How switching costs can act as a barrier to entry

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Switching costs create difficulties for customers to change their supplier

Switching costs are the ‘costs’ incurred by customers in moving between suppliers. Such costs can including both monetary factors involved in changing suppliers, such as termination fees, as well as other difficulties in changing suppliers, such as the disruption associated with changing suppliers. Switching costs essentially lock customers into a particular supplier, increasing the difficulty to change suppliers.

Locked in customers can make it difficult for new firms to acquire customers

By locking customers into existing companies, switching costs can act as a form of entry barrier, make it difficult for new firms to enter the market. If it is easy for customers to change their suppliers, new companies may be able to pull away customers from their existing suppliers. On the other hand, if switching costs are high, it is a lot more difficult for new firms to enter the market and acquire customers.

Reducing industry entry barriers by reducing switching costs

While high switching costs can make it difficult for new firms to be able to acquire customers, it may be possible to reduce the difficulties that customers have in moving to you as a supplier, in turn reducing the difficulty that you as a new entrant would have in gaining customers. 

Systematically analyzing switching costs can reveal the key challenges that customers will have in changing their suppliers. Some of these may be monetary considerations (such as early termination fees), as well as other intangible switching costs (such as time required to train on a new system). Once you have identified the primary switching costs, it becomes easier to target customers that may be less susceptible to difficulties moving suppliers or to develop approaches to minimize the costs of changing to your firm. 

For example, if you identify that termination fees are a substantial barrier to entry, you can target customers approaching the ends of their contracts, or potentially offer to subsidize the transition (with an offer to offset early termination fees). Similarly, if you discover that training costs are a significant switching cost, you could potentially provide free training to your platform or service, or make your offering more directly integrate with the products that your target customers already use.