In time, all subscription-based businesses will need to understand how to raise their price levels. The motivation behind an increase can be multi-fold. You might want to increase the perceived value of your product, adjust for inflation or increased costs, or maybe your competitors have increased their prices.
Frankly, raising prices is one of the easiest ways to increase the profitability of your business. Once you do, however, it is critical to understand how the dynamics behind a price adjustment works. In this article, we walk you through the most important factors and show how to estimate the effect of an adjustment.
When a subscription business raise its prices, usually three things happen:
1. The churn will increase. The existing subscriber base will react negatively to a price increase, and their churn will increase. Likely, a short-term bump will occur when the price increase is announced, and the underlying churn is likely to increase long-term.
2. New sales will decrease. The higher the price, the harder it is to sell. It is simply harder to get new customers to jump on the higher the product price. Here, you can balance the price increase with introductory offers to take back part of the reduction in sales.
3. Average revenue will increase. And finally the obvious. The revenue per subscription (ARPU) will go up when the price is increased. That’s kinda the point.
The question is: Will the increase in ARPU be greater than the loss of new sales and the increased churn? Calculating this in detail requires some thought. Fortunately, there are rules of thumb we can use to understand the outlines. We can do this by looking at the customer lifetime value (CLV).
To calculate the CLV for a subscriber, you can use the formula: ARPU / Churn %. Example: $10 / 12% = $83. This is the estimated total revenue, each subscriber will give on average, during its lifetime. Note that both the average income and the churn must be calculated in the same time period, for example monthly (or yearly).
The next step is to multiply the CLV by the sales volume for a certain period of time, for example a month. In this way, we get the total future revenue for all sales. Example: 500 new sales * $83 in CLV = $41,500. This figure should be interpreted as “if we sell 500 new subscriptions, we will get $41,500 in total future revenue – on average”.
Now we have the tools to estimate the effects of a price adjustment. Estimate the current churn, current APRU, and current new sales – to calculate a baseline. Then the same estimate based on what these figures might look like after a price increase. The ARPU is easy (we know it), but for churn and new sales, some reasoning and maybe even tests are required.
When you’ve gathered all the data, you can calculate a “Total lifetime value before price adjustment” and a “Total lifetime value after price adjustment”. If the CLV after is higher, then you’re in luck and should proceed. If it is lower, then it is a good opportunity to revise your estimates, or consider whether a price increase is really the right way forward.