Wi-Fi In Airplanes – Stuck in $0 Reference Price

Update 2/1/2010: Southwest planning to offer Wifi (for a price). It definitely will help them to read this.

How much is getting Internet connectivity at 30,000 feet above sea level and while moving at 240 miles per hour worth to you?  How much are you willing to pay for it? How much are you willing to pay for WiFi connection in an airplane?

I predict that most will say different numbers  for these questions, progressively decreasing from a non-zero number to none other than $0 for the Wi-Fi question. The Wall Street Journal writes on the uptake of Wi-Fi in airplanes:

“There’s a very substantial decline in passenger usage the minute you start charging for the service,” said Michael Planey, a consultant specializing in in-flight passenger technologies. “It really begins to invalidate the model on which this service is being built for the next 10 years.”

wifi_demanAlaska Airlines found that even at a price of $1 lot fewer people used its service then when it was free. So the demand curve for this service will look something like the one shown here, dropping abruptly at a price just above $0.

Having connectivity is definitely of value to customers, some segments valuing it more than the others. But why are customers unwilling to pay for this value? The answer once again is the same one I showed in my Airline Unbundling study – Reference Price. Reference price is the price a customer used to paying for the service or expects to pay despite the value they get.  The purchase context does not matter to the customers, it is the price for the service. Everywhere they go, from coffee shops to hotels they received free Wi-Fi. So their reference price is $0.

The airlines should not have made this offer free to begin with but they need to do that for testing. They should have recognized this reference price effect and should have first worked on improving it before charging for it. One option I showed that worked in the unbundling study is introducing options, one high priced and another low priced. Presence of high priced option helps to improve reference price and hence customer acceptance of lower priced option. The airlines could have introduced a guaranteed speed, unlimited bandwidth version and a limited speed, limited bandwidth version at two different price points.

Another takeaway in this story is how a marketer can destroy future profit by setting a low (or $0) reference price. I am afraid however that this story is going to be  used by “Free” proponents like Mr. Chris Anderson. A case will be made about why free is the future and once again a reference will be made to the attractiveness of  $0 price, quoting Prof. Ariely’s work. I would like you as a marketer to be aware of the reference price effect and find ways to charge for this service that adds value to customers.

It is true that providing Wi-Fi at 30,000 feet is a high fixed cost operation and once you rolled out the service your costs are sunk and your marginal costs are $0. But before you made the business case for the investment the costs were not sunk and you should have made an analysis how much you expect to charge and how many customers would pay. You should not have invested with the hope that you will first get the customers and then figure out how to monetize it.

The net is, if the service is of value to customers then you should charge for it. What the customers are willing to pay for the service is not commensurate with value but lower because of the reference price. Focus on improving the reference price to capture a fair share of the value you add.

Defusing Customer Backlash From Price Increases

My previous consumer behavior experiment led me to conclude that customer backlash to pricing changes stem from the reference price, the price they used to pay or a service despite the value they get. Recently I saw a blog post about Frontier Airlines by Mr. Andrew Hyde regarding its changes to standby policy. Frontier now charges a fee for going standby on an earlier flight. Before they did that they did not allow standby on earlier flights, this had caused Mr. Hyde to revolt and even say that he would never travel by that airline.

Mr.Hyde, as he points out in the comment, did not object to price increase per se and contrary to what I wrote earlier his objection was to change in policy without notice.  The net is customers will be less than willing to pay for services that used to be free because their reference price is $0.

This situation is no different from the customer backlash faced by US Airways before it decided to drop its $1.99 drink fee. It makes perfect business sense for Frontier to charge for this service regardless of the  costs associated with admitting a standby passenger on a partially empty flight. Frontier should have recognized the reference price effect if they were were planning to charge for the standby before they denied it to some. They should have  first worked to improve this from $0 to a positive value before introducing the price changes.

For instance, it could have sent all its travellers (anyone whose email address it has, past, present and future) a coupon or two for “Free standby”. Stated clearly in that coupon is the price of the standby and the value those customers get by using the coupon for a standby. This would have cost them nothing more than the cost of sending out the coupon but the effect is to improve the reference price of the standby service from $0 to the dollar amount marked in the coupon.

A business simply cannot ignore the effects of reference price and should actively work to manage it.