Research over the years has shown that a 1% increase in price results in a 2.6% loss in customers for brands in general. More recent research shows that for high-end products, a 1% increase in price often results in a 1.8% loss in customers as high-end customers are less price-sensitive than consumers in general. Findings from our research indicate that a more personalized approach to price increases that takes into account the characteristics and demand for the product by the customer can help reduce customer churn rate following a price increase.
Case studies from companies such as Netflix, Chargify, ClassPass, Starbucks, and Close.io show that price can be successfully increased if the increase is properly communicated and if the customers see great value in the product. The Case studies show that even when companies lose customers or have to endure negative backlash from their customers after a price increase, the company’s revenue, customer base, and profit improve overtime after the price increase as long as they are offering great value.
Customer Sentiment With Changing Pricing Study
- A study on the effect of price increase on customer happiness found that the greater the percentage increase in price, the less happy customers. The relation between price increase and customer happiness is captured in the chart below:
- The study showed that customers are happier with frequent, smaller price increase than a sudden large increase.
- Hence, it is smarter for a company to be constantly thinking of marginal price increase rather than leaving it until the unit economics forces them to increase the price by 100%. According to experts, the anchor for price rises is the previous price. And a modest beginning price restricts your ability to increase it—even if your rivals charge much less.
Study of Consumer Response to Price Changes in Higher-Priced Brands
- Researchers conducted a study to determine consumer response to increase in price in high-priced products, using wine as the test item.
- According to the research, the price elasticity of demand for expensive wine is -1.8 percent. This implies that for every 1% rise in price, sales fall by 1.8 percent.
- Numerous research have shown that the price elasticity of brand demand is about -2.6 percent. That is for every 1% increase in price, sales/demand decrease by 2.6%.
- The above suggests that companies operating at the upper end of the market in terms of pricing have fewer price-sensitive customers and can increase prices with fewer customer attrition.
- According to the researchers, price elasticities were shown to be lower when (1) the perceived significance of the consuming situation was high, (2) frequent high-priced wine consumers were present, and (3) brands with a higher starting price position were present. These findings indicate that the price elasticity patterns for high-priced goods are mostly consistent with those for other FMCG products, although consumers are somewhat less sensitive.
Dynamic vs Traditional Price Increase Case Study
- Researchers at Mather Economics conducted a study to determine the effect of increasing the price of a product using a market-based pricing (MBP) strategy on customer churn rate compared to using a traditional price “Step Up” strategy commonly used in the media industry. The research was done in a large media market with over 290,000 subscribers.
- Market-based pricing (MBP) is a dynamic pricing model “which incorporates individual subscriber characteristics, such as tenure, autopay status and demographics to determine optimal pricing strategies.” The objective is to determine price depending on the customer’s willingness to pay.
- The traditional Step Up pricing model in the media industry is a pricing strategy where customers are tiered to a predefined higher rate.
- For the market-based price increase model, each subscriber’s price increase was tailored dynamically according to their individual characteristics. The researchers increased price by an average of 90% over 6 months (first half of 2017) of the research for customers paying less than a $1.50 weekly rate, and 20% for customers paying more than $10.
- The incremental churn rate for this group of customers whose price was increased dynamically based on their individual characteristics was about 3.8% for those initially paying less than $1.50 and less than 1% for the group of customers paying more than $10.
- For the second half of 2017, a more traditional Step Up price increase was implemented where subscribers were given a flat increase of $0.50 increase by weekly rate.
- The average price increase for customers paying less than $1.50 weekly “was approximately 250%, with the increase percentage decreasing as the price of the segments increased. The highest paying customers who were paying more than $10 a week were given an 11% increase.”
- At the end of the research, the churn rate for customers initially paying less than $2.50 weekly was about 7.5%. For customers paying over $10 weekly, the churn rate was 4.2%.
- The MBP pricing strategy was more effective at reducing customer churn rate, especially for high-paying customers where churn rate was less than 1% despite an average increase in price of 20%, compared to a 4.2% churn rate after just 11% price increase when a traditional price increase model was implemented.
- According to the researchers, “blended across all rate ranges, the MBP program was three times more effective at reducing volume loss per unit of increase compared to the step-up program.”
- The research above demonstrates that using a dynamic pricing strategy that takes into account the customer’s characteristics and demand for the product is better at minimizing the churn rate.
Chargify Case Study
- Chargify, an online billing startup that makes system that small businesses used in handling billing, needed to change from its freemium business model and start charging its customers for its service.
- The company’s initial business model was to allow small businesses to sign up for free and keep using its services for free until they grew to more than 50 customers. However, after 12 months in business, less than 1% of the company’s customers had paid a dime to the company.
- The company understood that their earlier model was no longer sustainable and needed to start charging for their service and increase prices for clients with over 500 customers.
- The company wrote to its 2,500 customers announcing that they were eliminating the free option and increasing price for companies with over 500 customers from $49 monthly to $99 monthly. The company also introduced a $39 option for clients with 10 customers or fewer.
- Chargify’s customer responded angrily to the increase in price, even more than the company had anticipated. The company’s social media pages have received comments such as “I’m sure you’ll be laughing all the way to the bank, but not with my money”; “Today you’ve turned around and informed us all that we don’t matter”; and “Wow. What a kick in the nuts.”
- The company admitted that many of its customers felt betrayed by the price increase. There were even some communication gaffes that exacerbated the problem, such as a tweet by Siamak Taghaddos, co-founder of Chargify, in which he stated, “Moving away from freemium eliminates freeloaders and bad customers, allowing you to focus on providing better products and support to good customers.”
- Although they apologized for the sudden increase and the poor choice of words by the Taghaddos and further explained the need for the increase, the company stuck with the price despite the hundreds of complaints from their customer. The company chose to stand firm and not show weakness while being empathetic.
- The result was that the company lost 35 customers the month after the increase, compared to 15 for the entire year prior to the change. However, the business added 225 paying clients over the same time, up from 25 the year before.
- According to Jeremy Butler, the company’s marketing director, “we did damage our image a little bit, but the strategy is already doing what we set out to do: increase sales.”
Starbucks Case Study
- Starbucks is an example of a company that is great at communicating and implementing price increases without alienating their customers.
- Starbucks is able to achieve this because of a deep understanding of its customer persona backed by research and customer analysis that enables them to formulate targeted price increases that captures the highest price its customers are willing to pay without losing them.
- When Starbucks increased prices for the first time in 18 months in August 2020, the company’s communication strategy was to explain that the increase was necessitated by rising labor and non-coffee commodity costs.
- In addition, they emphasized that the increase would only affect less than a third of their products and that the price increase was just 1%. Note that for products that Starbucks increased prices on, the increase was more than 1%, but since they only increased prices for a few products, the average increase in price across all its product was 1%.
- The goal of emphasizing that the price increase was just 1% was to make customers think the price increase was insignificant.
- While a 1% price increase may seem insignificant, it is important to note that a 1% increase in price can raise profits by 11%.
- According to industry experts, price hikes throughout Starbucks’ history have already turned away the most price-sensitive consumers, leaving a devoted, higher-income consumer base that views these coffee drinks as an attainable luxury.
- It’s important to note that although Starbucks’ price increase may be based on the company’s analysis to determine what their customers will be willing to pay, the company’s communication of the price increase associates it with what the customers would judge as a fair reason to increase the price.
- ClassPass, a fitness startup company that reached a valuation of over $1 billion in 2020, needed to evolve its pricing strategy from its fixed pricing of $99 per month.
- The company was charging customers $99 a month and granting them access to unlimited number of boutique classes. The company had struck a deal with several boutique classes for a discount of 50%.
- ClassPass’ business strategy was designed on the assumption that its customers would spend less than $99 per month on average, with the company benefiting from the difference. However, as more of its customers started attending 10s of classes every month, the pricing model was no longer delivering success and they were losing significant money to superusers it attracted.
- To evolve its pricing, ClassPass eliminated the unlimited attendance option and introduced tiered pricing tied to capped attendances. The pricing model was met with significant push back from its customer base and lost about 10% of customers as a result of the announcement.
- However, the company successfully offset the complexity of the pricing structure by providing additional value to customers in other ways: by increasing their chances of accessing top-rated classes and by improving their own product by offering workout videos for free and incorporating personalized recommendations into the app.
- The new pricing resulted in positive unit economics for the company and increased gross margin by 20%. Revenue grew to over $150 million and the success has enabled the company to be valued at over $1 billion.
- Netflix is one company that has learned the hard way how to increase prices properly. The company learned the hard way after losing 800,000 subscribers and 77% of its stock value after it effectively increased prices by 60% in 2011.
- The reason for the big failure in the past was because the company didn’t conduct enough research, with the CEO suggesting that they didn’t run any focus group research before making the decision in 2011. They also failed in communicating the increase properly.
- More recently, however, the company has successfully raised prices in 2017 and 2019, without much outrage. Subscriber base increases by 2 million new subscribers after the recent price increase and the company’s stock soared.
- The company is able to do this by communicating the price increases as necessary to improve consumer experience and value. The customer believes them because of the increased value they are offering and because media report of the price increase often highlights how much the company is spending on new content and that the price increase is expected.
- According to CEO Reed Hastings, as long as they can continue to enhance our content and overall experience at a phenomenal rate…asking consumers to help finance it at greater levels is fair. However, if they were not increasing the relative worth of their consumers, they would not be altering their prices.
- Close.io is another company that was able to successfully increased prices recently.
- The company’s customer lifetime value increased by 10% after the price increase. According to CEO Steli Efti, “when we raised pricing, our conversion rates remained stable, our clients remained satisfied, and we saw a significant rise in paid seats.”
- Efti advised that the best way to raise price is to be honest and straight forward about the increase. He explained that customers should be informed on time about the increase and sent personalized communication to that effect.
- According to Efti, “Get right to the point. Avoid making excuses for the price rise. Avoid salesy explanations. Avoid BS. Just tell them straight: We’re raising prices. Here’s what it will be. Here’s how it will impact you. Let us know if you have any questions.”
- A sample of the email that Close.io sent to its customer informing them of the price increase is attached below:
- As Close.io shows, a price increase can even be turned into a promotion where you offer current customers the chance to either keep the current price if they upgrade or offer them a discount on the new price.