By Rashaqa Rahman
Understanding how a product or service offering creates differentiated value for the customer is the foundation of value-based pricing. Prices should align with the value the customer receives, thus ensuring the seller is maximizing returns from and targeting customers that derive the most value from the offering. These are the customers that will be happiest and most successful, the kind of customers you want to build a business on. For pricing to be effective, it should track the value metric. This is the unit by which the product or service offering is consumed that best reflects how the customer gets value.
Let’s look at an example of how identifying the right value metric can impact pricing, and a company’s immediate and long-term profitability.
In April 2016, Starbucks introduced their newly revamped Rewards Program which shifted away from customers earning stars "per visit" irrespective of dollar amount spent, to stars earned "per $1 spent." Customers now earn 2 stars per $1 spent and must collect 125 stars (equivalent to $62.5 spent) to receive a reward. Previously, only 12 stars (equivalent to 12 visits) was required to earn a free drink, irrespective of dollar amount spent.
Predictably, this shift in pricing for the Rewards Program, based on the per dollar spent value metric, was initially met with overwhelming customer backlash. However, by June 2016, the Starbucks Rewards Program boasted 12 million active loyalty members in the US, up 16% from the previous year. In fact, the customers spending the most money were the ones getting the most value, and the ones that Starbucks most wanted.
Here are the key takeaways from the new Rewards Program pricing that is relevant across all organizations types, irrespective of whether B2B or B2C.
1. The right value metric FOR the RIGHT (target) segment
In Starbucks' case, the small spenders who ordered the cheapest (lowest margin) item on the menu to collect rewards were outraged, but they were also the segment that had the highest cost-to-serve. Therefore, dis-incentivizing or losing this customer segment to churn was more profitable for Starbucks in the long-term.
In order for the value metric to make sense, the customer must understand how a product or service offering creates value that is differentiated from the seller's next best competitive alternative. Starbucks' target segment is not interested in basic drip coffee at the cheapest possible price. They are there for the customized frills-that is Starbucks’ value proposition, which come at a higher price point.
Tracking the right value metric to determine rewards points meant that Starbucks’ target customer base, the big spenders now derived more value from the Rewards Program. They could earn their rewards faster than before. So, in this case, spend tracks the right value metric for the right customer segment.
2. Communicate & re-emphasize the perceived fairness of your pricing
The seller should take every opportunity to emphasize the perceived fairness of their product or service offering in the minds of the customer. This gives the seller pricing power and the ability to change prices if needed without facing too much customer push back. For more on pricing and fairness see Steven Forth's post for OpenView Labs: Psychology says make your pricing appear fair.
Starbucks addressed the customer backlash head-on and communicated how it would be easier to earn rewards faster based on the new value metric. If one spent $5 or more per visit, one could earn a reward in under 12 visits. Starbucks also communicated how purchasing specific food items with beverages could earn buyers stars faster - items that are not necessarily expensive for the customer, but higher margin for the seller.
Uninformed customers have a lower willingness-to-pay. Good pricing should be mutually beneficial to both buyer and seller, and communicating that to the customer is key. So, the Rewards Program was reframed as more fair from the perspective of the customers that count - the target base.
3. The right value metric drives usage
The right value metric should incentivize use. Starbucks' new “per $1 spent” metric incentivizes customer usage in a manner that is beneficial to the company’s top and bottom line, by dis-incentivizing free-loaders who have a high cost-to serve and incentivizing those that have a higher “willingness-to-pay.”
Also, the pricing is simple for the customer - spend a dollar, earn 2 stars. So it isn't a surprise that loyalty members pay three times more than non-loyalty members and help push up profits. The simplicity of Starbucks’ Rewards Program encourages use and makes the purchase decision easy for customers who already have a higher willingness-to-pay.
Also paying with the physical Starbucks Rewards Card itself encourages usage. Because, for the customers the perceived cost is lower as it feels less like an "out of-pocket" expense.
4. The value metric should align with LONG-TERM strategy
According to Marketwatch in 2016, 41% of North American customers used a Starbucks Card , while 24% paid with the mobile app. Between February (when the changes were announced) and April 2016, five hundred thousand new members signed up for the Rewards Program. The popularity of the Rewards Program has helped boost mobile sales, which as of 2016 accounted for more than $6 million orders per month in the US.
Starbucks was able to leverage the right value metric that serves as the foundation to their overall long-term, digital strategy. Mobile sales has improved in-store efficiency, speed of service and improved customer satisfaction, resulting in increased revenue and decreased operating costs.
So, for all organization types, whether B2B or B2C, understanding customer value creation and usage model is the the cornerstone to an effective pricing strategy. Identifying the right value metric will ensure fair pricing that is beneficial to both buyer and seller. It is important to remember that pricing is an iterative process because customer usage informs price, and price in turn drives customer usage. So within dynamic markets, the seller must constantly assess the effectiveness of their pricing and the underlying value metric, and not be afraid to make changes as required.