Switching Costs and Lock-In

How businesses make it costly or inconvenient for customers to leave, when this benefits customers, and when regulators step in.

Why do people stay with the same bank, phone ecosystem or software even when alternatives look better? Often the answer is switching costs: the costs, effort or risk involved in changing providers.

Types of switching costs

Financial: cancellation fees, lost discounts or buying new equipment.
Learning: time needed to learn a new system.
Data and compatibility: difficulty moving files, contacts, photos or business records.
Relationships: losing a trusted adviser or loyalty benefits.
Ecosystems: devices, apps and services that work best together.

Lock-in as strategy

Companies often deliberately build switching costs:

Ecosystems: phones, watches, laptops and cloud storage from one company that work seamlessly together.
Loyalty programmes: points and status that would be lost by switching.
Enterprise software: once a company’s operations run on a system, switching is costly and risky.

Economists Carl Shapiro and Hal Varian analysed lock-in in their 1998 book Information Rules, showing how technology firms compete fiercely to win customers, then earn profits from locked-in users.

Good and bad lock-in

Lock-in is not always bad. Integrated products can genuinely work better. But high switching costs can:

Let firms raise prices or reduce quality.
Reduce competition and innovation.

Regulators step in

Governments often reduce switching costs to boost competition:

Mobile number portability, introduced in India in 2011, lets customers keep their number when changing operators.
Account aggregators and data-sharing rules let customers move financial data between providers.
Rules in Europe, such as the Digital Markets Act, require large platforms to allow more interoperability.

The business software trap

A company runs its accounts, payroll and inventory on one software system. When the provider raises prices by 30 percent, the company considers switching, but moving years of data and retraining staff would take months and cost a lot. It pays the higher price.

Thinking customers who stay are always satisfied

Customers may stay because switching is costly, not because they are happy. High switching costs can hide dissatisfaction.

Key takeaways

Switching costs include financial, learning, data, relationship and ecosystem costs.
Firms build lock-in through ecosystems, loyalty programmes and software.
Lock-in can let firms raise prices and reduce competition.
Number portability and data-sharing rules reduce switching costs.