Science Fair Project Encyclopedia
In many markets, consumers are forced to incur costs when switching from one supplier to another. These costs are called switching costs and can come in many different shapes. The definition of switching costs is quite broad. Thompson and Cats-Baril (2002) defines switching costs as "the costs associated with switching supplier", while Farrell and Klemperer (2002) write that "a consumer faces a switching cost between sellers when an investment specific to his current seller must be duplicated for a new seller". As these definitions indicate, switching costs can arise for several different reasons. Examples of switching costs include the effort needed to inform friends and relatives about a new telephone number after an operator switch, costs related to learning how to use the interface of a new mobile phone from a different brand and costs in terms of time lost due to the paperwork necessary when switching to a new electricity provider.
Types of switching costs include:
- exit fees
- search costs
- learning costs
- cognitive effort
- emotional costs
- instillation and start-up costs
- financial risk
- psychological risk
- social risk
Switching costs are of interest to study since they affect competition. When a consumer faces switching costs it will not pay for the consumer to switch to the supplier offering the lowest price if the switching costs in terms of effort, time, uncertainty, etc outweigh the price differential between the two suppliers. If this happens, the consumer is said to be locked-in to the supplier. If a supplier manages to lock-in consumers, the supplier can raise prices without fear of losing customers since the switching costs prevents the consumer from switching.
Understanding how switching costs work and affect market performance is important, as switching costs are likely to be present in a large class of markets. The importance of understanding switching costs has been emphasised with the rise of information technologies, since switching costs seems to be a phenomenon that is especially strong in the so called information economy. Shapiro and Varian (1999) writes, "You just cannot compete effectively in the information economy unless you know how to identify, measure, and understand switching costs and map strategy accordingly". But not only businesses need to be aware of and understand switching costs. Since switching costs affect market performance, governments and regulators also have incentives to study switching costs in order to be able to promote competition effectively.
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