MarketView

Flat Pricing Paradox
Lowering Prices Can Increase Monthly Pass Profits

Customers who pay more for all-you-can-eat buffets feel compelled to take more food in order to get their money’s worth, even if they are not hungry. In other words, the higher flat price resulted in higher consumption.

Cut the price of a product or service, and you’re likely to increase volume. Everyone knows that – everyone also knows that this jump in sales doesn’t come without a cost. Just as it drives up volume, lowering prices is sure to drag down profits. But in the case of flat priced items like all-you-can-eat buffets and monthly passes sold with the SiteWatch® Automatic Recharge Module®, “everyone” may well be mistaken!

At least that’s the informed opinion of Cornell University professor Dr. Brian Wansink. To prove his theory, Wansink and his associates journeyed to the all-you-can-eat buffet at a popular pizza eatery for a three-day research project. With the cooperation of restaurant management, Wansink greeted customers before they sat down to the buffet and asked them to take a “market survey.” He divided these customers into two groups. The first group received a free beverage for completing the survey, while the second was given a 50% discount on the buffet itself.

Interestingly, the group that received the buffet discount took 27.9% less pizza from the buffet than their counterparts who paid full price. Wansink and his team also carefully measured the uneaten food that was left on the plates of the customers who participated in their study. They found that the customers who paid full price left roughly twice as much uneaten pizza on their plates as discount customers. This indicated that the people in the full-price group didn’t necessarily eat more pizza than the 50% off customers, but they took more slices off the buffet table even when they were no longer hungry.

Perception Is Reality When It Comes To Consumption

Why the big difference in the behavior of these consumers? For Wansink and the other Cornell researchers, the conclusion was unmistakable: customers who paid more for the buffet felt compelled to take more pizza in order to get their money’s worth. In other words, the higher flat price resulted in higher consumption.

University of Chicago behavioral economist Richard Thaler illustrated this principle rather humorously by recounting the story of a man who spent $300 to join a tennis club and then developed tennis elbow a week later. The man continued to play anyway even though he was in considerable pain. When asked why, he responded that he wanted to get his $300 worth of playing time out of his club membership.

According to Harvard Business School researcher, John Gourville, consumption is driven not by the actual cost of a good or service, but by the perceived cost.

Gourville maintains that consumers make an emotional investment in using a product or service based on what the perceived cost feels like to them. The higher consumers view the cost to be, the more determined they become to get their money’s worth out of their purchase by using it more. At an all-you-can-eat pizza buffet, this means loading your plate with extra slices of pepperoni pie; for pass customers at a health club or carwash, it can take the form of visiting an extra two or three times a month.

Customers who pay less for monthly pass programs tend to visit less, and are less likely to drop out of the program. SiteWatch's Automatic Recharge Module® helps you manage to this behavior.

Do Customers Who Pay Less Visit Less?

Applying this principle to your carwash’s monthly pass program, it’s reasonable to ask what the impact of offering a lower priced option would be on your overall volume and profits. Would a less costly pass option attract more customers? Since these customers paid a lower price, would they then be less prone to excessive pass usage?

No two carwashes are alike, so the ultimate answers to these questions will depend on your particular situation, but if research from some of the nation’s leading business schools is any indication, lower pass prices are likely to curb overuse and protect your profits. If this is the case, you would be able to make a reasonable profit with a lower priced monthly pass plan, even though you’d be charging customers less. At the same time, you could reasonably expect the lower pass price to attract more customers to your monthly program, giving you the best of both worlds.

More Stickiness

Apparently, customers who pay less for a pass are also less likely to drop out of a program. A study of 7,978 health club members conducted by Stefano DellaVigna and Ulrike Malmendier of Harvard Business School found that members who paid for a lower priced monthly pass were 18% more likely to remain in the club beyond one year, than those who paid more for an annual pass.

According to DellaVigna and Malmendier, monthly pass holders are slow to drop out of their health club programs. In their study, the average monthly pass holder remained enrolled in the health club for 3.07 months after he or she stopped visiting the club completely. (The average length of health club membership in their study was 27 months.)

When determining the price of their monthly passes, carwash owners would do well to consider what Harvard’s Gourville calls the consumer’s tendency to “over value the status quo.” According to this theory, customers who are drawn to a monthly pass program by an attractive price are likely to remain in it, even if they don’t visit a carwash very often, because of the natural tendency almost all of us have to want to preserve the status quo.

Gourville conducted an interesting experiment to illustrate this point. Acting like he was doing a marketing study, he invited student volunteers to participate in his research. He divided the students into two groups. Students in the first group were given their choice of taking either a coffee mug or a large chocolate bar as their thank you gift for participating in the study. About half of these students chose the coffee mug and half selected the chocolate bar, indicating that the two gifts were equally popular.

Students in Gourville’s second group had no choice of which gift to receive; and instead were randomly given either a coffee mug or chocolate bar. After completing the volunteer study, students in the second group were asked if they wanted to trade either their coffee mugs for chocolate bars, or their chocolate bars for coffee mugs.

Since coffee mugs and chocolate bars were equally popular with students in the first group, it would be logical to assume that a large number of students in the second group (who were randomly assigned gifts) would have taken Gourville up on his offer to trade. Surprisingly, only 10% of these students agreed to swap the gift they had been given for a new one.

Why had so many students in the second group refused to trade the gifts that had been randomly assigned to them? Gourville theorized that these students placed a greater value on the coffee mugs or chocolate bars after these items had been given to them because, by that time, these gifts had become part of their status quo.

According to this theory, a customer who already has a monthly pass will view it as part of his or her status quo, and will therefore place a greater value on it. This should make that customer less likely to drop out of a program, even if his or her visits to a carwash decline.

Flat Rate Bias

There are a number of good reasons beyond Gourville’s status quo theory as to why customers tend to value monthly passes. Belonging to a pass program simplifies buying decisions, makes budget planning more secure and predictable, and saves time over paying for each transaction separately. Click here to learn how SiteWatch FastPass® can help you offer monthly pass customers speedier service.

Researchers Fabian Herweg of the University of Bonn and Konrad Mierendorff of the University of Zurich refer to this phenomenon as “flat rate bias,” and argue that consumers are will to pay a “flat rate premium” for the emotional and time-saving benefits of being on a monthly program. They point to the “taxi meter effect,” which describes how passengers paying a flat rate for taxi service enjoy the ride more because they don’t have to watch the meter ratchet up during their entire journey.

About 10 years ago, AT&T labs ran a study which found that consumers preferred to pay flat rates for telephone service, even though metered rates were cheaper. A key reason given by consumers for this seemingly paradoxical behavior is that they wanted to avoid the “mental transaction cost” of having to monitor telephone usage.

According to AT&T Wireless, about 66% of iPhone subscribers use less than 0.2 gigabytes a month and 98% use less that 2.0 gigabytes monthly. Yet, by being on a flat rate plan, consumers in the first group are spending about twice as much as they would with measured service and those in the second group are spending 20% more, despite their relatively heavy usage.

Harvard’s DellaVigna and Malmendier found similar results in their health club research. Roughly eight out of ten of the club members they studied would have spent less money if they paid for each visit separately rather than paying monthly dues.

However, it seems that for the majority of consumers, the benefits of being on a flat rate monthly pass program far outweigh the added costs associated with this option. In light of this, you would appear to have room to expand your monthly pass program by lowering its price to attract more customers. Since these newcomers are likely to visit your carwash less often than those customers paying for your higher priced passes, you may well find yourself in the unusual position of being able to cut prices without cutting into profits.