High Switching Cost | Value Research High switching costs in a market segment also act as an entry barrier for competitors who may be considering entry into that market segment

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Companies with Moat

High Switching Cost

High switching costs in a market segment also act as an entry barrier for competitors who may be considering entry into that market segment

High Switching Cost

One way to create an economic moat is by creating high switching cost for customers, thereby forcing them to stay over thinking of shifting to another product or service. Of course, one may still shift if the benefits of shifting far exceed the costs associated with switching.

In companies with high switching costs, the cost of switching goes beyond pure costs and may entail time as well, which may make one to stick to the product or service over the competition. For instance, if one were to switch from one technology to another, there would be delays in terms of need for training to manage the new technology.

Successful businesses can manage to retain a high percentage of their customers by employing strategies that incur high costs for their customers who intend to switch over to their competitors. Such high switching costs dissuade their customers from crossing over to their competitors.

High switching costs created by an enterprise in a particular market segment may also act as an entry barrier for competitors who may be considering entry into that market segment. Moreover, switching costs can be of different types such as capital investment in equipment, cancellation fees, learning and training costs and installation costs or uncertainty. Mission-critical products and those that require a lot of training for users usually carry high switching costs.

Take for instance SLR cameras. There are those who swear by Nikon and then there are those who will not pick anything other than a Canon. To ensure that a photographer sticks to his stables, both camera manufacturers have designed the lenses that will only fit with respective camera bodies. Even if one camera maker introduces a better feature, the user will find the cost of shifting to be immense.

In the case of professional photographers, one may need to be trained to use competing products, for which they may have to contend with lost time and money resulting from their learning phase or switching phase from one camera to the other. The switch from one platform to the other is expensive and it also takes time to unlearn and learn afresh ways to get used to the new camera with new features.

Indian case
In India, both DTH service providers and banks benefit from high switching costs. When you take a dish from a DTH service provider, you pay a cost for the set-top box and the dish (around `2,000). If you wish to switch, then you will have to pay this amount again to the new service provider. This acts as a deterrent to switching.

Switching from one bank to another has become such a painful exercise today that few customers would undertake it unless they have a strong reason. Typically, the customer would have given his bank account for dividend payment from mutual funds and for income-tax refund. He would have issued post-dated cheques for the repayment of loans and given ECS mandates for SIPs. Thus, there are just too many things linked to the bank account. To open a new bank account, he would have to get KYC done again, go through a lot of documentation processes and then re-issue all the instructions given in the past. So, the switching cost in terms of the pain involved is high.

The ushering in of mobile number portability by allowing subscribers to take their numbers with them to a new player works in the opposite direction by lowering switching cost for the customers in telecom.

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