Switching cost

Being able to maintain a loyal customer base has always been a major concern for businesses all around the word.  With so many choices of suppliers and distributors, customers are also faced with a problem within that concern.  There are many different methods and strategies businesses use to maintain their customer base.  Some of these methods came come in the form of customer loyalty reward programs such as: rewards points, coupons, discounts, etc.  Other methods tactics used to retain current customers may even look like a form of punishment.  A very good example of this is that of the cellular phone companies.  These companies get the customers to apply for a contract for 2 years and penalize them for several hundred dollars if the customer were to cancel the contract before the end of term.  With so many options to choose from, consumers are faced with the problem of switching costs.

By definition, switching costs are costs that occur when switching suppliers, brands, products, or into a new marketplace.  Usually, the higher these costs are, the harder it is to perform the switch.  Most of the time, these costs occur in the form of monetary decisions.  For consumers, some examples of these costs could be the cost of new equipment, the cost to remove and install new equipment, opportunity costs, or the cost of training to use the new product.  However, other costs that may incur are not about monetary costs, but rather psychological or emotional costs.  Some examples of this would the lost of time, cognitive effort, aversion loss.  First, this is due to the fact that most people are very sensitive to advantages and disadvantages to any change from the status quo.  Secondly, everyone has a different reference point (a teenager may have different interests than that of their grandparents).  Lastly, the pain of giving up a benefit is usually greater than gaining a new one.  If a person must experience pain when exhibiting switcihing suppliers, they will be less likely to switch.  For example,  although a person may be extreme dissatisfied with their current physician, switching to another physician would require that person to transfer all medical records, insurance, and other miscellaneous paperwork.  Also, they must also take the time to trust the new doctor with their medical needs.  In other words, a person would need to be extremely dissatisfied to switch their supplier even if the alternative is superior.

            If switching costs for buyers are high, the situation can be similar to a monopoly.  This is because buyers will feel like their options are slim and will likely stay with the current supplier.  If switching costs for suppliers are high, then it would be similar to a monopsony where the buyer faces multiple sellers.  And if switching costs are high for both buyers and sellers, it would be known as a bilateral monopoly; this is where market price and output are determined by the bargaining power of both buyers and sellers.  Suppliers and its competition are the parties mainly affected by switching costs because it helps strengthen current players in the market and weakens new entrants.  New entrants must surpass the challenge of individual and collective switching costs in order to succeed.  As for the consumers, it is assumed that when a consumer is faced with switching costs, the rational consumer will not switch to the supplier with the lowest costs in terms of money, time, or effort.  If this were to occur, then the supplier has locked-in the consumer.  Suppliers who have locked-in consumers may choose to raise prices without worrying about losing the customer.

            Traditionally, switching costs have been present in a large class of markets.  The rise of information technologies has highlighted the importance of understanding switching costs because switching costs are known as a phenomenon in the information economy.  Because switching costs affect the performance of markets, institution of regulations such as governments also have the incentive to understand switching costs more in order to effectively promote competition.