(Mark Blank)
When it comes to moats, most investors think of advantages such as network effects or superior brand recognition. And while those are both very strong competitive edges, there is an underrated moat that could create an incredible advantage for many of today’s high-growth companies.
The call here purchase costs.
Think of switching costs as the hoops that a customer has to go through to switch to a competitor’s product. It can be as simple as paying a fee to get out of a contract as with cell phone service providers or as complex as reorganizing an entire company’s internal processes when replacing integrated software products such as tools. in customer relationship management (CRM).
The harder it is to move, the wider the moat.
Photo source: Getty Images.
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Let’s take a look at how shifting costs provide a competitive advantage to the following industries and companies:
1. Smartphones
Apple (NASDAQ: AAPL) has some of the strongest switching cost advantages of any company.
In many instances, Samsung has released smartphones with superior iPhone features, but few have chosen to switch. While branding certainly plays a role, shifting costs are a huge factor in maintaining it.
To swap phones, you need to navigate the complex process of transferring your photos and other data from the Apple ecosystem to Android. You also need to learn a completely new operating system at a time when most people rely on their phones on a daily basis for both work and their personal lives.
Finally, by switching, you will lose the convenience of having your phone seamlessly integrate into the Apple device ecosystem. For those who have invested in more than one Apple device, this is a big hoop to skip. And with over a billion devices sold, that represents a large portion of Apple’s customers.
IPhone users know from experience how difficult it is to switch to a non -Apple phone. This barrier to change contains the power of shifting costs and is no small part of why Apple has led the industry for many years.
2. Enterprise software companies
Software-as-a-Service (SaaS) companies are some of the biggest benefactors of transition costs, especially those serving businesses. The deeper the SaaS solution integrates into a company’s day-to-day operations, the harder it is for the customer to transition.
This is because, even if a competitor offers a similar service at a lower price, the business will need to use its IT team to deploy the new software and migrate any data needed from the old platform. . Once that is completed, they will need to train staff on how to use the new software and go through a period of reduced efficiency as the entire transition takes place.
That process is very complicated and very time consuming. Most organizations would rather stay with their current software provider than go through all of that. This makes high-quality enterprise software products extremely sticky and gives these companies significant pricing power.
This stickiness is evident in the market-beating return of key SaaS leaders. Consider the 10-year return of Salesforce (NYSE: CRM), Adobe (NASDAQ: ADBE), Microsoft (NASDAQ: MSFT)at Service Today (NYSE: NOW) compared to S&P 500 at the same time:
CRM Total Return Level data by YCharts.
As these software companies continue to add additional products and services, they are increasingly immersing themselves in their clients ’core operations, only boosting their moats.
The high dollar-based net retention rate (over 100%) gives investors an indication of product quality and the strength of the company’s relocation costs.
3. Medical equipment companies
Although the medical device industry may not be covered by the financial media, it offers one of the best opportunities for high transition costs.
This is because health care providers such as doctor’s offices and hospitals have the luxury of largely ignoring the cost because it is passed on to the patient and insurance companies. This means they are primarily focused on the functionality of the devices, and if such devices work well, healthcare providers don’t want to switch to a competitor.
This can be seen in Masimo‘s (NASDAQ: MASI) dominance of the pulse oximeter market (those electronic clips that extend beyond your finger to measure your blood’s oxygen level).
Their devices are found in 90% of top U.S. hospitals, and there is little reason for medical facilities to switch to a competitor because they are innovative and ultimately paid for by patients and their providers. insurance. .
The highest pricing power
As the economy seems to worsen, only brand loyalty will begin to lose pricing power. When people’s wallets tighten, they’re more likely to start trading with their $ 5 Starbucks (NASDAQ: SBUX) latte for cheap, home-brewed Joe.
But the pricing power found in moving costs is strong enough to withstand an economic collapse. Replacing coffee is easy, but a multibillion-dollar corporation that changes its payroll software is a whole different story.
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Mark Blank has positions at Masimo. Motley Fool holds positions in and recommends Adobe Inc., Apple, Microsoft, Salesforce, Inc., ServiceNow, Inc., and Starbucks. Motley Fool recommends Masimo and recommends the following options: long January 2024 $ 420 call to Adobe Inc., long March 2023 $ 120 call to Apple, short January 2024 $ 430 call to Adobe Inc., short July 2022 $ 85 call to Starbucks, and short March 2023 $ 130 call to Apple. Motley Fool has a disclosure policy.
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