Price-hikes do not always deliver
MarketingProfs Get to the Point: Invest 60 seconds in your SMALL BUSINESS newsletter refers to Seth Godin’s post “Breakage” to discuss “The Price-Hike Gamble”. The post discusses the how small successive increases lead to a breaking point at which you the customer bolts. As Seth points out:
My car insurance bill has been steadily rising, year after year, despite the fact that I have a clean record. The logic, I’m sure, was, “well, let’s raise it a little and see who quits…”
If revenue increases enough to make up for the few who quit, you come out ahead. So, quarter after quarter, year after year, repeat the same process. Raise it a little, check to see if revenue rises in aggregate, and repeat.
Having worked at financial institutions and with a number of consulting firms that support them, I can tell you that the strategy is designed to have the customer leave! It goes like this: 80% of the revenue comes from 20% of the customers. It takes the same amount of work to cover a small customer and a large customer if as in this case it is purely billing and collecting for a service. Without the impetus for more profitable business (new higher margin products, custom services or in this case claim experience), fees increase little by little every year.
Let’s set insurance aside as premiums are supposedly calculated based on risk. The theory is that the 20% of the clients that generate 80% of the revenue are to be “hugged” and serviced and “relationship” managed so that they stay and are “referenceable”. The price hike for the remaining 80% of the customer base will do one of two things:
- Those clients that are not profitable will be upriced to a point where they are
- Those that were unprofitable for the institution with the legacy pricing who choose not to accept the price hike, will leave.
My experience is that 20% or more of the the client base leaves. What is sad is that many of the departing clients have been in a relationship with the institution for many years. Determining the level of the price hike is therefore a critical balance.
The problem for my insurance company is that a whole bunch of people will do this at once. When you hit the breaking point with one person, it might be 1,000 or 100,000 people who do the same thing at the same time. And you don’t get a second chance. They’re gone.
It’s not just money. It’s service. Or trust. Or spam.
In most cases, the strategy is designed to INCREASE profits while lowering costs and possibly (but not necessarily) increasing revenue. The result is fewer clients (cost and revenue reduction), greater margins (higher pricing for the same service), increased workload (more work fewer people).
Why does this strategy sometimes go wrong?
- Miscalculation of the new pricing level (too many or too few leave)
- Miscalculation of the impact of the fixed costs (same fixed costs spread over fewer clients)
- Miscalculation of the remaining workload (downsize too many or too few – many institutions announce the strategy and take the headcount reduction before the results are in)
- The consumer uses their community to share their experience – and the better deal they got elsewhere!
Not all people are as respectful as Seth Godin was – notably Seth did not name his former insurance company. With his level of influence (through his multiple platforms), naming names could possibly have created a major problem for the company.
Comments
Cable TV is another type of company that keeps inching prices upward. We don’t watch TV much, but hang on to a middle tier of cable service just because we always have.
A couple of days ago the family decided, unanimously, to break the cycle by downgrading to $15/month “Basic cable” right after the election.
It’ll be interesting to see how this works when trending away from the FREE internet, (which is hardly free), as yhoo,goog have been “throwing their investor’s money at free services.”
Leave a Comment