These 3 companies have incredible switching cost moats

Xero Ltd (ASX: XRO) and Pushpay Holdings Ltd (ASX: PPH) have powerful switching cost moats which add incredible long-term value.

| More on:
Economic moat

Image source: Getty Images

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

One of the best investing books I think you can read is Pat Dorsey's The Little Book That Builds Wealth. The book is an excellent guide to identifying businesses with robust economic moats or competitive advantages.

One of the most powerful moats described in Dorsey's book is switching costs. These are barriers that make it hard for customers to jump to another competitor.  

The incredible power of switching costs

When was the last time you changed banks?

Most of my banking is through the same bank I've been with for the last 30 years! It has become a hub for my money: managing all sorts of arrivals and departures automatically, receiving cash, paying bills and allocating savings. To switch banks would be a huge hassle.

This is great news for my bank! Businesses that can retain customers with switching costs can charge these customers higher fees and earn higher returns without fear of losing customers.

The 3 companies with strong switching cost moats

Accounting platform Xero Limited (ASX: XRO) is a perfect example of a product with high switching costs. Once set up, Xero's software becomes deeply embedded into the daily operations of the businesses it serves. It becomes a daunting task to consider shifting to a competitor.

This helps to explain why Xero has such good customer retention rates. The number of customers that leave Xero is known as 'churn' and in the 12 months to 31 March, 2020 Xero had an average monthly churn of just 1.13%. This strong customer retention gives Xero a pricing power that it can deploy to counter-cost inflation.

A similar example is digital church payment service Pushpay Holdings Ltd (ASX: PPH). Once Pushpay's church customers are set up with the software, and the congregation has downloaded the app, it is a time-consuming and disruptive process to change to a competing product. PushPay has been growing strongly and has a revenue retention rate of 97.5%.

A different kind of switching cost is possessed by Transurban Group (ASX: TCL), one of the world's largest toll road operators. In many places that Transurban operates, transport projects' switching costs come in the form of time and convenience. Sure, you could get to Melbourne airport by avoiding the Citilink M2 toll road. But for many people, the extra 25 minutes of driving is just not worth it to avoid the $5–$10 toll.

Foolish takeaway

Keep an eye out for companies that have high switching costs, hinting that they have strong economic moats. If we can pick up these companies at a reasonable price and add them to our portfolios, the powerful returns they produce offer us a good chance of compounding our wealth handsomely over time.

Regan Pearson owns shares of PUSHPAY FPO NZX and Xero.

You can follow him on Twitter @Regan_Invests.

The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns shares of and recommends Apple. The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns shares of PUSHPAY FPO NZX and Xero. The Motley Fool Australia owns shares of Transurban Group. The Motley Fool Australia has recommended Apple and PUSHPAY FPO NZX. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

More on Share Market News

asx share price boosted by us investment represented by hand waving US flag across winning athlete
Best Shares

Here are the best-performing ASX 200 shares since the US election result

We reveal the 10 ASX stocks that have had the highest share price gains since the US Presidential election.

Read more »

A young man sits at his desk working on his laptop with a big smile on his face due to his ASX shares going up and in particular the Computershare share price
Share Market News

5 things to watch on the ASX 200 on Friday

A decent finish to the week is expected for Aussie investors.

Read more »

A smiling man at a shop counter takes payment from a female customer, with racks of plants in the background.
Best Shares

Here's why I think Wesfarmers shares are a great buy for any ASX investor

I argue that Wesfarmers offers investors both growth and income potential.

Read more »

A golfer celebrates a good shot at the tee, indicating success.
Share Market News

Here are the top 10 ASX 200 shares today

ASX investors finally enjoyed a win this Thursday...

Read more »

a man sits back from his laptop computer with both hands behind his head feeling happy to see the Brambles share price moving significantly higher today
Industrials Shares

Up 39% in a year, is there more growth to come for this ASX 200 share?

IML Equity Analyst Josh Freiman shares his views on a major ASX 200 industrial stock.

Read more »

Man looking at his grocery receipt, symbolising inflation.
Share Market News

What the latest US inflation print means for ASX 200 investors

The ASX 200 is likely to benefit if the US Fed cuts interest rates again in December. But will it?

Read more »

guy helping girl invest in shares and dividends
Opinions

5 ways for investors buying ASX shares to stay focused during economic uncertainty

AMP Chief Economist, Dr Shane Oliver, offers advice on how to handle the Trump factor.

Read more »

A worried man holds his head and look at his computer.
Share Fallers

Why Graincorp, Light & Wonder, Orica, and Wildcat shares are falling today

These shares are having a tough time on Thursday. But why?

Read more »