How to measure switching costs

Ask a trusted panel of respondents how they feel about costs switching before you make critical business decisions.

What do a legal contract, a frequent flyer program, and a razor have in common? They all help brands lock-in their customers, making it difficult for customers to abandon their brand for a competitor. Marketing professionals call any deterrent for customer defection “switching costs” and if you can understand and manage them, you’ll be in a great position to cultivate loyal customers.

What are switching costs?

Switching costs are simple to define: they’re the sense of burden or the obstacles that a customer perceives if they were to switch from one product or service to a rival. Consumers don’t like feeling locked into buying a particular product or service—they enjoy the flexibility to choose between alternatives. But consumers also want clarity on the status quo. 

Having to search for reviews of a competing brand, learning how to use a new piece of equipment, or even physically visiting a different store may keep customers from buying your product. If the switching costs for your product are high, customers will be deterred from defecting to a competitor.

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Many switching costs emerge naturally, but others are manufactured by companies themselves. For example, fans of video games observe high switching costs because they are socially and emotionally involved in game play. This makes gamers unlikely to abandon their favorite video games for an untried alternative. 

When a customer buys a brand new, expensive item like a kitchen appliance or even a house, switching costs are naturally high. For large purchases, there are more psychological and financial implications to switching costs because much has been invested in the purchase, making it difficult to switch. Over time, as the item ages, switching costs lower and replacing the item becomes a possibility. Or, if the customer becomes bored or fancies a change, switching costs also lower. 

You can also keep customers loyal through strategic marketing techniques that increase their perceptions of switching costs. If you’re a cellphone plan provider, you might require that customers sign an 18-month contract, and demand that they pay an early termination fee for ending the contract before the 18 months has elapsed. Or, if you sell packaged goods and there are many similar, or even identical competitors, you might aim to offer the lowest possible price. Customers are usually unwilling to switch to a higher priced rival for an undifferentiated product such as packaged ice or bleach.

How do you know if your product has natural switching costs or whether it's time to think about creating some?  Predicting buyer behavior will help you understand the decisions people have behind what they purchase and what would make them purchase something else. Such insights are valuable in helping you understand whether you need to be strategic in keeping your customers loyal, or whether your product already enjoys high switching costs. For any given product, switching costs can be classified as high or low.

Defining switching costs

High switching costs

In an ideal world, switching costs for your product will be high, cultivating lucrative customer loyalty. Firms that create high quality products or products which take time to learn and understand how to use tend to enjoy high switching costs. For instance, many users of Apple MacBooks are fiercely loyal, and one of the reasons is that switching to Windows or another competitor would mean unlearning Apple’s interfaces and software, and mastering a different set of skills. Apple cleverly increases those particular switching costs by providing free classes for customers to learn Mac’s operating system. Switching costs will also be high if there are few substitutes for your product, if it is very high in demand, or availability for it is restricted. 

Low switching costs

When switching costs are low, you are at risk of losing customers to rivals. Grocery stores tend to have low switching costs, because shoppers are able to find the same products easily in a competing store and can compare product range and prices either online, or by simply walking from one store to another. This is one of the reasons why supermarkets have introduced loyalty programs: customers may be willing to continue shopping at a certain store if they have the opportunity to gain rewards based on spend.

Why should you measure switching costs?

Do you need to know whether switching costs for your product is low or high? There are five main reasons for measuring switching costs:

  • Understanding the competitiveness of your industry: High switching costs discourage customers from swapping to an alternative product or provider. If firms in an industry know that switching costs are high, they have little incentive to actively compete through aggressive marketing strategies. Investing in expensive advertisements, or engaging in costly price wars in an effort to entice customers is a waste of resources in an industry with high switching costs.
  • Deciding whether to introduce loyalty-inducing marketing strategies: If the switching costs for your product are low, it might be worth implementing techniques to keep customers loyal. For example, you might create a legal contract that specifies the amount of time that a customer must use your service, or set up a loyalty program that offers discounts for repeat purchases.
  • Informing your pricing strategy: If the switching costs for your product or service are very high, you have much more freedom over how to price your goods. For example, the accounting, payroll and tax software developed by Intuit are closely integrated with one another, which makes it very difficult for small businesses to switch out one product for a competitor. This stickiness allows Intuit to charge high prices for its products—all while retaining highly loyal customers. 
  • Making critical decisions when customer satisfaction changes: High switching costs keep customers loyal - but only as long as they remain satisfied. Imagine you own a popular hotel for tourists. Your guests are usually happy, but this summer, you expect satisfaction to fall because of planned construction work. If switching costs are high, you might not need to worry about whether your guests will come back for another season. But, if switching costs are low (say, because a new boutique inn has just opened in the vicinity to raving reviews), you might need to introduce a sweetener, like free breakfast, to entice your unhappy customers back.
  • Forecasting sales and business objectives: Believe it or not, switching costs can be a valuable component in forecasting models because they are predictive of buying behavior. When switching costs are high, customer repurchase intentions are also likely to be high, which can help you estimate sales—crucial information for making decisions as diverse ase how much inventory to order and what times to open. 

Examples of switching costs

There are many different ways of categorizing switching costs. Switching costs might be classified in dollar amounts and estimated in terms of the price difference between the current supplier and an alternative. Vendors, products, and services that offer the lowest prices tend to have high switching costs. Many flyers, for instance, stick to discount airlines (even if service quality is relatively poor) because the price difference between their air tickets and those of full service airlines is often considerable. 

Manufacturers and retailers of low priced items have clever ways of further increasing monetary switching costs in the minds of consumers. This can cause customers to stay loyal, even where the monetary costs are higher than if they were to abandon the product for a competitor. One popular technique has come to be known as the “razors and razor blades” model, whereby a core product is sold very cheaply, but costs are recouped through relatively expensive replacement parts, consumables, and maintenance fees. 

Manufacturers of branded razors often offer the main product at a low price, but charge a premium for the razor blades, which must be purchased regularly. This causes the consumer to remain loyal to the brand, because if they switched to an alternative razor blade, they would have to buy that brand’s matching razor, making the existing razor a sunk cost, or an unrecoupable loss. Printers (which only work with certain types of ink), and vehicles (which often have parts that can only be replaced with manufacturer-branded parts) have high switching costs for similar reasons. These revenue models essentially create psychological commitment to the brand that translates into high loyalty and high spend.

However, switching costs can also be non-monetary in nature. Many brands are so well known and so well trusted that customers feel unable to switch from them to a competitor, even if the competitor offers a better quality, or lower priced product. Heinz’s ketchup is a prominent example. Michelin-starred restaurants that have tried to offer patrons fancy alternatives have found that guests simply don’t want them.

Types of switching costs

There are four common switching costs that you can use to deter your customers from jumping ship and going to a competitor: convenience costs, emotional costs, contractual costs like exit fees, and time-based costs.

Convenience costs

Convenience costs are costs associated with the inconvenience of switching to a competing product or service. For example, if your products are widely available, or if you have many different retail outlets compared to a rival, it will be more convenient for customers to buy your products instead of your competitors.This puts you in a great strategic position, even if your competitor has cheaper products or sets up an enticing promotion, your customers are likely to stay with you for convenience. However, convenience can be psychological as well as physical. 

If you have ever tried to change your provider of electric or wireless services, you know it is often simply more convenient to stay than to invest the time and effort in switching. And, if customers perceive that they have to spend time and effort to reach the same level of comfort of knowledge of a new product as they have with their existing product, they may decide that the learning effort is not worth their time. 

Emotional costs

Many customers stay with their preferred products and existing service providers because of the implicit switching costs associated with psychological involvement and emotional commitment. When a customer has been with a provider for a long period of time, they have likely built up trust in the product or service, or a personal rapport or bond with the provider. This presents a psychological obstacle to switching and that psychological cost shapes decision making, even where performance or quality is less than satisfactory. Seeking out a new product or supplier and building a new relationship could simply incur too high a psychological cost. There are also higher perceived risks associated with changing from a known service provider to an unknown competitor which cannot be evaluated before actual purchase. Customers usually want to avoid the accompanying psychological discomfort and emotional stress, as well as the risk and uncertainty that the termination of the current relationship could bring.

Contractual costs

Contractual switching costs are the financial costs associated with terminating a relationship with an existing provider and starting a new relationship. The most common type of contractual cost is an exit fee or an early termination fee which is typical in service-based relationships. For example, a bank might charge customers a cancellation fee for closing their account. However, contractual costs can also be understood in terms of opportunity costs: the financial benefits lost when switching to a new product or service provider. If a credit card customer decides to close their account and open another with a different company, they might lose all of the ‘points’ they’ve accrued through historical spend and access to other rewards like vehicle breakdown coverage or collision waiver for car hire. 

Time-based costs

If customers expect that switching to a new brand will take a long time, they will often choose to just stay with their existing provider. For instance, if the paperwork involved in cancellation of an existing service is perceived as burdensome, customers might decide that it is not worth filling out. Search costs also grow with the length of time that a customer has been buying a product or service. Search costs are the time, effort and learning costs associated with searching for an alternative, and if customers believe that the search for a replacement will take a long time, they will often opt to continue with their existing provider. Loyalty also includes habit and routine behaviors. The apathy brought about by time constraints on customers’ time creates an inertia that impedes switching.

How to measure switching costs

Switching costs can be estimated based on your knowledge of the product and your consumer. However, unless you directly tap into your market, you could easily under- or over-estimate switching costs. Imagine, for example, that your company offers a proprietary piece of tax preparation software. For consumers, preparing their own taxes is cumbersome, difficult, and could lead to expensive mistakes. In addition, hiring an accountant could cost three times the price of your product, making your software very popular. Your software is sophisticated, but once customers have mastered it, you may assume that they are unwilling to switch back to doing their own taxes or hiring a professional. You might therefore think that switching costs for your product are high.

But, what happens when a competitor comes along with a new solution? Perhaps their software uses AI and can be learned in a flash. Perhaps it's free. Unless you’re certain that your customers are loyal, and crucially, you know why they’re loyal, you run the risk of losing them in droves to new rivals.

The best way to avoid pitfalls like these is simply to ask your customers using a survey. An easy way to do this would be to ask a question like this:

If another [product] were offered at a lower price, how likely would you be to switch brands for your next purchase?

Your audience might then be presented with a range of answers like extremely likely, very likely, somewhat likely, not so likely or not at all likely, from which they can make a selection. This question can be changed, customized and added to, for a comprehensive evaluation of switching costs.

Calculating switching costs is crucial if you’re to keep your customers loyal and beat off the competition. Ready to measure switching costs using surveys? Choose your audience now.

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