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Containing the Anger over Customer Fees

When assessing penalty charges, companies must be fair, flexible, and transparent.

(originally published by Booz & Company)

Title: Getting the Right Payoff from Customer Penalty Fees (fee or subscription required)

Authors: Stephen S. Tax (Peter B. Gustavson School of Business), Young “Sally” Kim (Shenandoah University), and Sudhir Nair (Peter B. Gustavson School of Business) 

Publisher: Business Horizons, vol. 56, no. 3

Date Published: May–June 2013

How can companies use penalty fees to stay in the black without causing their customers to see red?

That’s what many firms are asking themselves as they impose more and more charges, and confront more and more irate consumers, over missed payments, late cancellations, no-shows, tardy returns, and overdrawn bank accounts. The short answer is that so long as companies see fees as a revenue generator, they will always lose some angry customers. But, according to this paper, firms can limit the damage if they build into their penalty program a dollop of forgiveness, a lot of transparency, and a host of other features that foster flexibility and fairness. With such safeguards in place, the authors of this paper say, penalties can continue to be a powerful source of revenue without driving too many customers away.

Corporate America’s love affair with penalties and fees has been out in the open for some time, and the charges are now an important contributor to the bottom line at many firms. For example, penalties for late payments and overage fees in the credit card industry almost tripled from 1997 to 2007, amounting to about 10 percent of profits during that time. In 2009 alone, airlines in the U.S. reaped about US$2.4 billion (or roughly 3 percent of their overall revenue) from fees assessed for changing or canceling flights. Golf courses, hospitals, hotels, and restaurants now routinely impose no-show fees, and some retailers charge customers a restocking penalty when they return merchandise.

But seeking such revenue breeds resentment and risks fraying or even cutting the bonds with longtime customers. Given that the penalty fees aren’t going away, how can companies reduce those risks? The authors looked to customers for an answer. They first identified which aspects of the penalty process result in consumers’ dissatisfaction and then drew up guidelines for companies to balance the goals of revenue creation and customer loyalty.

The authors surveyed more than 200 consumers who had been charged a penalty in the previous six months. The penalties were imposed in a wide range of industries, most levied by bank and credit card companies, airlines and hotels, telephone companies, retailers, and healthcare providers. Participants were randomly selected from a huge online consumer database, Zoomerang, to ensure a representative sample of age and gender. The participants answered open-ended questions, including whether they found the charge to be fair and how the experience affected their feelings for the company and their subsequent shopping behavior.

The reaction of the surveyed consumers, 84 percent of whom said they had a positive outlook toward the company before being assessed, was strong. Nearly three-fourths reported being angry or upset at receiving the penalty; 22 percent said they had stopped doing business with the company and 18 percent had “bad-mouthed” the firm.

The negative reaction largely stemmed from a sense of unfairness: 64 percent of participants said they thought the charge was not warranted. Almost half of these customers said they were unaware that they would be charged a penalty - in some cases, because the firm’s policy had changed or was buried in fine print. Those who felt they had little control over the process were noticeably angrier, especially if they incurred the charge because of a personal hardship (such as a family emergency that necessitated a last-minute cancellation).

The magnitude of the penalty also mattered: 74 percent of the respondents said they considered the fee to be too high, particularly when their actions caused no loss of income to the company. As one of those surveyed noted: “I made a mistake and missed paying the full amount of my credit card balance by $1.00 and ended up having to pay interest on the entire $2,317 statement.” When these “near misses” occurred, most respondents expected the company to be more flexible.

The experience of contesting the charge also played a large part in determining customers’ attitudes. In 27 percent of the cases, the company either wiped out or reduced the fee, usually as a one-time courtesy. The refusal by the rest of the companies to make adjustments went over particularly badly with those who had cited family, medical, or other emergencies as the cause of the problem.

“Our research indicates that the design and application of penalties is central to perceptions of fairness and that can dramatically influence the likelihood that customers will continue with the firm and not engage in damaging word of mouth,” the authors write.

To that end, the authors advise companies to adopt the following safeguards to make the penalties less onerous to consumers, and thus less damaging to themselves.

• Help customers avoid incurring a penalty unintentionally. Simple awareness of a potential charge plays a large role in whether customers believe the fee is fair. Reports have indicated that only about 8 percent of financial institutions that charged overdraft fees informed customers that they had insufficient funds to complete a transaction. The lack of notice “may lead to short term revenue gains,” the authors write, but “not being more diligent in keeping customers informed of impending penalties leaves the impression that firms prefer customers [to] fail and wish to capitalize on that happening.

• Manage the magnitude of penalties. The authors cite the Telus Corporation, a Canadian mobile phone carrier, which has tried to enhance its reputation for fairness by making its termination policy and limits on data usage less costly and more transparent to customers.

Educate customers on the offer and ensure that penalties are clear. American Airlines now offers a “boarding and flexibility” package designed to alleviate any future fees. Explaining to customers how their actions affect the firm’s costs could also be beneficial; those surveyed said they were more likely to accept larger fines if they understood the impact their behavior had on the business.

Take responsibility for some penalties. Because the analysis showed that customers grew more upset when they believed the cause of the assessed fee was not their fault, it’s important that fines be waived or reduced when the company itself, its partners, or unpredictable circumstances are to blame.

• Consider giving customers a break when they narrowly miss avoiding a penalty. With close calls, firms should consider reversing the charge, especially if it’s the first occurrence. In a slightly different context, the authors note, General Electric has adopted a policy of “unofficially” extending its warranties by a month, because the firm noted that customers were most angry when their product failed shortly after the warranty expired.

• Be flexible: Take into account the customer relationship and empower frontline employees. Flexibility is especially important with regard to high-value or long-standing customers. Research has indicated that the top 20 percent of customers account for as much as 80 percent of a firm’s profit, and companies can curry favor by granting loyal customers some latitude regarding penalties. Frontline staff need to be given the freedom to make quick decisions about reducing or removing fees, assisted by training and access to databases of customers’ shopping history.

Bottom Line:
As companies try to balance the twin goals of generating profits and nurturing relationships with consumers, the growing use of penalties represents a tricky challenge. By being fair, transparent, and flexible, companies can reduce the risks of alienating customers while still using fees to bolster the bottom line.


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