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Supplying Principles and Practices > USPS Supplying Practices Process Step 2: Evaluate Sources > Perform Switching-Cost Analysis
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.
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.
• 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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