Customers often choose flat-rate pricing plans for services over pay-per-use plans even though flat-rate plans cost more. Their choice is affected by several psychological factors, including the perception that for pay-per-use plans, with every gain of usage, there is loss through payment. Marketers can alter this perception by reframing the pay-per-use plan so that customers pay an initial amount for a certain usage volume and then get compensated or pay more based on under or over-usage.
When using services, customers often choose flat-rate payments (paying a single, fixed fee
regardless of usage) over pay-per-use plans (paying for each unit of consumption). For example, a person might choose to buy a month’s membership at a gaming arcade instead of paying for each visit. Customers choose a flat-rate option even when the cost of the pay-per-use plan is lower, though it seems irrational to do so. A study tries to understand why customers avoid pay-per-use plans to answer the question: How can customers be encouraged to opt for pay-per-use rather than flat-rate plans for services?
The study found that customers tend to pick flat-rate options due to several psychological
factors. Customers prefer to avoid the risks of varying costs of pay-per-use plans (as the amount to be paid differs with usage, which makes mistakes in calculation or payment more likely) and to pay a fixed rate instead. They also tend to overestimate how much they will use the service. For example, they might believe that they will go to the gym every day and so it is better to pay ₹4000 for the month than pay a total of ₹6000 per month at the rate of ₹200 per visit.
Customers also prefer flat-rate plans because they want to minimise the effort needed to
make a decision by comparing different pricing plans. They avoid the calculation and choose the fixed rate, which is clear and direct. Finally, the linking of consumption and usage also affects customers’ choices. Having to think about costs while consuming a service reduces the pleasure of the consumption. This is explained brilliantly by Dan Ariely in this video on the pain of paying. So, customers prefer to reduce the pain of paying by choosing a flat-rate plan which keeps payment and consumption separate.
Pain of paying depends on the timing and mode of payment. When people pay by cash, for instance, they are more conscious of the money going out of their pocket, so they feel higher pain of payment. Similarly, when they pay alongside consumption, they feel more conscious of the outflow of money and experience higher pain of payment. Paying by credit card or paying in advance, on the other hand, reduces pain of payment. An example of this is buying daily tickets versus monthly passes for local trains. For daily tickets, a passenger has to pay every time they travel, which makes them more aware of the expense. But for a monthly ticket or pass, they have to pay once a month in advance, so they don’t have to think about the money outflow every time they travel, which reduces pain of payment.
<You can check out this post for some interesting information regarding pain of payment and mobile payments>
The study also found that customers avoid pay-per-use plans because the reference point
they use to decide is “zero usage”. When customers evaluate a pricing plan, in their minds, the cost they pay is a “loss”, and the usage of the service is a “gain”. In pay-per-use pricing plans, at zero cost/loss, there is zero usage/gain as well. However, every unit of consumption/gain is accompanied by more payment/loss. In the customer’s mind, an increase in gain is always accompanied by an increase in loss, which prompts them to avoid pay-per-use plans.
The study suggests that reframing the pay-per-use plan can change customers’ attitudes towards it. Instead of presenting it as a plan where they pay nothing for zero usage and a fixed amount for every unit of consumption, the plan can be presented as one where they pay an initial amount for a certain volume of usage and either get compensated for non-usage or pay extra for additional usage.
For example, a mobile data plan can be presented in one of two ways:
Option 1: Pay ₹5 for every hour of data use.
Option 2: Pay ₹50 for 10 hours of data use. If data use is less than 10 hours, you get cashback of ₹5 for every unused hour. If data use is more than 10 hours, you pay ₹5 per extra hour.
Option 2 has the same cost structure as Option 1, but it shifts the reference point for customers from zero to the initial amount of ₹50. It also shifts their perception of loss and gain. They feel that if usage is below 10 hours, they make a further gain through the cashback. And even if they have to face loss due to extra usage, they perceive the loss as less than that in Option 1 because of the shift in the reference point from 0 to 50. This mental calculation makes them more open to choosing the reframed plan.
The study’s findings are important for both marketers and customers. Marketers can reframe their pay-per-use plans to make them more lucrative for customers. Customers can choose the reframed plans over flat-rate plans and save money, which will also improve the relationship between the service provider and the customer. Marketers can also improve overall sales through these reframed plans because the lower price point will attract more users.