I fly more than 100,000 miles every year speaking at industry conferences, which means I spend a lot of time interacting with airlines as a customer. I also have a lot of opportunity to experience the way airlines price their tickets, charge for their services and try to attract my business (or retain my loyalty). A look at the best practices in what works for the airline industry leads to some striking parallels—and contrasts—for financial planners.
For instance, while in the financial planning world there is often a focus on trying to ensure that every client is equally profitable and to avoid a situation where more profitable clients “subsidize” less profitable ones, airlines recognize that strictly trying to equalize profitability can have harmful unintended consequences. For example, the cost of traveling is highly sensitive to weight, but does anyone really think it’s a good business idea to charge heavy people more for airline tickets than thin passenger?
Simply put, extreme efforts to equalize profitability across clients can actually be perceived unfavorably by those clients.
Similarly, airlines have long recognized that value is not based on what you pay for; rather, value is intrinsic to the service/feature/benefit provided. Accordingly, charging separately for a service is not something you do to enhance its perceived value, it’s something you do to discourage people from using it (e.g., baggage fees).
In fact, the best use for some of the most highly valued services is not to charge for them at all, but to give them away for free as perks to attract and retain otherwise-high-value customers/clientele.
Airlines constantly struggle to bring down their costs to be economically viable businesses, given the significant costs involved. But that challenge has also forced them to recognize how important it is to establish clear and consistent tiers of service, and price them accordingly…not require phone calls, data gathering forms and a meeting or two just to find out what the service will cost in the first place, as financial planners are notorious for doing!
In the end, customized pricing may sound appealing for a business, but if doing so makes the process difficult for consumers to buy a service, that transparent and simple pricing/service tiers win out in the end.
Lesson 1: Not Every Customer Has to Be Equally Profitable
At the most basic level, the airlines are in the transportation business, and the inputs to the transportation business are pretty straightforward: the greater the distance and/or the greater the weight, the more expensive it is to move the object, because moving an object requires energy, and energy costs money. This is true whether you’re shipping a package or flying a human being, and is the reason that fuel expenses alone account for as much as 1/3rd of the cost of a plane ticket. To be profitable as a business, you need to ensure that the cost to move a certain amount of weight over a certain distance is less than what you’re charging for the service.
In the context of shipping packages, these metrics are incorporated quite directly into the pricing structure; the farther you’re shipping a package, and the greater its weight, the more it will cost. This allows shipping companies like UPS and FedEx to earn a somewhat consistent profit on any object they transport, and their business grows as the volume of objects shipped increases.
By contrast, with airlines there are some constraints to this kind of pricing model. To put it mildly, it would not be considered in good taste to charge fliers based on their weight, with thin people paying lower ticket prices than those who are obese. While theoretically it could be done (just step on the scale before you purchase your plane ticket!), in situations like this we can clearly acknowledge that it’s better to accept an imperfect model based on the average weight of a passenger than it is to make the pricing model too “perfect” (so that you can make the exact same profit per passenger by adjusting their plane ticket price for their body weight).
Fortunately, though, that’s not necessarily crucial to the business model to be effective; the good news is that airlines fly a large number of passengers, have good information on the average weight of an individual person, and as a result can price tickets in a manner that technically means some (lighter) passengers will be more profitable than other (heavier) ones, but that the profitability averages out overall. The airlines can manage the extremes by having some reasonable limitations (e.g., checked bags limited to 50 lbs., carry-ons limited to one per person, and people of a certain size must buy a second seat).
In the context of the financial planning business, this similarly means that sometimes it might be better to just have a standardized retainer fee or AUM fee schedule, and recognize that, yes, some clients will be less profitable (more time-demanding) while others will be more profitable (less time-demanding). As long as the utilization of your services averages out relative to your pricing model and cost structure, and you have reasonable minimums and some maximum service levels built in, there’s no reason that every client has to be precisely equivalently profitable. Yes, it’s important to know how much revenue you’re generating from each client relative to the time you spend servicing each, but that doesn’t necessarily mean clients will appreciate paying for every service by the hour and always feeling like they’re on the clock (any more than they want to pay for airline tickets by the pound and have to step on a scale before buying a ticket).
A precisely priced fee can work for a finite service, whether it’s a pay-by-the-weight shipping fee for a package or an hourly fee for a specific financial planning issue, but trying to ensure consistent profitability for every client/customer for a complex holistic service, whether it’s flying a passenger across the country or helping them plan their financial life, may cause more harm than good. In some cases, it’s better to just accept that a big customer is indirectly “subsidizing” a smaller one (or vice versa in the case of an airline).
Lesson 2: Value Is Not Determined by What You’re Willing to Pay For
In the financial planning world there has been an increasing focus on the virtues of serving clients on a fee-only basis because of the elimination of some potentially severe conflicts of interest surrounding certain types of commission-based products. Accordingly, many advisors have been increasingly focused on promoting the fee-only nature of their business. Yet while there may be some benefits to consumers for being served on a fee-only basis, that doesn’t necessarily mean it’s a good way to market and communicate those services.
For instance, while technically you might say that you pay a “fee” to get on a flight, the airlines don’t focus on the fee that you pay, they focus on what you get: a ticket, that gives you access to that flight, its destination, and the opportunities/adventures that lay at the other end. Airlines may be a fee-only business, but they don’t market that you pay fees to get their services; they market the services that you get, and the benefit of getting them.
In fact, to the extent that the airlines charge “fees,” the context is almost entirely negative (fees are so disliked, airlines try to hide many of them, leading to recent legislative proposals to force greater upfront fee transparency). The most prominent in recent years has been the dramatic rise in baggage fees, which racked up an estimated $3.35B of additional revenue for airlines in 2013. Their primary reason for those fees: they serve as a means to ensure passengers who are less profitable (by bringing more bags that take up more space and add more weight) pay up to become more profitable for the airline.
Since no one celebrates the extent of the fees they have the privilege of paying, just to fly somewhere, the reality is that the secondary effect of baggage fees is even more significant: it discourages people from bringing bags so they won’t have to pay the fees.
This has some striking parallels in the context of financial planning, where the recent mantra has been “people don’t value something unless they pay for it” which has been used as a justification for charging separate (and/or additional) standalone financial planning fees. Yet as the airlines have clearly demonstrated, charging a separate fee for an “additional service” doesn’t necessarily make people value it more. Instead, it can make people resent the fee and want to utilize the service less, and only pay if they absolutely have to!