"Our Take" - Profits Through Penalties

(Past Editions by: Date, Title, Topic)

 
About "Our Take" 
"Our Take" is a collection of daily vignettes covering a wide range of CRM topics. It's an attempt to add our own spin to the world of CRM. We will use the column to share our perspectives, opinions, epiphanies, web nuggets, or quite frankly anything that moves us. Get ready to expect the unexpected. And, don't be shy about sharing your thoughts.
 
 
5/17/06 - Profits Through Penalties
It might just be my pet peeve that I need to work through but penalty-driven business models drive me crazy. What do I mean by penalty-driven business models? Let me give you a few example - overdraft fees at the bank, overage charges for cell phone use, and late fees at the movie rental store.
 
In many businesses, the majority of profits are derived from the penalties rather than the core business. It seems that many businesses discount the value of their core products and services to appear more competitive when marketing to new customers. However, once snared, these customers find that the "extras" completely change the value proposition and quickly become disgruntled because the reality doesn’t match what was marketed to them.
 
We've already seen the impact of new business models like Netflix and their ability to make Blockbuster abandon the late-fee cash cow. When will other business like banks and cell phone companies realize they create more hatred than loyalty with these penalty-driven programs? I imagine those changes will occur when competitive alternatives discovers new ways to respect the customer.
 
Gary Lemke, Publisher
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5/18/06 - Profits Through Penalties - Part II
Yesterday I shared my feelings about the harsh penalties some companies institute as a way to bolster profits. I cited a few industries including banking, cellular networks, and movie rentals. Readers chimed in with the same concerns regarding credit card companies.
 
These penalties do more to create defection than loyalty and business that derive extraordinary profit from these penalties are at risk of competitive moves that can change whole business models. For example, Netflix is a great example of a reaction to late fees and Blockbuster’s response is viewed as reactionary.
 
One reader responded with a warning to banks suggesting they be wary of WalMart's interest in establishing banks in the stores. What if WalMart were to revamp the whole fee structure and put pressure on the $25 insufficient funds fee? How would that change bank's view of their value proposition and sources of profit? Would they be viewed as the reactionary bad guy?
 
Gary Lemke, Publisher
(Share your thoughts)
 
5/19/06 - Profits Through Penalties - Part III
Are penalties a good thing? The last two days I've used this column to call out what I feel are abusive penalties imposed by some companies when customers do not behave as expected. For some companies, these penalties represent the majority of the profits thus becoming an integral part of the business model.
 
A few readers responded that penalties are a necessary means to make sure customers aren't abusing the earnest efforts of the vendor. I totally agree with the necessity of penalties and I have no problem with them if they adhere to two conditions. First, they should not be a surprise. Surprise fees are a major source of customer defection and create distrust.
 
Second, penalties should be fair. As a general rule, I would suggest that the "fine match the crime." Another perspective is that penalties should not be more profitable than the core business. For instance, can anyone explain why auto companies think they have any chance of creating loyalty by charging fuel rates way in excess of market (full serve) rates?
 
Gary Lemke, Publisher
(Share your thoughts)
 
5/22/06 - Profits Through Penalties - Part IV
I thought I would start the week by moving to a new topic but something has been on my mind all weekend and I just had to share it with you. Of all the feedback I received on the practice of profitable penalties (see last week's editions to catch up on the conversation), not one company responded to defend the practice of profit inducing penalties.
 
I would have thought at least one person might respond to explain why they do what they do along with justification. What a perfect opportunity to educate a large group of customer advocates! I did have one person respond that companies continue the practice of high profit penalties for one simple reason - they can get away with it. In many markets, the extra fees seem to be tolerated.
 
That's a fair point. But I would say that consumer tolerance is often a long distance from customer loyalty. Tolerance to me talks about short term profits where loyalty is more about taking the long view. Do you agree?
 
Gary Lemke, Publisher
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5/23/06 - Profits Through Penalties - Part V
One reader responded to the on-going conversation about the high cost of consumer penalties by saying, "Here in Britain, consumers are taking it to the banks who charge penalty fees for things like late payment, exceeding overdraft limits, returned checks, etc. The premise is that by UK law, companies cannot charge punitive fees, only fees that accurately reflect the cost of the transgression."
 
The reader goes on to share a consumer web site that states: "Penalty clauses in contracts in English (and Scottish) law for breach of contract aren’t legal if the penalty exceeds the actual cost of the breach of either party. We all know that it does not cost a bank £25 to £39 to return a Direct Debit, Standing Order or cheque, and luckily so do judges, and indeed the banks. It’s purely a money making scheme, and a lucrative one at that – with estimates that the charges from the top 4 UK high street banks generated £3 billion alone."
 
In short, bank charges are not legally enforceable in that country and some consumers are asking for their money back and getting it. There is quite a bit at stake for both sides. The big question is whether or not the market will support high priced penalties in the long run. My guess is no but I hate to guess what the "tipping point" or change agent might be.
 
Gary Lemke, Publisher
(Share your thoughts)
 
5/24/06 - The Power of Penalties
I received a well constructed message from a reader that wanted to share the positive value of penalties. Her past experience in the banking industry gave her the insight that penalties generally exist "to encourage the low margin customers to use the self-service channels and to make profitable relationships that would otherwise be a drain on assets."
 
She went on to say that "a customer with a minimal balance that is often $5 from overdraw is one that contributes nothing to profitability without fees such as those for bounced checks, a charge to check their balance at the call center instead of doing it online or via an ATM, etc."
 
It is often the case that 80% of the profitability comes from 20% of the customer base and the rest cost money to serve. The fees are designed to even out the score a bit or encourage the draining customers to take their business to the competition. That's seems like a good use of penalties. However, it makes me wonder if the marketing programs are disconnected from the retention programs. In other words, should businesses do a better job of recruiting the right customers to begin with?
 
Gary Lemke, Publisher
(Share your thoughts)
 
5/25/06 - Retention and Customer Penalties
Yesterday's column about the "power of customer penalties" seems to have struck a nerve. I received a whole mailbag's worth of email just when I thought I was ready to move on to a new topic. But the responses are so good that I have to spend another day or so sharing some of them with you.
 
One reader wrote: "Customers typically fit into three buckets: profitable; unprofitable; and the largest bucket, borderline. The strategy should be to convert many borderlines into profitable customers and work to move many "unprofitable" customers to be very profitable." Another reader wrote: "If a business must use a penalty item to guarantee profitability then that business has lost all sight of customer service and in my opinion doesn't deserve to be in business."
 
Perhaps some companies institute penalties not only to create profit but to drive the "unprofitables" away. Unfortunately, today's unprofitable customer might merely be tomorrow's most profitable customer in disguise. More on that tomorrow.
 
Gary Lemke, Publisher
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5/26/06 - Retention and Customer Penalties - Part II
Yesterday we discussed placing customers into three categories: profitable; unprofitable; and the largest bucket, borderline. Today, I would like to expand the list to six specifically by adding an additional axis of profit potential. Therefore, you have 1) forever profitable, 2) profitable today but unprofitable tomorrow, 3) borderline becoming profitable, 4) borderline not becoming profitable, 5) unprofitable but becoming profitable, and 6) terminally unprofitable.
 
If you can categorize all customers into these six buckets, you have a good idea how to treat each differently. One reader wrote, "My college student offspring made a mistake and overdrew a checking account by $12, but was hit with $90 in fees because there were four checks presented that day. Now, tell me, does the department of this bank that is soliciting me for a student loan or a 401k rollover know that the checking department just hammered us?"
 
The "heavy lifting" is understanding the lifetime potential of each customer. However, just as important is taking the right time horizon. It seems penalties focus too much on this quarter's profitability rather than the long term potential of the customer. Where's the focus on retention in that strategy?
 
Gary Lemke, Publisher
(Share your thoughts)