Is ‘free’ the best way to get loyal customers?

When giving something for free might not be the best way to engender loyalty.

The late-American singer-songwriter Jim Morrison once said, “Some of the worst mistakes in my life were haircuts.” A few evenings ago I met a friend for a few Xmas drinks. Amongst everything else we spoke about my friend was excited to tell me that when he got his haircut a few days earlier he didn’t have to a pay a thing. Now, his wasn’t cut by a friend in return for a favour but at the same salon he goes to every few weeks.

It transpires that this salon, like many other business, like to give something away for free in return for something from the customer: loyalty. The salon’s promotion means that you get every fourth haircut for free. This got me thinking: is this really the best way to encourage loyalty with your customers?

Salons are not the only type of business to use such a loyalty scheme: coffee shops, DVD rental stores (when they existed), cinemas, restaurants, to name a few, have all deployed this tactic at some point. In some instances it can make sense, particularly when what you sell is close to being a commodity item or competition is especially fierce. Cinemas are a good example. The movie you watch will be the same regardless of where you watch it. There are some ways to differentiate, such as, with luxury seating, advanced screenings, free parking etc. But when that isn’t enough then resorting to giving a free screening after x number of ticket purchases might not be too bad a thing.

However, when it comes to salons I’m not sure it’s the best way to engender loyalty amongst your customers. Haircuts are complicated products. Everyone likes to have their hair cut in a particular style. Yours truly has been using the same stylist for nearly seven years. They know what I want without me even asking and so far they haven’t screwed things up. This is probably the same with most people when it comes to a haircut. You find somewhere that works and you stick to it. Price most likely isn’t the determining factor. A better way to encourage loyalty could be to offer an introductory discount on a higher grade stylist or a complimentary styling product.

I know for a fact that my friend was excited by his free haircut for the exact reason that he had no clue he was going to get it for free when he walked in. He was never going to switch salons because he was happy with them. Now, however, they’ve set a precedent. He’ll likely be expecting more free cuts in the future. With a simple gesture the salon have made price a determining factor of the purchase when it never should have been. All of a sudden haircuts for my friend are more price elastic than they were before and for the salon that’s not a good thing. A good salon should be engendering such a loyalty that a small price rise now and again isn’t poorly received by its customers. Jim Morrison was disappointed with the bad haircuts, but probably not how much he paid for them.

Decoy pricing and the iPhone 6.

Tim Cook shows off the new iPhone 6 (Image credit: Getty Images)

Tim Cook shows off the new iPhone 6 (Image credit: Getty Images)

My last post was about decoy pricing and whilst I wouldn’t normally write about the same topic in succession I’ve decided to break from the norm.

The reason for this is to give another good example of decoy pricing in action.

This week Apple announced the iPhone 6 and iPhone 6 Plus. Previous generations of the device have come with three storage options: 16GB, 32GB, and 64GB. However, this year Apple has made a change. The storage options now are: 16GB, 64GB and 128GB. Out goes the 32GB option and in comes 128GB.

Now let’s take a look at how this looks with pricing:

  • 16GB $649
  • 64GB $749
  • 128GB $849

Now, storage is an important consideration when you’re spending over $600 on a phone. Get it wrong and it’s an expensive mistake. So what’s Apple trying to do? Take a look below at the cost per GB (brackets) for each device:

  • 16GB $649 ($40.50)
  • 64GB $749 ($11.70)
  • 128GB $849 ($6.63)

All of a sudden the 64GB model becomes very attractive compared to the 16GB model. And the 128GB model even more so. For many people 16GB might just be enough storage. However, if you had any doubt in your mind, for an extra $100 you can pick up four-times the storage.

Essentially, Apple has deliberately made the entry-level model substantially less attractive to buy than the alternatives. The likelihood is that a large number of iPhone 6 buyers will trade up to the 64GB model, if not the 128GB version. For Apple this means an extra $100 revenue per customer.

The alternative would have been for Apple to have gone with a more mathematically natural line-up of: 32GB, 64GB and 128GB. However, that would have made the economics of purchasing a more expensive model less obvious to potential customers. For many people 32GB is most certainly enough storage.

So there you have it: another good example of (high-profile) decoy pricing in action.

Using decoy pricing to maximise profits.

Use decoy pricing to encourage your customers to trade up.

The main objective of any pricing manager is maximising revenue and profitability. It’s not easy and is in fact an endless task. One way we can try to achieve this is through trade up. If we can encourage our customers to buy our most highly priced (and presumably highest margin) product then we’re happy.

So how do we do that? One method is decoy pricing. Decoy pricing is whereby you offer three similar products of which two have a similar or equal price. The products are scaled variants.

This is best illustrated with an example…

Take a look at these two products for a subscription to a magazine.

  • One-year online subscription $59.
  • One-year online and print subscription $125.

Which would you choose? The majority of people would probably opt for the first product as at $59 it is far cheaper than the second. Now imagine if the product offerings were this…

  • One-year online subscription $59.
  • One-year print subscription $125.
  • One-year online and print subscription $125.

All of sudden the combined online and print subscription seems like incredibly good value for money.

This example comes from research conducted by Dan Ariely for The Economist. His research showed that by including the middle product (the decoy) it gave consumers an easier way of understanding the benefits of each product and lead to more purchases of the $125 online and print subscription. Without the middle option more customers chose the $59 option.

You don’t just see decoy pricing used for magazine subscriptions. It can also be deployed in the travel industry, in software, telecoms, consumer electronics and more. How could you use it in your business?

(A similar – but different – tactic you might like to read about is product sabotage, which I’ve written about before.)

Why the Amazon Fire Phone price isn’t cheap.

Jeff Bezos unveils the Fire Phone

Jeff Bezos unveils the Fire Phone

It’s been about three-weeks since Amazon unveiled its first smartphone to the world: the Fire Phone. Now the dust has settled it’s possible to try and understand exactly what Amazon is trying to achieve with the Fire Phone pricing.

Some commentators have criticised the company for not doing what it’s done in the past with the Kindle and Kindle Fire – sell at an incredibly low price to sell as many devices as possible and make money selling content. Admittedly, that was what I was expecting before the announcement.

However, when you look at what the device actually does it becomes much clearer why this isn’t a device being sold cheap. A feature Amazon took time to talk about during the announcement was Firefly. The technology allows you to use the phone’s camera to identify literally millions of different objects. Once identified you can then very simply purchase them from Amazon. It’s this feature which hints at the Amazon’s strategy – the whole purpose of the Fire Phone is to get users to buy more goods from Amazon and bring them ever more into the Amazon ecosystem.

So what does this mean for the Fire Phone price? Or put another way: why isn’t it cheap? Surely the more people who use this phone the better for Amazon? Possibly not.

For the answer you need only look at IBM’s latest report into mobile shopping. The report shows shopping via a mobile device to be growing at a fast pace and beginning to account for a significant chunk of total online spending. The IBM report details that the average online transaction in the U.S. is worth $132. This compares to $124 for tablet users and $108 for smartphone users. And here’s the nugget that we’re looking for: users of Apple’s devices outspent Android users by 37% in November 2013. Why? Well users of Apple’s devices tend to be wealthier quite typically because Apple prices its devices much higher than competing Android devices. And for that reason they have more money to spend.

And that’s why the Fire Phone price isn’t as cheap as other Amazon devices. It needs to sell the device to people who then have the disposable income to buy goods from the company through the phone. Selling the device at cost would most likely sell more devices, but if Amazon’s strategy is for users to then buy goods from the company via the phone then this would be unlikely to happen if those users have a lower level of disposable income.

Is Microsoft’s Xbox One price cut the right move?

The Xbox One launch. Microsoft needs more fans like these in the UK.

The Xbox One launch. Microsoft needs more fans like these in the UK.

Last week Microsoft announced it was it cut the price by $200 just months after launch.

In a normal scenario I’d advise against a straight price cut. Microsoft’s actions are a result of struggling sales because of an inability to communicate the value of its product vs. its biggest rival the PlayStation 4.

But, there is a bigger point to the Xbox One price cut that might be immediately obvious.

Technology companies are selling much more than a single product. Much like when Apple cut the price of the iPhone, Microsoft is selling an ecosystem. Getting a large user base is important to entice developers to the platform who can in turn write games to tempt even more people into buying the console as well as to retain existing owners. It’s important to get that traction early before a competing platform, in this case the PlayStation 4, becomes too dominant. Given the social nature of gaming there is the impact of network effects to consider as gamers opt to buy the same console as their friends so as to allow them to play together. Furthermore, the more games a user buys the more invested they become in the platform, making switching both costly and time consuming.

Whilst the price cut does speak of a little panic it does also hint at Microsoft’s belief that price is an important factor when people choose which platform to buy into. The company should also be commended for its bundle offer (£399 for the console with the major game Titanfall) that is closer to value pricing.

Clearly Microsoft has its work cut out growing Xbox One sales in the UK, but the price cut should help. If it can help it sufficiently enough that those extra customers stick around for years to come and in doing so buy games, accessories and other media, then it most likely will have been worth it.

Killing your pricing with bad customer language.

Using the right communication in your pricing is crucial.

Using the right communication in your pricing is crucial.

So, you have your pricing strategy. You’ve outlined which of your products/ product groups are EDLP and which are EDLP+. But, have you figured out the best way to communicate your pricing through customer language?

Take a look at this:

Imagine a deal for an item that was selling at £10, but has been cut in price to £5. Now look at these examples of customer language:

  • Save 50%
  • £5
  • 50% Off
  • Half Price
  • Was £10, Now £5
  • Was £10, Now £5, Save £5
  • Was £10, Now £5, Save 50%
  • Each of these different examples are saying the same thing and many of us are guilty of using a combination of them across our product range. The problem is that it can be hard to influence the perception customers have of your pricing when your communicating in so many different ways.

    So, which do you use? There’s no hard right or wrong answer. Sure there’s a truck load of academic research about this, but ideally you will need to test.

    It’s an important thing to try and get right. It could mean the difference between a sale or not and the same is true of volume deals:

  • 3 for £5
  • 33% off when you buy 3
  • Was £5 each, £3.33 each when you buy 3
  • Was £5 each, £3.33 each when you buy 3 (33% Off)
  • Was £5 each, £3.33 each when you buy 3 (Save £5)
  • Save £5 when you buy 3
  • Buy 2 Get 1 Free
  • 3 For 2
  • So what should you do? You should aim to streamline and only use a handful of value and volume languages. Secondly, understand whether to communicate in £s or in percentages. Which is more important to your customers and which communicates the price/ saving better? This will be influenced by your price architecture: for big ticket items it might be £s, but for lower priced items percentages may work better. Remember also that some customers may find it difficult to work out what a percentage saving actually means for their wallet.

    As I said, you’re going to have to test. There are many ways of doing so: if you’re an online retailer you can present different mechanics to different customers. If you’re a physical retailer then use a defined period of time to test some mechanics. However, always work out a control.

    So, as my mother used to say, “It’s not just what you say, it’s also the way you say it.” And so it is with your pricing too. If you do decide to do this I’d love to know how you get on.

    Can charity stores be too expensive?

    An Oxfam store. The charity is one of the largest in the UK.

    An Oxfam store. The charity is one of the largest in the UK.

    Are charity stores becoming too expensive? That’s a question that The Observer newspaper has posed. It would appear that regular shoppers of charity shops feel that they are being priced out. This is because of charity shops apparently choosing to stock more expensive donations.

    The bigger accusation is that charities are becoming more corporate, opting to maximise revenues and profits at the expense of customers.

    But, is there really anything wrong here? Charities are much the same as corporations in that they have stakeholders. They have employees, customers, communities etc. However, the key purpose of charities is to raise money for those in need. It is these people who are perhaps the most important stakeholders. If raising money for their cause is achieved by selling an old tie for £2 or a second-hand designer jacket for £150 then so be it.

    There is, of course, the risk of some seriously bad PR. So bad that it could drive some customers away. The better solution could be that charities offload expensive items in some other way, such as, eBay. (This will likely still cause some outrage.)

    It’s important to remember that like every other retailer charity stores are expected to pay rent for stores situated in increasingly desolate high streets. They need a pricing strategy to support it. Larger charities can be smarter by moving expensive donations to more affluent areas. Ultimately though, charity stores are exposed to the same market forces as businesses. This is particularly so given the proliferation of charity stores during the recession. Competition is fierce. They will soon adjust if revenues begin to decline.

    Product bundling: when is a good time to use it?

    Microsoft CEO Steve Ballmer presents Microsoft Office 2013.

    Microsoft CEO Steve Ballmer presents Microsoft Office 2013, a classic example of product bundling.

    When is a good time to bundle different products/ services together?

    Product bundling is what it sounds like: bundling multiple products into one package with a single price. It’s nothing new and is common in certain product categories: software (e.g. Microsoft Office), games consoles, airlines and even restaurants (the three course meal).

    So why bundle? Product bundling can be good for several reasons:

    • It can improve your offer by easily providing a total price for all your associated products and services.
    • It saves the customer time from having to work out the total cost for themselves. (Remember that convenience and speed are key priorities for some customers.)
    • It can make it harder for your competitors to price match if they can’t identify which parts of the bundle are your most profitable. (This only works if you only sell the products as a bundle only and not separately.)
    • If you sell software, bundling different software applications together can be a good way of trying to bring more customers into your ecosystem.

    So should you use product bundling?

    It’s a difficult question to answer and a lot will depend on the competitive environment that you are in and what you are trying to achieve. I’ve highlighted the main benefits above.

    Remember though that bundling does have its critics. A regular complaint is that it can make it difficult for consumers to compare products if different competitors bundle similar, but different, products together at different price points. Some also complain that businesses are not being totally transparent about their pricing when bundling products together. There is also the fact that some customers may feel unhappy if they think they’re paying for parts of a bundle that they’re never going to use.

    However, remember the key rules if you do decide to bundle:

    1. Ensure you establish the value of the individual products before you set the bundle price.
    2. If you can, avoid mixing basic and premium products. As a bundle is a whole it can be difficult to highlight the individual components and could result in sending a confused message.
    3. Finally, decide if you are going to bundle or use a bonus item (think of games consoles again, which often throw in free games).

    So, now you know what product bundling is, do you think there’s an opportunity for it in your business?

    Microsoft’s tablet pricing strategy.

    This is a counter argument to an article written by Tony Rizzo of techzone360.com. You can read it here.

    Tony Rizzo of techzone360.com has written a piece concerning Microsoft’s failed attempt at making a dent in the tablet market.

    Rizzo argues that a core problem with Microsoft’s strategy was pricing. In particular the fact that Microsoft didn’t meet the price points as established by Amazon and Google and that thus its tablet pricing strategy was way off. Rizzo says that had Microsoft met some of those price points then it would have been possible for them to shift more units and thus drive the adoption of its new operating system.

    However, there is a counter argument to this: the race to the bottom. By pricing at these extremely low price points Microsoft would have become stuck in a race to the bottom that would have left it struggling to breakeven, let alone make a profit.

    To support this argument there is a key point to consider: how competitors make a profit in the low priced tablet market.

    Amazon deliberately prices below cost or at breakeven to shift units. It then aims to drive profit through sales of digital content that customers consume on the device.

    Google does the same by pricing its Nexus device near breakeven. However, its strategy is to make Android even more ubiquitous and by doing so nudge people into using Google services that it can then sell ads off the back of.

    Microsoft doesn’t have either of these two strategies to fall back on.

    Apple doesn’t even compete at these price points. (The iPad mini is £70 more expensive than the Google Nexus 7.)

    What Microsoft did instead was deploy a value pricing strategy: that is pricing a product on the merits of its attributes. The bad news for Microsoft is that those attributes simply weren’t (still aren’t) good enough. Not enough consumers thought the value reflected the price they would be paying.

    This isn’t necessarily a pricing problem. It’s a product problem. If Microsoft wants to succeed in the tablet market it needs to build a more compelling product and communicate it’s value better to consumers.

    This may be the same for your business. Playing in a game for the race to the bottom is only going to end in disaster unless you have a strategy like Amazon and Google. It’s much better to have a value-based pricing strategy to maximise your product. However, just make sure you have a truly compelling product. Good luck!

    Using pricing segmentation to drive sales and profits.

    You can use pricing segmentation to drive your business’s sales and profits.

    It had to happen sooner or later: Samoa Air has announced that they will sooner begin charging customers based on weight.

    Is this fair? Most consumers would think not. (Though of course their opinion might be swayed based on how impacted they would be by it.)

    Discriminatory (or segmentation to use the proper term) pricing is nothing new. Grocery retailers will often charge different prices depending on a store’s customer base and level of competition. Up until recently car insurance companies have historically charged more to male drivers based on statistical risk. Cinemas regularly offer discounts to daytime screenings to try and fill seats.

    I’ve no doubt that many will be quick to criticise Samoa Air for their new pricing policy. However, at least take a moment to commend them for being innovative and daring. There is a lot of opportunity for innovation in pricing. Whether it is pricing a product or service differently by geography, time of day or age you should always consider how segmented pricing could be utilised in your business.

    Do you operate a service-focussed business, such as, a restaurant, that suffers from peak and off-peak trading patterns? Could you use pricing segmentation to boost those off-peak trading hours? Are you a specialist retailer who could benefit from a membership scheme that offers two prices per product: one for members (the lower price) and one for the non-member.

    The takeaway here is to remember that pricing shouldn’t always stop with the single price. Try and think of ways that pricing segmentation could be used to maximise your sales and profits. And if you need any more evidence that pricing segmentation is a good thing than look no further than this video.