Leg Zero: Porter´s model explained. Industry Rivalry. Switching Costs. (Part VIII)

eleonoraescalantestrategy 6 Sep 2017 Leave a Comment

Bonjour a tous again!

5-forcesporter mine This day is the turn of Switching Costs.

SWITCHING COSTS are the costs a consumer incurs when he or she decides to change product brands, suppliers, services or marketplaces. Although most prevalent switching costs are monetary in nature, there are also psychological, effort and time-based switching costs. A switching cost can manifest itself in the form of significant time and effort necessary to change suppliers, the risk of disrupting normal operations of a business during a transition period, high cancellation fees, and a failure to obtain a similar replacement of products or services.

According to professors Blut, Evanschitzky, Backhaus, Rudd and Marck from Aston and Newcastle University Business Schools in the UK, the switching costs can be classified into three groups: Procedure, Financial and Relational.

securing business to business relationships.jpg

Classification of Switching Costs.

Click here to download PDF file. switching costs pdf

Some examples of switching costs are:

The time it takes to migrate historical data to the new database: Let´s think about a hospital with physical paper records and files for each patient, and is going to implement a migration of the records to a new software database.
Establishing desired “default” settings in a newly acquired software
Learning new processes, instructions, etc.: Let´s think about the case of a person who decided to leave the blackberry 10 for an iPhone.
Establishing new relationships with your new vendor (who to call for …): When a client is used to contact a one to one personal service representative by phone, and the new vendor just provides an impersonal Whatsapp contact.
Throw away the old equipment, and replace maintenance parts and supplies
Having to admit you made a mistake with your first selection of product.
Branding and conversion expenses not reimbursed (gas station changing brands)
The shift in standards such as English to metric. Let´s say we are used to a product which gives us only pounds, and now we have to get used to using kilograms.
The cascade effect of one change leading to other needed changes.
The lowered productivity until the new system/processes is fully understood and implemented.
The lost productivity during the switchover.
The need to hire and/or train for new skill sets.
The psychological stress costs associated when we have to basically change the contact person.
The resistance (passive and/or active) to the change.
The small inconvenience of changing your cellphone number.
Millions of dollars for a corporate considering changing its enterprise accounting software.
The loss of your corporate rewards points by changing your hotel chain when traveling.
The loss of all your discount privileges by switching your credit card bank
The amount you pay extra by hiring a taxicab when you go to another grocery store outside your neighborhood store. To get to another store, you’d have to transit a long way.
Penalties for early termination of your IT contract supplier.
Penalty costs associated to early repayment of loans with your bank, because you wish to change to another financial institution with better interest rate offer.
The risk and uncertainty when you switch hairdressers.
If a consulting company is replaced, then, of course, the specific knowledge that a consulting company has built with this client is going to be lost.
Loss of loyalty programs and accumulated quantity discounts.
The loss of access to priority boarding and airport lounges if you switch to another airplane company.

All the latter examples are switching costs which can be categorized either as procedure, financial or relational. I encourage you to try to group them in each category. It will be a nice exercise for you to make at home, and we will get back to you with the solution next week.

Picture from ING website

“Successful companies typically try to employ strategies that incur high Switching costs on the part of consumers to dissuade them from switching to a competitor’s product, brand or services. For example, many cell phone providers charge very high cancellation fees for canceling contracts in hopes that the costs involved with switching to another mobile provider will be high enough to prevent their customers from doing so. However, recent offers by numerous cell phone providers to compensate consumers for cancellation fees nullified such switching costs”.

“Switching costs are the building blocks of competitive advantage and pricing power of companies. Firms strive to make switching costs as high as possible for their customers, which lets them lock customers in their products and raise prices every year without worrying that their customers will find better alternatives with similar characteristics or at similar price points”.

See you tomorrow with another key determinant factor of the Industry Rivalry Force. Thank you for reading me. I appreciate your time to read about strategy. Hugs for all of you.