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.
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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.
And What About the Tipping During a Fast Casual Experience?
The other day I ordered a sandwich and a salad at the counter at a fast-casual restaurant. When it came time to pay, the employee flipped around the screen, asking me how much I wanted to tip, 18, 20, or 22%. Moreover, there wasn’t a way to not tip other than to select “custom” and put a zero.
Seriously?
Tipping is out of control in the US. Tipping in the US has always been more customary than in other countries, but it’s also creeping into more transactions. Not only are the requests for one ubiquitous, but they are also for less service and at a higher rate.
For example, I was at the airport and bought some bottled water. The same thing happened. There was intense pressure to tip this person, but they hadn’t done anything. It was like being charged extra for buying water that I picked up and carried to the counter myself.
From my perspective, this example is another additional fee component. Labor costs are part of running a business. Instead of charging more for the water and covering their rising labor costs, they expect us to tip their underpaid employees to increase their compensation. It’s another form of Two-Part Pricing.
Plus, for those who don’t know, through a tricky loop in the labor laws, most servers and wait staff don’t make minimum wage; it’s around $2 an hour. The expectation is patrons will enhance their compensation with tips. This expectation creates pressure on customers to tip. At some point, we will hit a breaking point. My breaking point might be the 22 percent mark…
The primary difference between tipping and other additional fees is that tipping is optional. The other fees are not. They are part of your bill.
However, when that screen swings around without a “no tip” choice, does it feel optional?
Are Additional Fees Transparency in Action?
One could argue that additional fees are an example of transparency. When the extra fees are listed before the total, customers can see what makes up the overall cost of the transaction.
In the early days of Beyond Philosophy, our consultancy agreement used to break down every single element of our service with a corresponding price. It was a form of transparency for us, and it showed them how we were working for the client. However, we discovered that the downside of listing these fees was the inevitable negotiations they inspired, especially once the client had a competitive bid.
It led to some tricky conversations about us defending our consultancy fees. We spent a lot of time explaining what was happening “behind” that fee and why we needed to charge it.
Therefore, it is transparent to list the additional fees but don’t be surprised if you experience some pushback on them.
So, What Should Williams Do?
I have a couple of suggestions for Williams and his colleague regarding raising prices.
First, Williams should look at pricing from the customers’ perspective. For example, he should have a good idea of what his customers use for a consideration set. If the competition charges $80, plus $20 in fees, they could charge $100 upfront. However, they might lose business because of how customers evaluate baseline prices plus fees versus all-inclusive prices. Their price will seem more expensive, even though it isn’t.
Second, Williams should also consider what’s happening in the industry. If everyone else is taking the additional fees approach, Williams and the company should, too. If it’s unclear what’s happening industry-wide, firms will have more flexibility. Remember, of course, that having a lower baseline price is more palatable in the short term, but there isn’t much research exploring what the baseline price plus the additional fees does to the evaluation of the experience in the long term.
For my part, I don’t like it when it happens to me, and my gut tells me that it will deliver a poor experience in the long run. So, if it were me, I would test the effects of additional fees on my revenue and the experience we deliver. Not charging additional fees and raising prices instead could be the competitive differentiator we could be loud about in our messaging.
So, if you keep the price low and add additional fees, watch what happens in your return business. It’s essential to balance that need to generate more revenue without alienating your customers.
What do you think is better, raising prices or keeping them the same and adding additional fees? I’d love to hear your opinion in the comments below.
Colin has conducted numerous educational workshops to inspire and motivate your team. He prides himself on making this fun, humorous, and practical. Speak to Colin and find out more. Click here!
