Consumers often stick to a reliable service or product as the alternative to switching out may often be more trouble than it is worth. ETF investors can also capitalize on this intangible switching cost by focusing on companies that have locked in customers to their unique ecosystem.
Some companies “have the unique advantage of integrating their products or services into a customer’s daily activities and operations, therefore making it tough and costly to switch providers,” Brandon Rakszawski, ETF Product Manager for VanEck, said in a note. “Powerful moats can be built on ‘switching costs’ which are often embedded in strong business models. Switching costs lock customers into a company’s unique ecosystem, and make it expensive to move. Not just monetary in nature, switching costs can also be measured by the effort, time, and psychological toll it takes to switch to a competitor.”
Consequently, this switching cost may have the potential to help a company increase prices and generate greater profits over time, providing a key competitive advantage across a range of industry, such as camera equipment to computer software and hardware.
Morningstar research explains switching costs to when it would be too expensive or troublesome to stop using a company’s products, so the company often has pricing power. For example, consumers may have heard of the Nikon or Canon debate in the camera industry, Apple or PC in the personal computer industry, and AT&T or Verizon among telecom providers.
Rakszawski argued that Gillette razor blades were among the first to optimize the switching cost approach to lock in customers as the company developed and sold inexpensive razors with patented disposable blades to ensure a constant demand for blades since the alternative would be customers incurring additional costs with a new razor.