We use multiple online tools at SPS, and last month I called one of the providers with the intention of upgrading to a higher tier. I asked a few questions to clarify the differences between the tiers of service; and, unprompted by me, the customer service rep said, “I see you have been a customer for a long time, I can upgrade your account for free.” Of course, I was pleased, and I readily accepted; however, after the call I thought about whether the company was smart to give us the free upgrade. My conclusion is probably not. There are times when free upgrades make sense and other times when they just destroy margins.
As I mentioned, I was happy to receive the free upgrade, but I don’t think the company should have offered it. I was prepared to upgrade the service and pay double the current monthly fee. I had already determined the higher tier offered value, and I was not looking to switch to a competitor. My current service was competitive with others in the market, and I prefer not to hassle with switching. I was already a loyal customer, and although I appreciate the gesture, I am not any more loyal than before. So, in my case, the company just gave away incremental margin.
Let’s contrast that with Carnival Cruise Lines. In 2013, The Carnival Triumph was disabled at sea for multiple days. A month later, two more cruises terminated early due to ships becoming disabled at sea. Passengers had to be flown home early. As a result, several future passengers began calling to cancel their reservations, at which point Carnival began lowering prices and offering free upgrades. In that case, free upgrades made sense. Customers were defecting, and increasing the perceived value of the vacation was a critical step in reducing their losses.
Now consider airlines. Twenty years ago, it was very common for airlines to upgrade passengers to first class whenever space was available. Priority went to the highest class of frequent flyers, but any elite flyer could be upgraded if enough seats were available. Over the years, most airlines realized that some frequent travelers who might pay for first class, did not do so if they had a reasonable expectation of a free upgrade. If the plane was not full, an upgrade just moved an empty seat from first class to coach, and in some cases, lowered their revenue. Now many airlines require their frequent flyers to spend miles to get upgrades.
So, when does it make sense to offer free upgrades? There is no hard and fast rule, but here are the considerations:
- Your incremental cost of providing the upgrade should be close to zero. When this is true, the only cost of the upgrade is foregone revenue (the difference in price between the two tiers of service).
- The customer is actively making a buying decision or regularly makes buying decisions in which you are a competitor.
- Each time a customer decides what and where to buy, you are in a competition. The customer’s loyalty can tip the competition in your favor.
- If the customer has already decided to buy the product or service, and they make such decisions infrequently, the potential value of increased customer loyalty is very low.
- Your customer already decided not to buy the lower tier product.
- For example, a customer calls to cancel a satellite radio or cable tv service. They may not want the current package at the current price but would be willing to pay the current price for an upgraded package.
- If you do not have to spend any additional money to provide the upgrade, it can make sense to protect the revenue with an upgrade.
- You are compensating for a poor customer experience. In the Carnival Cruise example, customers had their vacations cut short and they endured some unpleasant conditions. A free upgrade on a future trip might overcome their negative experience.
- Although future Carnival passengers had not experienced the negative cruises, they rightly expected they could have a negative experience. Since they also called to cancel per #3 above, an upgrade might convince them to keep their travel plans, and Carnival’s cost of providing the upgrade was near zero.
- The tier your customer purchased is full or nearly full. For example, if coach class is oversold and there are empty seats in first, it makes sense to upgrade frequent flyers rather than bump other passengers (and give them vouchers for free travel).
- Similarly, hotels sometimes upgrade guests to a suite when all the regular rooms are full, and there is more demand for the regular rooms.
- What are the potential effects on future buying decisions from offering a free upgrade? Customers may be loyal, but they can be taught to ask for free stuff.
- If they believe you are likely to provide a higher tier of service without charging, they are more likely to request it, and less likely to pay for future upgrades.
We are all in business to provide value to customers and make money in the process. Our pricing strategies and pricing architectures are the mechanisms we use to turn customer value into shareholder value. Charge too much and we lose customers. Charge too little, and we leave money on the table. Sometimes offering a free upgrade increases the customer value and improves the long-term reward for shareholders. Unfortunately, upgrades can also damage shareholder value when they are offered too freely. Think through all the considerations before deciding to give things away.
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