Raising prices is one of the best things you can do if you want to build a successful business. This counterintuitive bit of advice comes from Chris Luo, VP of marketing at FiveStars, a loyalty program platform for small businesses. Luo joined the company two years ago, after stints in the marketing departments of Facebook and Google.
FiveStars has proved the concept. The company increased prices from $64/month when it launched to $99, then $149, then $199. If the growth in new customers has slowed slightly, the rapid rise in revenues has more than made up for it.
Because FiveStars has added desirable features with every price increase, it has also found that higher-paying customers are more loyal ones. Today FiveStars has more than 6,000 merchant customers and serves more than five million consumers. Luo attributes that success to the company's willingness to charge higher prices--and justify them with the quality of its product and service.
Here are some lessons every small business should learn from FiveStars.
Use psychology to your advantage.
Does $199 really seem like a lot less than $200? Dumb as it seems, that kind of pricing really works. "There are certain psychological thresholds," Luo says. He adds that $99, $149, and $199 are all examples. Understand those thresholds and set your prices accordingly, he advises.
Build a business that will actually be profitable.
This should seem like a no-brainer, but it doesn't in the online world, where the conventional wisdom is to offer a product at a low price or for free as a way to gobble up market share. Once you've got that big user base, the theory goes, investors or acquirers will pour in funds and they'll be the ones to worry about turning a profit later on.
But if that approached worked once, it doesn't anymore. "We made the decision to build a sustainable economic model," Luo says. Perhaps ironically, that model is what brought in investment funds. After the Groupon IPO, he adds, there were 40 or more startups built around rewards programs. Only a few of them were able to raise significant funds, but FiveStars has now raised $45 million. The reason, Luo says, is FiveStars' higher prices. It shows investors that this business has a future.
Spend a lot of time listening to customers.
If you're going to lead the market on prices, you had better have a product customers really want. So FiveStars puts a great deal of time into finding out what that is. Every quarter, the company sends a survey to all its customers asking how they are using the product and what their pain points are. And salespeople also regularly bring customer comments, complaints, and requests to FiveStars' leadership, plus the company has a council of customers it calls "FiveStars Elite Businesses" that provide feedback and advice on a regular basis.
FiveStars takes this input very seriously. For instance, the company recently introduced a highly popular function: automated marketing messages that businesses can set up to send to consumers at preset moments, for instance when they haven't visited the business in 30 days, have a reward that's about to expire, or on their birthdays. FiveStars' merchant customers love this feature but they turned a cold shoulder to a further option that would allow customers to prepurchase products in exchange for a discount. "If you get customers to prepay, they'll go back to the store 80 percent more often," Luo says. "But the merchants weren't used to explaining the concept to customers, and it was a little complex for them to execute. So we will do it sometime in the future."
Pay close attention to your metrics.
"Before raising prices, it's crucial to understand what your essential business metrics are," Luo says. "What's the cost to acquire a new customer? What's the lifetime value of a customer today? What's the ratio of customer lifetime value to the cost to acquire that customer? Raising prices forces you to ensure you're tracking the metrics that matter to your business both before and after the price increase. We really obsess about lifetime value divided by acquisition cost." As FiveStars raised prices, churn (customers who stay for a while but then leave) has gone down. Thus the average lifetime value of a customer has gone up dramatically, with customers both paying higher fees and paying them longer on average.
Tell a great story.
If you're going to raise prices, you had better have something that customers really want, and be able to convey that to them by telling a great story. FiveStars does this on its website, and in a slide deck that its salespeople use in presentations to small businesses. With each price increase, FiveStars added new features and explained why those features make its product different and superior. For instance, Luo says, the automated targeted marketing messages have a 10 percent conversion rate, where the average for traditional email marketing is more like 1 percent.
Customers are getting the message. When FiveStars raises prices and adds features, its existing customers have the option to retain their version of the product at the same price, or move up to the newer more expensive version with more features. The overwhelming majority choose to trade up, Luo reports.
Providing something customers come to depend on is a great way to build the kind of relationship that will allow you to charge sustainable prices and keep revenues stable for a long time to come. For FiveStars, the more full-featured the product became, the deeper the relationship with customers grew--and that's a good thing. "Anyone can sell a low-priced product as an experiment," Luo says. "But as a higher-priced product, we're a central piece of their operation. More and more of our customers tell us that the only thing they do for marketing is FiveStars."