Designing pricing models that are perceived as fair and valuable by customers on one side and profitable for wealth managers on the other side is a key challenge. Understanding how mobile phone operators are using pricing models to offer perceived value to their customers provides new ideas. Developing a competitive pricing model should proceed in three steps: 1) define the goal of the pricing model in the context of the business strategy, 2) define units of value for each service component, 3) associate a pricing model type to each service component and combine them focusing on a win-win situation. The success of a pricing model depends on understanding customers’ behavior and on testing with real customers.
In a previous insight, called Fee Based Advice: Winning Formula or Passing Fad?, I identified fee transparency as one of the seven key criteria for success in providing wealth management advisory services. In this insight I am providing ideas for designing innvative pricing models.
When looking for new ideas, it is often a good approach to explore seemingly unrelated business models, for example from the mobile phone operator industry (“TelCos”). At first glance, fee based advice (“FBA”) and TelCos do not seem to have much in common. Looking under the hood, one can observe that both business models rely on fixed costs, mainly infrastructure, and variable revenues, based on usage. In addition, the solutions provided are based on commodity and easily replicable services. Offering a simple differentiation, or more scientifically speaking, a unique value proposition, is hard. The following table summarizes the key characteristics of the respective business models.
|Services||▪ phone calls
▪ data transmission
|▪ investment advice
▪ trade execution
|Costs||▪ infrastructure||▪ advice time
▪ based on volume
|▪ based on assets
▪ based on trades
Understanding value creation
The concept of unit of value
Let’s start by understanding what the unit of value is for the different services provided by TelCos.
Unit of Value (definition)
A unit of value* is defined as the unit in which a service is measured and for which a customer is willing to pay.
For example, the duration of a phone call is a unit of value because the longer a person can talk, the more value (s)he sees in the call. The following table lists some key units of value on which TelCos rely.
|Service||Primary unit of value||Alternate unit of value|
|Phone call||# of minutes||# of calls|
|Messaging (SMS / MMS)||# of messages||Message size|
|Value added services||# of services||Perceived value|
Once the unit of value is defined (and validated), developing a pricing model relates to associating a price to each of the units of value, or a multiple thereof. For example, some TelCos charge €0.10 for each SMS sent, the unit of value being the number of messages.
But what is more important is to understand the structure of the individual pricing models rather than the specific numbers, especially when trying to learn from them. In addition, finding out what type of unit of value is preferred by customers is important. For example, one TelCo offers subscriptions that uses transmission speed rather than data volume as unit of value for internet access.
Different categories of pricing models observed
Pay-as-you-go models (“PYG”). In this category of pricing models, each unit of value is billed separately. In the early days, this type of pricing model was common. Nowadays it is mainly found in pre-paid subscriptions and for limited usage services, like calling abroad. It is most valued by customers for rarely used services, expensive services, and services where customers are unable to forecast their needs.
All-all-in models (“AAI”). In this category of pricing models, the customer pays a fixed price, known in advance, for consuming an unlimited units of value over a given time period. High-end subscriptions are found in this category. Customers value the “no surprises” property, even though they may pay more than with a PYG model. Operators tend to prefer these models as they generate predictable revenue streams (the only variable remains the number of customers) and allow to better match fixed costs. Determining AAI prices requires in-depth understanding of customer behavior.
Bounded all-in models (“BAI”). Most current subscriptions fall in this category. They offer a fixed number of units of value for a fixed price and charge per unit of value thereafter. The fixed price, for example €70 for up to 100 units of value, is set such that it is lower than when paying separately for the maximal number of units of value (100 units x €0.80 / unit) but higher than the current consumption of units of value (70 units x €0.80 / unit). This pricing model incentivizes the customer to consume more as (s)he has already paid for that additional consumption with the fixed price. The risk of under-estimating usage inherent to AAI pricing models is partially mitigated.
Increased unit of value models (“IUV”). Although similar in structure, but with a different goal, some TelCo operators offer PYG pricing models with extended units of value. For example, one operator offers phone calls at €0.70 per hour, compared to €0.07 per minute. From a customer perspective these pricing modes are valued because they perceive the price per unit of value as a real deal, although most of the time they do only consume a fraction of the unit of value. TelCos set the price based on usage analysis. The above example is in the interest of the operator if the average call duration is less than 10 minutes and the change in pricing model does not change customer behavior.
Options. Most TelCos offer BAI priced options that can be added to existing subscriptions, for example, covering international roaming.
PYG discount options. A quite common option type seen is to offer, for a fixed price, a reduced PYG fee. For example, for a monthly fee of €10, the price of calling one minute to Canada drops from €0.80 to €0.40. Customers get, in exchange for pre-paying part of their consumption, a discount on the actual consumption. This model is interesting for TelCos if customers over-estimate their expected consumption.
Pay for performance. Interestingly, the concept of performance fee, for example only paying for the actual data transmission speed rather than the promised one, has not been picked-up by TelCos. Performance fees are not used to increase the switching costs between TelCos, in the sense that they would support to pay less if the quality is inferior rather than to switch TelCos.
Win-win pricing models
Profile-based models. Most TelCos offer subscriptions that are based on a combination of AAI and PYG services. The idea is to match the customer’s needs for AAI pricing on high usage and PYG pricing on low usage services. Customers tend to like these kind of pricing models as they take into account their specific needs. They don’t have to pay for services they don’t use and get a deal on those services that they rely on heavily. The challenge for the TelCos is to combine the services in such a way that the offerings remain profitable.
Choose-your-profile models. An extension to the profile-based model is allowing customers to construct their own subscription by combining building blocks of the different services using different pricing models. Such models remain the exception as they much harder to price than other models and tend to work in the favor of the customer rather than the TelCos.
Always-the-cheapest models. Another idea seen is a subscription where the customer always pays the cheapest rate, when looking ex-post at his/her usage†. For example, if the customer only makes a few phone calls a month, these are charged along a PYG pricing model. Once a threshold is achieved, a BAI pricing model kicks in. And in the case the customer exceeds a fixed number of units, an AAI pricing model applies. The biggest advantage for the customer is that the subscription is seen as fair as the type of subscription is selected with hindsight. From the perspective of the TelCos, it fosters increased usage as the customer is ensured that (s)he always pays the cheapest rate. The challenge with this type of pricing model is that its profitability is very sensitive to parameter calibration.
Applying the learned to FBA
Setting a goal
As in any business model design exercises, it is key to define the goal to be achieved by designing a pricing model first. The goal must support the overall business model and strategy. Some of the most common goals are
- increase revenues,
- increase profitability,
- increase the number of customers serviced, or
- create switching costs.
Defining the units of value
Learning from the TelCos approach, wealth managers should define the individual building blocks making up their FBA solutions and associate units of value to each of the services. The following table shows a simplified version of such an analysis.
|Service||Primary unit of value||Alternate unit of value|
|Risk profiling & SAA advice||frequency||content|
|Generic market opinions||frequency||content|
|Actionable trade ideas||# trade ideas||frequency|
|Trade execution||traded assets||# trades|
Selecting units of value allows to define differentiating factors, especially if the units of value chosen are different from the ones of competitors. Validating the choices made actually represent the customer’s willingness to pay is key. And note, there is no single right answer!
It is important to note that, based on the review of TelCos pricing models, there exist different possibilities for the unit of value of each service. These different options define different customer segments. For example, some TelCos customers value speed higher than volume, when assessing the value of internet access. Similarly, some investor customers prefer to have a large number of trade ideas to choose from, whereas others prefer few trade ideas of high quality at regular intervals. Similarly, some investors prefer to see daily performance, whereas others prefer to have quarterly in-depth performance analysis, including contribution and attribution reviews.
Combining for value
The third step in developing pricing models for FBA is associate a pricing model to each service based on the unit of value and combine them into one or more possible solutions. Reviewing pricing models proposed by TelCos shows that it is sound to combine different types of pricing modes in on solution. For example, charging a fixed annual fee (AAI) for generic market opinions and using a BAI pricing model for trade execution. The decision does not need to be either-or. Depending on the specific customer needs, different pricing models should be combined. Some customer segments prefer PYG type models whereas others prefer AAI models. But avoid offering different models to the same customer segment.
The following observations help simplify the choice:
- Rarely used services should be priced using a PYG type pricing model.
- Customers often require PYG pricing models for commodity services with low switching costs where they can relate the value of the service directly to the effort required to provide the service.
- IUV pricing models should be used each time there exists a discrepancy between perceived use and actual use of a service for which customers prefer to pay using a PYG pricing model.
- Frequently used services should be priced using a BAI or AAI type of pricing model. Especially BAI pricing models are favored by TelCos. They allow offering customer, for a small increase in fees, a large increase in value.
- Services that are of value only to a selected segment of customers should be offered as tick-the-box options rather than being included in the core solution.
- Include services for which there exists a strategic goal to increase their usage, in the core solution and use a BAI type pricing model. TelCos for example, use this approach by offering the first 100Mb of data volume for free, to attract customers into accessing the internet via mobile devices. Similarly, a wealth manager could include the first 10 subscriptions of in-house funds as part of the FBA solution, leading customers to prefer in-house funds over third party funds.
As with the definitions of units of value, the combination of pricing models should try offering a win-win situation. Depending of available data on customer behavior, fine-tuned pricing models, like an always-the-cheapest model may be designed to increase customer trust and allow standing apart from the competition with respect to pricing.
As with any model developed, whether it is a pricing model or a whole business model, the model is only as good as customers perceive it. Therefore it is imperative to test the developed pricing models before finalizing and launching them.
- Be clear about your financial goal
- Assess other industries that have a common underlying structure and learn from their pricing models
- Define the units of value by taking a customer perspective rather than an internal view
- Combine the different units of value into customer segment specific packages focusing on win-win situations
- Make sure to test the developed pricing models before launching them
Interested? Don’t hesitate to contact us for a first noncommittal discussion.
*) It is critical that the unit of value is defined from the customer’s and not from the service provider’s perspective.
†) Note that the Oyster card payment system used by the London tubes offers a similar pricing model.