74-Pricing Taken Too Far

15 years ago, the imposition of ancillary fees on top of the base product price seemed an easy way to improve margins without jeopardizing the customer relationship. In the intervening years, ancillary fees have exploded and customers have become much more sensitive and distrustful of companies imposing them. Still, there are clear examples where customers will accept the fees even though they do not like them.

Posted 1/22/09

In the early 1990s, I was involved with a company that faced a very competitive price environment. The company felt it could not increase the prices on its standard product. Instead, it raised its prices on the ancillary services it offered to all customers, though not all customers used these services. The company felt, at the time, that it could continue to raise these prices until the market took note and complained bitterly, or until its prices notably exceeded those of its competitors.

We now may have an instance, several years later, where that approach to pricing has begun to wear out its welcome. A recent article on cruise ship travel took two newspaper pages to help readers avoid the ancillary price increases on cruises.

The article noted that the advertised price for a particular cruise was an attractive $699. However, many customers of this cruise line end up paying over $1200 for that same cruise because of these ancillary fees. (See the Perspective, “Is Your Industry Ripe for Hostility?” on StrategyStreet.com.) These fees include port fees, trip insurance, airport transfers, automatic gratuities, internet access and others. The typical customer uses most, if not all, of these extra services and ends up paying a price for the cruise 70% over the advertised cruise price.

This is a good example of pricing going too far. If the cruise industry keeps this up, no one will believe their advertised prices. Nor should they. Those advertised prices bear little relationship to the real price the customer will pay for taking the cruise.

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Update 2022: 

The practice of hiding fees continues where industry competitors are united in the practice and where industry leaders think they can get away with this pricing approach.  In 2022, advertised airline prices do not include various taxes and fees that increase the price of the ticket.  In addition, airline mileage programs vary significantly in value from one to another.  Apparently, flyers pay little attention to these differences.  The cruise line industry certainly continues the practice of charging hidden fees and by offering extra services during the cruise at relatively high prices.  VRBO, Airbnb and other vacation rental sites quote per night rentals that are significantly less than the full per night costs the customer will incur.  The customer doesn’t see these full costs until ready to check out.

Because virtually all airlines copied them, ancillary fees have been successful in the airline industry.  These ancillary fees cover services like checking a bag, providing extra legroom or changing a reservation.  In the early 2010s, these fees kept the entire industry in the black. More than half of the flying public dislike these fees, but the industry gives them little in the way of alternatives.   In addition, a large portion of airline ancillary fees comes from the sale of frequent flyer miles to their marketing partners.  In 2019, the 5 largest US airlines gained about $29 billion in ancillary fee revenue. 

Every price has at least three, and usually four, components: the Benefit Package, the List Price, the Basis of Charge and, often, Optional Components of Price. The airlines are using optional components of price to raise prices. These optional components have succeeded because all the competitors in the industry copied them. The customers had no alternative. The company may use these four price components to further contain the spread of its new pricing to customers within its target segments.  See HERE for more detail. HERE is a more comprehensive article on pricing when prices tend to fall. You can use our many price change concepts and examples to brainstorm improvements for your own company.

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Update 2/26

Ancillary fees have exploded in use over the last several years. They have become especially prevalent in B2C markets, though they have also emerged in B2B markets as well. We have enough experience with these fees to be able to predict when they will succeed and when they will fail. As a warning, they always risk damaging the relationship of trust (Reliability) with the customer.

The B2C market is rife with the emergence of ancillary fees. Hotels have instituted resort fees, cleaning fees, Wi-Fi and gym fees. Airlines started the boom with checked baggage fees, seat selection and early boarding fees. Subscription services offered tiered access and add-on feature fees. Car rental firms charge for young drivers, extra insurance, GPS devices, and tolling fees. Telecom and cable companies charge activation fees and regulatory recovery fees. Event ticketing firms charge service fees and convenience fees. Ridesharing firms and delivery apps charge service fees and small order fees and sometimes use dynamic pricing. In total, these fees often add 15% to 30% to the base cost of the product.

Usually, customers do not like any of these fees, but they will accept them in some specific cases:

               – the base product, without fees, remains usable

               – the base product price is low, with fees added later

               – the added fee is for services deemed by the customer as optional

               – the convenience level for the product the fee and service is high

               – the alternatives to the base product or the switching costs away from the base product are                         high

If the ancillary fees fulfill most of these conditions, they have a high likelihood of passing muster with customers.

On the other hand, there are conditions where customers see these ancillary fees as arbitrary and unfair and a breach of their trust of the supplier (Reliability failure):

               – fees are mandatory not optional

               – the fees appear late in the process, especially at check out

               – the fees are not tied to a specific valuable benefit

               – the fees are introduced suddenly

               – there are multiple fees causing customer confusion, uncertainty and the feeling that they are                     being bled by a thousand cuts

These cases always result in customer disappointment, and sometimes the abandonment of the purchase.

Ancillary fees have also emerged in the B2B market, though usually in the reverse. The customer charges the supplier the fee. Usually, these fees come about as a large customer company takes advantage of smaller suppliers. There are three common types of these fees:       

               – hidden fees in the form of greatly extended payment terms, up to 120 days

              – fees for the supplier to use customer’s vendor portal, which suppliers see as having to pay to                      get paid

                -various fees to cover some of the customers’ administrative costs

Most suppliers deeply resent these kinds of fees. However, they will accept them in these situations:

               – the ancillary fees are offset by more stable or larger purchase volumes

               – the fees are negotiated explicitly

                – the fees are tied to specific requests to the customers, for example, ESG audit fees

               – fees operate symmetrically, adjusting up or down with the specific situation, for example                           high fuel cost fees

                – the fees are indexed to common and transparent benchmarks

There have also emerged several key warnings to let the company imposing fees know that a customer rebellion growing:

               – product purchase abandonment at check out grows

               – social media commentary turns negative

               – fees begin receiving specific government attention and regulation

               – competitors advertise and begin gaining share on the basis of product prices that have “no                         hidden fees” or “no surprises.”

Most customers today have become much more sensitive to these ancillary fees. Many markets have, without question, carried them too far.

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