Beating their expectations is one way. But by how much?
Do you have to beat their expectations by a mile?
Do you have to forgo profits in the form of lower prices and higher service?
Can your business profitably beat customer expectations?For any marketer trying to gain customer loyalty in the form of repeat purchase, these are valid questions. After all there is no point in gaining loyalty of customers at the expense of profit.This article is about answering these questions using consumer behavior research.
Background and Hypotheses Development
Sometime back Tom Hulme sent me a tweet on his experience with Nespresso. Tom enjoyed using his Nespresso machine but one day the water container broke. Tom said,
Did Nespresso price its part correctly?
Did it have to price it so low to gain loyalty?
I posited that Nespresso gave away too much, priced it incorrectly and should have given choices.
These discussions led me to propose the following two hypotheses
H1: Brands do not have to beat customer expectations by too much. They can get the sameeffect by beating it just enough.
H2: When customers are given choices at different price points, they will self-select themselves to the right version and will exhibit same loyalty as those receiving large price discount.
The loyalty here refers to attitudinal loyalty as there is no easy way to measure behavioral loyalty.
Experiment Design
I designed a between groups experiment to measure the difference between the stated attitudinal loyalty of different groups. There are four groups in this experiment, all of them are filled in on Nespresso and were primed with a fixed willingness to pay of $30.
Since customers do not not what they are willing to pay and some of my experimental subjects may not know the cost of parts I used the price of $30 to normalize their willingness to pay.
Different groups were given different price rent by quoting them different price for the replacement part.
Group A: WTP = $30, Quoted Price = $2.99
Group B: WTP = $30, Quoted Price = $25.99
Group C: WTP = $30, Quoted Price = $19.99
Group D: WTP = $30, Choices: Basic $9.99, Exact $19.99, Premium $28.99
Group B and Group C are similar but test different price points.
I designed the experiment using survey format (thanks to SurveyGizmo and its very powerful split testing functions) and ran it as a survey on people in my network and bunch of MBAs from Haas School of Business, Berkeley.
Respondents were asked to state their likelihood of repurchase on a 6 point scale (a measure of loyalty). I also asked them to rate their likelihood to recommend the brand to others, more on this later.
Results
For testing the first hypotheses I compared the sample mean using 1 tailed t-test. Between Group A ($2.99) and Group B ($25.99) there was statistically significant difference (p=0.023) between the two samples. This could mean that beating customer expectation by a mile, in the form of very low price will have higher effect on loyalty than beating customer expectation just by a foot.
Between Group A ($2.99) and Group C ($19.99), the difference is not statistically significant (p =0.243). This is a critical finding. While $25.99 was no enough, $19.99 engendered the same level of loyalty as $2.99. That is a huge price difference. Brands do not have to give away the farm in the name of loyalty. This also points to lost profit opportunity for Nespresso.
Next let us take the second hypothesis that choices and self-selection (Group D) would perform at least as good as giving steepest price discount (the $2.99 option Group A).
Comparing sample means show there is statistically significant difference between mean likelihood ratings of Group A and Group D (p = 0.014). This is a big surprise for three reasons.
For one thing, when customers were given choices and self-select themselves to the version they prefer, they are more likely to feel ownership and increased utility.
Second, this Group was offered the same $19.99 price for the “Exact Match” version. This was the only option offered to Group C. While Group C showed no difference from Group A, this group did. Presence of choice negated any positive effect from $19.99 price.
Third, if we looked at the sub-group that chose the lowest priced Basic version ($9.99), there still is statistically significant difference between this sub-group and Group A.
One conclusion we can make is that presence of options for replacement parts causes customers to incur cognitive cost that is reflected in the form of low loyalty rating. However, this requires further consideration before casting aside versioning.
One interesting corollary is the correlation between loyalty measured as intention to repurchase and likelihood to recommend. As I stated before, I asked respondents to rate both. There is very high correlation (0.99) between the two metric. Likelihood to recommend is not a better measure as contend.
Marketing Implications
Loyalty does not have to mean “delighting, enchanting, astonishing” customers. You can beat customer expectations by just enough. This is attitudinal loyalty and may not translate into behavioral loyalty. So in general using price discount to generate future sales is not recommended.
Statistical significance does not mean economic significance. The mean loyalty rating for lowest price group was 4.4 vs. 3.68 for $25.99 group. Will gaining loyalty at the cost of $22 per customer generate more profit in the form of future purchases?
For pricing replacement parts, brands need to do Willingness to Pay studies just as they do for the full product. There is no reason to sell the replacement part at cost due to fears of customer backlash. Same principles of value based pricing apply for parts.
While multi-version pricing is effective in most scenarios, offering choices for replacement parts comes at a cost to customer (See 4 costs of versioning). While versions enable profit maximization its effect on customer loyalty needs to be considered.
Iterative Path 
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