on what they mean. Harder still is getting clear on what they mean for your business and how you can actually employ them to your advantage and employ them in retaining your customers. So let’s take a bit of dive into the concept of switching costs with simple illustrations that can help us understand how we can benefit from their existence.
Switching costs
Switching costs are simply the costs associated with a behaviour change. Used particularly to refer to the financial costs that consumers experience when they change product, brand or supplier. Switching costs can however extend beyond financial costs to include time, effort and psychological effects and costs. To illustrate let us consider Mr Moyo who owns a battery operated torch. For many years Mr Moyo has used Brand A torch, which uses standard-sized AA batteries. Mr Moyo comes across a new torch marketed to him as being an improvement on his current torch and proceeds to buy it. The Brand B torch however uses custom batteries for brand B torches. While the batteries last longer Mr Moyo can only get them from Brand B, via online shopping, and they happen to cost more.
To access the advantages of Brand B torch Mr Moyo will have to pay more for the batteries, order the batteries online. Compared to his buying behaviour with Brand A torch where he could just walk into any shop and buy batteries. These are the switching. We must also be cognisant of the fact that Mr Moyo cannot simply buy the Brand B batteries as and when he needs them and he must make a concerted effort to buy them before his current batteries run out allowing for, at the very least, delivery time.
How they work
If the combination of the financial cost plus the extra effort Mr Moyo has to make with Brand B torch exceeds the convenience he receives from leaving Brand A then nobody would advise Mr Moyo to switch from Brand A to Brand B. The reality of switching costs is this; your prospective customers tend to have an existing solution for the problem you want to solve for them. When acquiring new customers it is important to consider if there are switching costs involved and how you can mitigate them. It also goes the other way, your customers may consider switching from time to time, if there are significant switching costs they are less likely to switch to another supplier.
Types of switching costs
As outlined in the example of Mr Moyo switching costs are more than financial and do not just come from the costs associated with operating the product. Here are the types of switching costs;
Exit fees
These are associated with the cost of breaking a contract where the customer may be liable to the party they are contracted to.
Equipment costs
These are associated with requiring new equipment to take advantage of the product. For example to use a 3 blade razor the consumer might require a different shaving stick from the one they use with their one blade razor. These are not always high but can surprise you.
Installation costs
This is fairly easy to understand. The cost of installation of a new product may cost financially but also in terms of time. Imagine a business that chooses to change its point of sale system across multiple branches.
Learning costs
The change of product may come with some learning costs which can be very high in terms of time and effort required to get grips with the new solution.
Emotional costs
It is fair to say that while we may think business decisions are purely rational there are emotional factors to consider. Your usual lunch place probably knows what you like to order and just how you like it. A new place will likely have employees who do not know or perhaps the place does not even serve your favourite. Now you must establish new relationships while trying everything on the menu to find what works for you.
Startup Costs
These are the costs associated with breaking in the new system or solution which may include new ways of arranging your own systems to work with the new arrangement.
Convenience costs
We already touched on this when we spoke about how Mr Moyo must now order his batteries online and do so with lead time to avoid being caught out.
Risk
There is always the element of risk when dealing with change. Things may not go as planned and contingency plans may be required to keep things running smoothly in the event the new supplier does not deliver.
Making them work for you
As a business that seeks to retain customers, you can employ the concept of switching costs to your advantage. Offering customers things that other suppliers do not, especially where getting those added to the service will cost customers extra will reflect favourably on your business. Offering all in one pricing also helps to put this in perspective. If you offer food and your prices include delivery or you have a flat fee for delivery customers are less likely to switch to other suppliers with more complicated pricing.
If you are looking from the outside in, that is looking to lure customers away from an existing solution then your goal should be to minimise switching costs. If Brand B used batteries that Mr Moyo could easily buy in the supermarket the switching costs would be greatly reduced. Streamlining processes and offering all in one solution where the existing solution does not can make switching to you a favourable solution.
The issues around switching costs go much deeper than we have time to cover comprehensively here. However, the article should do enough to make you aware of their existence, understand how they work and take advantage of them in your business.
