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Perform Switching-Cost Analysis

Switching costs are incurred when the purchasing organization changes suppliers. These costs affect the Postal Service decision of whether to consolidate suppliers as part of its sourcing strategy and will also influence supplier development activities.

The exercise of evaluating the extent of competition in the market, combined with internal research, can lead to new findings on market dynamics, such as:

There are new suppliers who are worth investigating for relationship development.

Another supplier is expanding its expertise or product offering to include those offered by other suppliers, and the Postal Service can exploit its volume more effectively through fewer suppliers.

The Postal Service is sourcing similar products or services from relatively generic suppliers.

The Postal Service is losing bargaining power with certain suppliers because of the reduced degree of competition in those markets and must consider exploring backup suppliers as contingencies should the relationship with the current supplier prove no longer fruitful.

Another supplier is offering a new product or service that can meet Postal Service demand more efficiently than the current supplier.

While those observations need confirmation under a host of other operational and organizational factors, they warrant consideration to switch suppliers or consolidate them to reap better terms for the Postal Service. From a purchasing perspective, the Purchase/SCM Team needs to recognize how switching costs arise and how to minimize them in the purchasing process, specifically in its decision to consolidate suppliers or develop new ones.

Types of Switching Costs

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 total cost of ownership (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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Questions for Consideration

Is market highly competitive, with a high level of consolidation, or is it fragmented, with no dominant players?

Does the market consist of suppliers with specialized products and few substitutes or suppliers with undifferentiated products and many substitutes?

What are the specific plans to minimize switching costs?

What is the exit strategy regarding the selected suppliers?

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