Switching Costs

The lower switching costs are, the more direct network effects are – when we can switch easily between different platforms, the most “direct” platform wins. In a sense, what makes network effects indirect is steep switching costs. That’s why openness is hard to beat.

- Umair Haque [1]

Introduction

Robert Young of Weedshare.org describes a shift from walled garden approaches, which create high switching costs for consumers who want to change services, to community driven switching costs, based on accumulated reputation, etc... As walled gardens become counterproductive in an environment where consumers increasingly seek a free flow, creating services that let communities form and create their own switching costs, become appropriate.

Discussion

The Death of Walled Gardens

From http://gigaom.com/2005/09/08/inherent-truths-and-value-of-community/

Robert Young:

"As time goes by, the foundation of ownership and control for content and distribution is increasingly shifting from corporate entities to people and communities. A phenomenon that will cause countless sleepless nights for old media and old-line technology leaders who don’t fully comprehend the significance of the dynamics at hand.

This shift in the balance of power has immense strategic implications for traditional media conglomerates and technology vendors. It represents a classic disruption of markets and, of its many consequences, probably the single most important ramification is the impact that it has on the concept known as “switching costs”, a business model feature designed to extend competitive advantage. The most recent example of a company that executed almost flawlessly on the classic definition is actually a new media player, and one we’re all familiar with… AOL.

During Internet 1.0, AOL was the master of creating high switching costs. Using the email address as the cornerstone, they were able to lock-in their subscribers into a garden with very high walls. In fact, they locked up the gates so well that there are still 20+ million people who subscribe to AOL’s dial-up service (which, consequently, enables AOL to generate more annual revenues than either Yahoo! or Google, to this day). Even at a time when broadband access is oftentimes less expensive, their subscribers are hesitant to switch away from their AOL email addresses.

But in a world where people themselves are increasingly becoming the sources of content and the owners of distribution, any product development strategy that aims to proactively increase switching costs becomes antithetical to the gravitational pull of the market (as AOL is now painfully experiencing). In fact, in many markets, we are likely to see an inversion of control, where vendors will increasingly rely on their customers to provide them with their strategic and competitive advantages. Put another way, the tail will start wagging the dog.

So in such an open and unpredictable environment of consumer control, what happens to the notion of switching costs? The answer, on its surface, is actually quite simple. The importances of switching costs do not disappear. They will always remain a critical success factor for building market share and defending against competition. What does change, however, is who creates and controls it.

It won’t be the corporation that locks its customers into a walled garden any more; instead, it will be the people themselves who create their own high switching costs. For instance, if you are an eBay seller, your switching cost is not so much the relationship you’ve created with eBay itself and the store you set up, it’s the reputation and trust you spent years building with fellow members of the community. Similarly, if you are a member of MySpace, it’s not the web-page and blog you spent time constructing, it’s your social network of cyber-friends you’ve cultivated and accumulated over time.

At the end, the lesson is one of a paradox. As the power shifts increasingly towards community, the corporation loses its grip on the traditional means of control. Yet, by letting go of control, the corporation creates an environment where the community willingly creates its own switching costs. Such changing market behavior, which is structural and permanent for any industry being usurped by the Internet, must be met with a corresponding shift in corporate mindset. Otherwise, a “generation gap” will exist between the members of management themselves (old vs. new media), as well as the company and its market. In my view, if there is one company that seems to grok such dynamics better than anyone, and is in the process of executing superbly against these new set of challenges, it’s Yahoo!" (http://gigaom.com/2005/09/08/inherent-truths-and-value-of-community/)

Facebook's Beacon Fiasco shows Switching Costs do not create media monopolies

By Scott Karp in Publishing 2.0:

"Facebook’s user news feed, which are published to each of their friends, began to look like the next monopoly in new media. Want to find out what’s going on with your friends, who are all on Facebook — you HAVE TO go through Facebook. Just like you had to subscribe to the local newspaper if you wanted to get news in the morning.

The problem is that Facebook isn’t really a monopoly medium — it just has high switching costs, i.e. it’s a pain to get all of your friends to switch to another social network. But you CAN do it. In traditional media, natural monopolies like the local newspaper meant there simply were no other options.

But on the web, there are always other options. Google search isn’t really a natural monopoly either — Google has just managed to maintain the user perception that it’s better.

High switching costs and high brand equity are not the same as natural monopolies.

But Facebook acted as if it had a real monopoly — it treated its users, to user Umair’s term, like “brainless meat for the grinder” — kind of like TV networks did when they force fed us 3-4 for minutes of mind-numbing commercials.

Facebook figured that users would have no choice but to accept Beacon — but they forgot that high switching costs are not a monopoly. And when the backlash started, they came crashing back to reality.

They realized that if their users caught wind of all the negative media coverage about privacy violations, and started to look carefully at what Beacon was actually doing, they might get so annoyed that….they might actually leave.

Sure you could change TV channels, but those annoying commercials would crop up again soon enough. You were stuck in the land of 30-second-spot monetized content.

But not so with social networks — there are hundreds of online social networks that aren’t being driven to extremes by the pressure of a $15 billion valuation, who won’t (at least not yet) try to monetize your every action without your permission." (http://publishing2.com/2007/12/01/facebook-beacon-a-cautionary-tale-about-new-media-monopolies/)

More Information

See the Long Tail of Control