In the Spirit of Price Unbundling

Want a boarding pass? That will be $5, please. Thirsty? Water is $3, though Spirit Airlines say it is safe to drink from the bathroom tap. Carry-on bag in the overhead bin? $30-$45 (soon to be $100). – Spirit Rewrites Airline Economic Model, WSJ

Five years ago I was working on Unbundled Pricing.  At that time it was just the beginning of airline baggage fees. My goal for unbundled pricing was not about nickel and diming but about coming with a segment driven approach to align price with value delivered. I defined unbundled pricing as,

Unbundling a value component that used to be included in the whole and charging for its value

Remember, no value – no price. But value does not mean you can charge for it. That was the reference price effect.

If the customers have never paid for it and there are no other comparisons then their reference price for a product/service is $0 regardless of the value delivered. For example, will you pay for email?

So when introduced without focusing on reference price, unbundling faced customer backlash and castigation by customer service gurus who strongly believe in enchanting and delighting all customers at any cost.

Fast forward to present day. Spirit is now the number one airline on profit per plane metric.  Despite what customer service gurus say about delighting customers, Spirit delivered no service other than safely transporting customers, did nothing remotely to delight its customers and yet saw its market value double since its IPO.

Let us return to the quote in the beginning of this article. What Spirit airlines has done may look like taking unbundling to the extreme. But it is actually taking a segment driven strategic approach to unbundling showing us all the power of customer segmentation.

Target Segment: Despite what most believe, it is not possible to serve all customers. Stated more precisely, it is not possible to fill all needs at all situations. Spirit is not going after the lucrative business segment that does not pay out of its pocket. They are going after price driven segment that makes purchasing decision purely based on price and is flying on their own dime.

Competition: They don’t see any of the major airlines as their competition. Having chosen the strategy of low price and no-frills, they see as competition other cheaper options available to customers. That is, Spirit sees Greyhound bus as its competition, not American Airlines. They are happy to yield other segments to other airlines. As Spirit CEO said, “want to check-in a few bags? Southwest is a better option for you”.

Price-Value Alignment:  When introducing Kindle Fire, Mr. Jeff Bezos said, “premium product at not so premium price”. That unfortunately is a price-value misalignment. Spirit does not say such a thing. Having chosen the low price it wants to offer, it designed a product that it can deliver profitably. The number one reason its target segment hires Spirit airlines is to get to their destination at the lowest possible cost. Spirit does that well.

Marketing : We hear a lot about marketing from management gurus like how delighted customers create word-of-mouth marketing. For Spirit a few dissatisfied customers are actually creating negative WoM. That is actually a result of these customers wrongly self-selecting themselves to travel Spirit airlines. Spirit does not want to attract those who expect any kind of service.  WoM, positive or negative is a non-issue for them. Their marketing, at 0.1% of their revenue, is reaching the price driven segment. Nothing more. It is not about stories, not about conversations and not about engagement.

What we see here is the need for strategy in running any business and not blindly following one size fits all advice. You cannot deliver premium product at low price to all customers. Everyone will be delighted to get a great product and service. But not everyone will pay for it. There exist a segment that is willing to opt purely on price just to get their most primary need addressed.

Despite what you see and hear about a businesses’s number one goal as serving its customers, if serving customers does not deliver profit you don’t have a business.

Google Customer Surveys – True Business Model Innovation, But

Summary:Great business model innovation that points to the future of unbundled pricing. But is Google customer survey an effective marketing research tool? Do not cancel SurveyGizmo subscription yet.

Google’s new service, Customer Surveys, is truly a business model innovation. It unlocks value by creating a three sided market:

  1. Content creators who want to monetize their content in an unbundled fashion (charge per article, charge per access etc)
  2. Readers who want access to paid content without having to subscribe for entire content or muddle through micro-payments (pay per access)
  3. Brands seeking customer insights, willing to pay for it but have been unable to find a reliable or cheaper way to get this
When readers want to access premium content they can get it by answering a question posed by one of the brands instead of paying for access. Brands create surveys using Google customer surveys and pay per use input.

Google charges brands 10 cents per response, pays 5 cents to the content creators and keeps the rest for enabling this three sided market.

Business model is nothing but value creation and value capture. Business model innovation means innovation in value creation, capture or both. By adding a third side with its own value creation and capture Google has created an innovative three way exchange to orchestrate the business model.
This also addresses the problem with unbundled pricing, mostly operational challenges with micro-payments and metering.

But I cannot help but notice severe sloppiness in their product and messaging.

Sample Size recommendation: Google recommends brands to sign up for 1500 responses. Their reason, “recommended for statistical significance”.
Statistical significance has no meaning for surveys unless you are doing hypothesis testing. When brands are trying to find out which diaper bag feature is important, they are not doing hypothesis testing.

What they likely mean is Confidence Interval (or margin of error at a certain confidence level). What is the margin of error, at 95% confidence level? With 1500 samples, assuming 200 million as the population size it is 2.5%. But you do not need that precise value given you already have sampling bias by opting for Google Customer Surveys. Most would do well with just 5% margin of error which requires only 385 responses or 10% which requires only 97 responses.

Recommending 1500 responses is at best a deliberate pricing anchor, at worst an error.

If they really mean hypothesis testing, one can use a survey tool for that, but it is not coming through in the rest of their messaging which is all about response collection. The 1500 responses suggestion is still questionable. For most statistical hypothesis testing 385 samples are enough (Rethinking Data Analysis published in the International Journal of Marketing Research, Vol 52, Issue 1).

Survey of one question at a time: Brands can create surveys that have multiple questions in them but respondents will only see one question at any given time.
Google says,

With Google Consumer Surveys, you can run multi-question surveys by asking people one question at a time. This results in higher response rates (~40% compared with an industry standard of 0.1 – 2%) and more accurate answers.
It is not a fair comparison regarding response rate. Besides we cannot ignore the fact that the response may be just a mindless mouse click by the reader anxious to get to their article. For the same reason they cannot claim , “more accurate”.

Do not cancel your SurveyGizmo subscription yet. There is a reason why marketing researchers carefully craft a multiple question survey. They want to get responses on a per user basis, run factor analysis, segment the data using cluster analysis or run some regression analysis between survey variables.

Google says,

The system will automatically look for correlations between questions and pull out hypotheses.

I am willing to believe there is a way for them to “collate” (not correlate as they say) the responses to multiple questions of same survey by each user and present as one unified response set. If you can string together responses to multiple questions on a per user basis you can do all the statistical analysis I mentioned above.<;

But I do not get what they mean by, “look for correlations between questions” and definitely don’t get, “pull out hypotheses”. It is us, the decision makers,who make the hypothesis in the hypothesis testing. We are paid to make better hypotheses that are worthy of testing.

If we accept the phrase, “pull out hypotheses”, to be true then it really means we need yet another data collection process (from a completely different source) to test the hypotheses they pulled out for us. Because you cannot use the very data you used to form a hypothesis to test it as well.

Net-Net, an elegant business model innovation with severe execution errors.

Fixing Past Pricing Sins by Price Unbundling

Price unbundling is back in the news after its big splash during the recessionary times of 2008.  Most people do not use the phrase “price unbundling” or “unbundled pricing” in their everyday vernacular nor do they use it label the trend. Customers and newsmedia call it, “nickel and diming” or “squeezing the customer for extras”. Before we go further definitions are in order.

Unbundling is not the opposite of Bundling nor as the name implies undoing a bundle. Marketers deliberately introduce bundles for several reasons, I discussed a few of them here. Primary reason is customer perception of value. Take a sample case of two products A and B and two customers P1 and P2. Bundling of A and B delivers better profit when P1 and P2’s value perception of A and B are reversed. Before the bundling A and B were valued albeit differently by customers. Unbundling is not the case of reversing the decision the previous decision to bundle A and B.

Unbundling is breaking down a product or service that was perceived as a monolith and charging for parts that used to be included. Marketers did not start with two or more products that each had a customer demand, value and price.

A required condition for unbundling is the component that is being unbundled must be truly optional – selling left and right shoe separately is not unbundling.

So why didn’t the marketers start out by pricing separately for the included components?

  1. Either the components were not separately consumed. Likely no one wants to eat airline food without traveling in one as well.
  2. Even if they could be, the marketer had a different source of revenue that delivered higher profit than charging for the extra.This is the case of bank debit cards, banks were able to charge the merchants an interchange fee. It was easier for banks to drive up debit card  adoption and usage by including it for free as part of the “whole” because each transaction  brought revenue from the merchants.

All is well with these free extras if their current cost, market, demand and ecosystem dynamics remain unchanged. But what if

  1. The product price is inflexible due to regulations, competition or other reasons. For instance they can’t increase the price without drop in demand that will adversely affect profit.
  2. The other source of revenue dried up as in the case of debit cards. The new regulations severely cut the merchant fee and banks are stuck with a service they adds value to customers but nothing to the banks.
We should not lose sight of the fact that these extras do add value to customers and are truly optional (as I stated above). Since the marketers chose not to do value signal and not to charge for it, the reference price for these extras are stuck at $0 in the minds of customers.
It was their past sins – giving away more than what the customer wanted or rewarding one side with value gained through other sources – that leads marketers to unbundling.
When the marketers, airlines and banks, try to charge for this value-add without focusing on the customer reference price they face extreme backlash. Any price higher than the reference price will be seen the customer as unfair. It is especially hard when the reference price is $0.
So how can a marketer roll out unbundling without customer backlash?
  1. Maintain reference price of components even when they are included with the whole. Take the case of amazon free shipping for purchases over $25. Amazon always lists the shipping cost and then subtracts it.
  2. If they neglected to do this step the next best option is to improve the reference price before charging for it. There are many ways, one of them is to use options and another is to use cost signaling.
It is easier to not commit the original sin of including lot more than the customer wants and even if you did maintain the reference price.

Unbundling – Charging for What Used to be Included in the Whole

For 10 months I was knee deep in studying unbundled pricing and trying to find answers to the questions:

  1. Why do customers hate it and feel nickel and dimed?
  2. How can businesses successfully practice unbundled pricing?

The work culminated in two major experimental works on understanding consumer behavior. The first work was the finding that  answer to both questions lie in “reference price” and the second work found customer segmentations and how these segments value the “freebies” (or suffer from paying for them).

For definition of terms see here.

Recently I saw a press release from Continental airlines on their plan to discontinue free inflight meals. Surprisingly, they were the only airline to serve free in-flight meals (based on time and on select flights) until now. Their current plan follows the rules I set forth in my results.

The menu will include freshly prepared hot and cold mealtime selections similar to those served in casual-dining restaurants, such as Asian-style noodle salad, grilled chicken spinach salad, Angus cheeseburger, and Jimmy Dean sausage, egg and cheese sandwich. Snack and dessert options — including a gourmet cheese & fresh fruit plate, several types of snack boxes, a la carte brand-name snacks and chocolate-covered Eli’s Cheesecake on a stick — will also be available for purchase. Prices will range from $1.50 for Pringles Original Potato Crisps to $8.25 for the grilled chicken spinach salad.

Instead of simply charging for the same old airline meals, they are introducing both premium and basic meals over a wide range of prices.  Higher priced options increase customer reference price and presence of a range of options make it a choice among them rather than a referendum on just one.

While your cost concerns and profit motives may drive you to flip the switch and charge for the freebies, free to fee move should not be attempted without understanding and improving customer reference price and most importantly what is relevant to the different segments.

Kudos to Continental for effective execution of Unbundled pricing.

Unbundling is not about nickel and diming and it does not have to be a brand killer. When done right it can be a source of incremental profit.

Yes for Taxing Profit From Airline Unbundled Pricing

When the lawmakers start talking about taxing (instead of banning or regulating) airline unbundled prices – we know the prices are now mainstream and here to stay.   Gone are the days of  customer backlash against paying for extras. There is much less resistance from customers not because they embraced the fees because  they clearly see the value they get but because their reference price has budged from $0.

While SouthWest continues to make its strategy “Fees don’t fly with us”, rest of the airlines brought in $769 million in baggage fees alone just in one quarter. Since the baggage infrastructure costs are sunk and the marginal cost is $0, most of these fee revenue flow directly to their profit.

The question is should these extra fees be taxed by the Government? (quotes are from WSJ article)

House Transportation Committee Chairman James Oberstar (D., Minn.) called the fees a “backdoor price increase” in airfares, with consumers now paying for many items that until three years ago were included in the price of a ticket. Passengers are paying for meals, for pillows, for blankets, for headphones, for beverages, to check the luggage.

The airlines justified these fees with a cost argument that is mostly fixed cost allocation rather than true marginal costs. Now they are pointing out the “cost allocation confusion” in lawmaker’s case for taxing these fees:

Spirit Airlines Inc. President Ben Baldanza defended the “a la carte” fee model, saying it gives passengers a choice of what services to pay for. Taxing the fee revenue would hurt industry and consumers, he said. “Such taxes would surely harm competition, raise costs and slow the industry’s recovery from a decade of losses,” he said. He added the ancillary fees shouldn’t be taxed because such services “do not use the infrastructure that the tax is intended to pay for.”

Cost is irrelevant to pricing. Yes, tax is a type of price (more precisely price is a type of tax – hence the economic term tariffs).  Since practicing unbundled pricing generates value to the airlines and  they depend on the existence of public infrastructure and security processes to provide these services. For instance the baggage screening  and airport security processes enable the airlines to provide baggage service to its customers and charge for the service. Since they are using common resources the public (Government) must be  able to get a share of this value created.

So yes, unbundled pricing must be subject to taxation.

In the Spirit of Airline Unbundling

I have been a proponent of unbundled pricing. I have published methods, based on consumer behavior research, to improve customer acceptance of unbundled pricing. But I am not supporting Spirit Airline’s plan to charge $45 for the carry-on bags. Not as a customer rights advocate but as a marketer who  practices data driven decision making.

For pricing to be truly unbundled, the feature must be truly optional and the customers must have valid alternative. In the case of baggage fees for check-in bags, customers had options. But it is inconceivable to think of anyone traveling with no  bags – they either checkin bags and pay or carry-on bags in cabin and pay.

Yes there is value to the customer in not checking in and instead relying on carry-on bags. But that value component is inseparable from the main product. They justify this price as realignment of incentives to discourage customers from bringing in oversize carry-on bags to avoid checking in bags. But they could fix that by strict enforcement of carry-on size rules. Customers have the option of not bringing oversize bags but not no bags at all.

Something to think about: If Spirit is monetizing carry-on bags, should TSA get its share for scanning the bags?

So instead of trying to show a low ticket price plus the price for carry-on bags, Spirit will be better off with one price and stricter size enforcement.

I will go out on a  limb and predict other airlines will not follow Spirit.