Tech Companies: Avoid Sticker Shock at all Costs

January 31, 2012

Sticker shock is the visceral reaction a person gets when the price of a given product vastly exceeds their expectations. The first important thing to remember about sticker shock is that it isn’t always economically rational. The second important thing to remember is that it doesn’t have to be rational to have a tangible effect on the real world.

For instance, between 2002 and 2007 gas prices in the United States tripled, causing demand to plummet. The outrage wasn’t really in response to the absolute price of gas in the US, which was still about 1/3 the price paid in most of the developed world, but rather in relation to the previous price. Having anchored their expectations to $1.50 per gallon, the dramatic increase gave the United States a serious case of Sticker Shock.

Technology companies are especially vulnerable to sticker shock

That’s because tech companies often pursue a user-centric pricing strategy, which hooks subscribers at relatively low (or free) prices, and monetizes them later through a series of hikes. But because software can be reproduced at basically zero cost, it’s conceptually difficult for the customer to understand why they’re being charged more other than to increase the company’s profits. If they’re not careful, the necessary hikes a company has to make to monetize its user base can face a ton of backlash.

Last year, Netflix learned first hand how dangerous sticker shock can be when the company effectively increased the prices on its streaming product by 60%. Many customers who probably considered themselves pretty satisfied with their service dropped it due to the $8 price increase, while keeping their barely-used cable company with terrible customer service. They’re used to paying $80 for a crappy cable service. They’re not used to paying $16 for Netflix.

Avoid Sticker Shock with These Strategies

Increase prices gradually

While customers don’t love small price increases either, they’re not likely to start a riot over a nominal hike. Of course, if the increases are too frequent that causes its own problems, but generally annual increases of 5% or so are taken pretty well. This beats five years of flat prices followed by one 25% increase.

If you have to increase prices quickly, carefully justify why

Whether by email or on your website, find a way to communicate very clearly why you’re increasing prices and how those price increases are linked to improvements in the product. In the case of Netflix, their cost of buying licenses from the major studios was exploding, which put pressure on their profit margins. Most people would have forgiven them if this was communicated in a more palatable way.

Grandfather in existing accounts

If your company is growing quickly enough that your existing customers will only be a small fraction of your overall customers in a year or two, you may want to grandfather them into the old pricing scheme or at least catch them up incrementally. New customers won’t be anchored to the old pricing scheme.

Build a tiered pricing system

Recently added a bunch of features to your product at great cost to your company? Rather than jacking up the price for everyone, add a new pricing tier and allow existing customers to keep the old product at the old price. You may be leaving some revenue dollars on the table, but if the new features are really worth it, you’ll see a high upgrade rate. You can always upsell existing customers to the higher tier later if their use warrants it.

Keep add-on charges to a minimum

here’s nothing people hate more than to think they’re paying one price and then get hit with a bunch of add-ons and charges when they’re ready to buy. This is related to sticker shock: instead of anchoring to your previous pricing scheme, they’re anchoring to your ‘basic’ product. This doesn’t mean you can’t have the tiered pricing system described above, just make sure to clearly define the differences between products and make your customers want to upgrade rather than feeling like they got baited into it. 

Behavioral Data Analyst

Nick is a Behavioral Data Analyst at <a href="">Betterment</a>. Previously he analyzed OpenView portfolio companies and their target markets to help them focus on opportunities for profitable growth.