Magazine Fall 2010 Research Feature

When Should You Nickel-and-Dime Your Customers?

Every manager who’s ever set a price has had to wrestle with whether to “partition” the elements — charge separately for such things as shipping, installation or warranties — or to bundle everything into one price. Here’s how to decide.

Rebecca W. Hamilton, Joydeep Srivastava and Ajay Thomas Abraham Reading Time: 23 min 

Topics

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Image courtesy of Sean M. Brown

If you’ve spent time at an airport recently, you’re likely to have overheard a conversation between a surprised non-frequent flyer and a ticket agent about fees for checked luggage. That exchange may have been a loud one if the airline was charging $25 (or more) per bag. Although charging separately for luggage allows airlines to advertise lower ticket prices, potentially increasing sales, incorporating baggage fees into the ticket price might increase the satisfaction of customers en route as well as raise the retention rate of check-in counter agents. And therein lies the rub.

When should a company “nickel-and-dime” customers by charging separately for various extras, and when is it better to keep things simple by combining all of the charges into one total price?

Before answering, consider another example: The price of wall-to-wall carpeting may or may not include the cost of installation or delivery to the customer’s home. Given that most customers neither own a vehicle large enough to transport a living-room–sized piece of carpeting nor have any desire to rent one, delivery is, for all intents and purposes, a required component of the purchase. If nearly all customers will be buying both carpeting and delivery, should the price of the carpeting include delivery or should the company charge for it separately?

The Leading Question

When should companies bundle charges, and when should they list them separately?

Findings
  • One size does not fit all. How you answer the question depends on many factors, including industry norms.
  • If you don’t follow industry norms, you will be at a disadvantage when people quickly comparison shop.
  • But moving away from the pack — for instance not charging passengers to check bags — could give you a competitive advantage.

On the one hand, assigning a separate dollar value to the delivery component would decrease the price per square foot that the company charges for their carpeting, making its prices appear more competitive when customers comparison shop. Charging separately for delivery also might increase the perceived value of the delivery service to customers and discourage absenteeism when the delivery truck is scheduled to arrive.

Topics

About the Authors

Rebecca W. Hamilton is an associate professor of marketing, Joydeep Srivastava is a professor of marketing and Ajay Thomas Abraham is a PhD student in marketing, all at the Robert H. Smith School of Business at the University of Maryland.

References

1. V.G. Morwitz, E.A. Greenleaf and E.J. Johnson, “Divide and Prosper: Consumers’ Reactions to Partitioned Prices,” Journal of Marketing Research 35, no. 4 (1998): 453-63.

2. A. Daripa and S. Kapur, “Pricing on the Internet,” Oxford Review of Economic Policy 17, no. 2 (2001): 202-216.

3. B. Burman and A. Biswas, “Partitioned Pricing: Can We Always Divide and Prosper?” Journal of Retailing 83, no. 4 (December 2007): 423-436; Morwitz, “Divide and Prosper”; and L. Xia and K.B. Monroe, “Price Partitioning on the Internet,” Journal of Interactive Marketing 18, no. 4 (2004): 63-73.

4. Xia, “Price Partitioning on the Internet.”

5. R.M. Schindler, M. Morrin and N.N. Bechwati, “Shipping Charges and Shipping-Charge Skepticism,” Journal of Interactive Marketing 19, no. 1 (2005): 41-53.

6. M.D. Smith and E. Brynjolfsson, “Consumer Decision Making at an Internet Shopbot: Brand Still Matters,” Journal of Industrial Economics 49, no. 4 (2001): 541-58.

7. D. Chakravarti, R. Krish, P. Paul and J. Srivastava, “Partitioned Presentation of Multicomponent Bundle Prices: Evaluation, Choice and Underlying Processing Effects,” Journal of Consumer Psychology 12, no. 3 (2002): 215-29.

8. D. Prelec and G. Loewenstein, “The Red and the Black: Mental Accounting of Savings and Debt,” Marketing Science 17, no. 1 (1998): 4-28.

9. D. Kahneman, J.L. Knetsch and R. Thaler, “Fairness as a Constraint on Profit Seeking: Entitlements in the Market,” American Economic Review 76, no. 4 (September 1986): 728-741.

10. R.W. Hamilton and J. Srivastava, “When 2+2 Is Not the Same As 1+3: Variations in Price Sensitivity Across Components of Partitioned Prices,” Journal of Marketing Research 45, no. 4 (2008): 450-461.

11. C. Homburg, W.D. Hoyer and N. Koschate, “Customers’ Reactions to Price Increases: Do Customer Satisfaction and Perceived Motive Fairness Matter?” Journal of the Academy of Marketing Science 33, no. 1 (winter 2005): 36-49.

12. Morwitz, “Divide and Prosper.”

13. Schindler, “Shipping Charges and Shipping-Charge Skepticism”; and Y.H. Lee and C.Y. Han, “Partitioned Pricing in Advertising: Effects on Brand and Retailer Attitudes,” Marketing Letters 13, no. 1 (2002): 27-40.

14. G.E. Smith and T.T Nagle, “Frames of Reference and Buyers’ Perception of Price and Value,” California Management Review 38, no. 1 (fall 1995): 98-116.

15. Daripa, “Pricing on the Internet.”

16. Morwitz, “Divide and Prosper”; and Daripa, “Pricing on the Internet.”

17. Morwitz, “Divide and Prosper”; and J.M. Clark and S.G. Ward, “Consumer Behavior in Online Auctions: An Examination of Partitioned Prices on eBay,” Journal of Marketing Theory & Practice 16, no. 1 (2008): 57-66.

18. Clark, “Consumer Behavior in Online Auctions.”

19. Morwitz, “Divide and Prosper”; and Lee, “Partitioned Pricing in Advertising.”

20. S. Sheng, Y. Bao and Y. Pan, “Partitioning or Bundling? Perceived Fairness of the Surcharge Makes a Difference,” Psychology & Marketing 24, no. 12 (2007): 1025-1041; and Xia, “Price Partitioning on the Internet.”

21. Sheng, “Partitioning or Bundling?”

22. Schindler, “Shipping Charges and Shipping-Charge Skepticism.”

23. Smith, “Consumer Decision Making at an Internet Shopbot.”

24. M. Lewis, V. Singh and S. Fay, “An Empirical Study of the Impact of Nonlinear Shipping and Handling Fees on Purchase Incidence and Expenditure Decisions,” Marketing Science 25, no. 1 (2006): 51-64.

25. Hamilton, “When 2+2 Is Not the Same as 1+3.”

26. Ibid.

27. Ibid.

28. Chakravarti, “Partitioned Presentation of Multicomponent Bundle Prices.”

29. Sheng, “Partitioning or Bundling?”

30. Hamilton, “When 2+2 Is Not the Same as 1+3”; and Chakravarti, “Partitioned Presentation of Multicomponent Bundle Prices.”

31. Chakravarti, “Partitioned Presentation of Multicomponent Bundle Prices.”

32. C.E. Mayer, “Add-Ons Add Up,” Washington Post, November 17, 2002.

33. Hamilton, “When 2+2 Is Not the Same as 1+3.”

34. E.M. Okada, “Trade-Ins, Mental Accounting and Product Replacement Decisions,” Journal of Consumer Research 27, no. 4 (March 2001): 433-446; and J. Srivastava and D. Chakravarti, “Price Presentation Effects in Purchases Involving Trade-Ins,” working paper, University of Maryland, 2009.

35. Hamilton and Srivastava, “When 2+2 Is Not the Same as 1+3.”

36. Ibid.

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Comments (4)
almcfarland
It’s in a company's best interests to serve those who want flat fee and those who want variable pricing simultaneously.  Don't want to make the choice for consumers. http://bit.ly/fJ9CvV

(Interestingly... MIT's blog is headed toward a model where "customers" must buy.  Switching costs to HBR or Wharton (for example) are low so this makes little sense.)
Charvak Karpe
Excellent article that articulates the tradeoffs between bundled and itemized pricing!  A few comments:

I think consumers assume that pricing of components is related to the costs of those components, which suggests that the price sensitivity differences highlighted in the article are completely rational.  A higher-cost warranty implies a product is unreliable.  A $74.95 product must be superior to a $49.95 product that costs $25 to ship and handle.

Also, I would like to see further research on how separating S&H costs causes customers to put off purchases so that they can combine multiple items.  Do customers buy more items overall when they can buy them one at a time without feeling like they're wasting money on shipping.

Another topic only lightly covered in the article is the perceived "fairness" of partitioned prices.  DigiKey.com charges shipping fees that are unknown at the time of the order, but are charged later based on the true price paid to the shipping courier.  This "fair" price appeals to customers.  At the other extreme, Vonage charges an "Intellectual Property protection fee" which is perceived as unfair because it is not a direct tax or fee paid by Vonage.

Finally, readers of this magazine understand that there is general economic value to offering greater pricing flexibility.  Raising shovel prices after a snowstorm ensures that those who need shovels most get them, rather than customers who were lucky enough to get to the store first.  Separate baggage fees prevent travelers from carrying more stuff than they really need.  I believe good business strategy involves identifying this economic benefit and figuring out what customer messaging, through marketing and pricing strategies, achieves the win-win situation of operating at the economic optimum.
Babar Bhatti
Very interesting. We sell a software-as-a-service product for a flat price. Our competitors use partition pricing. Our strategy has worked quite well.

- Babar
A. Oyenuga
I think sellers willing to quote some other costs separately, such as delivery costs, should be ready to entertain requests from buyers to do the delivery themselves. If buyer can transport, for example, the carpet bought at a great savings from, say, the $100 charge, the seller must then be ready to part with the goods at the shop premises.