What are switching costs?
Switching costs are the costs, or difficulties, associated with changing suppliers for a particular product or service. They may be monetary in nature – potentially termination fees to end a contract – or they may be other challenges such as learning a new platform.
The impact of switching costs on customers
The key impact that switching costs have on customers is that they lock customers into a particular supplier. Rather than being easy to move to an alternative option, switching costs increase the friction with moving between firms – increasing the likelihood that a customer will remain with their existing supplier.
The impact of being locked in is that customers can be dependent on their supplier – potentially allowing the supplier to charge a higher price. If it is particularly difficult for you to move to a different company for a product or service, then the price that ends up being charge may be higher than if it were easy to change firms.
The impact of switching costs on existing firms
Similar to their impact on customers, switching costs impact existing firms. Things that make it difficult for customers to switch to a different supplier help retain customers – making it less likely that they will opt to move to a different firm.
While switching costs may be bad from the perspective of customers – making it difficult to move to a cheaper alternative – from the perspective of existing customers, this may be an advantage, allowing a higher price to be charged than if it were easy for customers to move to a different firm.
The impact of switching costs on new companies: Barrier to entry
Switching costs can also have an important impact on new firms due to the entry barriers that switching costs create. Entry barriers are the additional challenges that new firms face in entering a market, and switching costs are one way that it becomes harder for new firms to enter the market – it is hard to get existing customers to switch from their existing supplier to the new firm.