High Switching Costs MOAT Advantage for Companies
In this posts we’ll talk about how a company can create an economic moat by commanding high switching costs.
A company can go about building a sustainable competitive advantage is integrating high switching costs into their business.
Switching costs, or expenses or disruptions a customer will encounter when switching from one product or service to another, is beneficial for a company to have.
Companies that create high switching costs can help them retain their customers because the pain of disconnecting from what they are using and changing to a competing product or service is just too much for the average customer to be bothered by.
For example if you are an Apple user then everything is in Apple formatting and you likely use exclusive Apple services. Switching to a Windows system from Apple is something almost no customer wants to do.
Another example is cell phone service providers that can lock in customers because of their high switching costs. To change providers a customer might need to terminate an existing contract and purchase a new phone.
Both of which can be costly as such customers might be less motivated to switch providers, even if they’re dissatisfied with their current service.
You see how well a company is doing is determined by its ability to maintain its customer and supplier base regardless of how fierce the competition is.
When a company provides a customer with a product or service that is difficult to break away from, in terms of cost time or convenience, it’s far more likely to hold onto that customer over the long term.
And this makes competition more interesting because if the company’s competitors want to gain more market share, they must offer an extremely attractive price or performance alternative to entice consumers to switch from their current provider.
Companies that have already established a solid amount of users and have a network effect already working for them, in addition have at least good services at competitive prices, will likely continue to maintain their user base.
Their competitors will have a very difficult time taking market share away because of these cumbersome switching costs.
You know in many cases customers just aren’t interested in dealing with the fees or aggravation involved in making the switch regardless of how appealing a competitor’s offering is.
And especially if a company has something specific that other companies can’t easily copy, this is yet another technical advantage. For example FaceTime is one of those things that keep A LOT of people sticking with the iPhone. Because losing this would be something that they can’t do without.
When you fact that in alongside the switching costs of changing from iPhone to Samsung for example, it makes sense why users tend to stick with the iPhone over the long term. Even when the prices for it go way up.
Not only does this fact allow the company to maintain a strong customer base. It even makes it possible for them to incrementally raise their user prices you see, over time in order to consistently increase their profits.
Apple is a great example of a company which has utilized a network effect primarily, then introduced some services that are simply fantastic and hard to replicate, and then finally had high switching costs because things don’t work from Apple to other software.
So when all of this is combined, incremental increases in prices can be used by the company to increase revenue and profit. Because they know full well that the costs of switching to another company are simply too high and most will not switch over.
That is needless to say when a company is able to establish itself in an industry it can have higher pricing power over its competitors.
And this is something that will help it survive over the long run.
So as a value investor make sure you look for businesses that are industry leaders. Companies that they know how to integrate high switching costs into their operating and marketing practices.