SWITCHING COSTS - INCREASING YOUR SHARE

March 27, 2015

We’ve all experienced the power of well-executed business models that capture our attention, win our business, and create intentional mechanisms to retain us.   Studies have long purported that the cost of acquiring a new customer is 9X more than retaining a current customer.  It’s also been shown that repeat customers spend 67% more!  So why do most privately held firms evaluate growth by new client acquisition, often neglecting client retention and share of existing customer’s wallet? 

 

Growth companies interested in developing incremental, sustainable, and profitable organizations are keenly aware of market share and focus on retention as an integral part of their growth planning and value creation.  “Switching costs” result from a consumer’s desire for compatibility and/or added value when comparing a current purchase with a former investment.  These investments can be psychological, financial, informational, and/or procedural costs that a consumer incurs as a result of changing suppliers, service providers, products, or brands.

 

The most common categories of switching costs are:

  • Contractual – contracts that impute compensatory or liquidated damages for cancelling an agreement or service contract.  Cell phone carriers have used this for years charging high cancellation fees for cancelling their 2-3 year contracts.

  • Compatibility – the costs associated with supplies, maintenance, retooling, and service requirements from the incumbent supplier to the new supplier. The different components of a computer system must be compatible. Cameras must be compatible with their lenses, razors with their blades, printers with their refill cartridges, etc.

  • Procedural— the loss of time and effort resulting from brand specific training, service interruptions, troubleshooting, logistics, etc.  A switch to a new vendor / product often involves reconfiguring operational systems to meet the requirements of the new platform or offering.  Generally speaking, the implementation costs of a software conversion can be 4-7X the actual hardware/software and licensing fees for the product itself. 

  • Informational – the loss of accumulated data, information, preferences, buying patterns, and lost relationship.  In order to switch your personal banking you must must not only weigh the costs in setting up profiles, going through paperwork, loading all online bill pay info, alerts, etc.

  • Psychological – the unquantifiable cost of the discomfort experienced when adapting to the change and uncertainty of a new vendor, brand, supplier, or service provider.

  • Loyalty Programs – personalized pricing, access, services, referral fees, etc. accumulated based upon consumer behavior and loyalty.  Airline frequent flyer programs, credit card points, cash back rewards, discounts, etc. all provide an incentive for customer’s to retain their current relationship.

Switching costs are significant in highly competitive and consolidated markets; however, they are often low in fragmented markets with no dominant players. A market that consists of suppliers with specialized products and few substitutes would incur higher switching costs than a market with undifferentiated products and many substitutes.

 

The most valuable companies not only understand these switching costs, they consciously refine and deploy them into their service, delivery, and retention models.  Smaller organizations often attempt to use contracts as the predominant way to promote higher switching costs and encourage loyalty.  Contracts, however, are never a “loyalty tool” and often back-fire, over time, if you do not carefully balance innovation, experience development, and loyalty programs in a comprehensive approach to building retention and ultimate market share. 

 

Contact us at info@flvcp.com for more information on how to enhance your organizational value and build incremental, sustainable, and profitable relationships.

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