Promoting Lower Prices to New Customers Rankles Loyal Consumers
ANN ARBOR -- Companies that try to attract new customers by offering them lower prices than what their existing customers pay would be better off in the long run if they gave special deals to their loyal customers instead, according to a new University of Michigan Business School study.
While the practice of offering price breaks to prospective customers is common, it fails to take into account the effect such preferential pricing has on existing customers, say U-M marketing Profs. Fred M. Feinberg and Aradhna Krishna.
Consumer preference for a firm's goods is based on more than just the price offered to that particular customer, they say. The decision to buy is also influenced by what others pay for that same product or service.
"Loyal customers feel betrayed when 'switchers' get deals and not them," Feinberg says. "Switchers getting a lower price is, simply put, akin to loyalty being penalized."
Using a multitude of statistical models, Feinberg and Krishna, along with Z. John Zhang of Columbia University, confirmed the traditional "loyalty" and "switching" effects—consumers are more likely to buy from their favored firm if it offers them a lower price and less likely to buy from their preferred company if a competitor offers a better price.
However, the study also shows "betrayal" and "jealousy" effects---consumers' preference for their favored firm will decrease if it offers a special price to "switchers" and not to "loyals," and their preference for the company will diminish if a competitor offers special prices to its own loyal customers.
In a hypothetical scenario, the researchers found that in either case of betrayal or jealousy, formerly loyal customers are 12 percent more likely to buy from another company—even if the loyals, themselves, would not gain from switching.
Companies that ignore the impact that betrayal and jealousy have on loyals do so at their own risk, they say. Firms that mistakenly target switchers could see a significant decrease in profits (about 9 percent), while their competitors may see profits rise (by roughly the same amount).
"First, failing to take account of betrayal leads one to exaggerate the importance of targeting switchers," Krishna says. "In such a case, a firm is led to believe that when offering promotional incentives to switchers only, the firm will simply benefit from the switching effect and will not suffer from any side effects of alienating its own loyal customers.
"Second, by ignoring the jealousy effect, the firm fails to appreciate the important side benefit of targeting their own loyal customers—rival firms' customers becoming disgruntled with their relatively shabby treatment."
Of course, the researchers say that pricing strategies that target switchers can be effective, as long as a firm's loyal customers are not aware of the lower prices offered newcomers. With the pervasive presence of the Internet, however, that is highly improbable.
Even so, many consumers may remain unaware of competitive promotions or not care much about them, the researchers say. But even a small proportion of "enlightened" consumers can change a company's optimal pricing strategy.
"In all, firms may not wish to over-publicize their offering better deals to switchers," Feinberg says. "By contrast, there may be less need to keep a lid on better offers to loyals, since switchers may be tolerant of loyals getting a lower price. In fact, our research suggests that if jealousy effects are strong, a firm may even wish to publicize their promotion strategy."
"If firms want to offer deals to switchers in markets where the 'aware and care' segment of loyal customers is large, they may instead want to offer the promotion to everyone with the hope that only switchers will avail themselves of it," Krishna adds. "In other words, the price discrimination should occur by self-selection on the part of consumers."
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