Comments for Online banking, switching costs and competition: a complex story charlotte catfolis 17 February 2016 The banking world is a world that changes and adapts to new technology. Banks evolve and serve the needs of their clients. Technological developments allow banks to have a personal relationship with their client. Banks can offer more personalized services. One of the goals of a bank is to retain its customer and to prevent its customers switch to another…Read moreThe banking world is a world that changes and adapts to new technology. Banks evolve and serve the needs of their clients. Technological developments allow banks to have a personal relationship with their client. Banks can offer more personalized services. One of the goals of a bank is to retain its customer and to prevent its customers switch to another bank. Moreover, a satisfied customer is an effective way in terms of communication. This new technology has led to competitiveness. Banks therefore need to differentiate themselves from other. Internet has increased competition. This competition is present between banks but also among certain financial intermediaries. Customers can easily compare bank products and services. Which results in fact an increase of competitiveness. To increase customer loyalty, banks use new marketing channels. First, technology has allowed banks to offer a voice service. Customers could well see their account via phone or fax. Then internet has enabled the development of electronic financial services. This is a customer benefit. Indeed, the customer should not move and he benefits from a low cost. Internet allows a diversification of supply The advantage that enables customers to stay at home is a very important advantage of availability. Indeed the opening hours of an agency are not always very flexible. The client can perform all banking transactions without moving. E-banking is easy to use. E-banking service’s disadvantage is the lack of physical connection between the customer and the banker. The agency helps, advises their customers. E-banking has also a financial advantages. It reduces transaction costs. A net decrease in operating expenses and the cost of transactions carried out through the migration of a set of services to the Internet channel. Indeed, for the people using the service, the total cost of e-banking should be low and competitive. Sources: http://www.archipel.uqam.ca/3691/1/M11536.pdf http://www.imf.org/external/pubs/ft/fandd/2002/09/nsouli.htm http://www.rtl.fr/actu/economie/frais-bancaires-les-banques-en-ligne-restent-moins-cheres-que-les-reseaux-traditionnels-7776348962 http://www.rtl.fr/actu/economie/l-ere-du-numerique-destabilise-les-banques-7775463135 Show less Reply Fionn Whelan 7 May 2015 Firstly, it is important to note why switching costs exist. Businesses, such as those in the online banking industry, are attempting to achieve “consumer lock-in”. Consumers are more likely to continue buying a product or using a service, that they have already purchased or used. They are willing to pay a premium for convenience and safety, which is what…Read moreFirstly, it is important to note why switching costs exist. Businesses, such as those in the online banking industry, are attempting to achieve “consumer lock-in”. Consumers are more likely to continue buying a product or using a service, that they have already purchased or used. They are willing to pay a premium for convenience and safety, which is what is prevalent in the online banking sector. In the digital age, consumers have access to near perfect information. They can search a wide array of prices for a good or service very cheaply and efficiently by using the myriad of online devices at their disposal. This is true for online banking as well and consumer’s will quickly realise and adapt once they see how online banks are trapping them with hidden charges. Consumer’s can see these costs and explore better possibilities either themselves, or by having these costs highlighted to them, by competing companies such as Deutsche Bank in Belgium, with their innovative ad campaign. It is not up to consumer’s alone to fight these switching costs, which in the casde of online banking, is often not a monetary cost but merely the hassle or annoyance a consumer would experience in switching his/her bank payments. The opportunity cost of using this time for other endeavours, even for leisure, is what comprises the switching cost in this market. As illustrated above by the Deutsche Bank case, other businesses attempt to highlight and expose these switching costs, and offer an alternative, albeit with an ulterior motive. Regulators, and financial authorities also have a part to play in regulating online banking so as to limit the switching costs they ultimately impose upon often unknowledgable consumers. In a case study by Claire Matthews on New Zealands online banking it was found that switching costs pervailed yet the financial regulators gave these issues limited attention. Matthews explored the options available to regulators to limit the switching costs facing consumers, paying particular attention to the hassle, effort and time consuming nature switching online banking involves. She suggests bank detail portability, similar to phone number porting, which had such a profound effect on the Irish telephone market when it was implemented on July 25, 2003. In an industry where switching costs involved immense time consumption similar to onloine banking case, number porting essentially nullified this cost and made it extremely easy for consumers to search for the best deal available across providors and then choose accordingly, without having to consider any time consuming switching costs. Sources: http://www.nytimes.com/2011/10/16/business/online-banking-keeps-customers-on-hook-for-fees.html?pagewanted=all&_r=0 http://www.ipdigit.eu/2012/01/1159/ Claire Matthews, “Switching Costs in Banking: The Regulatory Response”, November 2009 http://www.comreg.ie/_fileupload/publications/odtr0103.pdf http://www.three.ie/keepyournumber Show less Reply Masson Martin 10 February 2015 First of all I want to react at the assumptions made in this article by speaking about the switching costs. And tackle the Belgian banking sector case. The value accorded to the online banking services are most of the time free or included in the price of the account management to push client to use this services in the purpose…Read moreFirst of all I want to react at the assumptions made in this article by speaking about the switching costs. And tackle the Belgian banking sector case. The value accorded to the online banking services are most of the time free or included in the price of the account management to push client to use this services in the purpose to reduce the costs of manual transactions that are higher. In addition to that we can see on the website of the Belgium federation of financial sector (Febelfin) in the rubric interbank mobility(https://www.febelfin.be/sites/default/files/files/service_de_mobilite-v30-2014.pdf) that in Belgium the switching cost are completely free and that lot of things are taken in charge by our new bank to facilitate the switching. It is clear that if the costs linked to a shift were high, less people will want to make the change but here it is not the case because online banking and switching cost are null. The competition remains fierce There is for me no causal link such as Nelson D. Schwartz suggested. In my opinion there are others reasons that make a client stay in his bank and that the number of bank changes requests in Belgium were reaching only 60.818 in 2014 (https://www.febelfin.be/fr/service-de-mobilit-interbancaire/le-service-de-mobilit-interbancaire-en-chiffres) Firstly the banks, despite the online banking, try more and more to increase the loyalty of its customers by paying attention to their satisfaction. The personalization of the service is the appropriate term used. Thereby, customers feel supported and treated as a unique person for which everything is done to attempt his own needs and do not want to change.(https://www.belfius.com/FR/publications/nouvelles/2014/Campagne95.aspx?firstWA=no) Secondly, the cross selling is practiced by a series of banks. People are obtaining better conditions for their credit or investment when buying others products from the same bank. Having this kind of contract means better conditions on the credit. But ending those contract involves a series of additional fees that can make the change valueless A third and last reason is that banks are all offering approximately the same products/services conditions and when something is a bit more attractive in one bank another one will be less attractive. There are only « the shoppers » that make use of the competition. But sometimes they threat to change and favour will be accorded. Show less Reply Linsmeau Hélène 10 February 2015 In my point of view, saying that there is a strict causality between the rise in online service and the switching costs it creates and the decrease in the number of switching by consumers is a too rude conclusion. Indeed, even if online banking increases switching costs it also reduce some other aspect that are less easy to value as…Read moreIn my point of view, saying that there is a strict causality between the rise in online service and the switching costs it creates and the decrease in the number of switching by consumers is a too rude conclusion. Indeed, even if online banking increases switching costs it also reduce some other aspect that are less easy to value as well as the comfort to stay at home to do a payment, … Moreover, in this electronics world I do think that if a bank doesn’t propose online platform, it becomes a disadvantageous “feature” for it. Concerning the concurrence, this is true that switching costs play the role of entry barriers. Indeed, only a small-scale entry is possible (by putting the assumptions hat the consumers are heterogeneous and that there isn’t economies of scales). But, on the opposite concurrence might become more “rude”. Indeed, consumers have more abilities to compare and choose the bank they want. In the rest of my comment I will focus more on switching costs in general into the bank sector because I believe that online banking is not the biggest explanation of the switching costs strategy into this sector. Banks have incentive to create switching cost; even if « competition can mean that firms price very low, even below cost to attract new customers. » ; firms will use the « bargain-then-rip-off pricing » strategy (Farrell & Klemperer). In this strategy, a company begin with low prices in the purpose of attracting new customers and then (once their basis of client is sufficient ; so, once the market is mature) they will increase their « exit » costs. In other word, a bank has less incentive to put low price when its customer’s portfolio is bigger. So, each banks will define its prices in comparison to the smallest one (with the smallest number of customers) which is the more « aggressive » bank on the market (Daley). Indeed, clients will not switch of bank if the difference offered by the new one doesn’t compensate the switching cost that its current bank implies. A second argument « against » the quote that justify to implement low switching costs to attract new clients is that a bank may apply a price discrimination process. Indeed, banks propose different account for young people, in the purpose of attracting them and once they are customer and they become older ; these persons don’t have the young advantage yet but stay within the bank due to the switching costs. The last reason that is related to this quote is that switching costs are not all money related ; indeed, the majority of the people choose a bank because their family is in that one (and parents choose for them when they were young), because of the reputation or the location of the bank,… all these factors influence consumers, they are different for each one and independent to the bank’s choices. Finally, the switching costs are a complex subject and cannot be analysed globally. Several research about switching costs in the bank sector show that, there are two « groups » of bank. In one hand, the one with relatively small market share ; in which banks keep approximately the same level of switching cost. On the other hand, the big firms don’t face a high price-demand elasticity from their customers and so, impose completely different « exit » costs. Research also explain that it is more relevant to analyse the switching costs by product. Indeed, banks put high costs related to the current account but small exit costs when it is associated to the credit services. In conclusion, I believe that online banking, concurrency and switching costs have correlations but are a too difficult and complex subject that we cannot confirm the way they influence each other. Indeed, it implies to take into consideration some subjective and non money valuable factors, the different products,… References used :  http://www.nytimes.com/2011/10/16/business/online-banking-keeps-customers-on-hook-for-fees.html?pagewanted=all&_r=0  http://www.hec.fr/heccontent/download/4775/115104/version/…/6361998.pdf  http://www.entreprises.gouv.fr/files/files/directions_services/secteurs-professionnels/etudes/nasse-annexe10.pdf  http://www.nuff.ox.ac.uk/users/klemperer/Farrell_klempererWP.pdf  http://webarchive.nationalarchives.gov.uk/20140402142426/http://www.oft.gov.uk/shared_oft/reports/comp_policy/oft655.pdf  http://www.banqueducanada.ca/wp-content/uploads/2010/09/domowitz-f.pdf Show less Reply Rita Ribeiro 5 April 2014 Schwarz’s article encompasses advantages and disadvantages of online banking, from the perspective of different agents. However, in his point of view, this new interface has contributed to both create switching costs and reduce the competition in the US banking system. In my personal opinion, and agreeing with the last sentence of the article, “it’s very convenient” tool which lead to…Read moreSchwarz’s article encompasses advantages and disadvantages of online banking, from the perspective of different agents. However, in his point of view, this new interface has contributed to both create switching costs and reduce the competition in the US banking system. In my personal opinion, and agreeing with the last sentence of the article, “it’s very convenient” tool which lead to emphasize some major drawbacks of the previous, along this comment. On the basis of the article, several of the arguments justify a critical assessment. To begin with, it is highlighted that it is not simple to move an entire life to other bank, which I only partly agree with. Indeed, recent technological developments have made it easier to transfer historical data for instance, which should be balanced by working with different banks. Despite the aforementioned lock-in, it is also underlined a monthly fee of $5 with an exemption on the abovementioned fee to valuable customers. Whereas that fee can be a consequence of the decrease of other revenue sources, stemming from automatic deductions and electronic checks, the fact is that online bank should not be seen as consequence but as a rewarding tool, since it has been contributed to banking downsizing. Furthermore, given that several banks are setting identical fees, this may suggest a collusive behaviour, which leaves room to regulation. Therefore, it was stressed a bill presented by Miller in order to make easier for customers to change. Subsequently, it is argued that online bill paying was advertised as a benefit, and now turned out to be an inconvenience to move to another bank. Nevertheless, currently online banking is a common feature of the financial system, being an option and not an obligation, associated with a decrease in transaction costs, such as transportation costs, eventually without default interest for payments delays, and for sure less time consuming. In addition, numerically speaking, according with Eurostat recent data that I found available, the share of individuals that use internet to online banking increased from 25% in 2007 to 42% in 2013; in Portugal, respectively, almost doubled from 12% up to 23%; in contrast, Norway accounts with the highest percentage in 2013, with 87%, which compares with 71% of 2007. Finally, by way of illustration, the article enhances that only 7% of consumers switched banks, in 2011, and 12% less one year later. Besides switching costs, many other factors have an influence on this consumer inertia which “is powerful in the banking industry” as pointed out, namely: convenience, trust, loyalty, satisfaction, among other behavioural aspects. Currently, banks are starting to introduce some financial expenses within online banking, related with automatic payments and inter-account transfers, as a way of receiving additional revenues. Despite the fact that switching to a different bank may induce temporary advantages, sooner or later, we will end up in an identical situation, since new customers are commonly more attractive. However, the advantages of online banking, in my opinion, more than overcome the past transaction costs. In the article a lowyer referred that “a product that was marketed to customers as a convenience is now being used against them”. As said by Eric Leiserson, (a senior research analyst) “I disagree with the notion that the consumer is a victim in all of this,” and indeed I need to subscribe this statement. In addition, questions have been raised in the article to assess switching costs and competition effects, associated with online bank, but in my opinion there are several other possible explanations that are lacking in the article. Beforehand, the internet is changing traditional behaviour, and the electronic banking offers unquestionable benefits to consumers either in the flexibility or in the cost of transactions. Turning now to the theoretical framework, it should be interesting to define switching costs. Therefore, switching costs are related with the opportunity costs that a customer may face in the case they decide to move to a different supplier, which is linked with the market power that firms encompasses when a client is locked-in. Following the approach of BP’s book (2010), regarding the sources of switching costs, some of its features are present for the online banking system in particular, and for banks in general. Firstly, transaction costs of choosing another supplier requires time and effort, as well as search costs, and in a disruptive way since seller-customer specific information is misplaced in the process as is the case of transfers identification, bills payment, among others. Secondly, contractual costs may lock the consumer in for a certain period of time, with compensatory or liquidated damages, especially in the case where loans exist or even when complementary products are compulsory, in order to get enhanced conditions or even proposal approval; in this case, having online banking is only another product that need to be kept as long as the other ones remain. Subsequently, compatibility costs are a constraint on online banking especially when referring to firms, since they commonly develop specific interfaces both with cash management and accounting software systems, which may be not compatible in the case of switching; therefore, in this specific feature the problems are related with software interfaces as well as information and databases that would demand a change of the format. Fourthly, learning costs also contributes to remain in the same system given the efforts and the previous knowledge on the online banking platform, although in my opinion nowadays this is less a problem since all banks share an identical and user-friendly interface; more important is the way of confirming an operation which remains different from bank to bank, either using a mobile text message code or a matrix card, and in the firm’s case it has different rules on how many people should participate in the process, which may amplify the spending time on acquiring new knowledge with. This type of switching costs tends to rise with time. Related with the previous two points, the dual sourcing applied to simultaneously working with different banks is the best way to diversify risk. Fifthly, uncertainty costs related with the future linkage with another online banking interface, as well as another bank, can only be assessed on a subsequent stage; in the firm’s case is even more complicated which would also depend on how stakeholders are going to react (for instance their clients may continue to pay to the initial bank; employers would probably be affected on the wage delay if they are now from another bank). Moreover bank’s equity stability may be also a concern, which is amplified by the recent global crisis. Another important issue to address in this case is how the bank would manage the situation when a client is affected by an online-fraud taken by hackers; On the bank’s perspective, uncertainty costs are also present because of possible adverse selection of future unknown clients. Finally, the psychological costs of changing ingrained habits or perhaps the current satisfaction is unquestionable; also the fact that our family are linked to the bank could be important. For instance, in the Portuguese case, a cheque contains information about the initial date of the account, which can be useful to inspire confidence in payments. Additionally, one important question raised in SV’s book (1999) is if “Do you really know you are getting the best deal possible? Will your search behaviour or loyalty change as more vendors become available on-line?” and this is indeed crucial. Even if search costs fall, however, there will always be some degree of pure consumer inertia and loyalty. As stated in SV’s book (1999) the “friction-free” economy as advocated in the modern era is fiction. “Like it or not, in the information age, buyers typically must bear costs when they switch from one information system to another”. Notwithstanding, “switching costs are the norm, not the exception, in the information economy”. But the same computational power that reduces these frictions allows for the creation of new “synthetic frictions”. The common criteria to choose a bank has more to do with standard operations rather than online banking, since nowadays all the banks offer an identical service. Thus, banks should be focused on their core operations and compete to offer the best conditions. Just to deliver a particular example, Portugal banks do not charge commissions on online banking operations in the case of households, only doing so for firms; though, this year it would be likely to change, starting to put some commissions on online transfers from different banks. Regarding the competition effects that are pointed out along the article, a more comprehensive approach should be followed. First of all, given the presence of switching costs on the banking sector, banks tend to compete aggressively for new consumers and therefore it is unclear what the competitive effects are. Notwithstanding, given the presence of a dynamic context,it is possible to identify two contrasting effects on competition if considering ex-ante competition versus ex-post competition. For the former, the competition to get consumers locked-in in the first stage is fiercer the larger the switching costs conducting to “bargain-then-rip-off” pricing (usually lower interest rates in loans, exemption in certain transfer, as well as other potential benefits); in the latter case, demand is less elastic for “locked-in” consumers and therefore banks have more market power on those, which can lead in higher pricing. Until now, the previous sources of switching costs were essentially exogenous, that is independent of the banks’ or costumers’ decisions, but there also exists endogenous switching costs to reward loyal customers such as lower spreads, which may induce higher credit levels, cash-back advantages when using credit card, etc. which would reduce the competitiveness of markets and is called in SV’s book (1999) by “artificial lock-in”. Thereby, it is valuable to manage the entire lock-in cycle. SV’s book raises an interesting question on attracting new customers with high switching costs that correspond to the need of subsidizing them, with potential high future benefits. Moreover, marketing aggressively to influential customers because from one hand, it may induce to others the format in which it insists on receiving information, for instance standards field of identifying payments which are important especially for firms when paying several invoices. Influential clients perceived as leaders may also induce a trustable relationship, as entertainment presenters, football coaches or players, etc. being more frequently used in baking advertising. Recent technological developments also enhance the possibilities of targeted advertising of product design and pricing. The pursuit of several related “multiplayer” strategies are also a convincing approach that is more common nowadays as well as selling complementary products. Acording with an IMF report (https://www.imf.org/external/pubs/ft/fandd/2002/09/nsouli.htm) “banks can provide services more efficiently and at substantially lower costs”. In the previous IMF report it is stated that electronic banking can increase competition among banks, and allows banks to penetrate new markets and thus expand their geographical reach. Furthermore, it should be emphasized the role that pure internet banks are now competing also with the traditional ones with online facilities as complements. Pure online banks linked with traditional ones may also reach further market segments. To sum up, in my opinion, competition is therefore prompted in the internet world. Show less Reply Paul Belleflamme 18 April 2014 Although your comment is a bit long, I invite readers of the blog to read it thoroughly because it contains a lot of very useful information. Elias Pereira 4 April 2014 Online banking, switching costs and competition I would like to address this question as follows. First of all, we should indentify the kind of switching cost that it is concerned. Second, it is important to consider two stages of decision (1st and 2nd stages) and two kinds of customers: the old customers (locked-in) and new customers. The switching cost that is…Read moreOnline banking, switching costs and competition I would like to address this question as follows. First of all, we should indentify the kind of switching cost that it is concerned. Second, it is important to consider two stages of decision (1st and 2nd stages) and two kinds of customers: the old customers (locked-in) and new customers. The switching cost that is at issue is the value that costumers attribute to these services. Suppose, for the sake of argument, the first bank that moves (first mover) to supplying online banking services offers services evaluated by their costumers by 100. We are in the first stage. Even the “first mover” charges a fee of 80, their customers have a surplus of 20 and so new customers are attracted for the “first mover”. Thus, ceteris paribus, switching costs increase by 20 because switching the bank mean a loss of 20. I thing we are all agree that, in the first stage, online banking services increases switching costs and keeps customers on “Lock-in”. However, in the second stage, the others banks perceived threats from the “first mover”. Thus they react supplying the online banking services also. The race to offer online services by banks increases competition among them, translating in greater varieties and qualities of services. Further, competition decreases fees and the switching cost since the surplus of 20 is now supplied by all banks. Therefore, personally, I think that D. Schwartz is not entirely correct in this regard, when he said that online banking services reduces competition. From a general point of view, the online banking services are themselves attractive services since they have package of facilities allowing banks’ costumers to makes their operation more conveniently. As is well known, the main objective of the bank in maximize its profit. The profit is greater the larger is the number of costumers. In the first stage, the first bank offering the services get a competitive advantages by attracting more costumers, less need for vis-à-vis operation and charging extra fees. However, the best response of others banks is to offering these services to keep their client and attracts new ones. This competitive behavior by banks lower the fee charged and increases the variety of services supplied. As result, there are an increase on costumer’s welfare, increase on the profit of banks as they capture all transitions costs by charging fees and decreasing the clerks. We should see the market as has moved from the old equilibrium (stage) to the new equilibrium (second stage) (equilibrium may be technically incorrect since switching costs affects differently each consumer). In the new equilibrium the level of consumer switching is near to zero. So, banks realize the advantage of offering online services (extra fees, fewer clerks) without jeopardizing the consumers’ welfare. These advantages lead banks to charge the lowest price as possible in order to capture new customers while keeping different prices (higher) for old customers (lock-in). In the new equilibrium the advantages of a consumer to switch banks are virtually zero and the switching costs that arise in the first stage with “first mover” disappear. I think that the low level of switching observed is not due to high switching cost but due to degree of customers’ satisfaction. Both banks and consumer are better in the second stage. Banks capture all costs like transportation costs, time required to go an office, and others, in the form of fees. Customers, in turn, receive benefit by joining online services (e.g. instead of paying 100, pay only 80). As Prof. Belleflamme stated, the causality between online banking services and the level of consumer switching should be cautious. The empirical observation that the level of switching has reduced over time may be explained by the fact of the banking market has achieve a new stage where all are offering the banking services, and so no one has incentive to switch as he is satisfied. Show less Reply Paul Belleflamme 18 April 2014 Nice effort to complement the analysis sketched in the post. Jose Luis Morais 28 March 2014 A significant body of theory explores the consequences of consumer switching costs: it highlights the role of “bargain then rip-off” pricing patterns, where a firm makes very appealing introductory offers and raises its prices in following periods. Paul Belleflamme and Martin Peitz (2010), among others, shed some light on this issue. These authors propose a formal two-period duopoly model with switching…Read moreA significant body of theory explores the consequences of consumer switching costs: it highlights the role of “bargain then rip-off” pricing patterns, where a firm makes very appealing introductory offers and raises its prices in following periods. Paul Belleflamme and Martin Peitz (2010), among others, shed some light on this issue. These authors propose a formal two-period duopoly model with switching costs and show that in a framework, where consumers maintain their second-period tastes, firms sell at a discount in the first period but still at a higher price than the one that would prevail without switching costs; switching costs relax price competition (p. 173). Should consumers facing switching costs, not necessarily maintain first-period tastes, then firms would charge a discount price in the first-period and subsequently charge a price equivalent to the price that would be pursued in the absence of switching costs, that is, in this context, switching costs increased price competition. On the other hand in a monopoly model or for that matter, in a collusion set-up, the overall effect of switching costs is neutral, in the sense that the average price and allocation remains unchanged. In his New York Times article, published on October 15, 2011, Nelson Schwartz broaches this issue, following the announcement by Bank of America that it was planning to start charging a $5 monthly new fee for debit card use. At this time online banking and internet services, which were actually promoted by banks as argued by several authors, such as Dennis Campbell and Frances Frei(2009), were fairly common and constituted a convenience for customers and banks alike. One may recall (I do, as I personally experienced it) that as soon as the late 1970s, early 1980s, particularly in North America, the banking system started divulging alternative channels through an ever increasing ATM network. Eventually, with the revolution in computational power and information processing, peoples’ lives became literally entangled with their banks, leading to the statement by Nelson Schwartz that “online banking keeps customers on hook for fees.” On one hand, Mr. Schwartz underlines the uproar caused by such an announcement leading to some Democratic lawmakers asking the Justice Department to investigate whether banks had colluded in setting the fees, thus suggesting that other banks were contemplating similar measures. On the other hand, he cites, for instance, Emmett Higdon, a consultant who managed Citibank’s online bill payment product, who said that “for the consumer, it’s a double-edged sword.” While customers value the convenience, inside the industry “it was known that it would be a powerful retention tool. That’s why online bill paying went free in the first place. Inertia is powerful in the banking industry.” Thus the keywords are inertia and switching costs. We have mentioned Belleflamme and Peitz. Another interesting paper was written by Fed economists Timothy Hannan and Robert Adams (2011) on the way switching costs shape bank pricing, while the economists Moshe Kim, Doron Klinger, and Bent Vale present an interesting empirical study (2003), which shows that switching costs are responsible for a sizeable chunk of a customer’s lifetime value to banks. Claire Matthews (2009) presents a survey and shows that while a significant percentage of customers would like to switch banks, only a small percent do so every year, in large part because of the hassle it entails. In another survey, carried out by Chi Wong (2011) it is confirmed the significant positive effects of customer satisfaction and switching costs on internet-user customer retention. Two Italian economists, Donatella Porrini, and Giovanni Ramello (2004) argue that reducing switching costs would, in fact, have a meaningful impact on competition, which suggests that regulators should look more closely at how to achieve this. Therefore it appears that these papers support Mr. Schwartz’s view that there is a causal relationship between the increase in the adoption of online banking services, the reduction of consumer switching and lower competition in the U.S. banking sector; and does not contradict the first quote that Prof. Paul Belleflamme extracted from a report by the (British) Office of Fair Trading. It would be an interesting exercise to find further developments subsequent to the announcement of the monthly fee by the Bank of America. Another interesting exercise would be to verify if the advertising campaign of Deutsche Bank in Belgium remains in place (online access through the blog page led to an unexisting webpage). One has also to bear in mind that the blog and the papers refer to different markets covering the United States, the United Kingdom, Belgium, Hong Kong, Italy and New Zealand; most likely these countries have different banking market structures. Switching costs probably affect mainly retail banking, since with big corporate loans or underwriting, switching costs are insignificant relative to the amount of money at stake. But corporate business also tends to be inertial, dominated by the same players year after year. In the U.S. the one big exception to this rule came with the repeal of the Glass-Steagall Act, which has been sometimes considered one of the culprits in the recent financial crisis. Whatever its flaws, one thing the repeal of this Act did was likely injecting more competition in the investment-bank business. But since then, the list of usual suspects has remained the same, with the obvious exception of the disappearance of Lehman Brothers and Bear Sterns. References Belleflamme, P., and M. Peitz, 2010, “Industrial Organization, Markets and Strategies.” Cambridge University Press. Campbell, D., and F. Frei, 2009, “Cost Structure, and Retention Implications of Self-Service Distribution Channels: Evidence from Customer Behavior in an Online Banking Channel.” Management Science, Articles in Advance. Hannan, T., and R. Adams, 2011, “Consumer Switching Costs and Firm Pricing: Evidence from Bank Pricing on Deposit Accounts.” The Journal of Industrial Economics, LIX (2). Kim, M., D. Klinger, and B. Vale, “Estimating Switching Costs: the Case of Banking.” Journal of Financial Intermediation, 12 (1). Matthews, C. , 2009, “Switching Costs in Banking: The Regulatory Response.” Massey University, New Zealand. http://www.nzfc.ac.nz/archives/2010/papers/241.pdf Porrini, D., and G. Ramello, 2004, “Competition in Banking: Switching Costs and the Limits of Antitrust Enforcement.” SSRN – id 530483. Wong, C., 2011, “The Influence of Customer Satisfaction and Switching Costs on Customer Retention: Retail Internet Banking Services.” Global Economy and Finance Journal, 4 (1) Show less Reply Paul Belleflamme 18 April 2014 Thanks for your comment. It is an excellent complement to the blog post and I invite the interested readers to follow the references that you mention. Carlos Ortega 12 February 2014 I consider Mr. Schwartz's thought is biased because he is only assessing the effect of switching costs in one part of Lock-in Cycle, that is, when the firms are getting the profit of previous efforts to build up a installed base of consumer and to make attractive breakthroughs like online banking services. This kind of firms usually gains quasi-profits and…Read moreI consider Mr. Schwartz’s thought is biased because he is only assessing the effect of switching costs in one part of Lock-in Cycle, that is, when the firms are getting the profit of previous efforts to build up a installed base of consumer and to make attractive breakthroughs like online banking services. This kind of firms usually gains quasi-profits and not real economic profits, at least in terms of switching cost effects. As The Office of Fair Trade expressed, in the same report, the switching costs can promote the competition in growing markets through innovations to convince consumer to use them, thus the demand is going to increase too. The competition is furthered because the firms have this expectation, so they want to compete in order to obtain the highest number of consumer as possible before the market becomes a mature one. Furthermore, the switching costs phenomena are not a static but dynamic by virtue of the Lock-in cycle. One lesson from this cycle is the fluctuation of switching costs, hence the new firms can take advantage and reinforce the innovation in the market by enter into it and snatch some consumers from incumbents. The only concern as consequence of switching cost is the ex-ante competition. I mean, if the initial phase doesn’t enjoy of enough competition then the incumbents can profit this situation through taking all the few consumers for that Lock-in cycle. That problem can create really economic profit for the incumbents and even a higher average price in the market. The regulatory authorities should be aware of that particular issue. Show less Reply Rubens Moura 12 February 2014 I would like to comment on two questions: (i) the potential reduction in the competition intensity and in consumers’ welfare due to the existence of switching costs (ii) the potential causality of reduction in the amount of consumer switching and their level of welfare. (i) The conventional microeconomics theory suggests that the level of consumers’ welfare is…Read moreI would like to comment on two questions: (i) the potential reduction in the competition intensity and in consumers’ welfare due to the existence of switching costs (ii) the potential causality of reduction in the amount of consumer switching and their level of welfare. (i) The conventional microeconomics theory suggests that the level of consumers’ welfare is positively related with the level of competition that firms face in a market. (if firms are subject to more competition, they would enjoy from lower market power, which would lead lower prices and higher level of consumer surplus). However, assessing this framework becomes a more complicated task when one intends to analyze the question in a more dynamic perspective, as it is the case of the bank industry. In this kind of markets, it is convenient to qualify the firms’ competitive process in two stages: the first characterized by the moment that firms are questing for new customers and, subsequently, after the purchase of the product. Let us assess the level of competitiveness in each stage. As suggested by the text of the blog, due to the existence of switching costs, the intensity of the competition among firms tends to be low during the second phase. Then, if there is the belief that banks can enjoy from an easy source of money once the consumers signed up for their services, then there must be the case that the banks would be willing to compete intensively to attract new customers at the first stage. This tough competition can be expressed, for instance, when banks decide to offer some free gifts or temporary promotional fees for the use of its products. The welfare of both consumers and banks cannot be predicted without further specifications. All we know is that in the first stage, banks (consumers) tend to have a lower (higher) level of welfare in the moment in comparison to after the second stage is materialized. After all, the economy may end up with a higher level of competition and consumers better off, which contradicts the statement of Mr. Schwartz. One can also argue that the existence of switching cost can intensify the competition within the banking market due to other reasons. For instance, if there are real evidences that banks are incrementing their profits by implementing an online banking service, then why not to believe that other banks that do not offer this service yet may feel encouraged to start operations in this branch? This argument becomes even more strengthened, if we believe that the online banking service is inserted in a “start-up” market on which consumers do not have yet a sound idea about their preference rankings (Office of Fair Trading). (ii) Stating that the rate of consumer switching has decreasing over time is not a definitive proof that they are more and more “hooked for fees”. Rather, the reduction on that proportion could also be explained by a diversity of factors. Mentioning some possibilities: (a) improvement in quality of services provided by the banks, leading to a higher level of satisfaction of their clients (b) consumers have started to examine more carefully their decision about what bank to become a client, which could have increased the likelihood that they choose the “best choice” and reduced the “regret of making bad choice”. References: (1) Belleflamme, P. and Peitz, M. (2010) Industrial Organization: Markets and Strategies.Cambridge: Cambridge University Press. (2) Office of Fair Trading (2003). Switching Costs. Available at: http://www.oft.gov.uk/shared_oft/reports/comp_policy/oft655.pdf Show less Reply CB 12 February 2014 Online banking is a service offered by many banks. On one hand, this complementary service is valued by consumers because it increases their satisfaction. It helps them to make their transactions 24 hours a day. On the other hand, it helps banks to threat data in an easier way, but it also allows them to reduce the cost of performing…Read moreOnline banking is a service offered by many banks. On one hand, this complementary service is valued by consumers because it increases their satisfaction. It helps them to make their transactions 24 hours a day. On the other hand, it helps banks to threat data in an easier way, but it also allows them to reduce the cost of performing many transactions. So it’s a win-win situation for both consumers and banks. However, as consumers are accustomed used to their bank, through their experience, they get some capabilities specific to their bank. Those capabilities can indeed act like switching costs; and banks can take advantage of it and increase their profits by selling complementary products. That kind of switching costs might be one reason that explains why customers don’t change banks but it’s certainly not the only one. For example, if consumers are satisfied with this service they might not want to change, as they might not even know what the other offers are and if they are better. Customers are worried about the security of their transactions so there is a need to trust the banker. A trust relationship is created, which is also part of switching costs. Switching costs do exist but they aren’t only created by online banking services. What’s more, there is also a search cost. It takes time and money to consumers to find information about other banks. So there is a relationship between the online banking service and the reduction in the level of consumers switching. But it’s not the only factor to take into consideration. We know now that online banking service does imply switching costs that might or might not lead to discourage consumers from changing bank. But does a low level of consumers switching lead to a lower competition? It’s not easy to say but I do think that yes, it does. I think that consumers that are satisfied with their banks (with or without online services) won’t change as it’s a service that implies trust. Having a bank it’s not like other services; it’s a decision that you make for a long time. Banks won’t have a lot of consumers changing bank for them. But banks still have the possibility to attract new young consumers (that still don’t have any bank) by making all information available. To conclude, I think that a low level of consumers switching lead to a lower competition but it’s not only because of the implementation of online banking services. Sources: Chapter 10: Banking industry: Structure and competition. Box1: E-finance (p.236) http://home.cerge-ei.cz/pstankov/Teaching/VSE/Reading/Mishkin6.2.pdf Brush T., Dangol R., O’Brien J. (December 15, 2012). Customer capabilities, switching costs, and bank performance. Strategic Management Journal 33(13): 1499-1515. Available from: Business Source Premier, Ipswich, MA. Show less Reply Quentin Castelain 12 February 2014 First of all, I agree with the general idea of this article. I do indeed believe that the increased use of online banking has increased the switching costs for the customers. The shift from over-the-counter banking to e-banking has given more and more responsabilities to the customers, whom does not need to go to a clerk to manage his day-to-day banking.…Read moreFirst of all, I agree with the general idea of this article. I do indeed believe that the increased use of online banking has increased the switching costs for the customers. The shift from over-the-counter banking to e-banking has given more and more responsabilities to the customers, whom does not need to go to a clerk to manage his day-to-day banking. It is, according to me, that shift in possibilities and responsabilities toward the customer that has also increased the switching costs. Indeed, the fact that a customer now has to do his banking by himself, only supported by the bank’s website or smartphone application has made it harder and harder to switch banks, as two websites will never have the same utilities or have the exact same features, and there is no clerk to do the switching for you. So yes, it keeps customers on the hook because of higher swtching costs But I disagree with the point made that it also reduces competition in the banking sector. I reckon the shift towards e-banking has changed the way competition occurs. As stated by Hippolyte in his comment, the shift towards internet banking has made place for a lot of new banks. But, due to the high switching costs, those banks – as well as existing ones – need to rethink their ways of being competitive. As it is very hard to switch banks, they can not longer “just” offer higher interest rates to be competitive. They need to either reduce the costs of being a customer of the bank, or they need to be able to reduce the switching costs to a minimum. Deutsche Bank, with its advertising, is a good example of it. But we now also see banks offering new clients a “switch kit”. That kit is a service offered by the bank to attract new customers. It collects all the data from the customer’s bank – saved beneficiaries, montlhy paiements to be done, … – in order to reduce the switching costs to a minimum. In a way, those marketing packets are just an updated version of the old services offered by the banks, where a clerk took care of everything for you, but that is the kind of differentation that is now needed to be competitive in the banking sector and attract new clients. So, event though we cannot neglect the impact of e-banking on switching costs, I reckon the main impact it has on competitiveness in the banking sector is that banks will need to understand the shift that is needed in order to differentate themselves. J. MacDonald (2008), ‘Switch kits’ help depositors jump ship, http://www.bankrate.com/finance/checking/switch-kits-help-depositors-jump-ship-2.aspx P. Laksamana, D. Wong, R. Kingshott and F. Muchtar, Switchng costs and Socal bonds in a blended bank service environment, http://www.academia.edu/1874283/Switching_Costs_and_Social_Bonds_in_a_Blended_Bank_Service_Environment Dr. D.. Cheng (2012), An Analysis of Customer Switching Internet Banks in Hong Kong, Show less Reply Hippolyte Dispa 12 February 2014 First of all I would like to say that the fact that switching costs reduce the ability of consumers to easily switch banks is quite obvious but that it does not necessarily play a role. Lets look at the obvious scenario where customers might well be satisfied with the quality of services that they are currently offered by their bank…Read moreFirst of all I would like to say that the fact that switching costs reduce the ability of consumers to easily switch banks is quite obvious but that it does not necessarily play a role. Lets look at the obvious scenario where customers might well be satisfied with the quality of services that they are currently offered by their bank and do not wish to switch. In that case, whatever be the switching costs, they would have no impact on the turnover rate. This is the idealistic situation but in reality people’s opinion and perception of the quality of the received service fluctuate over time. Let it be from a loss of trust in their banks or from the discovery of more interesting offers on the market, customers may be tempted to transfer their accounts to other institutions. In that case, switching costs do indeed reduce transferability. That is true both with physical accounts as well as with online accounts and due to the large number of complementary services offered by the latter, it may well be even harder to switch as the article argues. What I understood from the article is that switching costs induced by online banking reduce the overall competition in the banking sector: that is where I disagree. I believe that online banking has allowed many new actors to enter the market of banking institutions be it in the US or even in Belgium (Beobank, Keytrade, HelloBank…). With regards to that aspect of competition, there are proofs that competition has indeed increase thanks to online banking services. They indeed reduce entry barriers as costly physical infrastructures are not required and they also increase the availability of alternative choices for consumers. They have multiple alternatives to compare and are more able to leverage gaps between the different offers. If we now focus on second-stage competition where consumers balance the different offers and choose the one they believe to be the most suited for their needs then the competition level might indeed be reduced because of switching costs. The key is thus to evaluate the impacts of online banking both on the first-stage competition where institutions enter the market and on second-stage where customers draw advantages of different offers and evaluate the final sign of the equation. Dr. David S.Y. Cheng, An Analysis of Customer Switching Internet Banks in Hong Kong, The Journal of Global Business Management Volume 8, Number 2, August 2012, consulted through http://www.jgbm.org/page/14%20David%20S.Y.Cheng.pdf Brush, T. H., Dangol, R. and O’Brien, J. P. (2012), Customer capabilities, switching costs, and bank performance. Strat. Mgmt. J., 33: 1499–1515. doi: 10.1002/smj.1990, consulted through http://onlinelibrary.wiley.com/doi/10.1002/smj.1990/pdf Show less Reply Marina 11 February 2014 Probably the main goal for every economic organization is to offer such products and services that would maintain the loyalty of existing clients and would attract new. Online banking is certainly an important move in the right path since the convenience of the customer and the banker are concerned. Online banking is an lucrative aspect of banking that nobody can…Read moreProbably the main goal for every economic organization is to offer such products and services that would maintain the loyalty of existing clients and would attract new. Online banking is certainly an important move in the right path since the convenience of the customer and the banker are concerned. Online banking is an lucrative aspect of banking that nobody can resist. Online banking helps you become more of a banker, running your accounts every day. Recent studies have shown that 61% of the internet users do their banking online and 35 percent of cell-phone owners use mobile banking. These rates clearly show that this relatively new service is useful for the clients. It is a way of skipping the queues and managing time better. Since online banking is introduced on the market people rarely have to go to the bank office. In this way you can choose a bank that doesn’t have convenient branches. Since ATMs have been designed to offer cash deposit services as well, you don’t need a bank clerk to do that service for you. Although that for the moment online banking is seen as a way of increasing switching costs, it is a difficulty that have to be overcome. Through online banking the whole bank industry is transforming and soon the old office might be substituted by new entirely online service or the so called online banks. Using online banking service should have the opposite effect on bank switching. All the conditions offered should be more easy to understand as customers are more and more involved in the process of banking. Furthermore Switching to new bank should be much easier. For example in England, under the new Current Account Switch Service, you’ll be able to nominate any switching date to move to your new account, provided it is seven working days. Before the guarantee, switching took about 18 to 30 working days. http://www.moneysavingexpert.com/news/banking/2013/09/you-can-now-switch-bank-in-seven-days-time-to-ditch-and-switch http://www.academia.edu/4965030/E-Banking_Loyalty_A_Review_of_Literature http://moneyfor20s.about.com/od/findtherightbank/tp/Should-I-Switch-To-An-Online-Bank.htm http://money.usnews.com/money/blogs/my-money/2013/08/16/when-you-know-its-time-to-switch-to-an-online-bank Show less Reply Spiderman 6 February 2014 I personally feel uneasy with a number of points made by Nelson D. Schwartz. First, Mr Schwartz argues that online banking has created new switching costs. He refers to Mr Speck who would like to switch, yet “is staying put after being overwhelmed by the inconvenience of moving dozens of online bill paying arrangements to another bank.” In this example I…Read moreI personally feel uneasy with a number of points made by Nelson D. Schwartz. First, Mr Schwartz argues that online banking has created new switching costs. He refers to Mr Speck who would like to switch, yet “is staying put after being overwhelmed by the inconvenience of moving dozens of online bill paying arrangements to another bank.” In this example I fail to recognize any sort of switching cost that Mr Speck would not incur in the absence of online banking, were he to switch banks. Mr Speck would have to notify employers with regards to the deposit of wages, commercial enterprises (e.g. Electrabel, Proximus, Belgacom, The Economist, etc.) wrt automatic withdrawal agreements, and tenants wrt the payments of rents just as much as in the case of online banking. In fact, from a technological point of view, I could well imagine that the digitalization of asset management might eventually allow for a significant reduction in switching costs were companies to develop services that facilitate the transfer of assets from one bank to another, AND were banks to adopt these technologies. From an economics point of view it would be interesting to investigate under what conditions (if any) banks would like to adopt such technologies (i.e. under what conditions banks would want to reduce switching costs). See for instance Gehrig and Stenbacka (2004) who allow for endogenous switching costs and find that companies maximize them. It wouldn’t surprise me, however, if under some circumstances banks could find themselves in a prisoners’ dilemma where they individually adopt switching cost-reducing technologies to their mutual detriment. Note also that the existence of switching costs not necessarily increases industry profits in a dynamic game since companies might initially engage in fierce competition for market share in view of the higher rents that can be extracted from locked-in customers. Note also the relevance of the nature of switching costs for their effects on the economy. For instance learning costs occur only once; you won’t incur learning costs if you chose to come back to a product that you have already consumed in the past. Transaction fees, however, which inevitably form part of a switching process will be incurred even in the case where you come back to a product that you have already consumed in the past. Similarly, from a bank’s point of view the adoption of a technology which reduces costs for rival banks’ customers to switch to the adopting bank could well be adopted while it seems totally unrealistic for a bank to adopt a technology that allows consumers to switch more easily to a rivaling bank (unless perhaps if there is some sort of reciprocal agreement between banks). (On the importance of further specifying the form of switching costs see for instance Klemperer, 1987; Nilssen, 1992; Björkroth, 2010: 184-188). Prof. Belleflamme’s learning costs argument based on the notion that the switching consumer would have to get acquainted with a new interface is more plausible. This being said, again, I don’t believe that this alone is sufficient to explain the observed reduction in the level of consumer switching. In fact notice that by nature the appearance of online banking must coincide with a deeper penetration of PCs and the internet in the population. The internet has also brought about an increase in transparency and with it a reduction in search costs which mitigates (and, who knows, potentially offsets) the increase in switching costs due to the rise of learning costs. In light of the above, there is an obvious problem in Schwartz’s chain of reasoning. He observes the appearance of online banking, a reduction in switching and the levy of positive online banking fees, and concludes that online banking has increased switching costs. This then to him explains the observed reduction in consumer switching. But as already stated in the above there is no convincing argument to be made for an increase in switching costs to the point that a significant reduction of switching could be observed. So what else could explain a reduction in switching? To answer this question one would need to have a closer look at consumers’ switching behavior in the past few years. Unfortunately I was not able to get hold of any such dataset so I will give you two theoretical arguments that could be consistent in case that the previously higher degree of switching observed by Javelin Strategy and Research was only a temporary phenomenon. Both arguments rely on the notion of a shock-induced departure from equilibrium and transition to a new equilibrium. The temporary increase in consumer switching then reflects the period of disequilibrium. The shocks: (a) online banking as a disruptive innovation; (b) bubble bursts. (a) With the appearance of online banking we undeniably experienced some (innovative) disruption in banking services, banks having to reconsider their business plan. Following the commercialization of online banking, banks potentially want to reposition their “product” (i.e. the bundle of services) and the tariffs to which these services are offered while keeping in mind their competitiors’ repositioning. In fact online banking has enabled new business opportunities and possibilities of product differentiation to upspring. So for instance ING has considerably reduced the number of branches and staff thereby reducing its physical network. It has also launched a 100% online current account (ING Lion Account). Dexia on the other hand allegedly expanded its physical network (as a reaction?), see http://trends.levif.be/economie/actualite/banque-et-finance/web-ou-pas-dexia-mise-350-millions-d-euros-sur-ses-agences-belges/article-1194673603696.htm. Further, notice the emergence of 100% online-based banks like BinckBank, which target a specific consumer segment that is willing to sacrifice the possibility for face-to-face encounters for other advantages (in the case of BinckBank: low fees on stock exchange transactions). (Note also that consumer “sacrifice” can be mitigated by “shopping around” at different banks. In fact, in many cases, like mortgage, banking doesn’t figure as a good one stop shopping example). From the consumers’ point of view, the introduction of online banking and the tumult caused on the positioning of banking products might lead to mismatch between consumers and their respective banks. This could be corrected through switching. This would translate in a period of increased switching followed by “business-as-usual switching”. b) In periods of crises, bubble bursts and general discontent with some financial institutions’ unethical behavior, one can identify a number of other motives for switching banks (preventive switching to a bank that is deemed financially more stable, or portioning of ones’ deposits in a number of banks for portofolio risk diversion reasons and to reduce financial liability in Cyprus-like scenarios). Undeniably, the period starting with the Lehman Brothers bankruptcy in 2008 was one of the sort. Again such periods temporarily increase the number of switching until things go back to “normal”. Björkroth, Tom (2010): Exchange of information and collusion – Do consumer switching costs matter?, European Competition Journal, 6(1), 179-196. Gehrig, Thomas and Rune Stenbacka (2004): ‘Differentiation-induced switching costs and poaching,’ Journal of Economics & Management Strategy, 13(4), 635-655. Klemperer, Paul (1987): ‘The competitiveness of markets with switching costs,’ RAND Journal of Economics, 18(1), 138-150. Nilssen, Tore (1992): ‘Two kinds of consumer switching costs,’ RAND Journal of Economics, 23(4), 579-589. Show less Reply Pauline de Grady 21 February 2013 I don’t think there is a causal relationship between the increase in the adoption of online banking services and the reduction in the level of consumer switching from bank like Mr. Schwartz asserts. Indeed, these hassles of switching such as the possible disruption to service and the need to learn new systems at the new bank are also present when…Read moreI don’t think there is a causal relationship between the increase in the adoption of online banking services and the reduction in the level of consumer switching from bank like Mr. Schwartz asserts. Indeed, these hassles of switching such as the possible disruption to service and the need to learn new systems at the new bank are also present when you want to leave a bank that doesn’t provide these online banking services. Furthermore, as presented in the report published by the Office of Fair Trading, it isn’t true that the low level of switching imply that the switching costs are high and that it’s related with the online banking services. An important point to raise is that the banks maybe want high switching costs so that the consumers don’t go away from them but they would also benefit from lower switching costs so that the consumers can move to them. Concerning the competition issue, I do believe there is a relationship between the high switching costs and the lower competition among banks in the US. In my eyes, high switching costs discourage customers from switching to another bank. This can generate monopolistic profits for the banks that can equal the total switching costs and something has to change here. It’s a high disadvantadge for the customer. To conclude, I agree with Mr. Schwartz when he says that switching costs reduce competition in the US banking sector but I don’t believe that it’s the online banking that creates these costs. Show less Reply Daniel Scurtu 21 February 2013 Interesting point. To evaluate the claims about switching costs, we should first look at the situation more carefully. Where do they come from? Short version: automation. People who use the latest features simply link their bank account to the electricity company's website and their account there, and everything is done automatically every month. Assuming you don't lose your job and your…Read moreInteresting point. To evaluate the claims about switching costs, we should first look at the situation more carefully. Where do they come from? Short version: automation. People who use the latest features simply link their bank account to the electricity company’s website and their account there, and everything is done automatically every month. Assuming you don’t lose your job and your account is emptied, you will never have to deal with that again. A few years ago, it was different. You had to get online every month and plug in your credit card number on the electric company’s website, so you were just paying like you were buying another product. Before that, there was no online option. The biggest change was the move to online credit/debit card payments, the automation is just a simple step away. The perceived switching cost comes… for lack of a better way to put it… from people being lazy. There is also a discounting process here, future discounting and discounting of banking fees (if they indeed have an option where the banking fees are lower). In reality, if you offered someone 12 euros to pull out their card and pay the utility company directly every month, or offered a discount of 12 euros for the bills every month, they would probably do it. But in the case mentioned above, they won’t do it, because they discount the link. So automation and discounting are an issue here, and I think banks rely on this. As for banking fees and switching costs… those existed well before online payments. But consumers aren’t comparing then and now, they are comparing now and now. Even in the 1990s banks found all sorts of little reasons to insert a fee here, a fee there, just like a lot of companies of any profile. A good example of this are phone companies. Even with the readily available information nowadays, where you can see exactly how many seconds you talked to each phone number, they still sometimes overcharge: for instance, if you talked 3 minutes and 50 seconds, they might occasionally charge you for 5 instead of 4. This happens in the US with, I understand, virtually every company. I know it happened in Romania when we had a communications monopoly and it happens after the market was flooded with suppliers. And I’m pretty sure it happens with a lot of companies all over Europe. If you point this out to your company they will reimburse you, but they will still do it to all the other consumers. What’s sad is that consumers aren’t fighting for their rights more. If any regulation is attempted, banks will just say “it’s common practice” and “if consumers aren’t willing to fight for their rights, why should anyone else”. Banks know the behavior of consumers very well, and they are taking advantage. In this case, competition might take a completely different turn. If one bank introduces a new fee in a subtle way, if the rise is small enough, they won’t lose any customers. This provides the competition with the opportunity to increase their profits by introducing the same charge. And this upward trend can last, in theory, until one bank comes in to remove enough charges that they will gain a considerable share of the market. Unfortunately, there isn’t one charge, there are many, so instead of a cycle, we’re more likely to see a smoother pattern. Does anyone know where we can find some data to check this? I think it would be interesting to look at a time series of banking fees and bank switching. And finally, the switching costs are also amplified by the recent boost in distrust. This distrust may cause enough skepticism when a really good offer shows up by making it look “too good to be true”. A consumer might think that the lower fees are just temporary, and other hidden fees will appear later, once he engages in more operations. It’s similar to the distrust of all politicians: if you trust nobody, you’d rather face the enemy you know than the enemy you don’t. A little anecdote for you… When I was in the US, I had an account with Citizen’s Bank (yes, I know, the irony…). Besides all the annoying banking fees, they charged a ridiculous flat rate when receiving a wire from abroad… after the sending bank assured the sender that all the fees had been paid at the time of sending. When I confronted them on why the branch manager’s reply was “it’s not ridiculous, everybody’s doing it”. As a rule, just because everybody’s doing it it doesn’t guarantee it’s not incredibly stupid. And so, over the course of 5 years, the “receiving money” charge rose from 0 dollars to 35 towards the end. As a solution to banking greed, in my opinion, profit limits should be set to financial intermediation institutions. The externalities of the financial intermediation system are too significant to the rest of the economy, especially when it comes to small/medium entrepreneurs. But that’s not really related to switching costs, so nevermind that. Show less Paul Belleflamme 21 February 2013 Thanks for your thoughts, Daniel. They are interesting but I’d prefer if you substantiated more your claims with references. This is an academic exercise after all. Marie-Clothilde Quarles 21 February 2013 For me, online banking is not the most important reason to justify these high switching costs which explain why clients don’t change of bank. Indeed, the more you stay in a bank, the more you build a trust relationship with your banker, this relationship is very important because it determine for example the amount of loans he will give you.…Read moreFor me, online banking is not the most important reason to justify these high switching costs which explain why clients don’t change of bank. Indeed, the more you stay in a bank, the more you build a trust relationship with your banker, this relationship is very important because it determine for example the amount of loans he will give you. If you change of bank, everything starts over. Moreover, moving money takes time and money. According to an article of the Financial Brand (“Trapped at the Bank: Removing Obstacles To Consumer Choice In Banking”, S. Martindale, Staff Attorney, L. Bowne, S. Attorney, C. Tetreault), a consumer will be really motivated to switch bank only if he meets a noticeable change in service. Indeed, switching bank often means nightmares of transferring automatic deposits and debits to the new one. Still according to this paper, there are also a lot of fees to close an account and receive or transfer funds and “zombie” accounts can appear. It means that some banks reopen old account without the agreement of the old client and it can result in consumers owing hundreds of dollars in fees. I think that all those factors have a bigger impact on competition than online banking, even if online banking decreases even more the competition between banks. To conclude, according to a survey of November 2011, one in five American customers actively considered switching that year but despite this fact, the New York Times showed that only one in fourteen Americans actually did switch banks. Switching costs so huge that clients have no choice but to stay in their bank is a reality that is unacceptable in a society where everything is made by the government to promote competition. I think the government should take measures to limit this phenomenon, for example by limiting the fees for switches. Source: http://thefinancialbrand.com/wp-content/uploads/2012/07/Consumers_Union_Trapped_At_The_Bank.pdf Show less Reply Paul Belleflamme 21 February 2013 Very interesting statistics, thanks. ZHANG HONG 21 February 2013 I partly agree with Mr Schwartz’s opinion. He suggests that online banking creates switching costs and reduces competition in the US banking sector. This may be the initial intension for banks to create online banking services in the first place. However, on the contratry to what they designed, with the development of internet and ICTs, there’s better transparency in information…Read moreI partly agree with Mr Schwartz’s opinion. He suggests that online banking creates switching costs and reduces competition in the US banking sector. This may be the initial intension for banks to create online banking services in the first place. However, on the contratry to what they designed, with the development of internet and ICTs, there’s better transparency in information and consumers can compare services and costs from different banks before deciding which bank they want to be “hooked”. And it’s not “it becomes harder to substitute one service for another”,since there are plenty of offers and services from the various banks to choose. So Online banking services does not necessarily reduce competition and make customers worse off. What’s more, there’s an insightful study by three graduates from university of Chicago that finds that steady-state equilibrium prices may fall as switching costs are introduced into a simple model of dynamic price competition that allows for differentiated products and imperfect lock-in, which is another thought can be applied to this online banking case. And what Mr Schwartz’s predicted“ switching costs decrease the price-elasticity of demand and reduces the consumers’ sensitivity to price increases” will be quite unlikely to happen. Finally, since the online banking will be the natural tendency to make our life easier in the future, the ICTs and internet need to be further developed. Laws and regulations regarding online banking costs, privacy etc from perspective departments should be completed as well. Notes: Jean-Pierre Dubé, Günter J. Hitsch, Peter E. Rossi, Do Switching Costs Make Markets Less Competitive? http://neumann.hec.ca/cref/sem/documents/061207.pdf Show less Reply Paul Belleflamme 21 February 2013 Thanks for the useful reference. Thibaut Debruxelles 21 February 2013 In my opinion I think that there are just a lot of little things that discourage people from switching bank. Those constraining elements prove that switching costs exist in banking domain and that they are raising dramatically. Here are some of those elements I think are relevant and that deserve to be pointed out. First of all we usually are in…Read moreIn my opinion I think that there are just a lot of little things that discourage people from switching bank. Those constraining elements prove that switching costs exist in banking domain and that they are raising dramatically. Here are some of those elements I think are relevant and that deserve to be pointed out. First of all we usually are in the same bank than our parents. Parents create a banking account when children are young and those children receive it when they’re mature enough to spend money. Actually they don’t have any choice. Secondly, as it is said in the text, we are used to our bank. We know where are the offices, we are accustomed to the website, in short it’s “something” we’re used to live with. And to close an account, there are a lot of paper to fill in and to sign. It’s a lot of work to obtain a hypothetical advantage. Speaking about this advantage you could acquire by going to another bank, what are the real benefits of this switch ? Almost all the banks offer the same level of service to the customer : all the necessary net-banking functions are on the website of each bank. Offices are located in most cities and the gifts you receive when you enter a new bank are insignificant. In fact you don’t receive enough to make the effort of switching bank. In a financial point of view, the fee differences between the banks aren’t big in general (there are exceptions like the Deutsche Bank as seen in their marketing video). Moreover the banks are smart : the fee you pay for the bank services don’t appear clearly on your account statements. And you often pay little amounts that seem slight so you don’t pay attention. My last element is about the competitive situation. Banks aren’t fighting each other to acquire some new clients. So the concurrence is weak and banks don’t offer a lot of relevant advantages in case of opening a new bank account. In short you’re not attracted a lot by the other banks. In conclusion the switching costs are really present and are increasing because of the lack of motivation to go to another bank. But banks shouldn’t exaggerate with that : customers are loyal but they still can switch if account fees don’t stop increasing and if the service doesn’t evolve. And marketing advertisements like the Deutsche Bank’s one can open the eyes of a lot of customers who are used to their bank and who finally don’t even have the idea of switching bank. Show less Reply Paul Belleflamme 21 February 2013 Competition among banks is stronger on the credit market. If you need a credit (to buy a house for example), you will typically shop around and see which bank offers the best terms (or simply, which bank accepts to give you a credit). Gonzalez Diego 20 February 2013 First, I would like to talk about change. Humans are creatures of habit, we like our routines. These routines become automatic and simplify our lives. Change on the contrary brings uncertainty which people will tend to avoid. As the saying goes, “Better the devil you know than the devil you don’t know”. Change brings also more work. (1) That said, we…Read moreFirst, I would like to talk about change. Humans are creatures of habit, we like our routines. These routines become automatic and simplify our lives. Change on the contrary brings uncertainty which people will tend to avoid. As the saying goes, “Better the devil you know than the devil you don’t know”. Change brings also more work. (1) That said, we can agree that customers in the banking sector will tend to stay in their bank unless they are given good reasons not to. Banks are well aware of this and are all doing careful calculations about what the customer is willing to tolerate before leaving. Indeed, if the switching cost is greater than the annoyance the customers receive, they will stay. That’s why I don’t find the title of the article written by Mr. Schwartz: “Online Banking Keeps Customers on Hook for Fees” very accurate. Online banking is an excuse used to charge consumer with new fees but it’s not, according to me, the reason why consumers are kept on hook. The difficulty of moving accounts between banks which is used deliberately by banks is what makes the consumers reluctant to switch and thus keep them on hook. Mr. Schwartz sees a causal relationship between the increase in the adoption of online banking services and the reduction in the level of consumers switching between banks. His approach is based on the fact that online banking creates switching costs and that these switching costs are the reason why people don’t switch. There are other point of views. Indeed, a study from ForeSee Results and Forbes.com found that customers who pay bills through their bank’s website are more satisfied with the bank and the online banking experience than those who don’t. As we know, satisfaction is one of the key to keep consumer. Thus, people who use online banking services are more satisfied by their bank and tend not to switch. (2) Notes : (1) Rosabeth Moss Kanter, professor at Harvard Business School, http://blogs.hbr.org/kanter/2012/09/ten-reasons-people-resist-chang.html (2) http://www.businesswire.com/news/home/20070417005054/en/Online-Bill-Payment-Drives-Greater-Share-Wallet Show less Reply Paul Belleflamme 21 February 2013 Would it be fair to summarize some of the previous comments by saying that online banking services both increase the consumer’s satisfaction and switching costs, and thereby the consumer’s willingness to pay for such services? Le Déodic Marie-Laure 20 February 2013 First of all, I think that online banking does not create switching costs. They already existed in the previous system. There are different types of switching costs: financial, procedural and relational (Dahlia and al, 2011). We can cite some examples like “the length of the relationship with the bank”, “the fact that customers knew and were known by the staff”,…Read moreFirst of all, I think that online banking does not create switching costs. They already existed in the previous system. There are different types of switching costs: financial, procedural and relational (Dahlia and al, 2011). We can cite some examples like “the length of the relationship with the bank”, “the fact that customers knew and were known by the staff”, and to finish, the different steps you have to follow to close an account and to open another one in another bank. The difference is that today, with online banking we have financial switching costs and so we can see it and put a value on it. After that, my point of view is that online banking improved the life of the consumers and helped them to save time. Internet is everywhere and banks have to be on internet and offer the bests services to their consumers if they want to be on the top. Moreover, I disagree with N. D. Schwartz because I think that online banking increases competition. Indeed, with internet and the transparency, customers can compare all their possibilities and ask to other users their mind. They also can search on special websites which services (and online services) best fit to their profile and for which bank is the best and finally they can easily open a bank account on internet. Furthermore, there is today a new sort of bank with no physical counters, the banks like “Rabobank.be”, and so new competitors with other advantages and less costs. Finally, I think that an important factor we have to take account is the crisis in the financial services industry. It changes the reaction of people and their risk aversion. People saw the results of the crisis and chose banks which survived and in which they trust. The article “an empirical investigation of the relative effect of trust and switching costs on service loyalty in the UK retail banking industry” underlies the worth of loyalty in the banking sector. So according to me, the most difficult thing to do is to convince new consumers you are the best one for them. This is the step with competition. After that, you have to offer a good quality of services and consumers will be loyal. According to the previous article, the main drivers of loyalty are trust and relational switching costs (contacts with the bank employees). Another observation is that “financial and procedural switching costs exert no significant effects on the loyalty of the consumers”. So if you have good services, even if there are some financial and procedural switching costs, consumers can be loyal and satisfied. source: El-Manstrly, D.; Paton, R.; Veloutsou, C.and Moutinho, l.(2011). An empirical investigation of the relative effect of trust and switching costs on service loyalty in the UK retail banking industry. Journal of Financial Services Marketing, vol 16,2, p 101-110. Show less Reply Paul Belleflamme 21 February 2013 Thanks for the reference. Laurent Cochaux 20 February 2013 Before starting, I have to admit that I don’t really like banks. They are never open, they change of policies all the time, the rates, the clauses … The banks offer us various advantages to stay/enroll in their bank: free phone, free online account, free second card or what else. They say it’s to attract us but I think it’s…Read moreBefore starting, I have to admit that I don’t really like banks. They are never open, they change of policies all the time, the rates, the clauses … The banks offer us various advantages to stay/enroll in their bank: free phone, free online account, free second card or what else. They say it’s to attract us but I think it’s to confuse us. Indeed, all these information aren’t really linked to our money so normally we wouldn’t take into account this information when choosing a bank. This strategy leads to irrational choices made by the customers. About the switching costs, I think it may decrease the competition. If you can’t move from bank, the bank can act like in a monopoly and raise their prices easily. On contrary, we observe in Belgium a trend that allows the customers to open a bank account for free. Open an account for free means that the customer has the possibility ( and for me should do that) to have more than one account. Instead of choosing one, the customer could open different account in different bank. The customer will have more information about each bank and by spreading his money, he would be able to avoid risks and find the best arrangement. But still I think we should remove these switching costs. The regulation about the TIC services in Belgium changed his position this year and allows customers to change of telecommunication provider more easily. They should do the same changes about the bank services. They gain too much power, flexibility and freedom of action. About the switching costs themselves, I read other comments and I disagree with the argument that they compensate old customer habits like “the time and fuel to drive to the bank”. The world is changing; we use much more the internet and I think the bank world should adapt. Internet allows bank to reduce their costs so why do they do the exact opposite? They had some costs while the use of internet costs them maximum an IT employee to build the website.. No, I think they still need to earn money to pay all the (financial) engineers to build financial structure and complex mathematic programs (in order to earn more money). The bank service was “invent” to help people for their growth and investments and now it’s a bit the opposite: the customers have to “help” (unconsciously) the growth of the bank. It’s a non sense.. Show less Reply Paul Belleflamme 21 February 2013 The question about banking costs remains open: is it more costly to operate a network of physical branches or to have a secure and performing information system? By the way, unless the bank is purely offline, both infrastructures (physical and virtual) have to be operated, which increases the costs. Sophie Simonis 20 February 2013 Firstly, there is no doubt that switching costs induce a lower price-elasticity of demand. However, are switching costs for online banking significantly higher than for offline banking? Then, it is true that there is a decrease in the level of consumer switching to another bank, I think it is important to consider that the causal relationship between that and the higher…Read moreFirstly, there is no doubt that switching costs induce a lower price-elasticity of demand. However, are switching costs for online banking significantly higher than for offline banking? Then, it is true that there is a decrease in the level of consumer switching to another bank, I think it is important to consider that the causal relationship between that and the higher switching costs due to online banking is not clear. Psychological aspects can enter the calculation. In fact, consumers who choose their bank do not remain only because switching costs are too high. They may withdraw such a sense of security to belong to this bank. Although consumers are aware that there are banks offering lower fees on the market, many prefer to stay in their bank because they are satisfied with services offered. Moreover, if the online banking increases switching costs, it reduces other costs for the consumer. Indeed, thanks to online banking, consumers can make all payments from home. This leads to significantly reduced transportation costs! This can be seen as a compensatory effect. In addition, consumers are able to compare more easily the various offers on the banking market. Finally, I think it is important to differentiate between new consumers compared to existing consumers. To attract new customers, banks can price very low, like no fees or bonuses in case of accession. This increases competition in the banking market. Then, as we saw above, once consumers are locked-in, banks use higher switching costs to increase the price of services. This leads here to a reduction in competition. Show less Reply Paul Belleflamme 21 February 2013 You are right. Something that should be added is that consumers may well be clients with different banks (as is the case for me), which means that there is no need to switch altogether if one wants to take advantage of specific offers. An Vu Pham 20 February 2013 In the following lines, I would like to give my point of view on the link between online banking, switching costs and competition. I do agree that switching costs might be a brake to the competition between banks but we have to nuance that supposition. Indeed, when you offer a product or a service, the most difficult part is not…Read moreIn the following lines, I would like to give my point of view on the link between online banking, switching costs and competition. I do agree that switching costs might be a brake to the competition between banks but we have to nuance that supposition. Indeed, when you offer a product or a service, the most difficult part is not to find the idea but the way you can get people adopting your idea. People are often reluctant to change and they must feel a very higher profit to accept the change. In the case of online banking, most of the banks are proposing the same features, with a few slight differences. With the fee being a very important factor to clients, a slight increase or decrease of it will not be an incentive for users to switch, especially comparing to all the inconveniences this represents like changing the number of account, warning all your customers our contacts from your change and many others administrative procedures. While most of the people are already subscribed in a bank, the fact that switching costs will indeed prevent newcomers in the banking sectors to be able to attract potential customers. However, we also have to take account of the people who don’t have an account yet (especially young adults) so there is still an opportunity for competition. There are also other factors to take into account like the reliability of the bank. If a bank is not reliable and is not able to respect their commitment, then people will not hesitate to change even though the switching costs are important. On the other hand, a bank with good customer services will keep its customers easier. But the switching costs are not only related to online banking, it’s just more important than in other sectors. As said in previous comments, the telecom sector also faces switching cost than can be important or not following the situation. For example, for someone who has subscribed to a monthly subscription for the next two or three years, the costs of breaking the deal will be more important than for someone who only uses prepaid cards. Furthermore, there are some ways to attenuate the switching costs like allowing the customer to keep his phone number and contact list if he decides to change operator. In IT, there also are switching costs. When you switch from Mac to Windows (or vice versa), you also have to check that your software’s are compatible with the OS, you have to adapt to the new interface, etc. In summary, I think that switching costs might be one of the reasons why people don’t want to change banks but it is not the only one. It can affect the competition but there is still the possibility for banks to attract new customers. As we are now in a society where online communication has such a big part, I think that online banking is a positive aspect. It allows customers to do their transactions whenever and wherever they want and it’s also helping the bank to threat data’s and operations much more faster. Online transactions are already proposed in many other sectors (pay per view for TV, online reloading for phone cards, Playstation Store, PayPal and many others) so there are no reasons why banks shouldn’t use online banking. Show less Reply Paul Belleflamme 20 February 2013 Very good. Marielle Uylenbroeck 20 February 2013 I think we have to take distance from the point of view of the Nelson D. Schwartz’s article. Indeed, the way of using banking services has changed over time. Before enjoying online banking, we had to go to the bank office to be able to make a transfer for example. Now, we can do it without leaving home, without paying…Read moreI think we have to take distance from the point of view of the Nelson D. Schwartz’s article. Indeed, the way of using banking services has changed over time. Before enjoying online banking, we had to go to the bank office to be able to make a transfer for example. Now, we can do it without leaving home, without paying diesel for the trip to the bank office (and we know that would be a huge bill!). Moreover, we can find in Schwartz’s article: “People like online bill pay, it’s convenient and safe,” said Anne Pace, a spokeswoman for Bank of America. “The lower attrition rate that came along with it was simply a result of offering a valuable service.” The fee, she said, “allows us to continue offering the benefits that customers have come to expect from our debit card,” like fraud protection, overdraft prevention and a wide-reaching A.T.M. network. So we can conclude that yes, there are switching costs but in a certain way it is normal to pay the service of not having to go to the bank office. There must be benefits for both sides. We need to think about how much we save thanks to online banking. Similarly, we can read several statements in the article like : “the Internet banking services that have been sold to customers as conveniences, like online bill paying, serve as powerful tethers that keep them from jumping to another institution.” or “marketing studies like the one commissioned by Fiserv, which develops online bill paying systems, showing that using the Internet to pay bills, do automatic deductions and send electronic checks reduced customer turnover for banks by up to 95 percent in some cases.” and finally “there’s even evidence that fewer consumers are switching banks, with 7 percent of them estimated to be moving their primary account to a different institution in 2011, down from 12 percent last year, according to surveys by Javelin Strategy and Research.” In my opinion, those three results are also consequences of not having to go to the bank office. Indeed, for most of us, our primary account is in the bank of our parents. That was already the case when online banking did not exist yet! But the main difference is that before, people chosen the bank that had the nearest agency from home to decrease the time to reach the bank office. And, when children left home, we can suppose that they also changed bank to have the bank with an agency as close as possible. Now, with online banking, we do not care to have a bank office close to our house because we do not need to move! This can explain the reason why people do not change of bank anymore. To conclude, I think that having switching costs is normal but they must stay reasonable. Moreover, the fact that people do not change bank anymore is a result of online banking and not of switching costs. Furthermore, I think that switching costs do not reduce competition from the fact that we can easily find information about them and then, act accordingly. Show less Reply Paul Belleflamme 20 February 2013 I agree with you that switching costs may not be the only reason why customers stay with their bank; it might simply be the case that customers are satisfied with the services that they get and that they don’t expect to receive a better level of service elsewhere. Naert Sophie 19 February 2013 On the one hand, as Internet use is increasing dramatically, banks must update and offer an online service to their customers. They must grow and find a way to withstand competition. Indeed, I don’t agree with the fact that online banking reduces competition in the US banking sector. On the contrary, I think that online banking open the concurrence even…Read moreOn the one hand, as Internet use is increasing dramatically, banks must update and offer an online service to their customers. They must grow and find a way to withstand competition. Indeed, I don’t agree with the fact that online banking reduces competition in the US banking sector. On the contrary, I think that online banking open the concurrence even more than before. Now, small banks can enter on the market, because they don’t need necessarily a real agency, lots of employee etc. There are fewer barriers to entry for these smalls firms. Moreover, via internet, customers can find easily the diverse information about the different banks. They have more access to the different services, offer, etc. So my answer to the question: ‘Online banking services reduce competition and make customers worse off?’ is no, I don’t think so (fewer barriers to entry and transparency of the information). On the other hand, I think it’s important to differentiate the competition when customers are locked-in from the competition to attract new customers. When Mr Schwartz says that competition decreases, I think he talks only about the first situation (when customers have chosen their bank). It’s true that the increase of online bill paying reduces the competition because it increases the customers switching costs. The customers stay in the same bank because of the inconvenience of moving dozens of online bill paying arrangements to another bank. Concerning the relationship between online banking services and the reduction of consumers who switch of banks, I think that Mr Schwartz forget that now, banks try to offer the best to their customers and many of them are satisfied with what they offer. Finally, I think the life for customer is easier than before thanks to the online banking. Now, we can pay our bills, transfer money across our accounts or simply access our account information, whenever we want. These services are conveniences (travelling, energy and time savings) so I think that it’s natural to banks to find a small advantage of this situation. Show less Reply Paul Belleflamme 20 February 2013 Good points! Georgios Asoutis 19 February 2013 There are multiple reasons that could explain the hooked customers in the banking sector. The easily observable and measurable switching costs that are discussed by Mr. Schwartz that can reason the lock-in. Various costs, linked with the switching costs, prevent customers from moving to another bank. Transaction costs,such as the documentation needed in order to open a new primary account,…Read moreThere are multiple reasons that could explain the hooked customers in the banking sector. The easily observable and measurable switching costs that are discussed by Mr. Schwartz that can reason the lock-in. Various costs, linked with the switching costs, prevent customers from moving to another bank. Transaction costs,such as the documentation needed in order to open a new primary account, as well as the search costs of finding a better offer discourage customers. It could be argued that these two types of costs seem to decline over the years as e-governance tackles the bureaucracy and the use of internet minimizes the search costs. On the other hand, there are types of costs that remain high and do not have the tendency to fall.The most significant among them refer to benefits such as discount coupons that bank clients acquire when using credit cards (credit card points). Changing bank makes one to face the cost of these foregone benefits. Even though, it is generally accepted that switching costs remain high and significant in the banking sector, their impact on competition is questionable. The fact that every new generation of bank customers will use internet banking services (i.e.according to New York Times from 44 millions today to 55 million in 2016) is actually a good omen for competition in the sector. Switching costs make customers more valuable for banks and thus the ex ante competition, that is the competition over the new customers, is even more intense but the market still remains profitable. As a result, established banks concentrate on the exploitation of the existing customer base and there are incentives for new banks to enter the market. The existing banks do not need to compete with entrants or pose barriers as this would probably mean that any new attractive products provided to the new customers (e.g. better mortgages) could have been also applied to the existing customer base making profits to fall. On the other hand, the entrants provide their services only to the new generation of customers as switching costs do not allow the competition over the existing clients. In equilibrium, when switching costs are present, every new generation of clients is served by new firms and competition increases. In conclusion, it could be said that existing customers do not benefit from switching costs, but in the long-run the sector becomes more competitive (and future customers better off). Sources: Joseph Farrell & Carl Shapiro, 1988. “Dynamic Competition with Switching Costs,” RAND Journal of Economics, The RAND Corporation, vol. 19(1), pages 123-137, Spring. Paul Klemperer, 1992. “Competition when Consumers Have Switching Costs: An Overview”, Economic Series Working Papers 99142, University of Oxford, Department of Economics Show less Reply Paul Belleflamme 19 February 2013 Excellent references. Thanks Picavet Vianney 19 February 2013 Even if M. Schwartz points out some good relevant facts indeed, I think he omitted to write about two major points that I would like to share now. First of all, we should remind that the emergence of the online banking services has come at the same time as, of course, the explosion of the Internet in our houses. This means…Read moreEven if M. Schwartz points out some good relevant facts indeed, I think he omitted to write about two major points that I would like to share now. First of all, we should remind that the emergence of the online banking services has come at the same time as, of course, the explosion of the Internet in our houses. This means that, in parallel, this new technology led the banks to cope with more competition. Two main reasons for that: first, ICTs allows the consumers to benefit from a better transparency of prices, and so to switch more probably from an expensive bank to a cheaper one; second, Internet enabled the apparition of bank companies without agencies, which have consequent cost advantages. These two factors constrain the companies of the sector to fierce with more competition and so, to lower prices. I would also like to notice, as a second major point, the fact that the increase of the competition has forced the bank companies to make supplement efforts to attract new customers. Thing is, even if there has been a rising of the switching costs on the one side, the competitors, aware of the phenomenon, automatically has to make massive effort in order to palliate these costs to attract new customers. In other words, if the switching costs are important, the attraction offers by the competitors will be relatively as important. In order to illustrate my argument, I would like to make a comparison here with the mobile operators in Belgium. In fact, the sector is really comparable with bank companies on that point: huge inertia of switching in both industries, and switching costs quite important. In return, the competitors try to attract new clients by offering thing more and more valuable in the past years. For instance, we can mention the fact that most operators propose now to the customers to keep their phone number in case of switch, some competitors offer a new mobile phone if they choose to switch, etc. We can observe the same kind of proposals for banks in Belgium: different services totally free for people under 26 years old, some switching fees are proposed for free, etc. So, as a conclusion, how can we explain the fact that consumers nowadays seem to be less likely to switch from one bank to another? Instead of pointing out the increase of the switching costs, maybe we should better look on the improvement of the quality of services offered by the different bank companies, which have substantially grown over the past years due to a fiercer competition. That improvement may simply dissuade different customers to switch to another bank just because now they are more satisfied of the quality offered by their bank. Show less Reply Paul Belleflamme 19 February 2013 The parallel with mobile telephony is well taken. Turneer Benjamin 19 February 2013 In my opinion, I wouldn’t say there’s a link between the decreasing of competition among the bank and the online services. Bank offer a lot of services, like insurance and SICAV, etc. Competition between banks are thus according to me related to the combinaison of all the services and not to one of them. Furthemore, switching costs between banks aren't only…Read moreIn my opinion, I wouldn’t say there’s a link between the decreasing of competition among the bank and the online services. Bank offer a lot of services, like insurance and SICAV, etc. Competition between banks are thus according to me related to the combinaison of all the services and not to one of them. Furthemore, switching costs between banks aren’t only linked to online services. It’s already complicated and annoying to change of banks without considering the online aspect. Besides, the fact that customers can switch of banks because of the cost, the consumer lock-in, implies a strong marketing focused on young people who are choosing their first bank. Switching costs implies thus a change in the strategy of the bank’s marketing and in the target of their ads. Competition deacreses thus and changes of aspect, time and target. Finally, it seem’s following this sentence: “If switching costs are very low then prices may adjust to prevent customers from switching. So a low level of switching need not imply that switching costs are high.” That banks prevent the competition themselves for their sake by preventing customers from switching. Show less Reply Goudeseune Claire 19 February 2013 I think, like Mr. Belleflamme said, that the causal relationship between the increase in the adoption of online banking services and the reduction in the level of consumer switching is a little bit simplifying. Firstly, I think that with the bank crisis, a lot of consumers hesitate to change of banks, preferring the security of their current bank. In my opinion…Read moreI think, like Mr. Belleflamme said, that the causal relationship between the increase in the adoption of online banking services and the reduction in the level of consumer switching is a little bit simplifying. Firstly, I think that with the bank crisis, a lot of consumers hesitate to change of banks, preferring the security of their current bank. In my opinion and like Mr. Belleflamme said, there is maybe a correlation but not specially a causality. A lot of people have the impression that they have the best deal of the market and prefer to be loyal to the bank to continue to have these “best” deals. In the same time, the changing cost can be high if you have an advanced online banking and can so curb some consumers. Secondly, I think that parts of the population who use online banking are most young. They use banking online for small operation like transfer, etc. By instance, I have chosen my bank with my parents. And so, now, like I don’t have a lot of money because I don’t work, I don’t check every day, every month to see which banks is the most interesting. I think that the population who will change and who understand everything in the bank world is not the majority. In conclusion, I think that online banking and the correlation/ causality with other point is in the beginning. Because the users population is being stabilized. Because the crisis bank is not finished. Because a lot of consumers prefer the security for this moment. Take the time for a profound analysis is necessary to not advance some false links. Show less Reply Renard Pascaline 18 February 2013 I will tend to agree with the demonstration of Nelson D. Schwartz that online banking creates switching cost and reduce competition, but I will bring nuances: A customer who desires to change banks for many reasons, he knows for sure that he will be constraint to face some switching costs (but not only those that are related to the online service)…Read moreI will tend to agree with the demonstration of Nelson D. Schwartz that online banking creates switching cost and reduce competition, but I will bring nuances: A customer who desires to change banks for many reasons, he knows for sure that he will be constraint to face some switching costs (but not only those that are related to the online service) and the inconveniences that follow. Banks are perfectly aware of what customers face if they want to switch: service, online platform, bank advisor, interest rate, credit cards, advantages … In Belgium, competitors of big banks know exactly the offer of the other ones and the goal of a bank is to develop customer loyalty. So I will say that switching cost reduce competition. According my opinion, there are two others dimensions that are not taken into account with this article and which are indirectly related: Firstly, people face important cost in their online banking service but accept it because they benefit from other advantages bounded with their investments (for example) or other long term advantages. I would link this opinion with customers’ satisfaction or even with loyalty. Secondly, many people use online service of a bank because they are used to (for example: in a family: everyone is, most of the time, in the same bank, which characterize a traditional aspect). I also think that we must take the point of view of the bank services, switching cost must exist between firms; otherwise customers will tend to switch all the time between banks. They will change in function of their needs, their preferences of the moment, which will imply many costs and maximal competition. It will probably increase the welfare of the customers but reduce the company’s one. I will finish this comment saying that it is essential for banks to offer online services. Customers want to be able to do everything with internet, on their mobile, on their tablet, on their laptop or computer. So, banks must be on the top of what the competitors offer and be also “avant-garde” in IT, but to be aware and offer that kind of service, it has a cost that someone has to pay … Show less Reply Goergen Stephanie 18 February 2013 I don’t think that there is a relationship between the increase in the adoption of online banking services, the reduction in the level of consumer switching and lower competition in the banking sector. As we have already seen several times during our studies, there exits two types of competition. The first one consists in attracting new customers and the other takes…Read moreI don’t think that there is a relationship between the increase in the adoption of online banking services, the reduction in the level of consumer switching and lower competition in the banking sector. As we have already seen several times during our studies, there exits two types of competition. The first one consists in attracting new customers and the other takes place between firms as soon as clients are locked-in. Banks have to invest a lot in advertising campaign to attract new clients and to point out the advantages of their services. Methods like the one proposed by Deutsche Bank, meaning comparing their services to others bank’s services are intended to facilitate the evaluation of proposals and to help customers to make their choice. In this context, there exist a lot of websites offering this type of service, for example http://www.panorabanques.com/, http://lesbanquesenligne.fr/, http://www.banketto.fr/. Among these websites, there are also some which offer customer feedback. Once customers are locked in, they are more unlikely to change in the future. There are various reasons for staying. One of them is that to switch from one bank to another is not only time-consuming but also energy-consuming. While the time aspect is fairly reduced by shopbots, there is still the time needed to transfer data and to get used to the new services. For many customers it is more convenient to stay and to pay more than to make those efforts. The likeness to switch is also dependent on the type of customers. On the one hand, there are customers always searching for best deals and new offers. On the other hand, there are others who are more risk averse and loyal to their bank. Furthermore, the impact of switching cost will be different when the consumer is an advanced online banking user or a basic online banking user (Wong, 2011, Perceptions of customer satisfaction, switching costs and customer retention: an empirical study of basic and advanced Internet banking users in Hong Kong). Advanced banking users are more likely to pay for this kind of service than consumers who rarely make use of it. In a certain sense, the impact changes according to the dependence and the force of habit of customers. Moreover, since nearly everybody is constantly connected to the internet, the access to other banks is increased and so the competition between banks tends to be more amplified. The emerging banks are mostly unknown and so there exist a risk associated with picking that bank. Most of them come up with a wider range of facilities and attract customers with better or additional services. Comparison sites or shopbots, like those previously enumerated, can help to overcome some uncertainties and make bank comparison very easy and time-saving. So customers who are less risk averse could be even more tempted to switch to another firm. Another point is that customers should be careful about alluring offers because many of them are likely to change in the near future. What, at first, might be seen as very attractive in the short term might turn out to be less profitable in the long run and involve higher costs. Show less Reply Paul Belleflamme 18 February 2013 You point at shopbots that allow users to compare the offerings of different banks, thereby reducing search costs (which are a source of switching costs). We’ll come back to this in the coming lectures. Esselen Loïc 18 February 2013 I have different points of view concerning the content of this text; In one hand, I agree with the fact that online banking increases the switching cost that a consumer can perceive between different banks. Indeed, it is true that some pratical problems and procedures can appear if the consumers want to go from a bank to an other and that…Read moreI have different points of view concerning the content of this text; In one hand, I agree with the fact that online banking increases the switching cost that a consumer can perceive between different banks. Indeed, it is true that some pratical problems and procedures can appear if the consumers want to go from a bank to an other and that can persuade the client to not change. In the other hand, I strongly thing that when you choose a bank, the online banking (a service which is proposed by all banks nowadays) is not the most important argument. You choose a bank for the safety, the reputation, the interest rate, the family tradition … So, even if it exists a switching cost concerning online banking, I thing that you are “loyal” to a bank for others reasons that are more important! Switching costs concerning online banking are, in my oppinion, not the reason why clients are locked-in in a bank; If a bank can keep its clients by different way than online banking (Good rate, …) I thing that even if the switching costs are important, the clients will remain loyal toward his bank. However, in a more and more computerized world, I thing that if 2 banks propose the same products and have the same legitimity towards the clients, a friendly use and a perfect online banking can be a good marketing strategy to attract new young clients who are not yet in a bank. In conclusion, I thing that a well organized online banking is very important nowadays, but that it’s not the most important argument that influence the oppinion of the client to stay in a bank or to change. So in my oppinion, the switching costs could even be ignored. Show less Reply Paul Belleflamme 18 February 2013 You mention the "family tradition" as a reason to choose a bank. If you mean by that that special deals are made for families (e.g., free account openings for kids), then you refer to a form of "collective switching costs": to benefit from similar advantages at another bank, it is the whole family that has to decide to move their…Read moreYou mention the “family tradition” as a reason to choose a bank. If you mean by that that special deals are made for families (e.g., free account openings for kids), then you refer to a form of “collective switching costs”: to benefit from similar advantages at another bank, it is the whole family that has to decide to move their accounts, which makes switching much more costly, hence increasing the customers’ loyalty. Show less Avaux Fanny 17 February 2013 Mr. Schwartz sees a relationship between the increase in the adoption of online banking services and the reduction in the level of consumers switching of bank that brings to a decrease of the competition in the US banking sector. I believe that Mr. Schwartz forgot two sides of the reasoning: First when he says that the competition decreases. I think he takes…Read moreMr. Schwartz sees a relationship between the increase in the adoption of online banking services and the reduction in the level of consumers switching of bank that brings to a decrease of the competition in the US banking sector. I believe that Mr. Schwartz forgot two sides of the reasoning: First when he says that the competition decreases. I think he takes into account only competition between banks when customers are locked-in (ex-post competition) but if switching costs prevent customers to change of bank, banks must do all the more effort to attract customers when they haven’t yet selected their bank (ex-ante competition) or to attract customers who switch from lender so that they always take advantage of a special rate (“rate tarts”). So, are customers worse off? It depends on the balance between what they lose when they are locked-in and what they win with the ex-ante competition (bonus, free services …). Second when Mr. Schwartz finds a relationship between online banking services and the reduction of consumers who switch of bank. I believe that other items must be taken into account like satisfaction, good experience, long-term relationship between the customer and the bank,… before saying that online services reduce the level of consumer switching. For example, in Belgium, switching costs due to online banking services are low thanks to banking mobility that oblige the old bank to transfer all the banking services (banking domiciliation, permanent order, future bank transfer, …) to the new bank for free. It may be interesting to compare banking switching level in US and in Belgium to assess the effect of banking mobility (reduction of switching costs) on switching level due to online banking services. To bring switching costs due to online services to zero, one solution could be the “bank accounts portability” such as customers don’t have to inform people that they have change of bank and account number given that the account number would remain the same but set up an accounts portability is too expensive for banks. Finally, I would like to say that with online banking services customers are in a way better off because they should no longer move to their bank to carry out transactions. That’s natural for banks to charge this service given that customers save money in travelling expenses. Show less Reply Paul Belleflamme 18 February 2013 What you write about banks can also be applied for telecoms, as I wrote (in French) in this other post: http://www.ipdigit.eu/2013/02/la-nouvelle-loi-telecom-conduira-t-elle-a-une-baisse-des-prix/ Andres Chamba 17 February 2013 Online banking services are part of the several services provided by banks. The use of these services has become more and more appealing to clients who highly value it. As such, banks have started to exploit this necessity to make additional profits by charging extra fees. Nelson Schwartz, in an opinion column in The New York Times, has seen a…Read moreOnline banking services are part of the several services provided by banks. The use of these services has become more and more appealing to clients who highly value it. As such, banks have started to exploit this necessity to make additional profits by charging extra fees. Nelson Schwartz, in an opinion column in The New York Times, has seen a causal link between the increasing number of users of online banking services and the exploitation of this new niche by banks. “The steady expansion of online bill paying, they say [Former bankers and market researchers], has emboldened” banks to “turn to new fees on customer accounts as other sources of revenue dry up”. Nevertheless, there are two fundamental arguments behind this problematic. Firstly, it is important to make a clear cut distinction between current and future clients. Banks will behave differently between attracting new clients and with clients that are already “hooked”. Secondly, being “hooked” implies clients having transferred personal information to banks systems and doing the reversal is very costly. To attract new clients, banks have to be more competitive and offer reduced fees to capture more deposits. This has been the tone of online banking until recently when they started to charge fees. And if we look back to the era when banking services where vis-à-vis, we will see no charges. People used to go to the bank and make deposits, withdrawals, and transfers with virtually no cost. Back then, information about transfers was kept in the client’s hands. Hence, if a bank practiced increased fees, clients could change banks and have low information switching cost. Therefore, as Belleflamme et. at. put it, competition is “fierce ex ante” to bring new clients since banks have no power over clients information. With the advent of online banking, clients started investing time and digitizing their personal banking information in the bank’s platform. When clients do this they are immediately transferring negotiation power to the bank. Now banks are willing to charge fees without fear from clients switching banks generating “costumer inertia”. Banks, attribute this raising fees to costs. Clearly, online banking software represents a significant investment made by banks. But so was hiring cashiers, and paying rents for offices when all bank transactions were done at a branch. It is not costs but access to information that will lead to “reap ex post rents” once consumer is “locked- in” . In the end banks will have competitive practices to bring new clients if banks consider there are potential clients in the market. But if banks estimate that the majority of the population already have an online account in any bank, the ex ante fierce competition disappears. Then, only reap ex post fees could be exploited since banks are not looking anymore for new clients. The result is that banks would only focus to attract potential new clients, like students, that come with a growing population. Incentives will be channeled to this target group and only here competitive practices will flourish. REFERENCES NELSON S. Online banking keeps customers on hook for fees[online]. The New York Times, 2011. Available: http://www.nytimes.com/2011/10/16/business/online-banking-keeps-customers-on-hook-for-fees.html?pagewanted=all&_r=0 BELLEFLAMME, P. and PEIZTZ, M. (2010). Industrial Organization: Markets and Strategies. Cambridge University Press. P. 551 MATTHEWS, C. et. al. Why not Switch? Switching costs and switching likelihood. 2008. P. 2 Show less Reply Paul Belleflamme 18 February 2013 Good analysis. Xavier (3926-11-00) 16 February 2013 I am personnally using online banking on a regular basis. It's a very convenient way to manage my accounts whenever and wherever I want, especially when travelling abroad. I went twice on Erasmus out of Europe and online banking gave me the opportunity not to open any bank account during my stay abroad. However, these services were free of charge…Read moreI am personnally using online banking on a regular basis. It’s a very convenient way to manage my accounts whenever and wherever I want, especially when travelling abroad. I went twice on Erasmus out of Europe and online banking gave me the opportunity not to open any bank account during my stay abroad. However, these services were free of charge given the marketing strategy of the bank (free for students under 26). I already have been thinking about changing bank. However, the opportunity cost of switching is already quite high and, as explained in Belleflamme & Peitz (2010): “Such costs are called switching costs and give firms market power over those consumers who are locked in”. As related by Nelson D. Schwartz: “While customers value the convenience of online banking (…), it’s a double-edged sword […] It was known that it would be a powerful retention tool. That’s why online bill paying went free in the first place. Inertia is powerful in the banking industry.” (Emmett Higdon). Maybe another path to explore is the one by which banks who want to acquire new wealthy customers may want to pay customers to switch, as explained in a 2003 report published by the Office of Fair Trading. The point is that changing bank does need strong incentives while, according to Skinner (2007), bank’s users are more likely to leave their spouses than their banks. In my opinion, banks should allow customers to switch from one bank to another without having to change their bank account (such as we currently can do with mobile phone operators; i.e. telephone number portability). However, there would probably be other types of switching costs if bank account portability was allowed (i.e. contractual costs locking-in customers again), in addition to compatibility costs (need for new material), learning costs (how to use the new tools) and psychological costs (I used to trust my bank and all my family is with that bank since so many years, why changing?). Are switching costs a new business model strategy for banks? It might well be while more and more banks who have based a long-term strategy on online banking are now firing employees, explaining this is partly due to the popularity of online banking (ex. ING) and having less and less customers coming inside agencies to pay their bill. However, as Bruno Colmant recently declared on the radio: even if more and more people are doing online-banking, it doesn’t mean that all banks will disappear: people need physical agencies to go to in case of need. That’s a question of trust. SKINNER C. (2007), “The future of banking in a globalised world”, John Wiley & Sons, Chichester. Show less Reply Paul Belleflamme 18 February 2013 “Are switching costs a new business model?” This is a legitimate question. In marketing, one would talk (I guess) of “retaining your customers”. It would be interesting to draw a parallel with what strategy and marketing scholars say about that. Shoira Mukhsinova 16 February 2013 The first mover banks who offered online banking did profit from competitive advantage. However, almost all the banks provide online banking services today. Thus, turning the advantage into a competitive parity. Traditional banks have invested in local branches, thus, they can serve the segment of consumers who value a personal contact with their bank. Online-only banks (e.g.Keytrade, Rabobank) exploit the…Read moreThe first mover banks who offered online banking did profit from competitive advantage. However, almost all the banks provide online banking services today. Thus, turning the advantage into a competitive parity. Traditional banks have invested in local branches, thus, they can serve the segment of consumers who value a personal contact with their bank. Online-only banks (e.g.Keytrade, Rabobank) exploit the opportunity of serving the customers who prefer carrying out ALL their transactions themselves. By not investing in local branches, they offer bank accounts for free with higher interest rates and compensate personal contact with emails and skype calls. On the other hand, some traditional banks have a competitive advantage by providing a wide network of correspondent banks built throughout the years, allowing them to offer lower prices for worldwide money transfers. In order to make customers indifferent from switching to online banks, they also launched free online accounts. Further, I discuss the examples of switching costs listed in [1, p. 167] in the context of switching banks for personal banking. Transaction costs – changing banks simply requires time to search for a better/cheaper bank, and following new administrative procedures to open a new account. The emergence of intermediary platforms facilitate the price comparison of different bank accounts(e.g. http://spaarrekeningenvergelijken.be enables to compare different saving accounts). Contractual costs – it is very uncommon to sign a contract for a personal bank account for a certain period of time. Although banks offer long term bank accounts which have an opportunity cost if are closed earlier. Compatibility costs – some third party service providers forward consumers to their bank’s online banking application, but it is not the case for all the banks. For example, Base offers to pay invoices via ING and KBC online banking but not for Keytrade. Thus, consumers may encounter incompatibility of an online banking service with other automatic payment services they have been using. Learning costs – consumers will have to learn the new online banking user interface. Moreover, they have to learn new sign in procedures and remember new series of passwords. Obviously, the providers can compete on usability of their interfaces. On the other hand, the absence of standards for importing beneficiaries from one online banking to another requires time and effort to import them manually. Uncertainty costs – may be considered for the online only banks when the consumers would need a personal contact with his/her bank. However, Keytrade, for example, guarantees to answer customer emails within one working day. Shopping costs – next to personal banking, banks offer series of different products. For example when you rent an apartment you can open a locked account to deposit your guarantee and buy a fire insurance from the same bank. Thus consumer’ bank will be the first to appear in its evocative set, thus lowering the search costs for the consumers. To summarize, the learning cost seems to be the highest when switching banks for personal banking services. Obviously for fast learners this cost may be lower than for others. Sources: 1. Belleflamme, P; Peitz, M. “Industrial Organization – Markets and Strategies “. Show less Reply Paul Belleflamme 18 February 2013 Good idea to look at the different sources of switching costs for banking. Malgaud Quentin 15 February 2013 I would like to add three main comments about this article, concerning the causes of the growth in online banking, an informal switching cost and finally about the authorities' laissez-faire. To explain the online banking growth, a simple argument is the correlation with internet using (1) . But digging a little bit further leads us to the fact that "The high…Read moreI would like to add three main comments about this article, concerning the causes of the growth in online banking, an informal switching cost and finally about the authorities’ laissez-faire. To explain the online banking growth, a simple argument is the correlation with internet using (1) . But digging a little bit further leads us to the fact that “The high activity and penetration rates of Internet banking are due to the high levels of customer satisfaction. To satisfy customers, it is important to listen to their needs and desires (Sterne, 1998). Patterson et al. (1997) found that customer satisfaction has a significant impact on repurchase intentions in a range of services.” (2) The explanation about the growth is now more complete and implies something rather important: online banking grows because customers are satisfied. Satisfaction has implications on their repurchase intentions which implies then a natural switching cost. If satisfaction of the online experience explain [partially] the online banking growth, the argument of “learning to use another interface” has to be better considered. Indeed in marketing customer’s satisfaction is considered as an inertia to change: “the possibility of assessing product quality is a significant driver for customer satisfaction as a source of retention.” (3). To sum up, satisfaction of online banking explains its growth and implies a proportional switching cost. Another interesting switching cost is the reason why people would change. Let us first assume 2 hypothesis: -Big banks propose more or less similar offers. (4) -Small banks propose offers that are cheaper than the ones from big banks (5) According to those two hypothesis, consumers should logically leave big banks for small ones and the bank market should evolve from a concentrated market to a perfect competition market. But as said in your article, empirical results show the exact opposite. One explanation for people to stay in big banks is the “Too big to fail argument”: “bigness is associated with security” (6). For James Kwak: “(…) people don’t really trust the FDIC, or don’t realize how seamless the process is for them, and they would rather trust the Citibank logo” (7). Those two arguments can be summarized as preference for bigness or aversion to change, which can be seen as an informal switching cost. The last question is then why letting those big banks continue growing? Why is the antitrust policy not intervening? The answer for Donatella Porrini and Giovanni B. Ramello is that “antitrust intervention in banking has always been heavily influenced by considerations of stability. Regulation has historically given precedence to the stability objective, relegating thus competition to second place”. (8) The idea behind this is that big banks “have higher operating costs” (9), therefore, they have to make bigger margins, if they can not make bigger margin by law, they will take higher risks, such risks finally resulting to a large number of small customers (as they are large banks) which finally ends up as higher risks for the economy as a whole. Notes: 1: see the graph on :http://www.miteksystems.com/blog/11/15/10/phenomenal-growth-for-bill-pay 2: Dr. David S.Y. Cheng, An Analysis of Customer Switching Internet Banks in Hong Kong, http://www.jgbm.org/page/14%20David%20S.Y.Cheng.pdf 3: Mario Rese, Relationship Marketing and Customer Satisfaction: An Information Economics Perspective, http://mtq.sagepub.com/content/3/1/97.short 4: James Surowiecki, THE BIG BANKS GET BIGGER, http://www.newyorker.com/online/blogs/jamessurowiecki/2009/10/notes-on-this-weeks-column-big-banks.html 5: Stacy Mitchell, Free Checking is Rare at Big Banks, Common at Small, http://www.ilsr.org/free-checking-rare-big-banks-common-small/ 6: cited by James Kwak in Bank Switching Costs, http://baselinescenario.com/2009/10/26/bank-switching-costs/ 7: James Kwak, Bank Switching Costs, http://baselinescenario.com/2009/10/26/bank-switching-costs/ 8: Abstract of : Donatella Porrini, Giovanni B. Ramello, Competition in Banking: Switching Costs and the Limits of Antitrust Enforcement, http://ideas.repec.org/p/liu/liucec/153.html 9: “In line with this, Amel, Barnes, Panetta and Salleo (2004, Table 2) report that commercial banks in North America with assets in excess of $50 billion have higher operating costs than banks in smaller size classes” in Asli Demirgüç-Kunt, Harry Huizinga, Do we need big banks? Evidence on performance, strategy and market discipline, (http://www.bis.org/bcbs/events/bhbibe/demirguc.pdf) Show less Reply Paul Belleflamme 18 February 2013 You add a lot of instructive information to my post; thanks. Georgin Maxime 15 February 2013 I think Ms. Schwartz is taking only one facet of the impact of banks' online activities on the competition in this sector. He is probably right that the increase of online bill paying has a negative effect on the competition as it increase the clients' switching costs. But the system of automatic payments already existed before online banking and was…Read moreI think Ms. Schwartz is taking only one facet of the impact of banks’ online activities on the competition in this sector. He is probably right that the increase of online bill paying has a negative effect on the competition as it increase the clients’ switching costs. But the system of automatic payments already existed before online banking and was harder to stop or change than with two clics on a web page. This negative effect should be balanced with a positive one, which is about the transparency of information about offers and the decrease of barriers to entry. First, going online allows banks to advertise on a wider basis about their offers and a user-friendly interface for account information and bill payment can easily be detected, which is valued by customers. Secondly, the increase of internet use for bank operations and the agreements of bank to allows other’s customers to withdraw cash from every bank’s automatic machine allows international or small banks to enter the market without many real offices. Everything can be done online, it is cheaper for the bank and low cost banking appears. These two effects clearly increase competition in the sector. I also think Ms. Schwartz is misleading when he links the number of switching customer and the competition in the sector. There are two hypothesis to explain a decreasing switching percentage: high switching costs or high satisfaction. The author implicitly takes the assumption that customers don’t change their bank accounts because of the switching costs and link that with a low competition whereas new entrants competing with established firms may increase the quality of the current banks’ offers and then the satisfaction, leading to a low number of switching clients. I will conclude with my own explanation of why “unnecessary charges” are accepted in banks and not in a supermarket or a bakery. Competition in these two sectors are on price with a standard of quality and services. It is day-to-day products with no long-term view for the client. The banking sector is a service sector competing on the quality and complementarity of the offer in the long term (credit card, debit card, long-term placements, …) more than on prices. Charges in some banks are linked to other service: all client don’t want this offer but some need it. My personal customer view, without real study of the market, is that free/low cost account banks (like deutschebank) is attractive for short-term view customers that use their account on a day-to-day basis whereas long-term customer would be willing to pay charges on their debit card but have access to other services in the long term. This analysis seems consistent with my explanation of the charges possible in banks but not in supermarkets. Show less Reply Paul Belleflamme 18 February 2013 Thank you for this first comment and for your insightful analysis. Leave a Reply Cancel reply Your email address will not be published. Required fields are marked *Comment You may use simple HTML tags to add links or lists to your comment:<a href="url">link</a> <ul><li>list item 1</li><li>list item2</li></ul> <em>italic</em> <strong>bold</strong>Name * Email * Notify me by email when the comment gets approved.