Switching costs, lock-in and habits
Why customers stay even when a rival is cheaper: the money, time, risk and habit of leaving. Also the maths of how much pricing room that gives, and how regulators cut it.
Key takeaways
- A switching cost is everything a customer loses by leaving: money, time, effort, risk and habit.
- Common mistakes: Counting only the money cost of switching and forgetting time, risk and habit.
- Money: exit fees, the charge for taking your data out of a cloud service, losing a loyalty balance.
- Work and time: moving data, rebuilding links to other systems, retraining staff.
- Risk: the chance that the move goes wrong and the business stops working for a while.
Key idea
A switching cost is everything a customer loses by leaving: money, time, effort, risk and habit. The higher it is, the more a business can charge above a rival's price, or the longer customers stay, before they move. It is an advantage only while the customer's cost of leaving is larger than what a rival can offer them to leave.
Four kinds of switching cost
- Money: exit fees, the charge for taking your data out of a cloud service, losing a loyalty balance.
- Work and time: moving data, rebuilding links to other systems, retraining staff.
- Risk: the chance that the move goes wrong and the business stops working for a while.
- Habit: the default app on the phone, the bank your salary already goes into. Nothing stops you leaving, but you rarely think about it.
Worked case
How much pricing room does lock-in give a software supplier?
The prompt
Illustrative numbers. A manufacturer in Germany pays EUR 100,000 a year for the business software that runs its orders and accounts. A rival offers the same thing 20 percent cheaper. Switching would need a EUR 300,000 migration project and EUR 50,000 of staff training. It would also bring about three months of slower work costing EUR 25,000 a month. Should the customer switch, and how much room does the current supplier have?
The structure
- Switch only if yearly savings repay the cost of switching fast enough
- One-off cost of switching = migration + training + disruption
- Yearly saving = current price x discount
- Payback = cost of switching / yearly saving
Working it through
1. Cost of switching
EUR 300,000 plus EUR 50,000 plus three months at EUR 25,000.
One-off cost of switching (EUR):300,000 + 50,000 + 3 × 25,000 = 425,0002. Yearly saving
20 percent of EUR 100,000.
Yearly saving (EUR):100,000 × 0.2 = 20,0003. Payback
How many years of savings it takes to repay the move.
Payback (years):425,000 ÷ 20,000 = 21.254. Cost of switching per year, over five years
If the customer judges any move over five years, the switching cost is worth this much a year.
Switching cost spread over 5 years (EUR per year):425,000 ÷ 5 = 85,000
The recommendation
The customer should not switch: the move would take over 21 years to pay back. Seen from the supplier, lock-in is large. Over a five-year view, leaving costs the customer about EUR 85,000 a year. So in theory the supplier could charge far more than a rival before losing the account. In practice two things limit that room. Rivals can offer to pay the migration cost themselves. And a customer who feels trapped plans its exit for the next big upgrade, when it has to move anyway.
Risks: A rival who pays the EUR 300,000 migration removes most of the lock-in; Squeezing a locked-in customer turns them into a future lost customer.
Real cases: who sets the date, and who cuts the cost
- Europe, a supplier's timetable: in February 2020 SAP set dates for its older software. Mainstream maintenance for the core applications of SAP Business Suite 7 would end on 31 December 2027. Optional extended maintenance would run from 2028 to the end of 2030, for a premium of two percentage points on the maintenance fee. SAP also committed to maintain its newer system, SAP S/4HANA, until the end of 2040. When switching is hard, customers tend to move on the supplier's timetable rather than their own.
- Europe, a regulator cutting switching costs: the Data Act has applied since 12 September 2025. The European Commission says it will entirely remove switching charges between cloud providers from 12 January 2027. This includes charges for taking data out (egress charges).
- India, the same idea in mobile: mobile number portability lets a subscriber keep their number when changing operator. It started across most of India on 20 January 2011. The Telecom Regulatory Authority of India reports 15.98 million requests to port (move) a number in July 2026 alone. The same report counts 1,287.92 million wireless (mobile) subscribers.
In July 2026, 15.98 million Indian mobile subscribers asked to port their number, out of 1,287.92 million wireless (mobile) subscribers. What percentage asked to switch in that one month? Round to one decimal.
Habits: the quietest switching cost
Habit is often the biggest switching cost in consumer businesses. It shows up in churn: the share of customers who leave each month. A simple rule links the two. If a fixed share of customers leaves each month, the average customer stays 1 divided by that share, in months. So halving churn doubles how long a customer stays, and doubles what each customer is worth.
Illustrative. A streaming service in Brazil earns a contribution of BRL 10 a month per subscriber. Monthly churn is 4 percent. A new feature builds a viewing habit and cuts churn to 2 percent. By how much does the lifetime contribution of one subscriber rise, in BRL?
Counting only the money cost of switching and forgetting time, risk and habit. Assuming lock-in lasts for ever: rivals can pay the switching cost for the customer, and regulators can ban it. Squeezing locked-in customers on price, which builds the anger that makes them leave at the first chance.
A rival offers a 15 percent discount, but customers almost never move. What is the most likely reason?
How does the EU Data Act change the cloud market from 12 January 2027?
Sources, checked on 2026-10-01. Company figures are from the company's own reports or filings; per-unit figures and comparisons are our arithmetic on them.
- SAP News Center, "SAP S/4HANA maintenance 2040: clarity and choice on SAP Business Suite 7", 4 February 2020: https://news.sap.com/2020/02/sap-s4hana-maintenance-2040-clarity-choice-sap-business-suite-7/
- European Commission, "Data Act explained" (cloud switching and the end of switching charges): https://digital-strategy.ec.europa.eu/en/policies/data-act-explained
- Telecom Regulatory Authority of India, Press Release No. 116/2026, telecom subscription data at the end of July 2026, 28 August 2026: https://www.trai.gov.in/sites/default/files/2026-08/PR_No116of2026.pdf
Sources for this lesson (4)
- Recognized public explanations of case-interview concepts and terms
- SAP News Center, "SAP S/4HANA maintenance 2040: clarity and choice on SAP Business Suite 7", 4 February 2020
- European Commission, "Data Act explained" (cloud switching and the end of switching charges)
- Telecom Regulatory Authority of India, Press Release No. 116/2026, telecom subscription data at the end of July 2026, 28 August 2026
My notes on this lesson
0 of 5,000 characters. Saves automatically.
Try the 4 remaining checks and drills above to complete this lesson (0 of 4 done).
Keep going: lesson 5 of 8
It builds on what you just read, in Why some businesses win: competitive advantage and the economics of strategy.
Spotted something wrong or out of date? Report a mistake. We check every report and correct the page.