The IdeaDrive up revenue with a three-part pricing plan that capitalizes on consumers’ affinity for free goods.
In 1996, AOL stopped charging customers every time they connected to the Internet and introduced a flat access fee. As a result, demand soared beyond the company’s expectations — existing customers stayed online longer and a million new subscribers joined in the first month of the new plan alone. AOL wasn’t completely prepared for the surge. Its servers struggled with the traffic, and customers grew frustrated.
Why did usage rise so much? Recent research has shown that consumers value free services differently than services they pay for. They don't simply subtract the costs from the benefits — they perceive the benefits of free services as higher than when the services cost something. As a result, users place a greater value on free services than expected and they use them more.
Since AOL first introduced its flat-fee structure, other service providers have taken similar steps (without hiccups in service). Some now offer three-part pricing plans, which feature a regular access fee, an allowance of “free” usage, and a fee for when the customer goes beyond the “free” allotment. Telecom providers have done this with cellphone minutes. They often give users a choice of plans, including those that offer a certain number of “free” minutes per month and a charge for exceeding the limit.
Have these firms seen a rise in demand similar to AOL, and have they been successful at maximizing revenue? Professor Eva Ascarza, along with Anja Lambrecht and Naufel Vilcassim of London Business School, took a detailed look at what happened when a South Asian mobile phone service introduced a three-part pricing plan for the first time, in addition to its two-part plans (those that feature a regular access fee and a charge for every minute consumed).
You can use this research to incorporate the appropriate amount of “free” tiers of goods or services as part of a multipart pricing plan. The researchers found that, although the South Asian cell phone firm was ostensibly charging a lower rate on the new plan, the consumers that switched often spent more time on the phone than they had on two-part pricing plans, even going beyond their “free” allowance. As a result, the firm actually saw increased revenue of close to 20 percent from those customers. Since “free” goods are so highly valued by customers, consider advertising them intensely, too.
You can use this research to adjust your service capacity when your company introduces a three-part pricing plan. In the study, over 80 percent of the consumers that moved to the three-part plan used more minutes than expected based on their history.
Eva Ascarza is an Assistant Professor of Marketing at Columbia Business School. She is a marketing modeler who uses tools from statistics and economics to answer marketing questions. Her main research areas are customer analytics and pricing in the context of subscription businesses. She specializes in understanding and predicting changes in customer behavior, such as customer retention and usage. Another stream of her research...
Read the Research
Eva Ascarza, Anja Lambrecht, Naufel Vilcassim
"When Talk Is 'Free': An Analysis of Subscriber Behavior Under Two- and Three-Part Tariffs"