Switching Cost: Revealing The Hidden Fees Of Changing

Switching costs or switching barriers are the costs — economical, psychological, physiological — that we incur when switching from one alternative to another. Every consumer runs into them as a result of changing brand, suppliers, or products. The cost isn’t merely monetary, but also psychological, effort-based, and time-based. Changing to a new provider takes time and energy, it can cost money, and breaking bonds is an emotional inconvenience — sometimes to the point of feelings of loss of identity.

There are three main types of switching costs: procedural, financial, and relational. Procedural switching barriers emerge from the buyer’s decision-making process and the execution of that decision. These primarily have to do with the time and effort we expend: economic risk, learning, setup costs, evaluating alternatives. There are numerous procedural facets to think about, such as uncertainty costs — the perceived likelihood of acquiring a worse performing alternative — and search costs — the time and effort invested to research and make a switch. Even post-switching costs exist: the time and effort needed to become familiar with a new product or service, to set it up, to form a relationship with the new provider.

Financial switching costs are self-explanatory. They involve the loss of quantifiable, monetary resources. Sunk costs are the costs and investments incurred in maintaining relationships. Lost performance costs refer to the perceived loss of benefits as a result of switching. Relational switching costs center around the psychological or emotional discomfort caused by breaking a bond, and the time and effort needed to form a new relationship. We form bonds with brands — we identify with them, develop alongside them. The brands grow on us, and these bonds are severed when we switch providers. The result is a similar feeling to that of losing a personal relationship.

The idea: the higher the cost to switch, the more reluctant somebody will be to change brand, service, or supplier. Apple users, for instance, resist switching to Android because of how familiar and comfortable they are within the Apple ecosystem. Microsoft Teams users have been known to get into jiu jitsu sparring matches with Slack counterparts. The best thing you can do as a business is to design your product or service in a way that heightens the switching costs. In other words, to make your customers loyal, and to make it less likely that they will transition to another provider. Companies do this in various ways, some not as subtly as Apple’s strong brand: levying big fees when you terminate their service, instituting a complicated termination procedure, and mandating exhaustive reasoning for discontinuing the service.

Switching costs have gigantic implications for the economical landscape. A classic counter-maneuver is for competitors to absorb some of the costs — say, paying the hefty service termination fee to entice the consumer to make the switch. Companies with high switching costs can charge premium prices. They also tend to have more loyal customers: think Adobe and Amazon, where subscriptions bundle many services which make it costly for users to leave.

Firms have to recognize and capitalize on switching costs. There are various ways they can do that. Take, for instance, loyalty programs: airlines commonly leverage their frequent flyer programs, encouraging repeat business by offering points and perks. Or, a more invasive — verbatim — way is integration: deeply embedding products or services into consumer routines, companies that sell things like coffee makers, air fryers, and streaming services ensure that customers find it challenging to replace them. Better yet, building genuine brand loyalty: strong brand associations like the ones Nike has with sports keep consumers coming back for more. When you buy Nike, you aren’t buying shoes. You are buying the “swoosh” on those shoes that makes you feel sportsy.

Real-world implications of switching cost:

• Business Strategy: companies intentionally create high switching costs to lock in customers. Amazon Prime offers fast shipping, streaming, and exclusive deals as a bundle, making it hard to leave. Apple’s ecosystem encourages users to stay within their product family.

• Software-as-a-Service (SaaS) Business: they rely on high switching costs to retain subscribers. Adobe moved from one-time purchases to a subscription model to lock users in like this. Netflix’s watch history, recommendations, and saved lists discourage leaving. The playlists you’ve created on Spotify keep you from picking a new streaming service.

• Consumer Electronics: you are locked into ecosystems through device compatibility. Smart home brands like Google Nest and Amazon Alexa make switching difficult because you are enforced to buy “fitting” products. Gaming consoles like the PlayStation and Xbox tie players to exclusive games and networks.

• Finance: banks use high procedural fees to prevent switching. Automatic bill payments and linked accounts make switching banks a cumbersome process. Credit card reward programs incentivize you to stay loyal.

• Corporate Solutions: companies lock in other businesses via integrations. Microsoft Office and Google Workspace provide cloud-based collaboration, making switching nearly impossible — unless you want to do a full software overhaul in your company. SAP or Oracle ERP software requires extensive training — and no company wants to retrain their employees, since that’s costly.

How you might apply switching costs as a mental model (as a business owner or entrepreneur): (1) increase switching costs to improve retention — build a strong ecosystem (Google, Amazon, Apple, Adobe), create loyalty programs, and offer unique integrations that make switching difficult; (2) reduce switching costs for new customers — offer easy data migration (e.g. Google Drive to Dropbox), provide onboarding incentives (e.g. Verizon pays termination fees for new customers), and allow free trials to lower perceived risk; (3) leverage switching cost in pricing — create long-term subscription models (Netflix, Adobe, Microsoft Office), offer discounts for multi-year contracts, and use exit fees to discourage customer churn.

How you might apply switching costs as a mental model (as a consumer, business decision-maker, or regular person): (1) evaluate switching costs before you commit — consider how compatible you will be with a provider long-term, take into account the true cost of switching (money, time, effort), and avoid being locked into a vendor if you can; (2) use switching costs to negotiate a better deal for yourself — if leaving a certain provider is costly you can ask for loyalty perks, and make sure you leverage competitors’ offers to negotiate a better rate; (3) minimize personal switching costs to remain flexible — avoid locking yourself into ecosystems, use cross-platform tools when possible, and keep transferable data to reduce migration hassle.

Switching costs are a silent but potent force. They have an incredible ability to shape consumer behavior and company strategy. Anyone that wants to understand finance in a deeper sense has to grasp switching costs. They typically occur naturally — fans of video games are simply emotionally and socially invested into their games, making it unlikely they will abandon their favorite past-times. But they can also be strategic marketing techniques used against you as the consumer. Be mindful of those two-year cellphone plans with massive early termination fees and lucrative customer loyalty as is present in the owners of Apple MacBooks.