New Strategies / GfK MIR 17 MANAGING YoUR CUSToMER’S TARIFF CHoICE: WHAT To Do WHEN YoUR CUSToMERS PAY Too MUCH Anja Lambrecht and Bernd Skiera Telecommunications companies traditionally offer several Similarly, T-Mobile offers Relax 50, 100, 200 and 1000 the authoRs tariffs from which their customers can choose the tariff tariffs, allowing customers to make 50, 100, 200 and Anja Lambrecht, that best suits their preferences. Yet, customers sometimes 1,000 minutes of calls calls a month for € 10, € 20, € 30 London Business School, make choices that are not optimal for them because they and € 60 respectively. Regent’s Park, London NW1 4SA, do not minimize their bill for a certain usage amount. United Kingdom, We show in this paper that companies should be very offering more tariff choices allows customers to pick alambrecht@london.edu concerned about choices in which customers pick tariffs those that best fjt their individual preferences, but may Bernd Skiera, that are too small for them because they lead to a signifi- also lead them to choose less than optimal tariffs that School of Business and cant increase in customers churn. In contrast, this is not do not minimize their bill for a certain usage amount. For Economics, Goethe University the case if customers choose tariffs that are too big for example, a customer may pick T-Mobile’s Relax 1000 Frankfurt, Grüneburgplatz 1, them. The reason is that in particular flat-rates provide tariff, but regularly make less than 200 minutes of calls 60323 Frankfurt am Main, Germany, customers with the additional benefit that they guarantee per month. As a consequence, they will end up with a skiera@skiera.de. a constant bill amount that consumption can be enjoyed monthly bill of € 60 when they could just as well use the more freely because all costs are already accounted for. Relax 200 tariff at half the price. Tie article is adapted with permission from the Journal of Telecommunications companies traditionally offer tar- Such a mistake is known as fmat-rate bias, because Marketing Research published by the American Marketing iffs that charge a fjxed monthly fee and a price for each the customer picks a tariff that offers too many free Association: Lambrecht, A. and quantity unit that is consumed. Such strategies have be- minutes and pays too high a fjxed fee. Put differently, Skiera, B. (2006) , “Paying Too come increasingly prevalent in many industries; pay TV the tariff is too “big” for him. In many instances, the Much and Being Happy About It: companies, for example, offer different packages for “biggest” tariff a customer can choose would be the fmat Existence, Causes and different selections of channels, but charge an additional rate; hence the term “fmat-rate bias”. Consequences of Tarifg-Choice Biases” , Vol. XLIII (May 2006), fee for special broadcasts such as live football games. 212–23. The German national railway company, Deutsche Bahn, Alternatively, another customer may pick T-Mobile’s offers a fjxed-price BahnCard that entitles the passenger Relax 50 tariff, but frequently use 100 minutes per to travel at a discount price for a year, and health clubs month. She would end up paying € 25 per month (€ 10 and recreation centers use similar pricing structures. plus roughly € 0.30 for each of the additional 50 min- Frequently, such companies offer more than one tariff to utes), but could have saved € 5 per month by choosing achieve better market segmentation. Deutsche Bahn, for the Relax 100 tariff at € 20 per month. Such a mistake is example, offers BahnCard 25, BahnCard 50, and Bahn- dubbed a “pay-per-use bias”, because the customer has Card 100 at yearly prices of € 55, € 220 and € 3,500 for chosen a tariff that is too “small. The “smallest” tariff a second-class travel. The fjrst two tariffs allow 25 and 50 customer can choose is often a pure pay-per-use one percent discounts on standard fares, while BahnCard with no fjxed fee. 100 allows free unlimited travel on the whole network.
18 GfK MIR / New Strategies The crucial question for companies is whether these mis- than the break-even volume required to have a lower bill takes are benefjcial. They allow them to charge higher than under standard measured service. Kridel / leh- bills and boost their short-term profjtability, but cus- man / Weisman (1993) fjnd that of the 93 percent of tomers may be upset when they recognize that they customers having selected fmat rates, nearly 65 percent have paid more than if they had made a better tariff would save money had they purchased local measured choice. In the best case, an upset customer will simply service, whereas of the 7 percent that selected local switch to the appropriate tariff. In the worst case, measured service only 10 percent would benefjt from however, customers are so frustrated that they take switching to the fmat rate. their business elsewhere, in which case the boost in the company’s short-term profjtability substantially harms Based on health club usage data, Malmendier / DellaVi- its long-term returns. We therefore wanted to explore gna (2006) observe that customers choose annual the effects of such biases on profjtability to better contracts, even though they would pay less per visit understand how managers should manage their cus- and thus forgo an average savings of $700 during their tomers’ tariff choices. membership. This means they pay 70 percent more than they would have done on a per-visit basis. Customers often do not choose wisely Train / McFadden / Ben-Akiva (1987) observe that US All these studies indicate that fmat-rate bias is much households have a general preference for fmat rates com- more prominent than pay-per-use bias. only Miravete pared to standard measured service, and prefer fmat (2002) fjnds that 6–12 percent of customers wrongly rates for a more extended area to fmat rates for a smaller choose the fmat rate but 62–67 percent wrongly choose area. Hobson / Spady (1988) report “a fair number of measured service. apparent ‘mistakes’” when analyzing single-person household tariff choice, which for the most part involved What should you do if customers do choosing fmat-rate service when the monthly billing rate not always choose wisely? under local measured service would have been lower. We wanted to know what managers should do when customers make the wrong decisions. Should they tell Similar results are reported from an AT&T experiment them, or just take the extra money? We therefore had to where customers with zero consumption chose a block- understand the extent of these mistakes, their causes of-time tariff instead of a standard usage-based rate and, most importantly, their effects on customer switch- (Mitchell / Vogelsang 1991). Also, 45 percent of the ing, churn, and long-term profjtability. customers that pay a fjxed monthly rate for a percent- age discount on evening and weekend calls, use fewer We collected a unique set of transactional data for a rep- resentative sample of 10,882 customers of a European internet service provider (ISP), covering a sample period of up to 5 months, which could be matched to the results of a survey of 941 of the ISP’s customers. This allowed us to carry out a detailed analysis of tariff choices. There was a choice of three DSl tariffs: » Companies do not need to be con- > Tariff 1 had a fjxed fee and a low monthly allowance, cerned about customers with a flat-rate with an additional charge per megabyte of data over and above the allowance. bias, though they should be worried about those with a pay-per-use bias, > Tariff 2 had a higher fjxed fee and a higher allowance than tariff 1, but the same charge for usage exceeding because the increase in short-term the allowance. profitability is completely offset by the substantial increase in churn rates. « > Tariff 3 was subject to a fmat rate with unlimited usage.
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