Improve Pricing and
Revenue through Irrational
Consumer Behavior
Subscription-based companies that effectively apply
the lessons of behavioral economics can increase
revenue by up to 20 percent.
Improve Pricing and Revenue through Irrational Consumer Behavior
1
The “Rational Customer” Is a Myth
For many years, achieving growth was smooth sailing for subscription-based industries. Telcos,
insurers, utilities, media companies, and others added both new customers and new offerings,
and they grew their businesses year after year by relying on classical economics and “trustyour-gut” revenue management. But those days are long over. Subscription-based companies
are facing the strong headwinds of market saturation, low entry barriers for competitors, and
widespread price transparency.
Like most powerful storms, this one is wreaking financial turmoil and damage. It stunts growth,
causes higher churn, and flattens profits. No subscription-based industry has escaped these
destructive effects. The result is a downward spiral that begins with the emergency response
that many companies find irresistible: price cuts. When that happens, customers quickly hunt
down these attractive low prices and switch suppliers, which in turn drives up churn rates and
often causes competitors to counter with lower prices of their own. Yet it turns out that much
of the damage is preventable, and companies can even recover from it—if they understand
what really drives customer behavior.
The world of consumer irrationality is
a place where less is more and where
higher prices can lead to higher volumes.
Customers are predictably irrational
For decades now, evidence has been mounting that the classic economic model of the “rational
man” fails to explain several well-established customer behaviors. The idea that consumers
often behave in an irrational manner when they buy goods and services was popularized
especially by Dan Ariely in the best-selling book Predictably Irrational and by Robert B. Cialdini
in Influence: The Psychology of Persuasion.1 Teams of psychologists, neuroscientists, and
behavioral economists have made groundbreaking discoveries about how people make choices
and decisions—and documented the neurological and physiological effects that trigger them.
Their often-counterintuitive findings fly in the face of what many companies thought they
understood about customer behavior.
The world of consumer irrationality is a place where less is more and where higher prices can
drive higher volumes. Figure 1 on page 2 shows one of the many examples from A.T. Kearney’s
work with subscription-based companies: when a company decreased the performance of
its entry-level product from good to acceptable, its revenue rose by 15 percent, even though
prices were left unchanged.
Instead of treating consumers’ irrationality as a curiosity, then, companies in subscriptionbased industries should capitalize on it to improve their pricing and optimize their portfolio.
The financial upside is clear. Companies that use this approach can increase their total
revenue by as much as 20 percent, depending on industry and market conditions.
Dan Ariely, Predictably Irrational: The Hidden Forces That Shape Our Decisions (London: Harper Collins, 2009); Robert B. Cialdini,
Influence: The Psychology of Persuasion (New York: Harper Business, 2007).
1
Improve Pricing and Revenue through Irrational Consumer Behavior
1
Figure 1
Less can be more for entry-level products
Impact on major business indicators when entry-level performance is reduced
Index (good entry performance = 100)
Good entry performance
+2%
100
Acceptable entry performance
+13%
102
100
113
+15%
100
115
Revenue per customer
Customer uptake
Revenue
Negligible effect on
revenue per customer
Significantly higher
customer uptake
Higher overall revenue
(despite lower performance)
Source: A.T. Kearney client example
Four Key Insights
In figure 2 on page 3, we summarize a handful of powerful consumer insights that can help
shield subscription-based companies from current market trends and offset their negative
effects. All four insights are counterintuitive, but have clear implications for how companies
should optimize their portfolios and their pricing—and explain why companies have less to
fear from price transparency than they might expect.
Insight #1: Most consumers don’t recall prices very well. In fact, 53 percent of them cannot
remember the price of an item they just placed in their shopping cart. Even when they guess,
some 63 percent of consumers fail to come within 10 percent of the actual price.2 This lack of
memory is important because it implies that our minds treat each price comparison in isolation.
Each one is fresh and not necessarily influenced by previous comparisons. For subscriptionbased industries, this effect is even stronger. The vast majority of consumers do not know the
monthly price of their subscriptions, as they are typically paid for automatically.
Insight #2: Consumers try to minimize the cognitive effort needed to make a decision. There
is a discrepancy between what customers say about choice, and how they actually choose to
spend their money. In one quantitative study we conducted, respondents expressed a strong
preference for a “build-your-own” portfolio. In contrast, a “good-better-best” portfolio—which
included three options but no “build-your-own” possibility across features—registered a much
weaker preference: only 5 percent of respondents rated it “excellent,” versus 16 percent for
“build your own.” When asked about their intention to buy a portfolio, however, the overall
preference shifted sharply toward “good-better-best.”
Marc Vanhuele and Xavier Drèze, “Measuring the Price Knowledge Shoppers Bring to the Store,” Journal of Marketing 66, no. 4 (2002):
72–85, doi: 10.1509/jmkg.66.4.72.18516; Peter R. Dickson and Alan G. Sawyer, “The Price Knowledge and Search of Supermarket
Shoppers,” Journal of Marketing 54, no. 3 (1990): 42–53, doi: 10.2307/1251815
2
Improve Pricing and Revenue through Irrational Consumer Behavior
2
Figure 2
Consumers are predictably irrational
Insight #1
Consumers don’t recall prices well
Consumers recalling price of
item just placed in shopping cart
63%
Consumers correctly guessing
price of item within 10% range
Insight #3
37%
High anchor price improves
revenue of entire portfolio
Anchor price €59.99
Insight #2
Consumers minimize cognitive
effort when they actually plan to buy
Stated preference
Stated intention to buy
Insight #4
11%
19%
100
Revenue index
Goodbetterbest
107
+22%
Anchor price €39.99
Build
your
own
Odd price points and promotion
prices increase top line
Odd price points
(for example, €39.99)
122
16%
5%
+7%
Round price points
(for example, €40.00)
100
Revenue index
Sources: Marc Vanhuele and Xavier Drèze, “Measuring the Price Knowledge Shoppers Bring to the Store,” Journal of Marketing 66, no. 4 (2002): 72–85,
doi: 10.1509/jmkg.66.4.72.18516; Peter R. Dickson and Alan G. Sawyer, “The Price Knowledge and Search of Supermarket Shoppers,” Journal of Marketing 54,
no. 3 (1990): 42–53, doi: 10.2307/1251815; primarymarket research (n=4,111 respondents); A.T. Kearney analysis
Cognitive effort helps explain what is going on in customers’ minds. Understanding a “goodbetter-best” portfolio—and then choosing the most appropriate option—requires less cognitive
effort. “Build your own” offers flexibility, but it requires too much thought.
This counterintuitive conclusion—that consumers will sacrifice freedom in favor of less effort—
is robust. We have tested it for many clients in a range of industries including telecoms, utilities,
and insurance, and every time customer research showed that bundles generate higher uptake
and revenue than a “mix-and-match” or “build-your-own” approach.
Insight #3: A high price anchor amplifies the appearance of affordability and boosts revenue.
A price anchor is a focal point that the consumer subconsciously compares to other price
points. Making the customer’s focal point a high price anchor makes other prices in a set look
cheaper.3 More than almost any other insight, the power of price anchors supports the belief
that consumer behavior is not only irrational, but predictably irrational.
One of our own studies showed that if you have a portfolio with three packages, you can
increase the overall revenue from the portfolio simply by raising the price of the highest-priced
package (see figure 3 on page 4). When we tested 15 different portfolios with €39.99 as the
highest price point, 32 percent of respondents did not buy, and the total revenue came to 100
Rashmi Adaval and Robert S. Wyer Jr., “Conscious and Nonconscious Comparisons with Price Anchors: Effects on Willingness to Pay for
Related and Unrelated Products,” Journal of Marketing Research 48, no. 2 (2011): 355–365, doi: 10.1509/jmkr.48.2.355; Joseph C. Nunes
and Peter Boatwright, “Incidental Prices and Their Effect on Willingness to Pay,” Journal of Marketing Research 41, no. 4 (2004): 457–466,
doi: 10.1509/jmkr.41.4.457.47014
3
Improve Pricing and Revenue through Irrational Consumer Behavior
3
Figure 3
A high anchor price improves the revenue of the entire portfolio
Anchor effect in three-tier portfolio
Anchor price €39.99 in 15 different portfolios
Anchor price €59.99 in 21 different portfolios
–9%
% of
non-buyers
32%
29%
+22%
Revenue
index
122
100
Sources: Primary market research (n=4,111 respondents); A.T. Kearney analysis
(indexed for comparison purposes). When we tested 21 different portfolios with €59.99 as the
highest price (while keeping everything else the same), the percentage of non-buyers declined
to 29 percent and revenue rose by 22 percent. In other words, increasing the price of the most
expensive package (that is, the anchor) in the portfolio by 50 percent resulted in more
customers and higher revenues.
Insight #4: Odd price points and promotion prices increase the top line. Predictable irrationality
affects how we perceive something that’s free, how long discounts should last, and how
consumers respond to odd or “crooked” prices as opposed to round ones.
First of all, our research confirmed that odd price points are financially and commercially
superior to round ones. The best-performing prices are those set just below €5 increments,
such as €59, €69, or €74. The improvement from using odd price points instead of round
ones showed up in all three metrics we monitored (revenue per customer, uptake, and
total revenue).
A subscription-pricing tactic that has spread like wildfire in the telecommunication industry,
especially fixed-line Internet, is the use of promotional prices for a limited period—for example,
pricing an item at €49.99 for the first 12 months and then at €59.99 for the remaining subscription
period. Sometimes a company goes all the way to a promotional price of zero. You might expect
that the lower the promotional price, the greater the impact. Figure 4 on page 5 shows how a
leading telco advertised a service at no charge for the first six months of a contract. The company
tried to give away something attractive, but was disappointed by the unexpectedly slow uptake.
How can that be? The answer, once again, is irrationality.
A customer would indeed receive service for free for six months, which is an effective value of
between €150 and €240, depending on the package. The problem with stressing a promotional
Improve Pricing and Revenue through Irrational Consumer Behavior
4
Figure 4
A €0 sticker price makes customers more aware of the list price
Basic Internet
Internet up to 1 Mbit/s
€24.95
€0 in first six months
Best
seller
Internet and telephony
Internet, telephony, and TV
Flat-rate calls to national
mobile and fixed numbers
28 HD TV channels
Internet up to 1 Mbit/s
Flat-rate calls to national
mobile and fixed numbers
€29.95
Internet up to 1 Mbit/s
€0 in first six months
€39.95
€0 in first six months
Go to offer
Go to offer
Go to offer
Note: HD is high definition.
Sources: Client experience; A.T. Kearney analysis
price of zero is that it deflects consumers’ attention to the original, and often much higher,
list price. The telco got no traction with this offer and subsequently discontinued this tactic.
How long should the promotion price last? To answer the question, we looked at three parameters a subscription-based company would track: average revenue per user (ARPU), uptake,
and revenue. What we found is that offering promotional prices for three to six months
increased customer uptake. Offering them for more than six months, however, led to no
additional uptake—and overall revenue obviously diminished.
A Holistic Approach to Pricing and Portfolio Optimization
To unlock their full top-line potential, companies in subscription-based industries should take
a holistic approach to pricing and portfolio optimization, bearing in mind the behavioral insights
we just explained as well as pertinent legal requirements. It is no longer adequate nor wise to
look at individual parts of the portfolio without understanding the effect that any changes will
have on the business as a whole.
1. Define your pricing and promotion strategy (or how to avoid a price war)
In a saturated market, any significant volume gains must come at a competitor’s expense.
But companies need to pay particular attention to their competitive response. For example,
let’s assume a company wants to grow its customer base and decides to use an aggressive
promotional offer to draw customers away from competitors. The logic seems solid. Demand
curves in classical economics make it clear that lower prices lead to higher volumes. In a transparent market in which customers can make price comparisons at a glance, low prices will also
get noticed faster, which should lead to greater conversion. If Company X cuts the price of its
Improve Pricing and Revenue through Irrational Consumer Behavior
5
primary service package by 50 percent, classical economics tells us that Company X should
grow its customer base significantly. That logic may be worth a passing grade in Economics 101.
In real life, more often than not, it deserves an F.
A European service provider with the second-largest share in its market learned that lesson
the hard way. It launched a two-month promotion, slashing the price of its primary package by
40 percent. It assumed that the market leader would never respond to the move. Yet that is
precisely what the market leader did. The market leader launched a new bundle within a month,
which it offered at a 50 percent discount to its traditional plan.
The intent of this response was clear: capitalize on price transparency. The market leader knew
that its new package was likely to prevent a large number of its customers from switching—and
indeed it did. But if the counterattacks continue, companies can drag each other down like two
punch-drunk fighters staggering through the late rounds of a boxing match. As the fight goes
on, consumers’ price expectations are reduced and margins are progressively eroded. Soon it
becomes clear that even the “winners” lose, achieving at best a Pyrrhic victory.
What could the challenger have done instead? Was there a more rational course of action?
The key is to understand what we call “price contamination.” Price contamination occurs when
competitors quickly match a company’s pricing moves and when consumers switch providers
as soon as they learn about a lower priced alternative. If the company had truly wanted to launch
an attack to grow market share but believed there was a high risk of price contamination, it still
had several options (see figure 5). These include surgical price cuts, new bundles offered under
a different brand or sub-brand, and a communication strategy that ensures the marketplace
understands its intent.
Figure 5
The right pricing and promotion strategy depends on the risk of price contamination and
the company’s overall market strategy
Premium
pricing
Surgical
EDLP
Surgical
Aggressive
pricing
Determined
by company’s
overall
strategy:
HiLo
Lower
Determined
by how
customers and
competitors
react to your
pricing moves
Contamination risk
Higher
Pricing and promotion strategy framework
Get
Grow
Attack
Keep
Defend
Market strategy
Get: Capture
market share
Grow: Grow
existing base
Keep: Retain
existing base
Notes: EDLP is every day low price. HiLo is high average prices with deep discounts.
Source: A.T. Kearney analysis
Improve Pricing and Revenue through Irrational Consumer Behavior
6
Surgical price cuts, as the name implies, are highly targeted and therefore less visible to
a company’s customers and its competition. How should a market leader or a threatened
competitor respond? If the defender wants to keep its existing customers, but assumes that
contamination risk is high, it should make little or no direct response. Rather, it should try to
preserve its premium price position. We see that combination in the top-right corner of figure 5.
At first glance, “turning the other cheek” may not seem like an effective response in a highly
competitive market. It takes courage. But sometimes it is the least of all evils. The situation also
depends on the size of the threat: when a competitor’s price cuts are surgical and relatively small,
it does not jeopardize profit margins in the market, which makes doing nothing a more appropriate
response. In fact, it may even help the market leader prune its customer base by encouraging its
most price-sensitive customers to go elsewhere, leaving it with a more lucrative clientele.
Communicating your company’s strategy can also help the market understand the risks it may
face with an aggressive price move. This works both ways, which means a company must
communicate consistently and also pay attention to what the rest of the market is saying.
In general, we recommend companies be more cautious than confident if they are considering
an aggressive price move.
2. Design your portfolio to make it easier for customers to choose
When a company designs its own bundled offerings, it can lead to higher revenue than if
customers are allowed to build their own packages in an à la carte fashion. The nature of
the bundle matters. Simply offering packages at a discount is not sufficient to unlock the
full pricing potential within a portfolio.
Directional versus nondirectional bundling
Figure 6 shows the difference between two kinds of bundling: directional and nondirectional.
In a directional bundle, each option has the same attributes and the buyer is not forced to
Figure 6
Directional bundling increases how much customers are willing to pay
Directional vs. nondirectional bundling
Directional bundling
Basic
€100
Some
€110
Nondirectional bundling
More
€130
Even more
€150
77% selects one of the options
All
€170
Basic
€100
Basic + A
€110
Basic + B
€130
Basic + C
€150
Basic + D
€170
40% selects one of the options
Sources: John T. Gourville and Dilip Soman, “Overchoice and Assortment Type: When and Why Variety Backfires,” Marketing Science 24, no. 3 (2005):
382–395, doi: 10.1287/mksc.1040.0109; A.T. Kearney analysis
Improve Pricing and Revenue through Irrational Consumer Behavior
7
Why Bundling Works: Transferring the Customer Surplus
A customer surplus is the difference between what customers
are willing to pay and what they
actually pay. Bundling exploits
this consumer surplus by transferring that excess willingness
to pay from one product to
another.
We can use a simple example of
hamburgers and fries to illustrate
this. Assume that a burger costs
€2 and fries cost €1. Then assume
your willingness to pay for a
burger is €2.25, but your willingness to pay for fries is only 50
cents. Your friend is not a big
burger fan, but loves fries. Her
willingness to pay for each of
them is €1.25.
If your only option is à la carte or
“build your own,” you will only
buy the burger and your friend
will only buy the fries. Together
you spend €3.00
However, if the restaurant offers
a bundle of burgers and fries at
€2.50, you and your friend would
both buy the bundle. Together
you spend €5.00. The restaurant
increases its revenue significantly,
even when it offers a discount on
the combined price of burgers
and fries, which would cost €3.00
if you bought them separately.
This bundling technique works
because the combined price
better reflects the combined
willingness to pay for the
individual items. The customer
has transferred his or her excess
willingness to pay—the customer
surplus—to other products so that
one sees value in buying them
together at their reduced price.
These fast-food-style bundles
are common across many
subscription-based industries.
They include triple-play options
in telecommunications (Internet,
television, phone), comprehensive insurance coverage (home,
car, liability, travel), and home
management (utilities, guaranteed heating, and home security,
all centrally managed).
make trade-offs. The only difference is the quantity of each attribute within each bundle, which
increases incrementally from one option to the next. The price goes up too, but not at the same
rate, which reassures the buyer that the larger the option purchased, the better their deal will be
on a per-unit basis. For example, a homeowner's insurance policy that includes both dwelling
and personal property protection might raise coverage for both types of risk when moving from
the “basic” to the “more” package. Similarly, a premium directional bundling offer at a car dealer
might combine a more expensive vehicle with an extended warranty and with zero-deductible
collision, liability, and comprehensive insurance coverage. Some 77 percent of respondents will
choose one of the options from the set with directional bundling.
In the nondirectional set of bundles, the variation comes from the attributes themselves. This
forces potential buyers to make trade-offs. They need to decide “do I want this one or that one
or the other one?” An example could be offering customers a choice between a contract for gas
and electricity, the same gas and electricity contract with maintenance of gas-fired appliances,
or the gas and electricity contract with a smart thermostat. In psychological parlance, choices
like these increase the cognitive effort required from a buyer. Compounding the problem is the
risk of regret. Buying one option means not getting something included in another option, and
that creates uncertainty: will I regret this decision? These proven psychological factors explain
why only 40 percent of respondents chose an option from the nondirectional set.
In short: consumers are more comfortable making a choice when someone offers them “more”
as opposed to “different.” There is a clear and intuitive progression from one option to the next.
Companies should use directional bundling—which means building a portfolio across attributes
common to all options—in order to avoid forcing good customers to make unnecessarily difficult
choices. When companies fail to take advantage of irrationality by making choices easier for
their customers, they jeopardize uptake and thus put revenue at risk.
Improve Pricing and Revenue through Irrational Consumer Behavior
8
3. Migrate your customers, don’t lose them
Before you redesign your company’s portfolio, you should clearly understand how your
customer base will react to the planned moves. Driving away profitable customers not only
harms the business, it also makes competitors’ jobs easier.
You will need to consider several questions to get this right. For example, how many customers
are currently above, below, or already at the desired price points in the revised portfolio? Is it
worthwhile to migrate customers to the new offers? And presuming that migration is worthwhile,
should prices be increased? If so, by how much? Our findings from testing migration plans
reveal that price increases are, in fact, almost always the right way to go. However, success
depends on how companies execute them, and that in turn brings us back to irrationality.
Once awakened, some customers will
inevitably “churn,” even if prices don’t rise.
The best approaches include odd price points and delayed price increases. The magnitude
of the price increase should also lie within an optimal range determined through up-to-date
customer testing. Whenever a provider contacts customers about their current offer, customers
“wake up” and think about what they are getting in return for their money. Inevitably, some
customers will choose to leave, or “churn,” even if prices don’t rise. In fact, the wake-up effect
is often the single largest contributor to churn—and sometimes it occurs even when prices
go down or product value goes up. So if a price increase is too low, the incremental revenue
from remaining customers can be insufficient to offset the loss of customers who have been
“awakened.” On the other hand, if the increase exceeds a certain threshold, it can make
successful migration unlikely or even impossible. These insights are broadly applicable to
migration in any company with a subscription-based business model. Figure 7 gives a real-life
example of how it played out for a leading subscription-based firm.
Figure 7
Most customer churn is caused by the “wake-up” effect, not higher prices
Immediate churn under various scenarios
0.1%
!
0.2%
0.3%
0.9%
0.5%
Wake-up
churn effect
(no increase)
Incremental churn
due to price increase
< €1 per month
Incremental churn
due to price increase
< €2 per month
Incremental
churn due to
operational change
Full churn
Sources: Actual customer reaction from Direct Customer Contact Method (n=4,111 respondents); A.T. Kearney analysis
Improve Pricing and Revenue through Irrational Consumer Behavior
9
In order to assess price elasticity, you can run tests by sending different price adjustments
to groups of customers and informing them about the change. In our experience, you can
substantially raise the price for existing customers and still limit churn if you offer a six-month
grace period before the price increase takes effect. Again, using irrationality to your advantage
is the key.
Achieving Top-Line Growth in the Face of the Storm
The storm that has settled over subscription-based markets shows no signs of letting up.
Market saturation, increased and intense competition, and widespread transparency are here
to stay. The old approaches of classical economics and trust-your-gut pricing decisions are
no longer viable.
While consumers are predictably irrational and there are many “eternal truths,” make no mistake:
predicting your consumers’ choices can be very difficult. A holistic approach to pricing and
portfolio optimization, grounded in a firm understanding of customer irrationality—and supported
by processes to continually test propositions and prices—can increase total revenue by up to
20 percent. That’s a top-line argument no company can afford to ignore.
Authors
Frank Bilstein, partner, Düsseldorf
[email protected]
Hans Boezel, principal, Amsterdam
[email protected]
Jan-Piet Nelissen, partner, Amsterdam
[email protected]
Martijn Nuijten, consultant, Amsterdam
[email protected]
Improve Pricing and Revenue through Irrational Consumer Behavior 10
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