Last week I read an article in the Wall Street Journal, The Secret Other Reason Basic Economy Is Everywhere. In the article, the writer seemed to imply airlines are doing something shady to force businesses to pay higher prices. In reality, the airlines are using smart segmentation techniques. They are simply finding combinations of features that are valued by some groups more than others; and they are matching them with price sensitivity of the groups.
At Strategic Pricing Solutions, we often have conversations with clients who are considering lowering prices to capture incremental sales. They are trying to appeal to more price-sensitive buyers. The problem is, if they drop their prices, they will make less money on existing customers who are already paying a higher price. Most often, the math does not work; and the margin they make on the incremental customers is offset by the margin reductions they suffer from existing customers. Therefore, our advice usually involves finding a way to reduce features on their product or service and offering lower prices only on the descoped items.
One of the keys is to find features that some buyers can do without, because they are not critical to the use of the product or service. Those features might be something tangible like physical components, or they might be components of the service. Another key is to make sure you can manage the provision and use of those features.
Consider some examples, with airlines being a great one. The service is always the same, getting people from one city to another; but the amount people will pay for that service varies widely. Expansive seat room, meal and beverage service, and the ability to board and exit the plane early are all features of first class service for which some customers will pay extra. In years past, that was one of the few segmentation differences. However, the airlines realized that customer willingness to pay was not the same within each segment, and they have paid attention to other features customers value. Tall customers want more leg room, and most people do not like the middle seat, so the carriers created options to price those things separately. Some customers want the flexibility to change or cancel flights, while others have set plans and will forego that option for a lower fare.
As the article above pointed out, businesses often are willing to pay more than leisure travelers, and to capture the full amount the airlines structured fares with options the business travelers are unlikely to exclude. If business travelers are willing to accept trade-offs like no carry-on bags and extra fees for checked bags, they can benefit from the lower fares. It is the customer’s choice.
In automobiles, customers can make trade-offs on horsepower. Everything else being equal, we all prefer more horsepower, but many of us will accept less horsepower for a lower price on the car. We can also make trade-offs on the level of trim. For a lower price we can choose to exclude high-end electronics, premium wheels, leather seats, power seats, etc. So, even premium car makers can offer a range of price points to attract multiple segments of buyers. The auto companies can offer their premium products at lower prices, but the buyers will not receive all the features and benefits when they pay the lower price.
Cable TV and internet providers are also good examples. Basic cable with just a few channels has the lowest price; but there are several options for more features and services at higher prices. The most price-sensitive customers can get service which includes the major “free” networks and a few others. For those who are willing to spend a bit more, several options exist with additional channels and features. For internet service, those same cable providers can offer options at a variety of speeds and price points. Customers who want to download movies or other files quickly can pay a higher price for faster speeds. Those who rarely look at videos or rarely use large files do not need the faster speeds and can obtain service at a lower price.
All these segmentation examples are demonstrations of matching price sensitivity with features of products or services. Equally important, the providers of those features are also able to control who receives them. If the airlines did not have a way of enforcing the cancellation provisions and baggage restrictions, they would not be able to charge more to customers willing to pay for them. Similarly, if the ISPs could not control the internet speeds, they would not be able to set higher prices on greater bandwidth.
The trade-offs customers can make may not be obvious initially, but if you study all the areas where your customers receive value, including physical product components and intangible services features, you can begin to identify attributes that can attract differentiated prices. Then make sure you can efficiently control which customers receive which features. Creating a range of service offerings with differentiated prices is a much more profitable approach than lowering the price to everyone and hoping to make it up on volume.
Thank you for pointing out that the cheapest cable choice is a basic cable with a limited number of channels. However, there are numerous versions with additional features and services available at a greater cost. My television isn’t working because I bought the wrong cable. I’m looking for a cable TV service that can assist me in picking the best and most affordable cable and installing it for me.