Loading the player...

What are 'Switching Costs'

Switching costs are the costs that a consumer incurs as a result of changing brands, suppliers or products. Although most prevalent switching costs are monetary in nature, there are also psychological, effort- and time-based switching costs. A switching cost can manifest itself in the form of significant time and effort necessary to change suppliers, the risk of disrupting normal operations of a business during a transition period, high cancellation fees, and a failure to obtain similar replacement of products or services.

BREAKING DOWN 'Switching Costs'

Successful companies typically try to employ strategies that incur high switching costs on the part of consumers to dissuade them from switching to a competitor's product, brand or services. For example, many cellular phone carriers charge very high cancellation fees for canceling contracts in hopes that the costs involved with switching to another carrier will be high enough to prevent their customers from doing so. However, recent offers by numerous cellphone carriers to compensate consumers for cancellation fees nullified such switching costs.

Switching costs are the building blocks of competitive advantage and pricing power of companies. Firms strive to make switching costs as high as possible for their customers, which lets them lock customers in their products and raise prices every year without worrying that their customers will find better alternatives with similar characteristics or at similar price points.

Example of Low Switching Costs

Companies that offer products or services that are very easy to replicate at comparable prices by competitors typically have low switching costs. Apparel firms have very limited switching costs among consumers, who can find clothing deals and easily compare prices by walking from one store to another. The rise of Internet retailers and fast shipping made it even more easier for consumers to shop for apparel at their homes across multiple online platforms.

Example of High Switching Costs

Companies that create unique products that have few substitutes and require significant effort to master their use enjoy significant switching costs. Consider Intuit Inc., which offers its customers various bookkeeping software solutions. Because learning to use Intuit's applications takes significant time, effort and training costs, few users are willing to switch away from Intuit. Also, many of Intuit's applications are interconnected, which provides additional functionalities and benefits to users, and few companies match the scale and usefulness of Intuit's products. Small businesses, which are the primary buyers of Intuit's bookkeeping products, can incur disruption in their operations and risk incurring financial error if they decide to move away from Intuit's software. These factors create high switching costs and stickiness of Intuit's products, allowing the company to charge premium prices on its products.

RELATED TERMS
  1. Switching

    Switching refers to the process of transferring investments. ...
  2. Gilt-Edged Switching

    The selling and repurchasing of certain high-grade stocks or ...
  3. Unit Cost

    The cost incurred by a company to produce, store and sell one ...
  4. Cost Accounting

    Cost accounting is an accounting method that aims to capture ...
  5. Cost of Revenue

    The total cost of manufacturing and delivering a product or service. ...
  6. Portability

    An employee's ability or right to retain certain benefits when ...
Related Articles
  1. Investing

    Nintendo Shipped 740K More Switch Units in March Than It Expected to

    Nintendo sold 2.74 million units of the Switch in March, surpassing its own estimate.
  2. Investing

    Nintendo Ups Switch Production for the Holidays

    The game maker is reportedly gearing up to produce 18 million units for the holiday selling season.
  3. Personal Finance

    How To Break Up With Your Bank

    Whether you're moving or have just found a better no-fee plan, find out how to switch banks with ease.
  4. Investing

    Nintendo Stock Has 18% Upside Despite Recent Gains: Nomura

    Nomura thinks shares of Nintendo could climb even higher this year thanks in large part to the Switch game console and the online offerings around it.
  5. Investing

    Nintendo Switch Sales Outpace Wii Weekend Launch

    Nintendo's Switch game console outsold the successful Wii during its launch weekend.
  6. Investing

    Nintendo Switch Lifts Fortunes of Best Buy Stores

    The retailer reported a surprise gain in comparable store sales thanks largely to Nintendo.
  7. Investing

    IDC: Nintendo Could Ship 8M Switch in Next Year

    Nintendo could ship around 8 million Switch consoles by the end of Q1 2018, says IDC.
  8. Investing

    Nintendo Raises Switch Shipment Target Amid Strong Demand

    Nintendo raised its Switch shipment targets to 14 million units from 10 million units for its fiscal year ending in March.
  9. Investing

    Nintendo Denies That the Switch Shortage Is Artificial

    A Nintendo spokesman said the lack of supply of the Switch game console is not on purpose and isn't designed to create a frenzy.
  10. Investing

    Streaming Video Coming to Nintendo’s Switch

    Nintendo's Switch game console will soon include streaming video services Netflix, Amazon and Hulu.
RELATED FAQS
  1. What is the "bait & switch" technique?

    The bait and switch is a advertising technique which can be considered illegal, but in most cases is merely looked upon as ... Read Answer >>
  2. What are the key barriers to entry for companies in the electronics sector?

    Learn how the entry barriers of economies of scale and scope, research and development, capital and brand loyalty affect ... Read Answer >>
  3. Move from an OTC to a major exchange

    In order to move a company from over-the-counter market to a major exchange, a number of conditions must be met to being ... Read Answer >>
  4. Do production costs include the marginal cost of production?

    Learn more about marginal costs of production and production costs. Find out how businesses can use marginal cost calculations ... Read Answer >>
Hot Definitions
  1. Return on Assets - ROA

    Return on assets (ROA) is an indicator of how profitable a company is relative to its total assets.
  2. Fibonacci Retracement

    A term used in technical analysis that refers to areas of support (price stops going lower) or resistance (price stops going ...
  3. Ethereum

    Ethereum is a decentralized software platform that enables SmartContracts and Distributed Applications (ĐApps) to be built ...
  4. Cryptocurrency

    A digital or virtual currency that uses cryptography for security. A cryptocurrency is difficult to counterfeit because of ...
  5. Financial Industry Regulatory Authority - FINRA

    A regulatory body created after the merger of the National Association of Securities Dealers and the New York Stock Exchange's ...
  6. Initial Public Offering - IPO

    The first sale of stock by a private company to the public. IPOs are often issued by companies seeking the capital to expand ...
Trading Center