Switching Costs

Overview

Switching costs are everything a customer must pay, learn, redo, or risk to move from one product to another — financial, learning, data migration, integration, process, relational, and risk premium. They are routinely larger than founders model and customers anticipate at purchase time.

When switching costs are high, incumbents retain customers even when competitors offer better products, and new entrants must offer dramatically more value to break even. Paul Klemperer formalized this in 1987 (QJE 102(2)). IBM's 25-year mainframe dominance is the canonical empirical case.

Composes with network-effects, signaling-games, anchoring, and pmf-crossing-the-chasm.

When to Use

• Building a product and want to design defensible switching costs into it
• Evaluating investment: does incumbent switching cost make the market unwinnable for new entrants?
• New entrant trying to win customers from an incumbent; need strategy around actual cost magnitudes
• Incumbent experiencing churn; need to diagnose which switching-cost component is broken
• Someone says: "lock-in," "vendor lock-in," "stickiness," "data moat," "Klemperer"
• Assessing an AI-compute / chip moat under the AI capex boom, chip export controls, or "AI bubble" fears (e.g., can rivals displace Nvidia's CUDA ecosystem?)