Q. My competitors have started to advertise very low prices. Customers are attracted to the low prices, but then my competitors hit them with lots of additional charges on the back end. What’s going on?
A. You didn’t give us much detail on your business, but we suspect you are experiencing price splitting. Prospective purchasers often make the buying decision based on a published price, but then the seller finds a multitude of opportunities to increase the cost of what the customer is purchasing. For example, retail outlets often advertise one product at a very low price, in hopes that customers will purchase many other products when they visit to buy the lost leader. Electronics stores advertise low prices, but then push extended warranties, which are very profitable for the store and expensive for the customer. Construction companies will submit low bids, but then charge high rates for change orders. When sellers use a low published price to close a sale and then try to make profit on subsequent transactions, we call this price splitting.
Consider a business trip we recently took to Colorado Springs. We went online to book flights. We conducted a search for the appropriate dates and times. When the results came back, we clicked on the least expensive option. It was a USAir flight. Within the next few minutes, we began to witness a seemingly endless array of offerings, which served to increase the price of the flight.
When we clicked on the icon to select a seat, we discovered that sitting in the exit row or near the front of coach class, carried an additional tariff. If we wanted to check luggage, it would cost $25 per bag. The site automatically presented us with deals on rental cars and hotel rooms. At the airport, the check-in kiosk offered us the opportunity to upgrade to first class for $175 each. For an additional fee, we could board the plane ahead of our fellow passengers.
Once onboard, the barrage continued. Snacks and alcoholic drinks had to be purchased. The days of a free bag of peanuts were apparently long gone. In-flight shopping was encouraged in the Sky Mall magazine. Wi-Fi was available! When we connected, we discovered more items for sale on the landing page. However, if we wanted access to the internet, it would cost $12.50. Finally, we were offered the opportunity to apply for a USAir credit card.
We’re old enough to remember when most of these services were free and the others didn’t exist—what happened? What happened is that airlines have gained a better understanding of how people purchase airline tickets. Like us, many passengers decide which flight to take based on price. Price shopping used to require calling multiple airlines. The internet changed all that. Now, passengers can price shop with just a few clicks and many sites show possible flights from the least expensive to the most expensive. There is tremendous value to being able to publish a low fare. However, if airlines are going to lower the price of published fares, they’ve got to make up the revenue somewhere or face bankruptcy, hence all of the upsells.
There are many examples of price splitting. Consider the credit card industry. Price sensitive credit card customers will typically make the buying decision based on the amount of the membership fee and/or the interest rate, if they plan to revolve a balance.
However, there are other charges such as over limit fees, foreign exchange charges, or late fees. Most often, people don’t factor these fees into their decision-making about which cards to accept and use. Therefore, these fees can be outrageously high. Fees for being $1 over limit or one day late with a payment might be as high as $39. Yet, many will occasionally be a day or two late with a payment or go just a little bit over limit. Credit card companies make a lot of money on the charges that people don’t figure into the buying decision.
Price splitting makes sense when there is a large segment of the market that makes the buying decision based on price, but that doesn’t factor back end charges into the decision.