Customer segmentation for price increases
Steven Forth is a Managing Partner at Ibbaka. See his Skill Profile on Ibbaka Talent.
Are you planning a price increase for 2023? Before you execute on a price increase you need to segment your customers. The segmentation is based on Value to Customer (V2C) and a measure of the value of the customer to the company like ARR, LTV (life time value of the customer) or gross profit contribution. You want to move customers into the top right segment, where they are getting a lot of value and providing a lot of value back to you.
The basic segmentation frame looks like this.
Let’s look at each quadrant.
High Value to Customer x High Customer Lifetime Value
This is where you and your customer both want to be. There is a lot of value being created for customers (V2C) and the pricing is fair so lifetime customer value (LTV) is high. Remember that V2C > LTV. What does the value raio need to be? (The value ratio is V2C/LTV.) That will depend on your strategy ad the industry, but generally it is at least 2X, in most cases 5X and in new categories as much as 10X.
Low Value to Customer x Low Customer Lifetime Value
This is the quadrant where no one is happy. Customers are not getting enough value and they are not generating enough value for you. LTV can be low for one of two reasons.
High Churn - if not a lot of value is being created or if V2C < LTV customers can be expected to churn
Prices are too low
There are actually three subsegments in this quadrant.
There are ways to increase value
Price increases will be tolerated
Price increase will lead to churn
If you can’t increase value and/or raise prices in this quadrant you should let the customers churn out. Unhappy customers are a drag on a business. They lead to unhappy employees (no one wants to be burdened dealing with customers they can’t really help) and they will drag down your net promoter score (NPS) and hurt you in the market.
Low Value to Customer x High Customer Lifetime Value
These customers are at risk. You are not creating enough value for them relative to what you are charging. Raising prices in this quadrant will add insult to injury. Don’t do it.
Instead, look for ways to enhance value. This means diagnosing why you are not providing enough value and taking steps to correct the situation. There are many types of value enhancers.
Services to help the customer get the full value from the solution (enhanced customer success)
Additional functionality (some customers have not bought functionality that they actually need to get value; this is a mistake in package design but mistakes happen)
Data gaps, a lot of software today needs lots of data to make it valuable (this is especially true of AI solutions), a lack of data can undermine value. Is there data or proxies for the data that you can provide?
When you offer value enhancers make sure you leave open a way to monetize them in the future. Otherwise you may just move the customer from this quadrant to the next quadrant!
High Value to Customer x Low Customer Lifetime Value
In this quadrant, the customers are happy, they are getting lots of value, but they are not paying enough for it. How much is enough? Basically, it is whatever you need to continue to invest in innovation and get the targeted return on investment. That will vary for different businesses, but in B2B SaaS the business has to generate enough value to support continuous innovation. If not, the best you can hope for is a commoditized business that competes with everyone else on price. More likely, someone will come along with a better solution and put you out of business.
You need to raise prices or reduce churn in this quadrant. The assumption is that you are delivering value, but it is possible that you are not communicating value effectively or that you are not documenting the value you do provide. Ibbaka Valio addresses both of these problems. Price increases should be combined with value communication and value documentation efforts.
Value and price paths
Use price and value to guide customers to the high value to customer and high lifetime customer value quadrant.
Up, across or out
Let’s start on the bottom left. There are four ways out of this box (only three are shown).
Improve V2C first. This is generally your best choice. Provide value enhancers and fix the V2C problem before you try to increase LTV. If the LTV problem is caused by churn and not low prices, this may be all you need to do.
Fix LTV. Depending on the root cause, this can be done by increasing prices or by reducing churn, often both.
Let the customer churn out. If you can’t fix the value problem then increase prices and let the customer churn out, or at least move to the high LTV quadrant if it turns out they will accept the price increase.
The fourth path out of this box is up and to the right. We did not include this because very few pricing and customer success teams can execute on this. It is easier for most of us to fix one thing at a time than to try and fix everything all at once.
Increase V2C first
For customers that are not getting enough value, that needs to be fixed before you try to increase prices. Here the three types of value enhancer mentioned above come into play: services, functionality data. As you go down this path, make sure you leave the way open to future price increases.
Then claim your fair share of the value
When the value to the customer is high but the value back to the vendor is low you need to fix this. How you fix this will depend on the reason that LTV is low. Is there a churn issue, raising prices will not fix churn and could make it worse. But many solutions are underpriced relative to their value. An investment in a value model (Economic Value Estimation or EVE ) can be a powerful way to communicate and document value.
B2B SaaS companies need continuous innovation
Finally, look at the top right. There is an arrow going up and to the right inside the quadrant. This is an important arrow. Just because you are in the top right you can’t rest on your laurels. You need to continue to create more and more value for the customers. But that is not enough. You have to capture a fair part of that value back in price. If you don’t, the value innovation flywheel breaks down.