Like many of you, our listener Brian Williams is grappling with the additional costs of doing business in our era of sustained inflation. He and his colleagues are in a pickle, and they asked for our help. Williams and the company wondered if they should raise prices or add additional fees to cover it. Since I am sure many of you have been wondering along the same lines, I wanted to share what we discussed about this business problem here, too.
In Williams' case, some of the indecision stems from the fact that the competition hasn't raised prices. So, if they were to raise them, Williams has concerns that they will no longer be competitive. The additional fees, however, would generate more revenue to balance additional costs while allowing them to maintain their current price point, and their competitiveness, ostensibly.
However, people are not huge fans of additional fees. So, naturally, they are concerned about this course of action, too. It's been a debate for them, so they implored my podcast partner and me to help them.
Watch Colin talking about this on YouTube:
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Inflation has been a problem for a couple of years now. At this point, everybody's dealing with these pricing problems. Everybody's worried about raising prices so you can keep the lights on. However, customers are also sensitive to increased costs.
For example, England does something that might be helpful here. Our sales tax is called the VAT, which stands for Value Added Tax. However, instead of calculating it at the register, retailers in England put the VAT into the price. I always feel like I am getting a real deal on things when I return to the States and see the prices without the (20%) added VAT.
That said, customers aren't wild about additional fees either. For example, I took my grandkid to the movies and bought the tickets online. However, as I finished my transaction, I noticed an added processing fee of £3 to the ticket price, around $5. It annoyed me because I was doing all the "processing" work, so why were they charging me a fee?
Of course, the movies aren't the only ones charging processing fees; Ticketmaster has taken this to a new level. I went to Wembley to see the play-off final of my beloved Luton Town Football Club (back in the Premiership, thank you very much!), and my ticket had a processing fee, a booking fee, and an admin fee. For those of you counting at home, that's THREE additional fees for Ticketmaster.
There's a reason that these fees have become so familiar: raising prices is tricky. All of these fees fit under a category of theory called Two-Part Pricing or sometimes Two-Part tariffs. The canonical example would be like a razor and blade model, where you pay one upfront fee for the razor handle, and then you pay an ongoing fee for each blade you buy that goes into it.
Another reason why a firm will engage in Two-Part pricing is that it works. For example, if there are two taco stands selling tacos, and one sells two tacos for $8, and the other stand sells them two for $5 but charges for extras like lettuce, cheese, salsa, etc., so the all-in price is $8 for two tacos, which would you choose? Most of us would go for the $5 taco pair because we see that as the base price and don't consider the additional fees as part of it.
Ryanair, a European discount airline service, has made a whole airline out of this concept. Sure, the ticket is lower than the competition, but there is an extra fee for everything you do, including processing that ticket. Eventually, they will charge you for a seat, for your share of the jet fuel, and possibly, for the oxygen you breathe while you are there. (I shouldn't joke; they might!)
Psychologically, we anchor on that base price, choosing it over the all-in price. This behavior encourages firms to keep costs low and charge additional fees to make up the revenue. Customers respond better to split out expenses than an increase in the base price.
We All Wish That Fees Would Go Away
To be clear, the customer would prefer a price cut. They would choose the bundled price to be lower than the base price. No one is excited to pay additional fees, especially when they notice them in small print at the bottom of a ticket or adding up on a sporting event booking online. Fred Reichheld would call these fees bad profits.
From a Customer Experience perspective, I find it challenging to champion telling Williams to add additional fees. What makes them especially bad is that they surprise customers if the costs seem hidden. Discovering a "hidden" additional fee can leave a sour taste in their mouth. Plus, there can be long-term effects on customer satisfaction and loyalty, although there isn't a lot of research on that.
Remember the taco stands? Most people would probably choose the two for a $5 deal with additional fees vs. the $8 all-in model. However, after getting charged the extra fees, will they come back? Or does the nickel-and-dime experience damage the relationship?
Therefore, regarding Williams' pickle, it is fair to wonder if they might poison the customer experience in the long term. If it were me, I wouldn't do it. Not because I have data but because I think we should have a test and assess the long-term effects of additional fees on the experience.
Airlines started charging for checked bags around 15 years ago in the US. Before this, passengers would get two bags for free. So, instead of raising the ticket price, many US carriers engaged in Two-Part pricing by adding a $50 fee for a checked bag. The exception is Southwest Airlines.
Now, Southwest has a significant brand promise about not charging for bags. They recognize that by not charging, they have a competitive difference.
British Airways battles the additional fee strategy employed by its competitors. A calculator shows you what your actual fare will be once you add the extra fees for a checked bag, a carry-on, a printed ticket, etc. The calculator would sometimes reveal that the British Airways fare was lower than the so-called low-fare airline.