Strategy

Introduction

Module 1

Advanced Competitive StrategyTobias KretschmerProfessor of Management, LMU Munich

Switching Costs I:

Importance of Customer Loyalty

Module 1

Why Prevent Switching? (I/IV)

Keeping your old customers is better than gaining new ones…

…because often customers are not profitable immediately!

1

1

1

2

223 3

34 4

45 5

5

-300

-200

-100

0

100

200US $

Why Prevent Switching? (II/IV)

Example: Annual profit per customer after acquisition

WholesaleCar insurance Credit cards

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)

0100200300400500600700800900

1000

1998Q4 2001Q2 2003Q4 2006Q2 2008Q4

E-Plus

O2 Germany

T-Mobile

Vodafone

Churn(in 1000)

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)


Investment in software / hardware

Training of employees

What Are Switching Costs? (III/IV)

Example: Toner cartridges for printer


Investment in printer

What Are Switching Costs? (IV/IV)

Example: Telephone network


Administrative costs

Number portability


Switching Costs II:Types of Switching Costs

Module 1

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)


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)


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)


Replacement of complementary goods for the product

E.g. replacing software when changing from PC to Mac

Product-Related Switching Costs (III/III)


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


Customer Value and Switching

Module 1

Consider the following questions:

When will a customer switch to a new supplier?

How much should a supplier invest to make a customer switch?

Customer Value and Switching

Benefit from Switching (I/II)

Customer’s switching costs

Switching “goody” received from new supplier for switching

Utility increase from switching

Customer’s benefit from switching to new supplier

Benefit from Switching (II/II)

When will a customer switch to a new supplier?

Customer’s switching costs

Switching “goody” received from new supplier for switching

Utility increase from switching

Profits for New Suppliers (I/II)

Profit increase from new customer

Supplier’s switching costs

Switching “goody” given to the new customer

Profits for the new supplier

Profits for New Suppliers (II/II)

Profit increase from new customer

Supplier’s switching costs

Switching “goody” given to the new customer

How much should a new supplier invest to make a customer switch?


Lock-In Strategies I:

Old Suppliers

Module 1

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 increasingswitching costs

Increasing Customer Switching Costs (I/III)

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

Gather miles Bonus miles Status miles

Example: Lufthansa’s loyalty program “Miles & More”

Loyalty Programs (I/II)

Flying Lufthansa and partner airlines

Purchasing with Lufthansa credit card / from retail partners

Free flights

Bonuses with hotel and car rental companies

Translate into status (Frequent Traveler, Senator, Hon)

Booking advantages, better service, lounge entry (depending on status)

Example: Lufthansa’s loyalty program “Miles & More”

Loyalty Programs (II/II)

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


Lock-In Strategies II:

Customers

Module 1

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 decreaseswitching costs

Strategies of Customers (I/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 (II/IV)


Use a second supplier / second sourcing

Strategies of Customers (III/IV)

E.g. IBM purchases processors from Intel and AMD


Use anticipated switching costs to negotiate a price reduction before supplier lock-in

Strategies of Customers (IV/IV)

E.g. Delta negotiates lower prices from Boeing


Lock-In Strategies III:

New Suppliers

Module 1

Strategies for New Suppliers (I/II)

Decrease customer switching costsE.g. banks offer services for switchers

Increase utility from switching E.g. increase quality

Offer a goodyE.g. no fee for 1st year credit card

How can a supplier decrease customer switching costs?

Strategies for New Suppliers (II/II)

Decrease own cost from customer switchingE.g. make software compatible

Increase profit from new customer

Find “goodies” that are valuable to customers but inexpensive for firmE.g. free flights

How can a supplier decrease customer switching costs?


Wrap Up

Module 1


Documents

Strategy