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In many Market s, Consumer s are forced to incur Cost s when switching from one Supplier to another. These costs are called switching costs and can come in many different shapes. The definition of switching costs is quite broad. Thompson and Cats-Baril (2002) defines switching costs as "''the costs associated with switching supplier''", while Farrell and Klemperer (2002) write that "''a consumer faces a switching cost between sellers when an Investment specific to his current seller must be duplicated for a new seller''". As these definitions indicate, switching costs can arise for several different reasons. Examples of switching costs include the effort needed to inform friends and relatives about a new telephone number after an operator switch, costs related to learning how to use the interface of a new mobile phone from a different brand and costs in terms of time lost due to the paperwork necessary when switching to a new electricity provider. Types of switching costs include: exit fees, search costs, learning costs, cognitive effort, emotional costs, equipment costs, installation and start-up costs, financial risk, psychological risk, and social risk. Some of these costs are easy to estimate. Exit fees include contractual obligations that must be paid to the current supplier and compensatory Damages that may be awarded for Breach Of Contract . Often, vendors combine sign-up incentives with penalties for early cancellation. Careful buyers who read the Fine Print should not be surprised by exit fees. Search costs and learning costs, the effort and expense required to find an alternative supplier and learn how to use the new product, are also usually expected. On the other hand, the psychological, emotional, and social costs of switching are often overlooked or underestimated by both buyers and sellers. Gourville (2003) lists several rules of thumb to help understand why many consumers do not immediately switch from a product they currently use to the latest innovative improved product, even if the cost difference is minimal. 1) People are sensitive to the ''relative'' advantages and disadvantages of any change from the Status Quo . So a new, improved product, no matter how great it is on its own merit, must be significantly better than what the consumer is currently using before he will switch. 2) Different people have different reference points. For example, a hi-tech traveling salesman would evaluate the advantages of a Cellular over a Landline phone from a much different perspective than a home-bound, fixed-income, retiree. 3) People exhibit Loss Aversion . The pain of giving up a benefit is much more significant than the pleasure of gaining that benefit. For example, DIVX technology may have failed, in part, because it offered the typical consumer no clear benefit to offset the perceived sacrifice of unlimited viewing time and the cost of having to hook into a phone line. Switching costs are a major reason for pursuing Order-of-magnitude improvements in costs, efficiencies, and benefits to the consumer. This business strategy has been called Andy Grove 's 10x rule. COMPETITION, COLLECTIVE SWITCHING COSTS, AND MARKET PERFORMANCE Switching costs affect Competition . When a consumer faces switching costs, the rational Consumer will not switch to the Supplier offering the lowest price if the switching costs in terms of monetary cost, effort, time, uncertainty, and other reasons, outweigh the price differential between the two suppliers. If this happens, the consumer is said to be locked-in to the supplier. If a supplier manages to Lock-in consumers, the supplier can raise prices to a certain point without fear of losing customers because the additional effects of lock-in (time, effort, etc.) prevent the consumer from switching. Competition is also influenced by collective switching costs, especially in markets with strong Network Effects . Collective switching costs are the combined switching costs of all users in a particular market. For example, the QWERTY keyboard layout illustrates the difficulty of collective switching costs and the problems associated with coordinating an escape from a collective lock-in. The QWERTY layout was originally chosen in 1870 to slow down typists because, otherwise, typewriters would jam. With vast advances in technology, the QWERTY layout is no longer necessary and alternative keyboards with more efficient layouts have been developed (e.g. the Dvorak layout). There are several reasons why a switch to a more efficient keyboard has not been made. First, users have individual lock-in problems; no person who already uses QWERTY wants to retrain and render their current QWERTY skills wasted. Second, new users who have to choose between QWERTY and another layout will choose QWERTY because it dominates the keyboard layout market. Individual lock-in leads to collective lock-in as network effects drive more and more new users to adopt QWERTY and prevent current QWERTY users from switching to another layout. Collective switching costs affect competition by strengthening incumbents and hindering new entrants, who must overcome both the collective and individual switching costs to be able to succeed in the market. Switching costs are likely to be present in a large class of s and Regulator s also have incentives to understand switching costs in order to be able to promote competition effectively. REFERENCES
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