How to Understand [any] Industry's Structure: Customer Switching Costs
These can include the time spent researching and evaluating alternatives, transaction costs like fees/penalties for ending a contract earlier, & learning costs associated with adapting to the product.
Following the previous discourse, we’ll be dissecting Customer Switching Costs, as the next major threat to entry into an industry (Check out the previous post(s) here to get up to speed).
Customer Switching Costs are the costs incurred by a customer when switching from one product or service to another. These costs can include the time spent researching and evaluating alternatives, transaction costs like fees/penalties for ending a contract earlier, and learning costs associated with adapting to the new product or service.
I think we’ve all been here before!
The higher the switching costs, the more likely customers will continue using the product/service they currently use.
Customer switching costs can create serious barriers to entry for new businesses in many industries, as new entrants struggle to convince customers to switch from established players to their new products or service offering. This can be challenging especially if established companies have built strong brand recognition and customer loyalty over the years.
This is one rationale behind my staying in abusive relationships with my current internet service providers, and other Nigerians can sure relate. From the stress of researching new providers to exploring new plan options, adapting to the new system, devices/interfaces, etc; you become hesitant to switch to another provider so quickly - however, I’m done, done this time, please! 😤
In fact, some companies deliberately create considerable switching costs for customers by offering unique products and services that are hard to replace. A unique example is Apple, which has created a tightly-integrated hardware, software, and services ecosystem. Once you invest in Apple products such as iPhone, iPad, or Macbook, you’ll know why 🥺. Personally, it has become such a part of me, I’m not sure how anything else can beat it.
Another example is Netflix - a dominant force in online video streaming, largely by offering exclusive content and personalized recommendations. People who use Netflix to watch their favourite TV shows and movies can become heavily reliant on the service and may have a hard time switching to another streaming service that doesn’t offer the same range of content.
So, let’s see how Customer Switching Costs play across several industries:
Customer Switching Cost: Automobile
Let’s assume you’ve been a proud owner of a Toyota car for years, and you have an emotional connection with the brand. You’re familiar with the car’s features, handling, and reliability.
Now, imagine that you decide to switch to another brand, like Tesla. You may first consider the cost of switching, which includes:
The monetary cost of buying a new car
The time and effort it takes to research the alternative car
Finding the best dealer and negotiating a fair price
Learning the new technology, etc.
Also, you may have to adjust to a new driving style, learn how to navigate a new system, and even find new mechanics for repairs and maintenance. All these constitute switching costs.
These become a hurdle for new entrants into the automobile industry as established brands have since built affinity with their customers. So, new entrants have to offer customers a considerable incentive, such as a significant improvement in quality, technology, or reliability, to overcome these switching costs and win people over.
Customer Switching Cost: Microprocessor
Imagine a new microprocessor brand entering the market and offering a cheaper but equally high-performing chip like Intel or Apple’s ARM. For your business to switch to the new entrant, you would consider the cost of transitioning. These include researching the new brand and finding suitable hardware and software that is compatible with this new microprocessor.
You may also need to train your employees on the new technology, program your software or even rebuild entire systems to work with the new chips. All these constitute switching costs, which would pose serious hurdles for any new microprocessor product to compete with established brands.
Customer Switching Cost: Fintech
So, you’ve been using Paystack to manage all your online transactions. You have integrated it into your online store and have built it into your shopping cart for processing customer payments. You’ve learned how to use it, and it’s easy for you to manage.
Now, TJ Fintech, a new entrant in the industry comes along and offers similar services to Paystack. However, to switch from Paystack to TJ Fintech, you would need to consider the cost of transitioning. These include familiarizing yourself with the new TJ Fintech platform, setting up new accounts, updating systems, and integrating TJ Fintech into your online store, website, or checkout process.
You may also need to convince your customers to switch their payment methods and re-educate them on how to use the new payment platform - all these steps constitute switching costs.
These switching costs become a concern for new entrants in the Fintech space as Paystack maintains good relationships with customers who’re probably reluctant to switch to a new service. So, new entrants will then consider reasonable incentives that outweigh the switching costs to win customers over..
Customer Switching Cost: Music
Having built an extensive collection of songs on Spotify; you’ve curated playlists, music libraries, and recommendations tailored specifically to your taste; you’re familiar with the interface and have integrated it into your lifestyle.
Then, a new streaming platform I’ll call TJ comes into the Market, offering a similar streaming service to Spotify. Bear in mind switching from Spotify to TJ would require you to consider the cost of transitioning.
You would need to:
Learn the new interface
Rebuild your library
Move your playlists over
Familiarize yourself with its unique features.
Moreover, you might lose some of the songs in your collection that are exclusive to Spotify. This echoes my personal experience with Spotify.
Driver’s License for instance is a song originally by Olivia Rodrigo but this Spotify-licensed version of Lewis Capaldi - another favourite singer of mine - keeps me glued to the platform as I can’t get it on any other streaming platform.
This is one of the ways streaming platforms try to personalize their offerings to court listeners. The switching cost of me leaving Spotify to another platform is losing access to some of my favourite records that I can’t get anywhere else.
So, for TJ to have a strong foothold in the market, they will have to look into spotting and addressing some of these potential threats to entry - which is guaranteed to not be some walk in the park.
Conclusion
In summary, established brands have a significant advantage in retaining customers, and new entrants must consider relatively reasonable incentives to encourage customers to switch.
The cost of switching could vary depending on the industry, brand loyalty, and other factors; and new entrants need to consider these switching costs from a customer's perspective to not plan amiss.