Advanced Competitive Strategy Tobias Kretschmer Professor of Management, LMU Munich
Module 1
Switching Costs I: Importance of Customer Loyalty
Why Prevent Switching? (I/IV) Keeping your old customers is better than gaining new ones…
…because often customers are not profitable immediately!
Why Prevent Switching? (II/IV) Example: Annual profit per customer after acquisition Car insurance US $ 200
Credit cards
3 4 5
100
4 5 3 2
0 2
-100 -200 -300
1
1
Wholesale
1
5 4 2 3
Why Prevent Switching? (III/IV) Example: Churn in German mobile telephony market
Customer churn: Customers leaving firms
Increase in average quarterly churn rate from 0.9% in 1999 to 2.3% in 2009
Why Prevent Switching? (IV/IV) Churn (in 1000)
1000 900 800 700 600 500 400 300 200 100 0 1998Q4
E-Plus
O2 Germany T-Mobile Vodafone 2001Q2
2003Q4
2006Q2
2008Q4
What Are Switching Costs? (I/IV) Example: Airlines
Cause of Switching Costs: Frequent flyer program
What Are Switching Costs? (II/IV) Example: Operating systems (Windows, iOS, Linux)
Cause of Switching Costs: Investment in software / hardware Training of employees
What Are Switching Costs? (III/IV) Example: Toner cartridges for printer
Cause of Switching Costs: Investment in printer
What Are Switching Costs? (IV/IV) Example: Telephone network
Cause of Switching Costs: Administrative costs Number portability
Advanced Competitive Strategy Tobias Kretschmer Professor of Management, LMU Munich
Module 1
Switching Costs II: Types of Switching Costs
Direct Switching Costs (I/II) Immediate costs of switching supplier • Search for a new supplier E.g. maintenance of IT network • Contract penalty for early termination E.g. phone contract must be paid out
Direct Switching Costs (II/II) Immediate costs of switching supplier • Risk that the new supplier is not a reliable replacement E.g. uncertainty about qualification of new car repair center • Costs of exchanging suppliers E.g. cost of moving apartment, administrative costs if “supplier” is an employee
Relationship-Related Switching Costs (I/III) Costs through interaction with new instead of old supplier Learning costs with new supplier Especially with specific knowledge / experience E.g. Customer-specific technical developments by supplier E.g. Knowledge of a consulting company about their customers
Relationship-Related Switching Costs (II/III) Costs through interaction with new instead of old supplier Loyalty programs and accumulated quantity discounts Customer gives up advantages of reached level E.g. Frequent flyer programs – lose right to better service
Relationship-Related Switching Costs (III/III) Costs through interaction with new instead of old supplier Psychological “costs“ through change of contact person E.g. missing the friendly welcome at your favorite restaurant
Product-Related Switching Costs (I/III) Costs through working with new product Training costs and loss in productivity during initial phase E.g. learning new software when switching from Windows to Linux
Product-Related Switching Costs (II/III) Costs through working with new product Replacement of complementary goods for the product E.g. replacing software when changing from PC to Mac
Product-Related Switching Costs (III/III) Costs through working with new product Switching costs for firm’s customers who are used to the firm working with the old supplier E.g. software programmers who are used to buying PCs with Intel processors
Advanced Competitive Strategy Tobias Kretschmer Professor of Management, LMU Munich
Module 1
Customer Value and Switching
Customer Value and Switching Consider the following questions:
When will a customer switch to a new supplier?
How much should a supplier invest to make a customer switch?
Benefit from Switching (I/II)
Utility increase from switching Customer’s switching costs
Customer’s benefit from switching to new supplier
Switching “goody” received from new supplier for switching
Benefit from Switching (II/II) When will a customer switch to a new supplier?
Utility increase from switching Customer’s switching costs Switching “goody” received from new supplier for switching
Profits for New Suppliers (I/II)
Profit increase from new customer
Supplier’s switching costs
Profits for the new supplier
Switching “goody” given to the new customer
Profits for New Suppliers (II/II) How much should a new supplier invest to make a customer switch? Profit increase from new customer
Supplier’s switching costs Switching “goody” given to the new customer
Advanced Competitive Strategy Tobias Kretschmer Professor of Management, LMU Munich
Module 1
Lock-In Strategies I: Old Suppliers
Increasing Customer Switching Costs (I/III)
Recap: Customers only switch if the costs of switching are smaller than the combined utility increase from switching AND the “goodie” they would be given for switching
“Old” suppliers seek to lock customers in by increasing switching costs
Increasing Customer Switching Costs (II/III) How can a supplier increase customer switching costs?
Loyalty programs
Long-term contracts
Sale of complementary products
Increasing Customer Switching Costs (III/III) How can a supplier increase customer switching costs?
Specific software / data formats
Specific interfaces
Close personal customer service
Loyalty Programs (I/II) Example: Lufthansa’s loyalty program “Miles & More”
Gather miles
Bonus miles
Status miles
Free flights Translate into status Flying Lufthansa and (Frequent Traveler, Senator, Bonuses with hotel partner airlines Hon) and car rental Purchasing with companies Booking advantages, better Lufthansa credit card / service, lounge entry from retail partners (depending on status)
Advanced Competitive Strategy Tobias Kretschmer Professor of Management, LMU Munich
Module 1
Lock-In Strategies II: Customers
Strategies of Customers (I/IV)
Recap: Customers only switch if the costs of switching are smaller than the combined utility increase from switching AND the “goodie” they would be given for switching
Customers may seek to decrease switching costs
Strategies of Customers (II/IV)
How can customers decrease their switching costs? “Open“ (non supplier-specific) standards for data and complementary goods
E.g. toner cartridges that can be used for printers of different manufacturers
Strategies of Customers (III/IV)
How can customers decrease their switching costs? Use a second supplier / second sourcing
E.g. IBM purchases processors from Intel and AMD
Strategies of Customers (IV/IV)
How can customers decrease their switching costs? Use anticipated switching costs to negotiate a price reduction before supplier lock-in
E.g. Delta negotiates lower prices from Boeing
Advanced Competitive Strategy Tobias Kretschmer Professor of Management, LMU Munich
Module 1
Lock-In Strategies III: New Suppliers
Strategies for New Suppliers (I/II) How can a supplier decrease customer switching costs?
Decrease customer switching costs E.g. banks offer services for switchers
Increase utility from switching E.g. increase quality
Offer a goody E.g. no fee for 1st year credit card
Strategies for New Suppliers (II/II) How can a supplier decrease customer switching costs?
Decrease own cost from customer switching E.g. make software compatible
Increase profit from new customer
Find “goodies” that are valuable to customers but inexpensive for firm E.g. free flights
Advanced Competitive Strategy Tobias Kretschmer Professor of Management, LMU Munich
Module 1
Wrap Up
Advanced Competitive Strategy Tobias Kretschmer Professor of Management, LMU Munich
