Switching Costs

Free Trial vs. Switching Costs

After a Customer selects a Product to buy, their Willingness To Pay (WTP) for all of the other Products in the Category may decrease due to Switching Costs. This might happen if a Customer invests in the use of a Product when they first purchase it. This investment would be lost if the Customer were to switch to a different Product.

This Market Simulation workflow shows how Switching Costs will imped a Customer changing suppliers. Switching Costs will continue to influence Customers even if a Competitor offers a Free Trial.

This Case Study provides a high-level overview of the workflow without detailed explanation. It assumes you are already somewhat familiar with KNIME and Market Simulation. If not, start by reviewing the Building Blocks and Community Nodes.

Competitive Story

In this Market, Spacely Sprockets and Cogswell Cogs are both competing for Customers. If a Customer originally selects one vendor then their WTP for the other vendor will decrease.

A Temporary Price Reduction (TPR) by a Competitor may induce otherwise loyal Customers to temporarily switch to that Competitor. But the switch may not be permanent if the Competitor’s Price were again to rise.

This Market Simulation can be compared to the previous Market Simulation MS-191 Free Trial.

As before, this Market Simulation also models the impact of a free trial on Customer Demand for Spacely Sprockets. But in this case, Customers who originally selected Cogswell Cogs will suffer from Switching Costs despite their growing appreciation of the value of Spacely Sprockets. The impact of these Switching Costs will remain even after a Free Trial.

The simulation again takes place over 3 steps:

  1. Both Spacely Sprockets and Cogswell Cogs charge full Price for their low-value Products. This sets the Switching Costs for the original Customers.
  2. Spacely gives away his Sprockets for free hoping to induce Cogswell Cogs Customers to switch over. Cogswell Cogs makes no Price adjustment.
  3. Spacely again charges Full Price. Original ‘No Sale’ Customers from Step 1 who tried Spacely Sprockets during the Free Trial are now more likely to buy that Product. But original ‘Cogswell Cogs’ Customers are not induced to permanently switch vendors – they return their loyalty to Cogswell.

Original Customers

Spacely Sprockets and Cogswell Cogs compete in this duopoloy Market. Neither Product is of high quality. Customers originally place a Willingness To Pay (WTP) average value of only $0 (nothing) on both of the Products, although demand is Normally Distributed and the Standard Deviation (SD) is wide at $50. When selling at $50, each Competitor attracts less than 15% of Customers from the 10,000 Total Available Market (TAM).

Duopoly Market

Step 1: Both originally charge $50 for their low value Sprockets.

Product Array

Initially only 2,928 (29%) Customers buy a Product.

WTP Matrix

More than 70% of Customers are ‘No Sale’ and decline to Purchase.

Benchmark Switching Costs

If a Customer originally purchased Spacely Sprockets then their Willingness To Pay (WTP) for Cogswell Cogs automatically decreases by $10. This is because switching to Cogswell Cogs would require a penalty investment of $10. The opposite is also true – Customers who originally purchased Cogswell Cogs will decrease their value of Spacely Sprockets by $10.

Note that Switching Costs only impact Customers who have bought a Product – not ‘No Sale’ Customers who have not yet bought any Product. 

Purchased Matrix

Originally Purchase if WTP > Competitor > 50

Scale If Not Purchased

If Purchased, reduce WTP for the Competition by $10.

Decreased WTP

Cogswell Cogs Customers will reduce their WTP for Spacely Sprockets.

Free Trial

As with the previous Market Simulation (MS-191 Free Trial) Spacely decides against making any improvements to his low-value Product. Instead, Spacely decides to grow Market Share by giving away a free trial.

Spacely hopes to convince original (Step 1) Cogswell Cogs Customers to switch over to Spacely Sprockets. He also hopes that once ‘No Sale’ Customers from Step 1 try his Product their WTP will increase and they will be more willing to buy Spacely Sprockets in the future.

Whenever a Customer buys any Product, their WTP for that Product will increase by $10. This is due to their greater familiarity with the Purchased Product – not because of Switching Costs (Switching Costs is a separate phenomenon).

Free Trial

Step 2: During the Free Trial 45% of Customers buy Spacely Sprockets.

Increase WTP

The ‘Scale Purchase’ node increases WTP when Customers Purchase.

Updated WTP

Customers who try Spacely Sprockets increase their WTP by $10.

Return to Full Price

When the Free Trial is over Spacely Sprockets and Cogswell Cogs again both set Product Price to $50.

Many of the ‘No Sale’ Customers from Step 1 who enjoyed the Free Trial become Spacely’s long-term Customers. Spacely Sprockets sales increase from the original 1,478 (Step 1) to 1,879 (Step 3).

However, none of the original ‘Cogswell Cogs’ Customers from Step 1 make the permanent switch to Spacely Sprockets in Step 3 regardless of whether they enjoyed the Free Trial. Cogswell Cogs’s 1,450 Customers from before and after the Free Trial remain unchanged. This is because their increased WTP from the Free Trial did not overcome the decreased WTP due to Switching Costs.

Full Price

Step 3: Spacely Sprockets again returns to the Full Price of $50.

Product Array

An additional 401 (4%) of ‘No Sale’ Customers now buy Spacely Sprockets.

WTP Matrix

The number of Cogswell Cogs Customers doesn’t change.