Sunday, September 16, 2012

A PS on grandfathering

If you've read my last blog post I still owe you a small PS. I mentioned that while I was writing the post I've learned two surprising things, so here goes. (Caveat: I usually try to provide some useful advice in my blog. What I'm going to write now doesn't have any practical value so feel free to skip it.)

Number 1: 

Do you know where the term "grandfathering" comes from? Maybe it's just my illiterateness and you're yawning but I had no idea that the term, which describes such a nice thing in the context of business and politics today, goes back to such a horrible concept:
The concept originated in late nineteenth-century legislation [...], which created new literacy and property restrictions on voting, but exempted those whose ancestors (grandfathers) had the right to vote before the Civil War. The intent and effect of such rules was to prevent poor and illiterate African American former slaves and their descendants from voting, but without denying poor and illiterate whites the right to vote.

(Source: Wikipedia)

Number 2:

I initially thought that the lower your churn rate is, the tougher it will feel for you to offer generous grandfathering. My thinking was: If you have a low churn rate and therefore a long customer lifetime, you're giving up a lot of incremental revenues by not increasing your prices for existing customers. If on the other hand you have a high churn rate you can more easily do without the price increase because you're existing customers won't stick around for a long time anyway.

Turns out this isn't true, at least if you expect churn to be constant – and if you're interested in the relative importance of the aforementioned incremental revenues as part of your total revenues (if you only care about the absolute dollars that you might be giving up, my original assumption is of course correct). If you take a look at this Google spreadsheet (let me know if you'd like to get the Excel version) you'll notice that the  relevant revenue portion that we're talking about (revenues from Group A customers due to pricing increase, cells E22-G22) is almost completely insensitive to changes in churn rate (cell B10)!

Look at cell G22 in the spreadsheet, which shows the revenue portion that you give up by offering grandfathering for year 3. If your churn rate is 1% p.m. that percentage is 7.35%. If it's 3% p.m., the percentage goes down to 7.22%, almost no change. And if your churn rate is 5% p.m., again almost no change to that percentage (7.08%). The reason is that revenues from your new customers ("Group B customers" in the model) are affected by your churn rate as well, and that effect almost completely offsets the effect of your churn rate on your existing customers with respect to the question that I was talking about. If you think about it, it's logical, but my original intuition was wrong.

1 comment:

David Mytton said...

There's another good article at about this topic and I commented at where I felt that you should never raise prices for existing subscription customers because it's not what they signed up for.

I think that's true for subscription customers but for consulting or "one time" customers then a different rule applies because you're making a new deal each time.

Unless you can model that you'll get significant revenue bumps from hiking prices for existing customers and you think that will offset the churn and hit to goodwill (which can be hard to measure), then I'd always go for new pricing for new customers only.