Switching Cost

What is Switching Cost?

Switching cost refers to the cost that is incurred by a customer while changing a service, product, supplier and is not limited to just the financial cost, but can also be psychological cost, time cost, etc. Every shift that a customer makes comes with a cost, so it should be evaluated properly before making the switch.

How Does it Work?

When a customer plans to use different products or services from a different supplier, then the main thing that the customer is worried about is the switching cost. When a customer is using a product of a particular supplier, then that product comes with a set-up that is being installed by the customer. When a customer plans to switch, then it will have to use a different set-up from the new supplier, which will involve the training process and hence loss in productivity for initial months. So if the collective cost for switching if huge, then the customer gets a bit skeptical about making a move.

Types of Switching Cost

The following are some types:

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#1 – Financial Cost

When a switch is made, the customer needs to reinstall the setup of the new supplier. This requires money and also space. If the old facility is not big enough for the new installment, then the customer will have to manage a bigger place for the set-up.

#2 – The Cost of Time

When a customer switches to a new product, then the new product needs to be trained first. This requires time. Old employees may not have sufficient skill to run the product. So new skilled employees will have to be hired. All these are time-consuming.

#3 – The Cost of Risk

The old machinery was already running and was producing finished products. The new machinery is not yet operational. Whether the new machinery will serve the purpose is still unknown. So there is a risk.

Example of Switching Cost

Switching Cost

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Company ABC is planning to change its car vendor. The company needs 90 operational cars for its employees to commute. The current vendor charges $20,000/month, and a new vendor has given a quotation of $18,000/month. So the company is planning to change the vendor. There are several switching costs involved in the transaction.

The current vendor provides well-maintained cars, so it is comfortable for the employees. Now the company is not sure about the cars that the new vendor will provide. So psychological cost is involved.

A huge amount of time will be spent on making the new vendor aware of the routes properly. This may take a few days. So the time cost.

The entry of all the drivers needs to be done along with background checks. So the operational cost is involved.

Adding all the above costs will lead to a huge switching cost, and in the end, it depends on the company, whether they are ready to incur the cost.

Strategies

Companies try to keep switching costs high, just to maintain competitiveness in the market. If this cost of a product is high, then it gets difficult for customers to switch easily, thus keeping demand at the proper level. So few strategies that companies apply are:

Benefit

It helps companies to stay competitive in the market. As the customer can’t switch the product easily with high switching costs, so the demand for their product is safe.

Recommended Articles

This has been a guide to switching costs and its definition. Here we discuss types, examples, strategies, and how does it work along with the benefits. You may learn more about financing from the following articles –