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There are three common types of switching costs:
- Procedural — the loss of time and effort resulting from training, service interruptions, troubleshooting, transportation, etc.
- Financial — the loss of money, such as replacement.
- Relational — discomfort experienced by customers of a new supplier when adapting to the change (this is an unquantifiable cost that requires the estimator’s best judgment). While this is an important factor, it must not be overemphasized.
These costs exist to various degrees when an organization switches suppliers. For example, when the organization switches from using an existing computer equipment provider to a new one, the change can introduce many time-consuming and costly activities, as well as personal stress.
- Procedural — the new system requires users to learn new routines, to reconfigure hardware and software to be compatible, and to reestablish communication networks with other users.
- Financial — there is the cost of moving parts or changing tooling from the incumbent supplier to the new supplier.
- Relational — because people tend to resist change, there will also be reluctance against adapting to the new routine.
Switching costs are significant in a highly competitive market with a high level of consolidation; however, they are relatively low in a fragmented market with no dominant players. A market that consists of suppliers with specialized products and few substitutes would incur higher switching costs than a market with undifferentiated products and many substitutes.
Because switching costs are inevitable and can figure substantially, the rule of thumb is to resist switching or consolidating suppliers unless the cost savings from the alternative supplier are greater than the cost of switching. A TCO analysis can be leveraged when making this comparison.
The Postal Service can reduce or eliminate future switching costs early in the purchasing process through sourcing and supplier selection decisions. The Postal Service should not only invest in acquiring skilled suppliers, but also focus on retaining them through partnerships and alliances when appropriate. Standardization and compatibility of inputs and selection of flexible technologies that are easy to adapt, given that they best meet Postal Service needs, are also encouraged. Anticipating the potential exit strategy with each supplier and preparing for a possible termination in relationship far in advance will also reap considerable savings for the Postal Service.
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