In any all you can eat pricing model, be it a lunch buffet or at&t iPhone subscription pricing, as long as the total revenue exceeds total costs, the business will make a profit regardless of whether they lose money on any one customer. There will always be a distribution of customers based on value they receive and price they pay
- Some customers get more value than what they pay
- Some don’t get as much value as they paid for
The problem occurs when the first segment uses a higher proportion of the service and risk completely starving the second segment.
the heaviest data users, saying that 40 percent of AT&T’s data traffic came from just 3 percent of its smartphone customers
To provide appropriate level of service to the second segment AT&T needs to size their services so the big appetite of the first segment is served. Facing customer backlash from slowness, AT&T is trying to reduce data usage by the heavy iPhone users – this implies they are either working on introducing metered pricing or a multi-version pricing.
Either of these plans require that their subscribers understand the value they get from the current unlimited plan. If the customers do not know how much value they have been receiving they will balk at any changes to current pricing. AT&T has a leg up on this, they have been itemizing data plan usage minutes (page after page if you received paper bill) even though the plan is supposed to be unlimited. It is arguable how many customers look at paper bill but the auditing does provide a way for AT&T to make a case with its customers when they introduce new pricing plan.
“Dear customer, do you know, on the average, you used 100 minutes of data service for 1GBytes download in the past 12 months. That’s $50 in value per month and $30 more than what other customers like you receive. To better serve your needs and those of all our customers like yourself we are introducing a new pricing plan …”
Which one will it be? Will it be metering, charging per minute or megabyte of download of data usage? Will it be a set of new data plan versions offering a combination of minutes and download? Which has better chances of succeeding?
I do not believe it will be usage based pricing. It does not align with the current minutes plan and the problem it introduces with customers constantly worrying about using the data service. AT&T already has a track record in executing a successful multi version pricing plan for its wireline high speed service (see figure left). Modeled after this we should expect to see three to six different data plans at different price points, each offering a combination of minutes and download (GBytes).
Versioning is about offering multiple versions at different price points so the customers self select- in this case it also helps to better align the value customers have been receiving with the price they pay.
The problem with unbundled pricing (pricing separately for each component of a monolith) is the multiple purchase decisions the customer has to make. Every time the customer opens the wallet and pays for an extra, they feel increasing pain (Prospect Theory). Customers will see each transaction as a loss and according to Prospect Theory the pain from multiple small losses can be more than the pain from a single loss of same magnitude. The pain from losses do not increase linearly with amount paid but the pain is felt every time customers have to pay.
Take the case of airline unbundled pricing, specifically the baggage fees. Profit from baggage fee is nothing to be sneezed at. For someone who travels a few times a year and checks-in bags, it is painful each time they pay for bags and leads to brand erosion. United has come up with an innovative way to reduce this pain by reducing number of payments – they now offer an yearly subscription for baggage check-ins for $249.
Forget about first and second bag fees for an entire year. With Premier Baggage, you and up to eight companions can check up to two standard bags each without fees, where applicable, every time you travel in the United States
Premier Baggage also makes a great gift for a frequent traveler.
This is a great pricing plan in many ways:
- It addresses the multiple pain instances by reducing payments.
- It captures value upfront.
- Someone buying this subscription is going to prefer the same airline for the entire year even though they should not (because after they paid the fee it is sunk and they should compare the cost of available options for each trip).
- The best possible case for United is people buying it not using it.
- The worst possible case is a group of eight companions checking in two bags even once. But in that case they are generating so much revenue from the tickets that it more than makes up for lost baggage fees.
- They have a good chance of getting businesses to buy it for their employees or gifting to their clients/customers.
- To United there is really no cost, all of this is profit. The only cost is the opportunity cost of lost baggage fee from high volume and or frequent users but that is made up and more from ticket sales.
Now if only they can turn profit from the rest of the operations.
Milton Friedman said, “the business of business is business”. Assuming every legal and ethical i-s are dotted and t-s are crossed, a business’ goal is to make profit on the investment. However this seem to be ignored increasingly in favor of gaining attention. The catchy phrase for this is “attention economics”. This is not different from the “eyeball economics” of the first Internet bubble. The first bubble and its aftermath showed us one cannot take number of eyeballs to the bank.
Newspapers fell into this trap by making their online content available for free. The business justification was the Ad revenue generated from page views and non-business justification was, “to be part of the web conversation, to be linked and commented on”. After making the online versions free they rationalized their decision by looking at other newspapers that made their offering free and the big jump in the number of page views over the paid version.
But they failed to ask whether making the service free will deliver incremental profit over the current offering. They only looked at the new Ad revenue generated and ignored lost revenue from subscription, limits of Ad revenue growth and the effect of a $0 price on their print media offering. For example, if WSJ were to make its online offering free its new Ad revenue must be more than $80 million. This number does not take into account lost revenue from loss in print subscription due to free online offering. Considering that most newspapers are suffering we can infer that the free model delivers net incremental loss and not profit.
The question is not whether or not a newspaper should be free or freemium or whatever fad name, rather the question is what path they should take that will deliver the best return on their investment over the long term.
Match.com is running a promotion for its service, “If you do not find your special someone in six months, your next six months is free”. Simple and elegant plan that may on the surface seem to give away too much and yet captures the full lifetime value of a customer.
If a customer did find the special someone, there is no reason for them to pay for the next six months. If they did not, then they may still be less likely to continue to pay for a service that is not meeting their expectations. The marginal utility of the service to a customer decreases as the time progresses and at some point the service adds no value to a customer. In other words, the lifetime of a customer is limited.
For any product or service with decreasing marginal utility that approaches zero, the pricing should capture all the value upfront and give away additional units at marginal cost.
For Match.com, the marginal cost of serving a customer is $0. So a pricing scheme that charges $60 for six months with additional six months free is better than a scheme that charges $60 for an yearly subscription.
There is one additional factor in the pricing of match.com, customer margin. The likelihood of a customer staying on after six months, intuitively, is very low. But if they stayed on, there are opportunities to make incremental revenue in the form of selling other products and help build critical mass to attract new members. This turns a cost activity into a revenue opportunity, squeezing extra profit from the limited lifetime of a customer.
I think Match.com is practicing effective price management with a clear understanding of consumer behavior and lifetime value of customers.
How do you price your offering when the lifetime of a customer is limited?