Pattern description
Add-on pattern card illustration.
This business model offers a core value at a competitive price, while numerous extras drive up the final price. So, in the end, customers pay more than the originally anticipated but benefit from several options that meet their particular needs.
This pattern requires a very sophisticated pricing and marketing strategy. Usually, the core service is advertised and offered at very low rates, to get the customers on board. Today, people usually compare prices at Internet platforms, so companies following this business model face strong competition, where winners take it all, as long as the customer will pay extras just to the company first selected.
The benefit for customers from this business model comes from customization. It´s up to them to pay for extras, but by adding them to purchased products, they will enjoy a better product or experience, according to their individual preferences and needs. In the end, the customer may pay more for the final product that they would have to for similar competing products.
The key point here for businesses is to select the product features that will yield the highest marginal utility for the greatest number of customers. Therefore, starting with the core functions or services of every product, customers can choose their preferred add-ons, until they find an optimal utility from the product.
Where is it used?
This business pattern is especially interesting for hard-to-segment markets, where customer needs diverge vastly, and where just dividing products or services into different versions is not enough to guarantee an optimal value proposition for large numbers of customers.
Add-on model is very much extended across many industries. Airlines, car manufacturers, and software companies are usually creating and capturing value in this way. Let´s see some examples of this business model:
Ryanair, the European biggest low fare company, founded in 1985, is widely known among their customers for its aggressive pricing strategy, imitated by many other airlines. The idea is pretty simple: the company removed all the services usually included in a flying ticket, such as meals and beverages, priority boarding, travel insurance, and additional baggage, which are sold as add-ons to the core product, a flying ticket at very competitive prices. This strategy, in fact, helped to popularize the low-cost airline business, allowing millions of people to afford flying much more often, and therefore increasing the whole market with million of new customers.
This model is particularly profitable to luxury cars manufacturers, such as Mercedes-Benz, Lexus, and BMW, which offer customized cars to their clients, and thus increasing their margins up to a 50%, or even more. Other companies, such as Harley Davidson, are following this business model, and even introducing cheaper bikes to create entry products and provide a wider platform for profitable customization.
This business model is also widely used in software industry. Many companies, building both B2B and B2C products, allow their customers to pay for different features, apart from the core software. This features greatly extend the scope of services provided, and users can even configure by themselves the software, addressing their needs.
When and how to apply Add-on business model
This business model works well if the customers are able to buy first a core product, and then later add some customization. Recent studies have shown that for consumer products choice is first made on the basis of price and other rational criteria, and after that it changes to more emotionally driven criteria. Therefore, companies can at first sell a product at a very competitive price, and later charge further services, products or features to increase margins.
So, to apply this business model we have to answer two questions:
Can we provide a basic product with a very competitive pricing and them add-on further services?
Can we lock our customers in our core product, so they will buy add-on products just from us?
If the answer for both questions is affirmative, probably our business can innovate following the Add-on business pattern.