To Unbundle or Offer Multiple Bundles?

If you are looking at pricing your new cloud based service, there are two Airline pricing stories in recent news that I want to call your attention to. These are relevant to X-as-a-service businesses that struggle with value maximization. The two stories are similar in their goals of maximizing their value capture while not taking away customer choices. But they go about that in two different ways.

FlySafair ExtrasFully Unbundled Pricing – South African airlines FlySafair completely unbundled its ticket. The base price you pay for the ticket gets you just that – a seat with assured safe travel. Everything else is extra – inducing selecting your seat or getting TXT alerts on status. Their business policy is recognizing there are many different customer types that value different features differently. But a vast majority they want to serve select based on base price. Instead of bundling features and set a higher base price they practice fully unbundled pricing.

investor-day-2014-32-638Option of Multiple Bundles – Delta Airlines reported its latest quarterly numbers and in that stated it made $75 million in profits from its “Branded Fare Initiative”.  Branded Fare offers customers five different versions at different price points and features mix and letting customers self-select. Each version is a bundle of features and targeted at specific segment. For instance,  the lowest priced version does not include the option of seat selection while it includes Wifi.

Delta calls this strategy as better customer segmentation. That is correct and likely they did extensive marketing research to find what is relevant to which segment and define the right number of versions. You can see a similar segmentation research on the airline preference I did a few years ago. FlySafair is practicing segmentation too – it allows for many different segments, not just five we see with Delta.

I have written at depth about Unbundling as pricing strategy and about price bundling based on customer segmentation. Which approach is better for your cloud service?

Should you take FlySafair approach of offering a base product at lowest possible price and make everything else extra? For example a APM SaaS may offer simple data collection at base price and offer advanced analytics, monitoring, alerts,  replay etc as extras. Or should it offer 3 to 5 versions?

I recommend Unbundling as experimental approach rather than a long term pricing strategy for your MVP.  A big advantage of complete unbundling is it drains the water in the pond and exposes all rocks and deep ends. When you are starting with a X-as-a-Service it makes sense to start with fully unbundled pricing. This is your marketing research unlike established businesses.

However it does have the ill-effect of being seen as nickel and diming. Even if that is not the case every time customer has to make a buy or no buy decision on an extra they incur significant cognitive cost. Paying for multiple extras causes more pain than paying once for a prepackaged bundle (Prospect theory).

Use unbundling to find the value distribution among customer segments. Then use the customer preference data to define specific and limited product versions like Delta did. That offers better customer experience and value maximization.

Perfect Packaging and Pricing – Delighting customers doesn’t mean over-delivering

Think about this pricing puzzle for a moment.

Apple includes a standard, good-enough, headphones with all its iPods. Even the cheapest iPod shuffle, priced at $49, comes with one. But there is none included with iPad. Even the most expensive Wifi version, priced at $699 does not include headphones.

If you consider the marginal cost of iPad, it is safe to say it is less than 50% for 16GB iPad and even lower for 64GB iPad. If the cheapest iPod shuffle can include one, it is highly likely the headphone don’t add too much to marginal costs (may be a $1).

Then why there are none included with iPad?

If your answer included words like – consumer surplus, perfect product packaging, utility and willingness to pay – you can skip the rest of this article and go straight to the bonus puzzle at the end of the article.

While you think about this puzzle let us take a diversion to what has become the conventional wisdom in customer satisfaction. Number one advice from customer satisfaction/loyalty proponents is turn your customers into loyal and raving fans. And how would a business achieve that? By delighting them, by going the extra mile, by delivering remarkable customer service and not by nickel and diming for extras.

Conventional wisdom is neither conventional not wisdom. The basic economic theory about consumer surplus and pricing is you don’t leave too much consumer surplus – in other words you don’t give more than what is absolutely needed with the product at a given price point.  From that perspective, Apple is offering the perfect Goldilocks package – include only the absolute minimum that is needed to sell the product.

Every additional item you include to the product package must deliver incremental value to customers that can be translated into incremental pricing for you. If either the customer does not see value or the value does not translate into higher willingness to pay, you should not be including it. (See also Value Step Function).

A moment’s reflection will convince you, an iPod shuffle  is pretty much useless without the headphones. So the headphones are indispensable. For an iPad, headphones are purely incremental and no way reduces the value from the device. Customers are hiring the iPad for a different job. By better positioning the product for those jobs Apple is able to avoid including headphones and as a result make $60 million a year in pure profits ($1 per headphone and 60 million iPads sold)

May be you buy this economic argument from selling the product perspective. What about driving loyalty? Wouldn’t the customers be even more delighted if Apple were to throw-in headphones with iPads?

In a research I conducted two years ago, I showed that you do not have to beat customer expectations by a mile to gain loyalty. Beating it just enough will do.  There is no statistically significant difference in customer’s propensity to recommend your product whether you just met their expectations or gave away the farm.

On a related note, Kindle Fire priced at $199 does not include headphones as well. That is likely driven by cost given Amazon’s approach to pricing.

How do you decide what to include in your product?  What is your perfect packaging?

Bonus puzzle:

Why didn’t apple offer yet another iPad offering at higher price with premium headphones?

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.

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.

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.