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Upselling

Guide to Understanding Upselling

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Upselling

Upselling Definition: Revenue Growth Strategies

Upselling consists of the strategies employed by companies to encourage their existing customers to spend more on additional products or services in an effort to derive more revenue from customers that already made purchases in the past.

Simply put, upselling is the practice of convincing existing customers to spend even more by offering upgrades to their current purchases, the option to add more capabilities, and/or loyalty discounts.

Revenue is a function of price and quantity.

Revenue = Price x Quantity
  • Pricing-Based Growth → Revenue Growth from Higher Pricing, i.e. Higher Average Selling Price (ASP)
  • Volume-Based Growth → Revenue Growth from Selling a Greater Quantity, i.e. Increased Volume

Supporting those two core drivers is a concept termed “expansion revenue”, of which upselling is a part.

The premise of expansion revenue, as implied by the name, is to obtain more revenue by leveraging the initial customer purchase, which can be tracked by metrics such as “Average Revenue Per User (ARPU)” or “Average Order Value (AOV)”.

Average Revenue Per User (ARPU) = Total Revenue ÷ Total Number of Users
Average Order Value (AOV) = Total Revenue ÷ Total Number of Orders Placed

If a company’s efforts to upsell are effective, improvements will be reflected in either metric.

Upselling is appealing to companies due to the fact that the customer is an existing customer, rather than a potential customer, i.e. the customer’s foot is already in the door. While there are exceptions, of course, selling to an existing customer tends to be significantly easier than to a new customer.

Types of Upselling Techniques

The following table outlines the most common types of upselling techniques:

Upsell Technique Description
Higher-Tier Upgrade
  • The customer is pitched the opportunity to upgrade to a different tier plan at a higher price point.
  • Usually, the selling point hones in on the current price paid instead of the standalone price (e.g. “only $10 more per month to upgrade”)
Product Bundling
  • The customer is offered complementary goods and services that are value-adds to the initial purchase, i.e. cross-selling.
  • The distinction is that in an upsell, the pricing is discounted with an “all-or-nothing” purchase structure.
Discounted Offerings
  • The customer is presented with discounted pricing on other products and services sold by the company, which is framed as a reward for their loyalty as an existing customer.
Loyalty Programs
  • The creation of loyalty programs is related to discounted offerings, but the motive tends to be more transparent in that the customer must spend more, instead of masking it as a loyalty reward.
  • For example, a retail company might offer a program where if a specified amount is spent, a $25 gift card is earned.
Product Customization (Customer-Specific)
  • Far more prevalent among B2B companies with a limited number of customers than with B2C companies, certain companies can integrate customizable features to the initial product or service sold based on the specific needs of the customer in question (and their feedback).
  • The difference between higher-tier plans and customization is that latter is truly specific to one customer, where the company goes out of their way to ensure the customer remains a long-term customer.

Upselling Example: Apple Product Line

Apple (NASDAQ: APPL) is a prime example of a company that is particularly adept at understanding the irrationality of consumer spending behavior and capitalizing on it.

AppleCare+ Upsell Example

  • Suppose a customer decides to purchase a new iPhone 14 from Apple. While in the process of checking out, the customer must decide whether to buy AppleCare+ or not for their new device, which is an example of a quick “add-on” upsell.
  • In fact, there is a sixty-day countdown from the purchase date during which constant reminders are sent to customers that time to purchase the coverage plan is running out.
  • The time constraint places pressure on the customer that might initially be reluctant to purchase the AppleCare+ protection, yet worries over time that he/she may eventually regret the decision not to purchase protection.

AppleCare+ Upselling Example

AppleCare+ Pricing (Source: Apple Store)

Apple iPhone Pricing Upsell Strategy

  • Even before the actual purchase of the phone itself, Apple is able to upsell its customers in a far more subtle manner, where each version of the iPhone 14 is strategically priced.
  • Customers that step into an Apple store, in all likelihood, have already made up their minds that they’ll purchase at minimum a pre-tax $799+ product, i.e. the base model of the iPhone 14 with the lowest storage.
  • But as the customer views the phones on display, convincing them to spend an extra ~$100 more for a larger display (i.e. the iPhone 14 Plus with equivalent storage) or increased storage (i.e. iPhone 14 128 GB → 256 GB), is relatively effortless because the product pricing strategy handles most of the work.
  • Consumers instinctively compare products side-by-side, with the baseline price adjusting upward to rationalize the increased spending.
  • Comparisons of each model (and its features) are frequently made in steps while neglecting the prior model, so the total price continues to gradually climb. Instead of comparing the base $799 price to the Pro Max $1,099 price, the comparison will instead be between the Pro $999 price to the $1,099 price.

iPhone Pricing Upsell

Apple iPhone 14 Pricing Options (Source: Apple Store)

Apple iPhone Trade-In Program

  • The trade-in option is also a form of an upsell, yet more subtle.
  • Through Apple’s trade-in program, customers can trade in their current iPhone for Apple Store credit.
  • Since the trade-in value is based on the condition of the iPhone, the customer is further incentivized to purchase AppleCare+ and Apple’s phone cases that conveniently work with the MagSafe Charger.
  • With that said, many customers are likely to spend more in anticipation of trading in the phone (and mentally deduct the trade-in value from the purchase price).
  • The trade-in program, when viewed in isolation, is technically a loss to Apple.
  • But since the customer is receiving Apple credit, the funds will inevitably return to Apple in some form of purchase (and the chance that the average customer will not spend more is practically zero).
  • By offering customers the option to return used iPhones for credit, the odds that their next phone purchase will be yet another iPhone substantially rises.

Apple Trade In Upsell Technique Example

Apple Trade In (Source: Apple Shop)

Once the other revenue sources in Apple’s business model are taken into consideration—items such as the MacBook, AirPods, Apple Watch, Apple TV, and Apple Store (i.e. commissions, ad revenue)—it’s easy to understand the effectiveness of the Apple Ecosystem, which has accumulated arguably the most loyal customer base among all companies.

The interconnectedness of Apple devices and their upselling tactics to further establish recurring customers are major contributors the long-standing success of the company.

Sales on the iPhone 14 were lackluster, after most criticized it for only having marginal improvement from the prior model, and the general consensus was that the added features did not justify upgrading to the newest model (or the pricing for new customers).

Still, Apple’s fiscal year 2022 report showed a 8% YoY increase in revenue, reflecting Apple’s reduced reliance on one-time hardware sales (and the overall strength of the current business model).

Apple Ecosystem

Apple Fiscal Year 2022 Results (Source: Press Release)

Cross-Selling vs. Upselling: What is the Difference?

Cross-selling also falls under the expansion revenue category but refers to encouraging existing customers to purchase complementary products and services that enhance the original purchase.

  • Cross-Selling → Cross-selling is more straightforward in that complementary products and services are offered because the existing customer could potentially benefit from them.
  • Upselling → In contrast, upselling is more price-oriented with more incentive-driven. The intent of the seller is to maximize their revenue per customer (e.g. ARPU, AOV).

On the topic of pricing, discounts or incentives are not even necessary in cross-selling. For example, cross-selling could be as simplistic as a salesperson notifying an existing client about a newly launched product to gauge their interest. There likely are synergies between the two products, but the two are viewed as separate transactions.

  • Cross-Selling Example → The “add ons” can be bought separately at any given moment. The appeal of cross-selling is that there is a pre-existing customer relationship, i.e. understanding of their unique needs.
  • Upselling Example → On the other hand, if the “add ons” are offered with reduced pricing for a limited time exclusive to existing customers, that would resemble a form of upselling.

Upselling and Recurring Revenue in SaaS Business Model

The efforts related to upselling existing customers are a critical component of the SaaS business model, where revenue is based on a subscription basis.

The necessity of upselling is of particular importance to B2B SaaS companies because their revenue is on a long-term contractual basis, while B2C is normally on a short-term, monthly basis (e.g. Spotify).

The valuation of a SaaS business is a byproduct of the quality of its recurring revenue—which in the context of multi-year contracts—is most often measured by the total contract value (TCV) and annual contract value (ACV).

  • Total Contract Value (TCV) → The TCV is the gross value of a customer contract and is time-independent.
  • Annual Contract value (ACV) → The ACV is derived from the TCV metric and measures the contract’s annualized value across twelve months, making it more practical for comparisons to industry peers.

The issue, however, is that recurring revenue can lose much of its value given an unsustainable churn rate.

  • Customer Churn Rate (%) → The customer churn rate measures the pace at which customers have canceled their subscriptions or have chosen not to renew over a specific period.

A high churn rate implies internal problems within a company, in which its customers are not satisfied with the quality of the current offerings.

In contrast, a SaaS company with strong, predictable recurring revenue base understands its customers on an individual basis. Hence, the provider is best suited to serve them relative to other competitors in the market.

There are many variables that can determine the churn rate—both internal and external—but one of the most effective strategies to reduce churn is upselling.

Upselling improves a company’s recurring revenue because price-related incentives are necessary to retain customers, especially in hyper-competitive end markets.

Specific to the SaaS business model, the price incentives are more often than not tied to extending the contractual commitments, which is the main takeaway here.

Therefore, upselling and offering incentives can be practical for the sake of securing the time necessary to understand the customer and for the company to customize its offerings to cater to their specific needs, with the objective of eventually becoming an integral part of the customer’s operations.

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