Identifying User-Fee Traps
And learning how to escape them
By Mark Nagel and Chris Austin
What do you do when some users will pay a higher fee if they have to, but others cannot? Do you set the fee lower and sacrifice revenue? Or do you set it higher and accept that some users will be priced out of the activity?
Photos: www.canstockphoto.com / lauria
What if it’s possible to increase fee revenue without decreasing the number and income diversity of the people you serve?
A thinking trap is an assumption about how the world works that keeps one from seeing other possibilities. This article will explore three thinking traps that may prevent a program from increasing its fee revenue. Along the way, four methods of generating fee revenue that respect differences in users’ ability to pay also will be discussed.
The Uniform-Fee Trap
The first thinking trap is the uniform-fee trap. This assumes that every user must be charged the same fee. The escape from this trap is to realize that different users can be charged different fees for the same (or nearly the same) activity. This practice is called differential pricing, and it can take several forms.
Perhaps the most common form of differential pricing is group-dependent fees. Here, the fee charged is determined by a particular group. For example, a city charges senior citizens a lower fee to play a round of golf than it does other golfers. In another example, a city charges non-residents a higher fee to use one of its park’s shelters than it does for residents.
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Using group membership as an indicator of ability to pay is a faster and cheaper way to identify users than collecting and analyzing their financial information. On the other hand, the criteria used to determine eligibility for a reduced fee may have little to do with that person’s ability to pay. As a result, one ends up giving a discount on something a person would have purchased anyway.
Another form of differential pricing is income-dependent fees. Users with lower incomes are charged less than users with higher incomes. For example, a youth-sports program awards “scholarships” to participants from low-income households.
Income-dependent fees correlate better with ability to pay than group-dependent fees. But the burden of proving participants qualify can discourage lower-income households from seeking assistance.
The Everyone-Must-Pay Trap
The second thinking trap is the everyone-must-pay trap. A variation of the uniform-fee trap, this assumes that, if some users are charged a fee, every user must be charged a fee. The escape from this trap is the realization that some users can be charged a fee, while others are charged nothing. For example, a city charges non-residents a fee to use one of its sports fields, but it does not charge its residents.
The Fee-Selection Trap
The third thinking trap is the fee-selection trap. A decision is made on which users must pay which fee. The escape from this trap is that users can decide which fee is right for them. The way to do this is by using a fee menu.
A fee menu is a list of different options from which all users can choose, and the corresponding fee for each option. Some of the options can even be free. For example, a parks and recreation program may charge different fees to use a particular sports field on different days and/or at different times. Users then select which fee they want to pay by selecting the option that best fits their budget. This is another form of differential pricing.
Fee menus are generally considered fair by users because the options to pay a lower fee are available to everyone. The key to success with a fee menu is charging higher fees for more valuable options and lower fees for less valuable options. Otherwise, users have nothing to gain by choosing to pay a higher fee.
Yet another form of differential pricing is the use of voluntary fees. Voluntary fees let users decide how much they want to pay, if anything at all. Technically, voluntary fees are really donations that look and act like a fee. For example, a city park has a collection box at the entrance to its conservatory with a sign asking visitors to “pay what you want.” Yet the conservatory doesn’t exclude anyone who cannot, or will not, pay.
Voluntary fees are ideal when it’s impractical to exclude people who don’t pay, or it’s too costly to collect a mandatory payment. On the other hand, you will need a collection mechanism, such as a donation box.
The table below lists four ways of charging different users different fees for the same (or nearly the same) activity.
Strategizing For Success
Remember, when every user is charged a lower fee, some users are getting a discount on something they would have purchased anyway. More often than not, the additional fee revenue from new users won’t make up for this. So, there may be more users, but less fee revenue in total will be collected. And, of course, that lost fee revenue has to be made up somewhere else.
On the other hand, when a lower fee is targeted at only some users, that is, the ones who otherwise would be priced out of an activity, it can increase both total fee revenue and the number of people served.
Using a differential-pricing strategy can increase the fee revenue an organization collects without shrinking the number of people served. More fee revenue can be collected from users who are willing and able to pay more, and some fee revenue can still be collected from users who are able to pay less.
Furthermore, a differential-pricing strategy makes it possible to collect more fee revenue while increasing the income diversity of a user base. Use the extra revenue collected from those willing to pay more to subsidize users who can’t pay more. Or use it to subsidize other important programs, where charging a fee isn’t practical or desirable.
When charging a fee is necessary to cover the costs of an activity, but there’s concern a fee will price some people out of an activity, a differential-fee structure is the way to go.
Takeaways
You don’t have to charge every user the same fee.
You don’t have to charge every user a fee.
You don’t have to select which users will pay which fee.
Mark Nagel, Assistant City Administrator for the city of Elko New Market, Minn., contributed to this article.
Chris Austin is a profit-growth pricing expert and a former economics professor at Normandale Community College in Minneapolis, Minn. Reach him at caustin@priceprofitadvisors.com.