Daimler needs 3 years to introduce their employee to a new product lifecycle platform. Switching Cost as Business Advantage can’t be overlooked.
Like many other things in the world, switching barriers or switching costs is not created all equal. A businessman could change their office 365 as productivity tools into WPS or Google docs. It is not popular1, but can be done – maybe takes just one or two months. In the Daimler switching case – from CATIA to Siemens NX, the transition needs much more time – and pain. Here we try to make an order of switching cost levels. The higher the switching cost, the better for an investor to put his money there.
Switching Cost as Business Advantage. In This Issue. Level Order
We begin with a product that has set the lowest bar.
Inconvenience as Switching Barriers
I always admire Microsoft (MSFT) – they could charge a premium on their product even when the competitor has a free alternative. Google suite and WPS Office offer similar features and ecosystems to Microsoft. Actually, moving from Office to WPS or G-suite is no pain at all. I was there. The alternatives have great compatibility – the user could edit xlsx or Docx files with almost no issue.
The reluctance of Office users may be rooted in the fact that Microsoft Office is one of the first productivity tools with Graphical User Interface. As a result, Microsoft is always associated with productivity – editing documents and Word are there, presentations? PowerPoint, Need computation and formula? Excel. In this case, we may conclude that the switching cost for Office is more illusionary than reality.
We move to a higher degree.
Transition Time as Switching Barriers
One factor that makes customers locked in the Windows ecosystem is the interface and environment which are different from MacOs and Chrome OS. The Interface between Microsoft Windows and Apple macOS is far different. macOS use dock style with a soft rounded edge while Windows use Tile and taskbar style. Not only the interface, but you also operate those two OS differently: Installing software, Opening, and Closing Application, File explorer system, shortcut.
When a customer wants to change their OS – both from Windows to Apple or vice versa, they need to learn from scratch. And It takes time. This business advantage of Microsoft Windows is testified by its own founder – William “Bill” Gates as quoted by course hero here, without Windows switching cost, Microsoft have been extinct.
Ok, moving forward
Network Effect as Switching Barriers
Change bank account only needs about an hour -and several days to receive the debit card. It is simple, yet we have statistics said that people not changing their bank account for seven years. This is happening because once we change our account, we need to adjust our payment system which is attached to that account.
This level of switching barrier is due to several things that are connected to the product.
Take Windows as an example. There are several Windows-exclusive software that can’t run on macOS. The programmer needs to rewrite the source code for Apple Operating System, and it isn’t an easy task.2
It is because Microsoft connected to so many products – software which I need so I can’t switch to another OS.
Amplified Network Effect
We get more serious here. If the former is about the customer, starting here we will deal with Business to Business. Spoiler alert: Switching Costs set a higher bar for this kind of relationship, business to business.
It is difficult to move away from the Quick Books accounting platform developed by Intuit, or Database software by Oracle. Because we need to rebuild our database. The bigger the business, the bigger its database. Imagine we will move our house from one location to another. The bigger our house, the more our furniture, tools, the more challenging it is for us to move.
Another company that has these advantages is again, Microsoft for its Cloud services. Microsoft is server native. It has a large base of installments for its local server – Windows server. For most companies, migrating from an on-site server (local) to a cloud-based is painful. Here Microsoft Azure plays beautifully because both are Microsoft and could deliver the transition smoothly. So it just moving from one Microsoft product to another.
This is why I love Microsoft, and it will be always in my portfolio. It is Wall Street darling in the 90s, and in 2021, it is still there.
In case you need to know Microsoft Office’s economic moat other than switching cost, you could read here.
The Massive Migration
And if you need a more serious example, let me bring you Daimler and CATIA case.
In 2010, Daimler migrate its all-in-one lifecycle design software from CATIA into SIEMENS. How much did it cost? More than 6,200 employees have been trained, 33 role-based training modules, 2 countries: German, English, in 4 languages: Japanese, Portuguese, Spanish, and Turkish. In extreme circumstances, more than 300 research and development employees bridging the transition database – more than 200,000 CAD objects – from CATIA V5 to Siemens NX.
I remember the old meme, a young Gamorra and Thanos conversation. In the Soul Realm, Gamorra asked, “Did you?”
Thanos answered,” Yes”
Gamorra continued, “what did it cost?”
Thanos said, “everything”
Like Thanos – regarding this decision – The CIO, Dr. Siegmar Haasis said, ” ….is like take his children to walk through the Grand Canyon.”
About Network Effect That Bring Switching Cost as Business Advanateg
We are interested in customer inertia that builds switching barriers. It is no coincidence that the first-mover company has the potential to enjoy high switching costs. It is simply because they get customer first(s) before competitor even exists.
The pioneer gets the privilege to build a customer database even before the competitor thinks about it. Along with time, the database accumulated, get bigger, heavier, and eventually, create large inertia to move on. When the counterpart comes and offers better, cheaper services – the pioneer has cemented its position. Game over.
So it does not merely about customer perception of the brand. It is also about technical issues.
Try to think Microsoft Windows and Microsoft server once again
Even when the switching bar is low, it almost impossible for customers to jump out because it is heavy.
Risk. The barrier to Keep You Not falling in The Edge
Climbing higher, we are at the top where if we move an inch, we will fall down.
Here we have General Electric Aviation, Roll Royce, Pratt, and Whitney – Unholy trinity that rule the airplane jet engine business. This is an industry with no tolerance for error. A crash cost millions. Thus leaving one vendor to another is risky. This is an industry in which the tagline “If not broken why fix it?” really true.
The same case goes to Precision Castparts. They sell advanced technology with durable material for jets and turbines. A failure in the turbine could bring all the cities into a blackout.
Guess who owns Precision Castparts? It is Berkshire Hathaway’s subsidiary. Seems that the Oracle of Omaha really living up to his own words.
Switching cost which driven by risk factors is characterized by the tight regulation that rule industry, error sensitive business like healthcare. Thus a company like GE Healthcare and Siemens Healthcare also has great advantages here. Galaxy Note could explode but people still buying it, or “bend it like iPhone” episode, still, people keep using the iPhone. The airline and healthcare are – like WWF in the 2000s – have no Mercy.
To get a better understanding of GE aviation, you can refer here.
We have talked about duopoly, The airline, the healthcare. Now we come to a different dimension. There is no switching cost because there is no switching. There is a Gimp, other image processing software, but nothing could be compared with Adobe Photoshop. That isn’t even a competition. Photoshop is rich in feature, community, plug-in, support – same case with Illustrator (still from Adobe, by the way, most of Adobe products enjoy monopoly) and AUTOCAD from AutoDesk.
It’s simply the only game in the town.
Switching Cost as Business Advantage: Takeaway
- Business to business model has high switching costs.
- Never confuse between high switching costs with the competition. Some of the company with high switching cost still has competitors.
- Several companies enjoy switching cost we could not make detail at the moment3
- but it cost nothing economically [↩]
- This is the problem that Apple faces now with their latest super processor, M1 that power Macbook. This new architecture requires the programmer to rewrite their code. Ok, there is an emulator that bridges the gap – Rosetta, but not perfect. Microsoft ever face the same problem with its ARM Surface device, and they fail [↩]
- Notable mention: Sartorius, Praxair, Silverlake Axis, Rolls Royce, Oracle, Kone, Howden, Fastenal, Ecolab, Novozymes, Symrise [↩]