Baggage Fee Unbundling

There is an additional fee to check in bags at the airport vs. checking them before flight. Once again this is very well executed pricing change with focus on customer reference price. Look at the right upper corner of the image, they are positioning online pre-checkin for bags as a convenience and time saver. The additional fee for airport checkin is not something that is forced on all customers  as most will add bags when they checkin from home/office/hotel.  The additional price is not about the cost since cost is irrelevant to pricing. If there is value to customers in delaying baggage checkin till they reach the airport then they United Airlines must be able to get a fair share of that value.

If there is one thing they could have done differently is to take a cue from Prospect Theory and position this as one price $25 (not $20) and for online checkin offer a $10 discount instead of listing the fee at $15.

I was at a bookstore the other day and I remembered reading WSJ article on summer readings. I looked it up on my BlackBerry using my WSJ online subscription. An article about a list of summer books is of value not only to the readers but also to the bookstores.  So WSJ could sell that article to Borders (and anyone else) for a fee. Borders then make this article available free to all. Their monetization is by adding “Buy Now” links to the article for each listed book and generating book sales.

Such a pricing scheme is still unbundled, each article is priced differently and sold separately  not to every single customer who wants to read it but to  distributor/middle-men.

Monolithic Pricing: Customers pay once and get all product features whether or not they need all the features and for all the time.

Subscription Pricing: This is pay-as-you-go scheme. Customers pay periodically and get all the features.

Add-Ons: Customers pay once and pay only for the basic version but can pay additional price to buy Add-On features.

Usage Based Pricing: Customers pay only for the features they want and only for the time period they need the features.

Note that both product and time dimensions can be further subdivided into coarse or fine granular units. For product dimension  customers can either buy next higher version with a set of features or buy specific a add-on without having to upgrade to next higher version. For time dimension customers can either buy pre-set time units like monthly subscription or pay per use based on metering.

Here is a graphical representation of the two dimensions.

US Mobile phone penetration is more than 90% and a service provider can grow its subscriber base only by stealing market share. As the Business Week story reports most customers in the high income bracket with a higher willingness to pay for data service are already taken either by at&t or by Verizon. The current churn rate (% of subscriber base that switch service) is about 1.1% for at&t, this means an average at&t subscriber stays with them for 8 years.

A service provider’s network costs are mostly sunk and even the ongoing maintenance costs are fixed its marginal cost to serve a customer is $0 – so it makes sense to add as many new subscribers as possible to amortize the fixed costs and deliver profit. So no surprise that at&t wants to grow its current subscriber base. The only relevant cost is the customer acquisition cost which is about $200 (including iPhone rebate) to customers.

Given these numbers, the lifetime value of a iPhone subscriber over  8 years (at 10% discount  rate) is $4400. So adding every subscriber and keeping them longer adds directly to their bottom line.

Despite reporting strong profit and increase in number of iPhone subscribers, at&t added fewer subscribers than Verizon wireless who beat out at&t with its portfolio of devices. at&t has not said explicitly how many unique iPhone subscribers it has. One source is to find from Apple’s earnings statement but ArsTechnica summarizes the number of  iPhone activations that it culled from at&t quarterly earnings report. The total iPhone activations since it was introduced is 8 million,  of which 2.1 million were pre-3G. If we assume 50% of the pre-3G iPhone subscribers upgraded to 3G the number of unique iPhone subscribers is  about 7 million.

If at&t simply reduced the pricing by $10 its current 7 million subscribers are not going to be happy. Like the iPhone price drop outcry that happened when Apple dropped the price of its iPhone by $100, there is bound to be customer demand to reduce their pricing. This means a total monthly loss of $70 million. So just to get back to its profit levels before the price drop at&t should acquire  1.16 million new iPhone subscribers.  Note that this 1.16 million is above and beyond its current subscriber growth rate  which is 1.6 million new subscribers per quarter. Since the competition is not going to stand still it is going to be a tall order.

So at&t will definitely introduce versioning and introduce the low priced plan with service restrictions/impairment. While it helps to avoid the need to reduce the fee across the board it does introduce two new problems. First, some of its current subscribers will switch over to the lower priced plan and second, majority percentage of its new subscribers will pick  the lower priced plan. If we assume a 50% downgrade and 100% pick $60 plan, then the  new break-even number of new subscribers is 580,000. This is still a high number.

So should at&t reduce its price? I think it should not to keep its profit at current levels.

There is a very nice Italian  restaurant called Trattoria La Siciliana in  Berkeley, CA. Their offering is premium – authentic sicilian cuisine, great wines and  great service. This is also a small place and is always packed. There is one thing – they accept only cash. No checks or credit cards. Checks are simply pain to process  but most people  expect to pay with credit cards especially when they add a bottle of wine to the dinner. Why does not the restaurant accept credit cards? I did not ask them but here is my theory on this.

Credit card processing may be free to you and I as users but the merchants pay a fee to the bank for each transaction. The fee, referred to as interchange, runs close to 3%. So for an average tab of $60 for two people, the net intake is reduced by  $2.8. Small businesses like restaurants are hurting with slowing economy and 3% fee is  directly affects their operating margin.

Paying with credit cards is a convenience. So why not restaurants unbundle this fee and pass it on  to the customers?   Why not ask the customers to pay for the convenience by simply adding the fee when a customer pays with credit card. Some businesses like gas stations do just that. But as we have sen before in this Unbundled Pricing blog, customers are bound to fee nickel and dimed.

In the case of premium priced restaurants,  like Trattoria La Siciliana, adding a separate fee does not fit the brand promise or its product offering. So instead of unbundling the service and risking brand erosion a business can simply not offer a particular service component. This is product/service  unbundling as well except that pricing is not unbundled – the unbundled service component is simply not offered.

What they sell it as a subscription service with recurring revenue. Their pricing is unbundled along both usage and product features dimensions

1. Subscription model is unbundling the product along the usage dimension – instead of buying the product all at once the subscribers pay for usage.
2. What they offer with subscription are PowerPoint slides  with the frameworks, about 400 of them,  that a subscriber can download. For those customers not willing to pay the subscription fee ($149) they unbundle their product and sell individual frameworks at prices starting from $5.50.

Their unbundled pricing for each framework is a clear recognition that the needs of the their customers are not all the same. Hence by unbundling the product they target each niche and allow these customers to purchase only what they need. This reduced customer resistance to purchase and exposes new revenue opportunities compared to a single price.

Another notable point is their unbundled pricing for each framework  ensures that  those who need more than a few frameworks will buy the subscription and not buy them one at a time.Even at the lowest price of $5 per framework and assuming an average customer needs only 50 frameworks, the sum of the prices of the unbundled components is same as that of the annual subscription.

Powerframeworks’ unbundled pricing offers lessons to newspapers trying to unbundle their pricing.

…in 2007 WSJ had 1 million paying subscribers and 20 million monthly readers who read the free articles. This 20 million readers are the potential market for unbundled pricing. When these readers click on a subscriber only article, the website will ask, “This is a subscriber only article but you can read it now for $0.25″. Suppose if 10% would take this offer and read just one such article at a price of $0.25, that is half million in additional profit per month, or $6 million in yearly profit.

This was just based on my assumptions on numbers. The WSJ has not announced their pricing for pay per article customers. The Editor-in-Chief of WSJ, Mr. Robert Thompson said (from FT.com story):

Pricing for individual articles and for premium subscriptions had yet to be decided, he said, but would be “rightfully high”.

This is of course pricing common sense. The price of the unbundled WSJ should be higher on a per article basis, otherwise readers can put together their own bundle at a cheaper price than the yearly subscription fee.

There are two problems that need to be addressed with unbundling a service and WSJ is solving both successfully:

1. Reference Price: If customers had had never paid for an individual article before then their reference price would be $0. But the reference price can be improved even with related offerings or decoy offerings. WSJ charges a high price of $4.95 per article for archived articles (older than 90 days). This serves as the reference price for the new pay-per-article plan even though the two services are different except for the fact that these are pay-per-article plans.
2. Transaction Costs of Unbundling: The WSJ cannot ask readers to pay every time they want to reade the article. This is cumbersome to the readers and there are transaction costs to WSJ. The FT.com story reports that they are working on their own proprietary Micro-Payments scheme to address this. It is conceivable that their Micro-Payment will take the form of prepaid mobile, asking you to buy $10, $25, $50  value credits and deduct from this every time you read an article. They will definitely have ways to send these credits as gifts as well.

One last point is cannibalization, loss from current subscribers switching over to pay-per-article scheme. If the price of unbundled WSJ is done correctly there will be minimal cannibalization. WSJ can further minimize this by communicating the value to subscribers by constantly reminding them how much it would have cost them if they had switched to unbundled pricing scheme.

A quick survey of articles written this morning on this topic shows that most bloggers and commenters in their blogs are not happy and do not think this plan will work. Techdirt blog calls the pay-per-article schema a sure failure. I disagree. The net is, I think this is a great plan. Getting $6 million or more incremental profit is well within reach with an unbundled WSJ.

Note: I quote the FT.com link here and not one from WSJ.com because I could not find it easily on the latter.

In this reverse unbundling case there are two possible scenarios

1. The bundled product is the sum of its parts – no other value-add. In this case the price of the bundle should less than or equal to the unbundled option as previously discussed.
2. The bundled product has a new component that was not offered  before and is not made available in the unbundled option. In this case the price of the bundle can be more than the sum of the prices of unbundled components, if and only if the value proposition of the new components are clear to the customers and they have a non-zero reference price.

In the second case, if the value communication is not clear then customers will be highly unlikely to pay the premium for the bundled option. More importantly, if the reference price for the new value-added component is $0.00, then customers will be more than likely to prefer the unbundled option.

So in both unbundling and bundling cases, reference price is key. If marketers want to capture part of the value-added they should focus on setting a higher reference price in the minds of their customers.