# Switching Costs ## The Idea in Brief Customers face friction—time, effort, money, risk—when leaving for a competitor. The higher the friction, the more pricing power you have. Switching costs don't require lock-in contracts or proprietary formats. They can emerge from learning curves, integration depth, or simply the pain of change. --- ## Key Concepts ### Types of Switching Costs **Financial switching costs.** Direct expenses: termination fees, new implementation costs, retraining, data migration. Easy to quantify, often contractual. **Procedural switching costs.** Time and effort: learning a new system, rebuilding workflows, re-establishing integrations. Hard to quantify, often underestimated. **Relational switching costs.** Trust and comfort: relationships with support teams, confidence in the vendor's roadmap, familiarity with quirks. Invisible but powerful. The mistake is focusing only on financial costs. Procedural and relational costs often matter more—and they compound over time as users embed deeper into your product. ### Vertical Software: Switching Costs by Design Vertical market software—purpose-built for specific industries—creates switching costs structurally. A church management system isn't competing with Salesforce. It's competing with other church management systems, and there aren't many. **Constellation Software's insight:** Vertical markets are too small for large competitors to care about but large enough to support a dominant player. Once you're the standard for marina management or transit scheduling, customers can't switch without betting their operation on an unproven alternative. **Vitec's approach:** Buy vertical software companies, help them modernise (SaaS transition, API architecture), and hold forever. The longer you hold, the deeper customers embed, the higher the switching costs, the more defensible the position. ### Mission-Critical Parts: The Ultimate Switching Cost TransDigm and Heico both exploit switching costs in aerospace aftermarket parts. A hydraulic seal costs pennies but grounds the aircraft if it fails. Customers don't switch suppliers casually—the cost of failure is too high. **Sole-source positioning.** TransDigm targets proprietary, sole-source components: parts with no approved alternative. Customers can't switch because there's no alternative to switch to. This is switching costs taken to the extreme: infinite friction. **Part-number lock-in.** Aerospace certification is part-number specific. Once a part is certified for an aircraft, qualifying an alternative takes years and millions of dollars. The installed base creates a 30-year annuity stream. ### Creating Switching Costs Post-Acquisition Acquirers can increase switching costs in target businesses: **Deepen integration.** Connect the product to more systems, more workflows, more data. Each integration point is a switching cost. **Expand the footprint.** Sell adjacent modules. A customer using three products is stickier than a customer using one. **Build relationships.** Invest in customer success. The trust relationship is a switching cost competitors can't replicate. **Improve the product.** Counterintuitively, making the product better increases switching costs—customers depend on it more, and alternatives look worse by comparison. --- ## Implications **In pricing:** High switching costs give you pricing power, but only up to the "switching threshold." Push too hard and customers do the painful work of leaving. Find the ceiling through testing, not theory. **In retention:** High retention with long contracts may be lock-in, not loyalty. The test: would customers stay if they could leave easily? If not, you're borrowing from the future—eventually, switching costs erode or competitors build bridges. **In M&A target selection:** Look for businesses where switching costs are structural (vertical markets, mission-critical products, deep integrations) rather than contractual (long terms, termination fees). Structural switching costs compound; contractual ones expire. --- ## Sources - [[7 Powers]] — Switching Costs is one of Helmer's seven powers; the barrier is the friction customers face when leaving - [[Better, Simpler Strategy]] — Switching costs raise WTP by making alternatives less attractive on a risk-adjusted basis --- ## See in Notes - [The Constellation Model](https://www.anishpatel.co/the-constellation-model/) — Vertical market software as switching cost engine - [The Vitec Approach](https://www.anishpatel.co/the-vitec-approach/) — Kaizen modernisation deepens customer embedding - [The TransDigm Equation](https://www.anishpatel.co/the-transdigm-equation/) — Sole-source positioning as ultimate switching cost - [The 95% Illusion](https://www.anishpatel.co/the-95-illusion/) — High retention with long contracts may be lock-in, not loyalty - [Context Beats Category](https://www.anishpatel.co/context-beats-category/) — In vertical markets, positioning on consideration vs retention attributes wins - [Vertical Market Playbook](https://www.anishpatel.co/vertical-market-playbook/) — Strategic framework for vertical software