By David Fuller, Fractional CMO

In our last article, we focused on The Substitution Effect to help Marketers understand who the real competitors are. In this article, we couple the substitution effect with the concept of switching costs, to explain why your great product is not gaining traction. 

We have talked about the 'fallacy of the better mouse-trap. You have innovated and solved a problem, you can use AI to automate and potentially reduce costs. The real challenge lies in overcoming the invisible barrier of switching costs. Many founders fall into the trap of believing that rational buyers will migrate as soon as they see a 10% or 25% improvement in performance. This assumption ignores the fundamental microeconomic reality of the incumbent’s moat.

The Math of Inertia

In a frictionless market, a buyer chooses whichever product offers the highest net utility. However, real-world markets are rarely frictionless. To understand why customers stay with mediocre incumbents, we must look at the switching cost equation.

A rational actor will only switch from an incumbent (i) to an entrant (e) if:

(Ue - Pe) - S > (Ui - Pi)

In this formula, U represents utility, P is the price, and S represents the total switching costs. The variable S is almost always larger than you think. It includes more than just the initial financial outlay for the new tool. It encompasses the "transaction costs" dealing with a new untested vendor, the "learning costs" of retraining staff, and the "sunk costs" associated with the previous investment. 

Why 10% Better is Actually Worse

If your product is only 10% better than the incumbent, you are functionally invisible. The "Path Dependence" of the customer, which is the tendency to continue using a specific technology based on historical preference, acts as a massive weight. 

For a technical founder, this means your product must often be 10x better or 50% cheaper to even enter the conversation. This is because the buyer perceives a high level of risk in a migration. This risk acts as a multiplier. If a migration fails, the individual who championed the change faces potential social and professional penalties. When you offer only a marginal gain, the buyer concludes that the potential reward does not justify the risk of the "Productivity Valley" that occurs during the transition.

The Three Layers of the Moat

Incumbents protect their territory using three specific types of switching costs:

1. Procedural Costs: These are the cognitive efforts required to learn a new system. If an engineering team has five years of "muscle memory" in an old technology, moving to your tool makes them temporarily worse at their jobs. 
2. Financial Costs: This includes exit fees and the loss of bundled discounts. Large incumbents like Microsoft or AWS use "Multi-product bundling" to make the marginal cost of their inferior sub-tools appear to be zero.
3. Relational Costs: These involve the psychological ties and trust built with a vendor or a brand. Try switching a Mac user to Windows. Try making a Ferrari fan support McLaren. 

Switching Costs as part of your Marketing Strategy 

Technical superiority is not a strategy; it is a prerequisite, table stakes. Your Marketing Strategy needs to bake in the impact of switching costs. To win, you must address the friction directly:

• Lower the Transaction Cost: Can you automate the migration or replatforming?
• Shorten the Learning Curve: Can you offer "white-glove" onboarding to bridge the productivity dip?
• Manufacture Trust: Since you aren't "Apple" (yet), who can vouch for you? Use social proof to signal that buying you is actually the "smart" (and safe) move.
• Consider Outcome Based business models (Outcome as a Service): Shifting payments from products or seats or hours to achieved results where customers pay for tangible value.