Debitoor's accounting dictionary
Switching costs

Switching costs - What are switching costs?

Switching costs, also known as switching barriers, are the costs associated with a customer switching from one supplier to another.

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The higher the switching costs, the more difficult, or expensive, the switch is.

The concept of switching costs

The concept of switching costs comes from the idea of building a loyal customer base.

Businesses use many different strategies to maintain a loyal customer base, such as loyalty reward programs. However, another strategy businesses use to keep their customers is to create high switching barriers, in other words, making it difficult and costly for them to leave.

We call this switching costs. Switching costs can be both tangible and intangible, and refer to the price a customer has to pay when switching between products, suppliers, brands, or even marketplace.

The reason why we refer to this as ‘switching costs’, is because sometimes the cost of giving up a benefit is greater than the benefit of gaining a new one. Hence, a customer will be less likely to switch suppliers if they believe it will be more costly for them to switch then for them to stay where they are.

Types of switching costs

Switching costs can arise from a number of different reasons, and the scale of impact can also vary immensely. As already mentioned, switching costs do not necessarily refer to financial costs. In fact, switching costs are often found in procedural costs and relational costs.

Types of switching costs include:

  • Exit fees (when breaking contract)
  • Equipment costs (when changing service provider)
  • Installation costs
  • Learning costs (time and effort, training)
  • Emotional costs (relationships, new employees, brand)
  • Start-up costs
  • Convenience (location)
  • Risk (financially, psychologically, and socially)

Examples of switching costs

Here are two examples that show different type of switching costs, in different settings:

Switching product:

Imagine you have a Windows computer, and have been using Windows for most of your time. You are familiar with the product and the operating system. If you suddenly decide to change to a Macbook computer, you will find that it is a completely different operating system.

In this case, the switching costs are associated with the time and effort you will spend trying to learn and familiarise yourself with this new product and system.

Switching brand

Imagine you live in a little town with only one grocery store close by. This grocery store is considerably expensive. In the next nearest town from you, you can find more grocery stores that are not as expensive as this one.

You might choose to just pay the extra price for the grocery store closest to you, if you think it is not worth it to travel the distance for slightly lower prices. In this case, the switching costs associated with changing grocery store is time, distance, convenience, and even gas costs. This is an example of high switching costs.

These are examples that show both tangible and intangible switching costs.

Strategy to loyalty

The higher the switching costs, the more difficult it is for the customer to leave. Businesses use this strategy to their advantage to create a competitive advantage.

Achieving loyal customers can come from a number of different reasons. As a new business, it can be tough to first establish loyal customers, but there are many inexpensive marketing strategies you can use to better reach and communicate with your customers.

Whether you choose to implement a loyalty rewards program, offer discounts, or even set up a referral program, building loyal customers is something that comes with time and trust. So, be patient, and never stop trying!

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