Originally posted on LinkedIn: https://www.linkedin.com/pulse/switching-costs-retail-transformation-financial-services-snitkof/

Nearly each week, we see another data point in the ongoing transformation of American retail. Once-bustling malls are becoming ghost towns. Department store sales are trending monotonically downward. Stalwarts of commerce are performing far worse than the market overall. The common thread running through these stories is the effect of near-zero switching costs on economic decision-making, something that has transformed many an industry, including retail, and is beginning to transform financial services as well.

Department store sales have consistently decreased since the turn of the millennium, according to data collected by the U.S. Census Bureau.

Mobile devices account for a rapidly increasing proportion of Black Friday sales, according to data collected by IBM.

The appeal of malls and department stores lies in their ability to offer many goods and services in close proximity. For decades, this gave stores or departments with close physical adjacency a natural competitive advantage over their far-flung counterparts. The “switching cost” of driving or otherwise transporting oneself to a location outside the mall or department store was a meaningful barrier to competition and perhaps a misinterpreted indication of customer loyalty.

The transformation we’ve observed in retail consumer goods parallels the change currently taking place in financial services. Banks built vast networks of physical branches and introduced an impressively wide array of consumer and business financial products — the often-referenced “financial supermarket.” Implicit in this strategy was the concept that a customer using one of the bank’s products would want to use that same bank for other financial products as well. The switching costs of evaluating another bank’s products, rates, and services provided a formidable barrier to competition. Just as in other retail markets, banks may have mistaken customer inertia for customer loyalty.

Today, consumers or businesses can evaluate multiple competing providers of financial services from the comfort of their laptops, smartphones, or tablets. A wave of new entrants to the market have used technology to promote their offerings to would-be customers and differentiate themselves with potentially better rates, friendlier customer service, or ease of use. There are even aggregators such as Bankrate, Lendio, Fundera, and LendingTree, which allow prospective borrowers to compare multiple loan offers at once!

The number of physical bank branches per capita in the United States has steadily decreased since 2009.

The volume of loans issued by online marketplaces has grown dramatically in the U.S.

The physical switching costs of adopting a new financial solution no longer involve traveling to a new bank branch, but rather navigating to a new website. Even the administrative switching costs are no longer particularly high, as personal financial management and business accounting software are able to integrate data from a variety of sources into a single user interface.  

The Internet has demonstrated its ability to reduce switching costs across a variety of industries, resulting in greater consumer choice, lower costs, and improved customer experience. As customers have more options, providers of products and services have a higher standard for customer acquisition and retention. This incentivizes them to offer better products at better rates and to consistently raise the bar on customer service.  Companies who embrace this thinking will be rewarded with brand recognition, market share, and customer loyalty for years to come.