Profit Maximization vs. User Loyalty

by Jakob Nielsen on March 5, 2000

The most important business goal for a website is to maximize user loyalty and the life-time value of the user's future visits and purchases. It is less important to maximize the value of the current visit, and indeed it is often counter-productive to do so.

Differential pricing is sometimes seen as a way to increase profit on the Web. For sure, it is easy to modify prices on a computer and to offer different prices to every individual customer based on his or her purchasing history and other tracking information. Much easier than doing so in the real world where most stores have a physical sign with a fixed price. On the Web, you can charge more from those customers who will pay more and less from those customers who would only buy at a lower price.

It is also very easy to plot a product's price elasticity curve on the Web: randomly serve up pages with different prices to the first thousand users or so who visit a given product page and measure how many buy at each of the price points. With this information, profits can be maximized by multiplying the profit margins and their corresponding conversion rates and picking the price that comes out best.

Even though standard economic theory says that you should employ both of these strategies, I warn against them due to their impact on user loyalty. It will quickly become known that different people are charged different rates and those customers who have been charged the higher price will rebel and refuse to return. Thus, the exact people who could have become the most loyal users (and willing to spend the most in the long run) will be the ones most likely to abandon the site. Customers can be quite upset when they discover that they paid more than others.

Differential pricing is certainly used in the old economy, with the most well-known example being airline tickets. The exact same product (a coach seat from San Francisco to New York) can cost anywhere from $150 to $1,200. This huge price differential does cause much resentment, but at least the airlines have some rules that can explain why customers are charged more or less (weekend stay-over requirements, non-refundable tickets, advanced purchase deadlines, etc.). If the price was determined by "that's what we feel you should have to pay" then people might be less willing to accept. And yet that's the exact strategy followed by some Web pricing schemes.

The classic example used in most presentations about differential pricing is to monitor a user as he or she is moving through a site. If they just keep looking instead of putting something into the shopping cart, then the user is considered unlikely to buy at the current prices and is offered a discount. This strategy probably works, but only until it becomes common knowledge. Then all users will start clicking on lots of random products until they see the prices drop. Another common example that is very easy to implement involves giving lower prices to users who enter the site from a shopbot than to users who enter at the home page. A sure way to make users stop bookmarking the site and always arrive from the shopbot in the future.

I prefer schemes that reward the best customers for their loyalty and give something special to people who need a nudge without making it seem that other customers are being discriminated against. How to resolve the paradox of giving some users rewards and not depriving other users? By using non-monetary rewards. Something the Web is perfect for.

In 1997, I recommended frequent-user programs as a way to encourage loyalty. There are now a few sites that run loyalty programs of the traditional kind where you get, say, the 10th CD free after you have paid for 9 CDs. But it is still rare to see frequent-user programs that use Web-specific ideas.

For example, a site that often deals in products that are exclusive or hard-to-come-by could offer these products to its most loyal users first. When something like a Furby craze hits, a site could decide to sell its Furby allocation to those customers who had bought the most in the past. (Paul Haahr sent me an email noting that online brokerage firms ETrade and Datek allocate access to "hot" IPOs to their most active users.)

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