Economics & Markets
Section 1
Core Idea
Four cost types shape decisions and markets. Sunk costs are already spent and irrecoverable — they shouldn't influence future decisions but almost always do. Transaction costs are the friction of making a deal: legal fees, time, paperwork, negotiation. Switching costs are the penalty for changing suppliers, tools, or platforms — retraining, data migration, lost integrations. Search costs are the time and effort to find alternatives. Each type distorts decisions. High switching costs create lock-in and moats. High transaction costs prevent efficient markets. High search costs let inferior products survive. The strategist manipulates these costs — raising them for competitors, lowering them for customers.
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Section 2
How to See It
Strategy
You're seeing these costs when a customer stays with an inferior product because switching is painful (switching costs), or buys the first adequate option because finding the best one takes too long (search costs).
Markets
You're seeing these costs when deals don't happen despite mutual benefit because the transaction friction (legal, regulatory, negotiation) exceeds the gain. High transaction costs block trades that should occur.
Decision-making
You're seeing these costs when a team continues a failing project because "we've already invested so much" — sunk cost reasoning that should be irrelevant but drives the decision.
Section 3
How to Use It
Ignore sunk costs in decisions — only future costs and benefits matter. Minimise transaction costs for your customers (frictionless checkout, simple contracts). Raise switching costs strategically (integrations, data gravity, habit). Lower search costs for your buyers so they find you (SEO, clear positioning, distribution).
Decision filter
"Which cost type is dominating this decision — sunk, transaction, switching, or search? Is it driving a rational choice or distorting one?"
As a founder
Audit each cost type in your business. Sunk costs: stop throwing good money after bad projects. Transaction costs: make buying frictionless. Switching costs: build integrations and data gravity that make leaving painful. Search costs: make your product easy to find and evaluate. Manipulate these costs deliberately — lower them where they block your growth, raise them where they protect your moat.
Section 5
Founders & Leaders
Sam WaltonFounder, Walmart
Walton built Walmart by relentlessly attacking costs — transaction costs (efficient supply chain, simple vendor terms), search costs (everything under one roof), and switching costs (everyday low prices eliminated the need to shop around). He understood that reducing friction for the customer while increasing the cost of competing with Walmart was a winning combination. Founders can apply the framework: lower the costs that block your customers, raise the costs that protect your position.
Section 7
Connected Models
Reinforces
Sunk Cost Fallacy
The sunk cost fallacy is the behavioural error of letting irrecoverable costs drive future decisions. Understanding that sunk costs are irrelevant in rational choice is the first step; the fallacy shows how often we fail.
Reinforces
Switching Costs
Switching costs are a subset of this cost taxonomy. High switching costs create lock-in, moats, and pricing power. Design them into the product (integrations, data, workflow dependency).
Leads-to
Barriers to Entry
All four cost types can create barriers. High switching costs lock in customers. High search costs hide alternatives. High transaction costs deter new entrants. Together they form the cost-based moat around a business.
Section 8
One Key Quote
— Ronald Coase, The Nature of the Firm (1937)"The main reason why it is profitable to establish a firm is that there is a cost of using the price mechanism."
Section 11
Summary & Further Reading
Four cost types shape decisions and markets: sunk (irrecoverable), transaction (deal friction), switching (change penalty), and search (finding alternatives). Ignore sunk costs in decisions. Minimise transaction and search costs for customers. Raise switching costs to protect your moat.
01
Paper
The original case that transaction costs explain why firms exist.
02
Book
Sunk cost fallacy, loss aversion, and how costs distort rational decisions.
03
Book
Switching costs as a source of competitive power and strategic moat-building.