Switching costs are those one-time inconveniences or expenses a customer incurs in order to switch over from one product to another, and they can make for a very powerful moat. Companies that make it tough for customers to switch to a competitor are in a position to increase prices year after year to deliver hefty profits. Companies aim to create high switching costs in order to "lock in" customers. The more customers are locked in, the more likely a company can pass along added costs to them without risking customer loss to a competitor.
Autodesk ADSK dominates architecture and construction-design software with its market-leading AutoCAD product. With roughly 6 million loyal users, it has a wide economic moat--high switching costs make it tough for customers to get comparable products elsewhere or do their jobs without the help of Autodesk. Because customers are essentially required to understand its software to be successful in their careers, it is nearly impossible for competitors to take meaningful market share from Autodesk.
Autodesk's software is also relatively affordable, making it somewhat immune when the economy turns south. While some software costs millions of dollars, Autodesk's products cost much less; the initial price of AutoCAD is only a few thousand dollars. This makes the company less susceptible to cutbacks in information-technology spending. In addition, using its software reduces expenses by shortening the design and manufacturing processes. The firm has also incorporated subscription sales, which add more predictability to its business model and further "lock in" its customers. As with many technology companies, uncertainty remains regarding its new product development cycle and adoption of new products, but Autodesk's committed customer base give the firm a wide economic moat.
The Network Effect >>