The relationship between customer churn and pricing analytics
Customer Churn Analysis: Why You cannot separate it of pricing.
Think for a moment of the last time you visited your favourite restaurant and had your favourite dish. In my case, it was an Argentinean filet together with a glass Rioja. How much did you pay? How much more will you spend in the future before stopping going altogether to that restaurant?
If you a regular patron of gastronomic premises, be a restaurant or a pub, you understand my point. You know that there is a certain price level where you would stop going to the place. Bear in mind that visiting a restaurant was commonplace before this current pandemic started and will return once it ends.
Now imagine the same for your B2B customers. You are a component manufacturer, an industrial distributor, or a services company. At which price level would your customers defect to your competitor? In other words, what is the relationship between customer churn and your pricing?
Interestingly, a 2019 Spiceworks State of IT Budgets listed an increment in pricing as the second most common driver leading businesses to stop purchasing from a cloud vendor. On the contrary, in other B2B industries such as construction, pricing comes as the last factor influencing loyalty.
In short: customer attrition depends on pricing and pricing strategies, although not exclusively.
Let’s discuss this idea in detail.
Pricing policies only partly influence Customer Attrition.
There is a thumb-rule that goes like this: “reduce your prices and your customer-base will stay loyal”.
While this idea might hold as a rule, it is not a flawless predictor of customer churn.
But first, what is customer churn? In simple words, customer churn or attrition is the situation where regular customers stop buying, usually because they switch to your competitor. Churn rate is a measure of the number of accounts that stop buying over a specific period.
In practice, there is no difference between churn and attrition, just idiomatic. Sales practitioners usually associate attrition with the process of losing customers due to a sustained attack from your competitor. In comparison, they often associate churn with frequent turnover, as in subscription-based businesses.
Successful companies also differentiate between “soft” churn and “hard” churn, using pricing as a trigger.
Soft churn refers to the decision by a customer to switch part of its supply to another less expensive provider.
Hard churn, on the other hand, describes the situation in which a customer changes vendor altogether, due to increases in pricing.
Studies have shown that in complex B2B industries, where vendors usually bundle prices of products with services, the price itself seems not to play a significant role regarding a voluntary customer churn.
Besides, what are the implications for pricing promotions? With price promotions, your company only appeals to customers who are most likely to churn. So why would you give a price reduction to every customer, if most of them would have continued buying at a higher price, nevertheless?
HOW WORKS AI SOFTWARE FOR PRICING AND CHURN FOR ME?
Reference Pricing Partly triggers Customer Churn.
The defection of a customer depends not only on yours but also on your competitor’s price. How would you know your competitor’s price? You will know it when your customers churn.
Many companies would ask their customers about their competitor’s prices. Really? Not everyone with a monetary incentive to lie will tell you the truth. There is a better indicator of whether you are too expensive, depending, of course, on how valuable the price is to your customer. If he buys, you probably have a better price.
Several studies of the last years have shown that customer attrition seems to incorporate critical elements regarding pricing: sudden price changes and reference pricing. The former is more comfortable to explain as the latter, so let’s start there.
Customers not only churn because your prices are high, but because you change them. We can empirically attest that in many cases, there is a significant correlation between changes in prices (or pricing model) and customer attrition.
There are, however, studies that show exactly the opposite. For example, in the field of Software-as-a-Service, there is a correlation between changes in pricing and sales growth. The more often that the company adjust its pricing, the more successful it becomes.
Furthermore, not every unsatisfied customer will let you know. Research and our empirical experience both show that customers that complain about your services do not churn more often that those that do not.
One can therefore infer that: customers complaining tend to be a bit more loyal; and customers that switch to your competitor never complain.
Why do you need to consider both customer churn and pricing to increase customer lifetime value in B2B?
As shown at the beginning, the correlation between pricing and customer churn in B2B varies from industry to industry. This means that there is no general, universally valid correlation strength for all industries. However, there is a correlation. Also, in your market.
Furthermore, this correlation does exist in B2C and is usually known as price-elasticity. Remember, nevertheless, that price elasticity does not manifest in B2B in the same manner. In most B2B markets, lower prices will not bring new prospective buyers. Similarly, due to the long-time nature of B2B relationships, small increments in pricing will not automatically cause your customers to churn.
Customers tend to be loyal to companies that match price expectations, notably when the price justifies the value created. Also, recent research from Syracuse University showed that alternative references pricing (the cost of your competitor) seems to correlate stronger with customer attrition.
Does this insight mean that you need to be cheaper than your cheapest competitors? No.
Saloni Vastani (School of Business of Emory Hospitals) and Kent Monroe (University of Richmond) presented in the Journal of Services Marketing in 2019 that absolute price thresholds affect purchasing decisions.
In their study, they have used sales data spanning over 44 months, 13,000 customers, with over 200,000 transactions, from a services provider.
Vastani and Monroe showed that customers would accept a price withing their acceptable price range. Prices inside their range will not trigger changes in their purchase behaviour. Therefore, customer churn is not originated by a reference price only, but rather by a price outside an expected price range.
Vastani and Monroe also found that specific identifiable customer attributes are affecting the propensity to churn. Moreover, these characteristics influence the acceptable price range of each. Customer attrition and pricing are then related – we do not know precisely how.
The relationship between customer churn and pricing analytics – Summary:
We discussed several studies and ideas about customer churn and pricing in this article.
In short: your most loyal customers know your competitor’s prices, while you charge them a price within their acceptable range.
We should reformulate now our original question regarding the relationship between customer churn and pricing. We need to think in terms of price ranges and price references. In the case of B2B, we also need to think in terms of “soft” and “hard” churn.
Would your customers pay 100 EUR for your product YXZ or would they buy it in your competitor? Wrong questions. How many of your customers will stop buying from you at 90 to 110 EUR, given your competitor prices a comparable product at 80 EUR.
However, how can you predict an acceptable range of reference prices for each customer? How do you find competitor pricing?
You can estimate your competitor pricing by using advanced sales analytics. Remember that customer churn is a piece of information that you have in your historical sales data. Using ERP Sales Data, any manufacturer or industrial distributor can evaluate and predict acceptable price levels.
Contact us today to know more about it.