Module 1

Introduction

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

Wholesale

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 firms 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
Customers switching costs

Customers
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
Customers switching costs
Switching goody received
from new supplier for
switching

Profits for New Suppliers (I/II)

Profit increase from new customer

Suppliers 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

Suppliers 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: Lufthansas 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)

Loyalty Programs (II/II)

Example: Lufthansas loyalty program Miles & More
Mechanisms

Bulk discount accumulates but comes with an expiry date

Bonus grows disproportionally fast

Awards (free flights) cost LH less than what they are worth to the
customer

Bribery: Employees choose flight / carrier and earn award,

companies pay

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