Switching costs can quietly change the balance of power between a customer and a service provider. The customer may remain perfectly free to leave, but freedom means less when the inconvenience, disruption, and uncertainty of changing make staying put the easier choice.
Anyone who has moved deeply into the Apple or Android ecosystem understands the problem. Switching remains possible, but years of apps, photos, passwords, devices, interfaces, and learned habits can make crossing to the other side annoying enough that a competing product must offer more than a marginal improvement to justify the trouble.
The same principle can apply to plan sponsors. The contract can be terminated. Competitors can submit bids. A fiduciary committee retains the legal authority to make a change. Yet the more deeply a provider becomes embedded, the greater the practical cost of exercising that authority becomes. Years of accumulated data, technology integrations, established procedures, employee familiarity, and institutional knowledge can steadily raise the barrier to change.
The better integrated the provider becomes, the more compelling an alternative may need to be before replacing the incumbent seems worth the disruption. No single development needs to eliminate the sponsor’s ability to change providers. It only needs to make changing providers sufficiently disruptive, expensive, or uncomfortable that remaining with the incumbent becomes the path of least resistance.
That creates a peculiar fiduciary problem. Legal authority may remain firmly with the plan fiduciary even while practical leverage increasingly resides elsewhere.
In the 401k industry, the recordkeeper may be the closest thing to an operating system. It connects many of the functions plan sponsors and participants rely upon every day, making recordkeeping a particularly useful example of what can happen when ordinary switching costs evolve into something more powerful.
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Switching Costs Can Create Operational Leverage
Changing service providers always carries some friction. Files must be transferred, systems connected, responsibilities reassigned, communications coordinated, and errors prevented or corrected. None of those tasks necessarily prevents a plan sponsor from making a change, but collectively they can make the decision considerably more complicated than comparing price and service.
The significance of those switching costs increases as the provider becomes more deeply integrated into day-to-day operations. Retirement plan recordkeeping illustrates how even improvements in technology and service can unintentionally increase that dependence by raising expectations for continuous access and reducing tolerance for interruption.
“Operational disruption has always been a concern in changing recordkeepers, but daily valuation really shifted that focus,” says Nevin Adams, independent consultant and thought leader, “retired,” in Maryville, Tennessee. “After all, if you’re only updating participant balances once a quarter, you have a pretty large timing window to accomplish that move. Human beings hate change anyway – and communicating change is a complex business, fraught with potential disruptions.”
Daily valuation gave participants something better, but it also changed the mechanics of replacing the company providing it. A quarterly system offered a comparatively generous window for transferring information and completing a conversion. Continuous expectations compress that window and make disruptions more visible when they occur.
Plan sponsors considering a change consequently must evaluate more than whether another provider offers better service, lower costs, or improved capabilities. Conversion risk, participant communications, data integrity, payroll coordination, and the possibility of administrative errors all enter the equation, increasing the hurdle an alternative provider must clear.
“For many years, it has felt like having your teeth pulled would be less painful than leaving a recordkeeper, and many recordkeepers pride themselves in their refusal to numb the plan’s pain by cooperating and sticking with timelines for the transition,” says Jeff Coons, chief risk officer at High Probability Advisors in Pittsford, New York. “We see these switching costs in the number of retirement plans with expensive and inefficient providers still able to hold onto plans despite the fiduciary risks and administrative costs of staying with a sub-par provider.”
The problem becomes particularly significant when switching costs begin protecting an incumbent from normal competitive pressures. A provider does not need contractual power to prevent termination if the practical consequences of termination are sufficient to discourage customers from acting.
Recordkeeping provides an especially vivid example, but the underlying issue is broader. Any provider sufficiently intertwined with a plan’s operations can potentially benefit from inertia created by proprietary systems, accumulated data, institutional knowledge, established workflows, employee familiarity, or simply the fear that something could go wrong during a transition.
That does not make the provider irreplaceable. It changes the calculation required to replace it, because the benefits of moving must become large enough to compensate for the costs and risks of getting from one provider to another.
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Switching Costs Meet Data And Participant Access
Operational dependence alone can create leverage, but that leverage becomes more consequential when the incumbent also controls something valuable beyond the service itself. In the recordkeeping example, the provider increasingly occupies a privileged position between the plan sponsor and the participants whose accounts it administers.
The recordkeeper may operate the website participants visit, answer their telephone calls, maintain their account information, provide educational resources, and possess increasingly detailed information about their financial circumstances. Those functions can make the recordkeeper highly visible to participants even though its formal legal role remains quite different from the role of those responsible for the plan.
“First off, recordkeepers have no fiduciary role, despite the attempts (thus far unsuccessful) of the plaintiffs’ bar to transform it,” says Adams. “Technically speaking, they are merely agents of the plan fiduciary. What’s emerged more recently is their (recordkeeper’s) attempt to leverage their relationship with the participant – expanded and enhanced by growing access to more individualized data about the individual – to “encourage” decisions that arguably benefit the recordkeeper – rolling a termination balance into an IRA, for example – or perhaps into a managed account product.
What’s interesting to me (as a former recordkeeper) is that once upon a time it was customary (at least with the clients I supported) for a plan sponsor to prohibit external dealings with participants on matters unrelated to plan administration. That no longer seems to be the “norm.””
Here the switching-cost problem begins to overlap with a different kind of leverage. Information obtained through an administrative relationship can have commercial value beyond the immediate task for which the provider originally received access to it, particularly when the provider also controls the channels through which participants interact with the plan.
Timing can make that combination particularly valuable. A participant changing jobs may need to decide what to do with a retirement account, while someone having a child may suddenly be reconsidering broader financial needs. The provider that already knows something about the individual’s finances may be positioned to offer additional products precisely when those decisions arise.
“The business strategy of many recordkeepers is facilitated by not being a fiduciary,” says Coons. “With their broker-licensed call center employees having access to both plan data and financial wellness site data, they are able to sell their investment and retirement products during key life events like the birth of a child or a job change with little concern for the fiduciary risks associated with those proprietary product recommendations.”
The issue extends beyond whether any particular product is appropriate or inappropriate. More fundamentally, an administrative relationship can create commercial opportunities that were not necessarily central to the reason the provider was hired, while individualized data can transform ordinary participant access into targeted participant access.
This creates an unusual division of responsibility and influence. The plan sponsor remains responsible for the plan, yet a non-fiduciary provider may possess the information and participant-facing infrastructure capable of influencing financial decisions occurring around it. Operational dependence can make that provider harder to replace at precisely the same time its access makes the relationship increasingly valuable.
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When Switching Costs Reinforce Brand Power
Participant familiarity can add another layer to the switching-cost equation because the organization a plan sponsor regards as a vendor may look very different from the participant side of the computer screen. Participants see the provider’s logo when they check balances, call its representatives with questions, use its tools, and may encounter the same brand outside the workplace.
Over time, the distinction can blur between the company administering an employer’s retirement plan and the company a participant regards as “my retirement company.” Once that happens, changing providers potentially disrupts more than technology and administration because the plan sponsor may also be replacing a financial relationship participants perceive as their own.
“About twenty years ago, I remember seeing TV ads for a major recordkeeping firm, and the ads were a clear attempt to build brand awareness with participants, not plan sponsors,” says Coons. “Targeting the participants’ brand perceptions both made it harder for plan sponsors to move their plan and fostered a growing rollover business. That strategy has been the backbone of most recordkeeper business and product decisions since that time.”
Brand familiarity can therefore function much like another switching cost. A conversion may require the plan sponsor to explain why employees are losing a familiar website, interface, call center, or financial brand, adding participant perception to the administrative considerations already weighing on the decision.
At the same time, that familiarity can increase the economic value of the participant relationship to the provider. Assets accumulated inside an employer-sponsored plan may eventually leave that plan, but the participant does not necessarily have to leave the financial company that administered them.
Operational dependence, data control, participant access, and brand recognition can then begin reinforcing one another. The harder the provider is to replace, the longer it may retain access to participants. The stronger its participant relationships become, the more disruptive replacing it may appear. The more individualized data it possesses, the more commercially valuable those relationships may become.
None of this eliminates the plan sponsor’s authority to change providers. It does reveal why the existence of that authority does not necessarily describe the actual balance of power within the relationship.
The Apple user can buy an Android phone tomorrow. The plan sponsor can hire another recordkeeper, too. In either case, the real question is not whether switching remains possible, but how high the accumulated costs of switching have raised the barrier.
For plan sponsors, that distinction matters because a service provider does not have to make leaving impossible to become entrenched. It only has to make staying easier.
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Christopher Carosa is an award-winning online news producer and journalist. A dynamic speaker, he’s the author of 401(k) Fiduciary Solutions, Hey! What’s My Number? How to Improve the Odds You Will Retire in Comfort, From Cradle to Retirement: The Child IRA, and several other books on innovative retirement solutions, practical business tips, and the history of the wonderful Western New York region. Follow him on X, Facebook, and LinkedIn.
Mr. Carosa is available for keynote speaking engagements, especially in venues located in the Northeast, Mid-Atlantic, and Midwestern regions of the United States and in the Toronto region of Canada.
