For the most part, there is never a fixed price for a burrito. The multitude of add-ons can either totally decimate your wallet or, if you pick the right combination, leave you in a splendid food coma with a few bucks to spare. Fortunately, through my own trial and error over many burrito orders, I've been able to boil my order down to a cylindrical fiesta food bomb that appeals to my sense of value.
Charging extra for add-ons isn’t exclusive to the burrito industry though. Yet, when I naturally began comparing their pricing strategy to the methods of businesses in other markets (I’m a pricing specialist, it’s what I do), two questions were raised. One, when is it beneficial to break up your product into new services or features that were originally included? And two, how do you “unbundle” a product effectively so that your bottom line gets a boost without aggravating your customers? I’m not a huge fan of additional fees myself, but let’s investigate the pitfalls of this strategy further before discussing some of the ways companies use it to increase profits.
photo credit: jeffreyw
What’s so bad about bundling?
In essence price bundling is a superb strategy. Companies have long been bundling products together and selling them for a single price, and here at Price Intelligently we’re big proponents of this (see: "Why Your Perfect Pricing Strategy Sucks"). However, while selling multiple features in a package deal may help you acquire new customers, it doesn’t always improve profit margins or maximize revenue. In many cases, selling products in a bundle at a discounted price will condition your customers to de-value your product.
In today’s economy, many industries are suffering because the products or services they offer have only existed as part of a bundle (the airline and cable industries are good examples). Customers have become accustomed to viewing all of the features under a monolithic pricing structure, which makes it difficult to sell them services and products individually at higher margins without losing their business.
Won’t my customers just feel nickel and dimed?
Before we examine some of the benefits of unbundling, we need to address this issue of customer backlash. The process of pricing features separately can be as tricky as walking a tightrope, and in certain cases you can feel the consumer outrage bubbling up (Ryanair’s new game plan to install coin operated aircraft toilets comes to mind).
photo credit: Richard Cawood
Fortunately, it doesn’t have to be this way. If you can create an ideal reference price (the price a customer expects to pay), you can break down your product into separate units and optimize the pricing of the features without being perceived by the customer as if you’re “nickel and diming” them. The reason charging extra for burrito add-ons like guacamole or white meat works is because customers are still given the choice to buy a core version of the burrito at a fixed price. This price becomes a point of reference for the consumer that alleviates any concerns over charges for premium ingredients, and as I’ve seen from watching other folks at Chipotle, plenty of customers will skip the free fajita veggies but gladly pay extra for a huge dollop of guacamole.
Use choices to create a new reference price.
Providing your customers with options is a great method for increasing customer acceptance of extra charges, and it works especially well if your customer base has nothing to compare your additional fees against (the reference price is $0 because the features were originally included in the purchase price). Example from the Economist below.
United Airlines does this effectively by charging a higher fee for checking your bags at the airport versus checking them before the flight via their EasyCheck-in online service. Customers were accustomed to one price for their flight that included baggage check-in, so United advertises the $15 online fee as part of a convenient service that saves time and money. In comparison to the $20 fee for check-in at the airport (an anchor price), the EasyCheck service looks like a better deal, and the customer is persuaded to use the cheaper option despite the fact that baggage check-in was initially included in the ticket price. Of course, this wasn't something that was instantly acceptable to customers, but through proper communication and referencing, we're surprisingly accepting of these add-ons.
Ok, I get it. What can unbundling do for my product today?
Most of you probably aren’t in the airline industry or selling burritos, so let’s examine the ways your company can unbundle elements of your product to increase revenue. The key is to focus on three variables: product dimension, add-ons, and time usage.
1. Reduce Product Dimension
Reducing the dimensions of your product so that customers can purchase only the features they need is a great way to use unbundling to attract customers. If you discover a target segment of your customer base doesn’t want certain portions of your service, then you can break it apart and optimize the smaller products for price, as well as customer satisfaction.
Apple’s iTunes store does this incredibly well, and effectively changed the music industry’s business model with their unbundling strategy. Prior to the introduction of online music stores like iTunes, customers were unable to obtain individual songs without purchasing an artist’s entire album. iTunes dismantles this album format, allowing customers to purchase only the songs they want at .99 cents a piece or an artist’s entire album at a modestly reduced price (usually $9.99). This technique appealed to frustrated customers who had grown tired of buying a whole album in order to acquire one or two hit songs, and iTunes effectively unbundled the product in order to cater to those customers’ valuations and profit from them.
2. Utilize Hub and Spoke pricing: customers buy a core product (the base model) and add what they want
Hub and Spoke pricing ensures customers can purchase your basic product with only the features they want (the Hub) with the option to pay for additional features later (the Spokes). Rather than offer potential customers a product that includes all the bells and whistles, the product is optimized for customization to appeal to multiple target segments.
photo credit: alexbcthompson
Dell does this to great effect. Rather than exclusively offering powerful computers with the most RAM or pricey graphics cards, Dell allows customers to purchase a basic yet flexible PC capable of being upgraded with add-ons as the buyer needs them. Similar to the iTunes model, this form of “mixed bundling” gives consumers the option to buy computers with everything included as well as the separate components found in those packages. The company’s revenue is increased due to the combined sales from upgrades, parts, and fully loaded computers, but at the same time the customer base feels empowered by the ability to avoid paying for components they don’t need.
3. Limit Time through Usage pricing
If your company utilizes a subscription-based revenue model then you can create a pricing structure based on time and product usage. Rather than granting customers access to your whole suite for one price, the amount the customer pays depends on the services they need and the extent to which they use them. Pricing along a value metric in this way capitalizes on demand and ensures your revenue numbers grow with the needs of your customers. Those who use your product the most are charged accordingly, but they don’t feel nickel and dimed because they can purchase exactly what they need at exactly the right time.
photo credit: bogenfreund
Google’s App Engine is a prime example of an unbundled service based on this technique. The product is essentially a cloud-based platform that allows web developers to build and host applications using Google’s infrastructure. Each application a developer creates can use a fixed amount of computing resources for free (set by quotas), but if the customer needs more they are charged for additional usage up to a daily maximum. Users can specify and change this maximum amount based on their traffic and data needs. This model assures customers they won’t be charged a fixed amount for a service they’re not using, but it also guarantees Google rakes in more cash from those web developers who hog all the resources.
Bottom line: One size does not fit all.
I’ve seen what high rollers put in their burritos. Other patrons’ enthusiasm for premium add-ons (I’m not one of them) is proof that unbundling doesn’t have to enrage your customers. You can effectively break up your product to appeal to different price points, and chances are spreading the love won’t cost you nearly as much as developing the core commodity of your business. Just remember to focus on the features your customers value the most as well as the perceived reference price for your product. When you introduce fees that were previously built into a fixed price or charge based on usage, it’s important to display choices and reassure buyers that they’re only paying for what they need. Understanding customer psychology with regard to your specific business model is crucial to segmenting your products or services so they do what they’re supposed to: capitalize on customer valuations and increase profits.
For more on Anchor Pricing, check out the slidedeck below: