Setting your prices right and retaining customers can be hard. However, get your pricing strategy right and you’ll be able to see both improved customer retention and increased revenue.

More and more companies are realizing the importance of retaining existing customers rather than focusing entirely on acquiring new ones.

Customer loyalty marketing is playing an ever stronger role within corporate strategy. Today, almost every industry offers a variety of loyalty schemes aimed at differentiating themselves from competitors.

In nearly all cases this is given as a discount either in a straightforward, upfront manner (e.g. members of a scheme getting a 10% discount) or in "soft" currency (such as air miles).

The lack of differentiation amongst benefits has however made many loyalty programmes within an industry almost interchangeable and consequently loyalty programmes are losing their competitive edge.

This is why the newer, value-oriented customer loyalty programmes attempt to establish an emotional relationship between company and customer to create long-term loyalty.

The main difference between value-oriented customer loyalty programmes and the historic loyalty programmes is that they do not focus solely on simple discounts but rather offer a powerful package of advantages consisting of hard and soft benefits (i.e., financial and non-financial).

The success of any loyalty programme depends to a large extent on the quality of the benefits on offer – and in order to be successful, they should have a high perceived value from the customer’s perspective.

While discounts still have a high value for most customers (after all, everyone enjoys saving money) they do not in themselves create loyalty. Long-term retention can only be established on an emotional level.

Customer loyalty must be earned over time with good value for money, superior products or services, and through the shining integrity of your company. Discounts by themselves attract bargain hunters who will be the first to leave a loyalty programme offering a 10% discount if a 15% discount is offered elsewhere.

You will be all too aware that giving discounts is really giving away your profit with no certainty that any increase in sales volume will compensate for the discount awarded. Smarter businesses use more sophisticated pricing methods that make customers earn discounts rather than simply give them away.

Their discounts are used to reward customers and to direct their behaviour in specific directions such as using other products, increasing purchasing volume, or switching to products with a higher profitability. Over time this type of discount builds a protection barrier which makes it more difficult for competitors to lure away customers.

Consequently, while discounts or other financial incentives will get customers to join a programme, it is the soft benefits that actually build the relationship. Thus, the identification of the right mixture of hard and soft benefits is crucial to the development of a successful customer retention strategy.

Pricing Schemes to Promote Customer Retention

Multi-step quantity discounts

Offer increasing discounts at higher purchase levels - for instance, a supplier of lightbulbs at £2.95 each will discount them to £2.76 when 5 or more are purchased. If more than 100 units per year are bought, all further units are discounted a further 5%.

As the purchased quantity increases, the discount is also increased progressively. The effect of such a multi-step discount programme is that it encourages increased purchases, as the next discount level is easily attainable, which leads to a consolidation of the customer’s overall purchasing activity, normally divided among several suppliers, to just one supplier – you!

In this particular case, a competitor can only break into the market by offering discounts greater than 10%. This discount scheme is a win-win situation for both you and your customers as the latter gets discounts of up to 20% and you are guaranteed a certain purchase level in return.

The two-part tariff

Is a mixture of an up-front flat payment and subsequent discounts spread out over a fixed period of time. One of the best-known examples of this is Railcards. All types of Railcards allow you to purchase a train ticket at a reduced rate, typically 1/3 off the price of an adult fare and 60% off a child's fare (for Family & Friends Railcard).

1-year Railcards are priced between £20 – £30 and 3-year Railcards are priced between £54 - £70, which works out cheaper than buying a 1-year Railcard for three consecutive years. There’s no limit to the number of times you can use a Railcard,

Today airlines and telecom companies are using similar two-part tariff pricing schemes to increase the loyalty of their customers. Two-part tariffs are commonly used with mobile 'phone packages combining different monthly rates with different peak/off-peak minute rates and free minutes.

Time and loyalty based pricing

Differentiates discounts over time or length of a contract signed. A Private Eye magazine costs £2.94 at newsagents.

An annual direct debit subscription for the magazine costs £30 (including delivery) or an annual credit card subscription costs £34.00 (including delivery); the incentive here is to take out the direct debit subscription at a lower rate with the probability of carrying on with the subscription once the year is up. Currently, the subscription includes free Christmas cards as well!

Instead of giving away discounts these pricing schemes offer incentives for increased and longer usage of existing services or by adding new services to an account. The more the services are used, the greater the customer benefit.

Similar systems are in place in frequent flyer programs. Time and loyalty based pricing is ideal for relationships between a company and a customer that are based on contracts as the length of relationship can be measured and discounts be determined.

With multi-product pricing

The strongly discounted sale of the main product is linked to a longer-term agreement with your customers to purchase complimentary products or services exclusively from you such as buying a copier at a discount and agreeing to purchase toner cartridges, paper and services in return (tie-in sales).

In some cases, the main product is even sold as a loss leader. This method ensures a regular stream of income to offset the discounted product and is an effective tool to ward off potential lower priced competition because the customer is tied to the long-term agreement.

The loyalty effect is very strong although additional action will be required at the end of the agreement.

Another form of multi-product pricing is price/product bundling which combines products and services that are generally sold separately. The bundle is sold at a significant discount versus the sum of the prices for the individual products.

Price guarantees

Are another pricing mechanism to build loyalty, widely used by supermarkets. For example, Asda guarantees they will be 10% cheaper than Tesco, Sainsbury's, Morrisons or Waitrose on a comparable shop or they will refund the difference.

Tesco guarantees that if you buy 10 or more different products (can be a mix of branded and own-label products), they will compare the total price of branded products in your basket with the same at Asda, Sainsbury's and Morrisons.

If the branded shop is cheaper elsewhere they will refund the difference instantly. These price guarantees are to dissuade customers from considering shopping at an alternative supermarket.

Does price fairness affect customer retention?

According to Xia et al. (2004), price fairness refers to consumers’ assessments of whether a seller’s price is reasonable, acceptable or justifiable. In a separate study on factors affecting customer satisfaction, the authors found that “charging a fair price helps to develop customer satisfaction and loyalty.”

This is backed up by another study from Herrmann et al. (2007), which concluded that customer satisfaction is directly influenced by price perceptions, albeit indirectly, through the perception of price fairness.

The price fairness itself and the way it is fixed and offered have a great impact on satisfaction. If you are charging a premium price, certainly more than your competitors, then they will expect a premium offering, faster response times and a priority service.

Alternatively, if you offer a budget pricing option, your customers’ expectations will be lower because they perceive the price to not include all the added benefits of a more expensive item.

With this in mind, how can you use pricing to improve customer retention?

Improve customer service

To improve overall customer satisfaction, you need to be pricing your products high enough to give you the resources to offer amazing customer experiences. By increasing your prices, you can allocate more resources to deliver a better customer service.

Boost quality

Researchers at the Stanford Graduate School of Business and the California Institute of Technology conducted a study on the influence of price and quality on customer satisfaction.

“What we document is that price is not just about inferences of quality, but it can actually affect real quality,” said expert Baba Shiv. “So, in essence, price is changing people’s experiences with a product.”

For example, if you have two different wines, one that costs £5 and the other £25, you would perceive the £25 wine to be of better quality - if you have to pay more you automatically assume the merchant is charging more because it is a better-tasting wine. But, is it really better quality or is it just perceived to be?

The researchers that conducted this wine study found that an increase in the perceived price of a wine did lead to increased taste expectation. Therefore, the study concluded that higher customer satisfaction is based not on real quality, but the price as people see it is an indicator of product quality.

Consumers use price as a reference for perceived quality so if you charge a higher price, customers’ expectations will be higher so you need to ensure satisfaction to retain customers.

Furthermore, if your price is in the medium range, but you offer a premium level of service (above customer expectations for the price paid), you can expect high customer satisfaction – as exemplified by John Lewis and Marks and Spencers.

Gordon Tan, founder of Client Heartbeat said: “There is a correlation between price and service. If you offer a low price, it means you have fewer resources - which makes it harder to deliver a good service. If you charge more, you can throw more resources at it, ensuring you deliver a high level of service.”

Are you charging enough to deliver a high level of service to customers?

A study that examined the relationship between customer satisfaction and price tolerance has found a positive association between changes in customer satisfaction and changes in price tolerance.

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In particular, the findings imply a 1% increase in customer satisfaction should be associated with a 0.60% decrease in price sensitivity.

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Eugene Anderson reported in that study: “The findings imply that increasing customer satisfaction is likely to decrease price elasticity of demand. In particular, the findings imply a 1% increase in customer satisfaction should be associated with a 0.60% decrease in price sensitivity.”

Over time, customer satisfaction does influence price tolerance. It means that as a customer becomes more satisfied with the level of service delivered by a company, price becomes less of a factor.

Anderson went on to provide a recommendation to companies considering improvements in customer satisfaction.

He said: “(Companies) should consider the financial benefits of improving satisfaction as a consequence of customers’ increased willingness to tolerate price increases.”

"As price tolerance also provides an important indicator of loyalty, firms interested in assessing the long-term benefits of customer satisfaction should consider using price tolerance measures along with more traditional measures of loyalty, such as repurchase intentions and willingness to recommend."

The correlation between pricing strategy and customer retention

If you deliver a high level of service that creates high customer satisfaction, your customers will be willing to pay more and remain loyal. If you are a premium provider, you must deliver a premium level of service that is superior to that of your mid-range competitors.

If you charge more, you can allocate more resources to customer service and actively put systems in place to improve customer satisfaction and retention.

Re-evaluate your pricing strategy to bring it in-line with your customer satisfaction goals. Ensure you are charging enough so you can deliver high customer satisfaction?

Raise Your Prices

Pricing is a powerful way to improve customer satisfaction and customer satisfaction leads to improved customer retention.

Try to raise your prices. You will see the benefits of being able to allocate more resources to creating better experiences, leading to stronger satisfaction and happier customers who consider your prices fair.

Always give the customer more than they were expecting because customers like to be pleasantly surprised and when they are, they shop again.They are more likely to stay around for the long haul.