As those who’ve attended our recent sessions on radical innovation know, MLC recently completed research into where organizations are falling short in generating market-shifting ideas. Basically, the gist is this: if you want to improve the ideas coming out of your company, you should focus on fewer, better ideas (as opposed to chaotic processes like crowdsourcing) and treat radical innovation as a separate process from incremental, within-category innovation.
But one of the ideas we presented at the meeting turned out to be a little controversial: the concept of switching costs – elements in product design that lock a customer in. We advocated for intelligent inclusion of switching costs into new product development because the speed to market of copycat products is now a third faster than it was in 1985; some element of user lock-in is essential to ensure continued returns after copycats are released.
A lot of members took this to mean we were advocating coercive measures like legal lock-in or reduced interoperability, and (correctly!) surmised that these would be unpopular with customers and end users. And, indeed, many switching costs are exactly that; for instance, Apple makes it difficult to use anything but iTunes to upload songs to an iPod, and iPods will not play certain file formats (for instance, Microsoft’s rival to MP3 files, WMA). Most users do not realize this, but Apple catches a lot of heat in tech circles for not being open enough.
But it’s worth emphasizing that switching costs can be elements of design that discourage switching, but by providing such a huge benefit to customers that they don’t actually want to switch. For instance, the technology that powers streaming radio service Pandora, the Music Genome Project, is probably the most developed music taxonomies in history; it’s also a switching cost, since other streaming radio services don’t have it. What’s more, Pandora’s large userbase continually reinforms the Music Genome Project so its recommendations improve.
Netflix’s first mover status in the movie-by-mail and home streaming categories ensured it a large userbase; it subsequently used that userbase to develop a recommendation engine, Cinematch, that has no real rivals. Sure, you could switch to Blockbuster’s service, but you’d lose those recommendations, as well as the viewing history you’ve built up over the years. There are competitors to the Nike+ run-tracking system, but none with the social features and size of community it has.
What’s the moral here? First movers have a big advantage in terms of building up a large userbase, and large userbases lend themselves to lock-in features like the Music Genome Project and Cinematch.
As an aside; we’re having a lively debate internally about how to metaphorically describe a positive switching cost; the leader in the clubhouse is “lobster trap”. If you have ideas, please add them in comments!
MLC members, if you weren’t able to make it to our December meetings, our research on radical innovation will be presented in a webinar series across the next few months. The first session is January 24 – register now!
Related posts:
on 13 January 11
Respond
How is this different from Buffett/Morningstar’s “wide moat/narrow moat” analysis? http://news.morningstar.com/articlenet/article.aspx?id=91441&
The topic of creating switching costs introduces a similar competitive problem: how to avoid comparison, which is the first step a consumer makes when considering switching.
Increased product complexity seems to be the default solution (e.g., overdraft protection on a checking account). Increasing product complexity raises switching costs by requiring more time/effort to understand alternatives.
For example, overdraft protection doesn’t work the same at every bank. Other examples of increasing product complexity in the personal banking business would be:
* the payee list you build when doing online banking
* direct debit/ach that banks allow you to set up for free
These features make checking accounts more complex and increase switching costs. Some increases in product complexity might be positive for the consumer, while others are neutral or negative.
Ever wonder why Graco strollers and infant car seats seem to be #1 sellers? The only infant seats that are compatible with Graco strollers are …Graco infant seats. Graco widened their moat by creating this (in)compatibility.
It’s up to marketers to leverage their positive and neutral product features to widen their moat!
on 13 January 11
Respond
Hi Dave – I hadn’t read that analogy from Buffett – very interesting framework for thinking about this, one that definitely touches on a lot of the issues here. I think that there are a lot of names for the general concept we’re trying to drive at – “economic rent” is another that I recall from Econ 201
On the other topic of avoiding comparison, we’ve noticed a whole lot of this going on as the web drives margins down for retailers. Best Buy’s announcement that they will accept trade-ins of electronics purchased in-store, for instance – it breaks down the customer’s comparison algorithm because they’re not sure how to value the trade-in offer. In fact, they probably over-value it, if the insurance industry is any guide – all the better for Best Buy!
on 17 February 11
Respond
[...] from music to kitchen appliances are hoping to leverage the power of their userbase to create positive switching costs. But there’s a big risk in putting your brand in the hands of a broad community: people [...]