After puzzling over why people are overly sensitive to service fees, I read this good article by New York Times columnist Ron Lieber 5 Ways to Think About Nuisance Fees. Ron posits that people judge service fees by a fairness score so-to-speak. Factors feeding into the fairness score include:
- the size of the fee compared to the cost of service
- whether the consumer already dislikes the service provider
- how the service provider justifies the fee
- the value of the service
This points me to find answers to why people seem to be irrationally sensitive to service price increases from behavioral economics. I came up with a new theory.
If consumers can get away with it, they want the service to be free, regardless how much it costs. Some will pay voluntarily, but most won’t. When they must pay, consumers want a bundled price for services considered as the core package. If there is an additional fee for some add-on not terribly crucial to the core, it’s usually not a problem. The tricky part of course is what’s considered as core. Different people will have a different view. Those views also change over time.
What happens when a service previously included in the core package now moves out of the core? People complain, because now they have to pay twice instead of one bundled price. Behavioral economics says people associate paying with a pain. Paying $5 twice inflicts more pain than paying $10 once.
Debit card usage fee falls into this category. The price of a free, no-interest checking account is the foregone interest. It was actually much higher when savings accounts paid 5% than it is now. If you kept $2,000 average balance in a checking account, you were paying $100 a year for checking services a few years ago. Now you are paying only $20. The price came down dramatically but people don’t realize it. When they hear a core service (debit card) is coming out of the bundle as an itemized charge, they protest.
Airline baggage fee is another example. I disagree with Ron Lieber’s argument that the baggage fee is unjustified. Just because airlines are not weighing passengers and their carry-ons does not mean charging for bags isn’t fair. It’s a better alignment between the price paid and the cost to provide a service than not charging for bags at all. Compared with shipping the bags by UPS or FedEx, the baggage fee charged by the airlines is a bargain.
Consumers hate the baggage fee because the service was previously included in the core package but now it moved out of the core. Checkin bags had never been really free — they were just bundled into the ticket price. People don’t have a problem with $50 higher fare when fares change all the time but they complain about baggage fees.
In both these cases, it has nothing to do with whether the fee is hidden. Consumers know about these fees. They still don’t like them.
Bank wire transfer fee doesn’t get much protest because it’s never part of the core checking account service. If you want a wire transfer, you pay the fee, even though banks charge up to $30 for a wire when Federal Reserve charges the banks only 30 cents.
What happens when a service previously considered as an add-on is now demanded as part of the core? People complain. Internet connection in hotel rooms is an example of this.
Internet access from hotel rooms used to be an extra charge. Now most lower-end hotels include WiFi as part of the room rate. Remember WiFi isn’t free. It’s just bundled. Some higher-end hotels still charge for WiFi separately. Consumers complain even though they don’t mind paying if it’s just bundled into a higher room rate. They complain because it’s now expected as part of the core package. The separate charge for Internet connection has become a "nuisance fee" even though it clearly provides value.
Lessons for consumers? Don’t get too hung up on whether the fee is bundled or not. Consider the total price you are paying. In general it’s better to have unbundled prices because you won’t pay for services you don’t use.
Lessons for businesses? Bundle the items most people use into one price and call those services free. People like to hear the word "free." The take rate will be higher when you ask consumers to make just one purchase decision instead of two or many.
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