The “Fees Savings” Link, or Purchasing Fifty Pounds of Pasta

Many consumers have had the experience of entering discount membership clubs to make a few purchases, only to leave with enough pasta to outlast a nuclear winter. We suggest that the presence of membership fees can lead consumers to infer a “fees savings” link, spurring them to increase their spending independent of the actual savings afforded by such clubs. Using both field data and studies in which we created our own “membership clubs,” we show that 1) fees serve as a signal of price discounts, such that stores that charge fees are perceived as offering better deals for identical items; 2) the presence of fees can increase consumer spending and overall store profitability; and 3) the presence of fees can drive choice of retail outlets, such that stores with membership fees are more popular even when they offer the same goods at the same prices as stores without fees. The “Fees Savings” Link 3 Discount membership clubs have a large and growing presence in retail – one recent survey reported that Costco sells to 1 in every 11 people in the United States and Canada (Spector 2005) and warehouse clubs are estimated to be a $120 billion industry today in the United States alone (HCC Publishing 2007). As a result, more and more people have had the experience of entering one of these popular clubs and leaving hours later with more goods than can fit in their car and enough pasta to outlast a nuclear winter; at minimum – as is the case with some of our acquaintances – many are familiar with a family member who engages in this kind of behavior. While one rational reason for such behavior is that membership clubs do offer lower prices than other retailers, we propose that the presence of membership fees alone – independent of the actual savings on any given product – can lead consumers to infer a “fees savings” link, leading them to spend more than they otherwise would to capitalize on these perceived “great deals.” These inferences can lead retailers who charge membership fees to make more money not just on increased sales due to consumers’ sometimes erroneous inferences about the deals they are getting, but, ironically, on collecting the very fees that lead to these increased sales. We explore this phenomenon by setting up our own “membership clubs” and comparing our profits across stores with varying membership fees. Across five studies, we demonstrate that consumers perceive stores that charge fees – both in the real-world and in our laboratory studies – to offer better deals than stores which do not charge fees, even when those stores offer the same goods at the same prices, perceptions which spur increased spending. The “Fees Savings” Link What might account for this generalized belief in the savings offered by discount clubs? We suggest that membership fees required for the consumption of a brand or service signal The “Fees Savings” Link 4 dominance on the dimension most salient to the particular brand or service: for country clubs, higher fees might signal greater exclusivity; for health clubs or healthcare plans, fees may signal higher service quality; for discount stores such as Costco or Sam’s Club, where the most salient dimension is cost savings, fees may signal greater price discounts. The presence of fees at membership stores thus may instantiate an implicit norm with consumers (see Grice 1975): “We wouldn’t charge you this fee if we weren’t making it worth your while,” leading consumers to infer a “fees savings” link. Just as consumers infer that stores which display a high proportion of in-store sales signs (Simester 1995) and those which use promotional messages like “Prices start at $49” (Shin 2005) have low prices, we suggest that they perceive stores that charge membership fees to have more attractive price discounts compared to those that do not. In support of this logic, prior research has demonstrated that consumers are indeed drawn to stores that charge fees, when those fees signal increased savings (Dick and Lord 1998). Such signaling of implicit norms is consistent with previous research that shows that consumers’ relationships with brands are based on similar contracts (Aggarwal 2004); when these contracts or norms are violated, consumers’ relationships with such brands are weakened and erosion of brand equity can ensue (Aaker, Fournier, and Brasel 2004; Fournier 1998). For example, consumers expect prices associated with particular brands to be generally stable within a short amount of time, and firms can raise prices without invoking wrath among consumers only provided consumers understand why those changes are made (Bolton and Alba 2006; Bolton, Warlop, and Alba 2003) and see them as fair (Campbell 1999; Janakiraman, Meyer, and Morales 2006; Kahneman, Knetsch, and Thaler 1986; Rotemberg 2005; Xia, Monroe, and Cox 2004). In a similar vein, when a store sells the same products as other competing stores but charges a The “Fees Savings” Link 5 membership fee, consumers may infer that the prices at the store must be lower to warrant that fee (see Wyer and Srull [1989] for a general discussion of such inference processes.) Of course, while we suggest that consumers overgeneralize the assumption that fees lead to lower prices, the assumption is not completely unfounded. Membership clubs frequently offer better prices per unit (e.g., per ounce of detergent), due to factors such as lower costs for store upkeep (the stereotypical concrete-floored warehouse club) and especially due to the volume discounts these retailers are able to offer given their ability to stock package sizes far larger than other retailers can stock. Indeed, when we visited both a Costco store (which charges a fee) and a Wal-Mart store (which does not) in New England and recorded the prices of a selection of 20 common consumer products ranging from Lipton tea bags and Goldfish crackers to regular household products such as Duracell batteries and Tide laundry detergent, we discovered two things. First, the two stores generally did not offer the same sized products. Second, when we extrapolated prices to calculate the volume discount, Costco had an average price advantage of 9.5% per unit across these product categories compared to Wal-Mart. Thus discount stores like Costco do allow consumers to enjoy lower unit prices due to volume discounts compared to other regular stores that do not charge a fee. If consumers believe that the savings offered by retailers like Costco are due solely to volume discounts, however, they would not infer the generalized “fees savings” link that we posit spurs increased spending. What might lead consumers to overgeneralize the relationship between fees and savings? As mentioned above, the different package sizes offered by the different stores make direct price comparison difficult for consumers; in addition, a discount club like Costco simply carries fewer items (some 4,000) than their competitors such as Wal-Mart (125,000) or grocery stores (40,000; Branch 1999), making it even more difficult for consumers The “Fees Savings” Link 6 to compare products at discount clubs to other stores. As a result, while consumers can see that a 64 ounce bottle of ketchup is cheaper per ounce than a 32 ounce bottle within a given Wal-Mart due to a volume discount, consumers often cannot directly compare the extent to which different prices for different sizes are due to volume discounts between Wal-Mart and Costco, a situation that creates ambiguity as to whether the savings are due to a volume discount or to Costco truly offering better deals. This kind of uncertainty can lead consumers to be particularly susceptible to cues induced by marketing efforts such as coupons and promotions (Lee and Ariely 2006; Simonson, Carmon, and O'Curry 1994) – or, we suggest, the inference that membership fees may be responsible for these perceived savings. Indeed, stores that charge fees attempt to manage this consumer uncertainty in favor of a “fees savings” inference: One Costco retailer, for example, sold $100 gift certificates for $80, implying a flat 20% price discount on all goods; even more tellingly, these gift certificates were placed strategically in a heavily-trafficked position at the entrance to the store. In sum, due both to the implicit norms implied in the membership fees that discount clubs charge and the difficulty of ascertaining whether this inference of better deals is correct, we suggest consumers may generalize from real savings offered on some goods by retailers that charge fees to a perceived “fees savings” link. If consumers do endorse this link, then they might erroneously perceive products to be a better deal if they encounter these products in a store that charges a fee than in one that does not, even when the two stores sell these products at the same price point. In short, we suggest that an overgeneralized consumer belief in the savings offered by these clubs is the trigger for the increased spending that can result in consumers arriving home with a 50-pound bag of spaghetti – and to an irate spouse. The “Fees Savings” Link 7 Overview of Studies To explore our hypothesis – that the generalized belief that stores which charge fees offer lower prices causes consumers to spend more in such stores than in stores which offer the same goods at the same prices but do not charge a fee – we ran a series of studies examining how membership fees affect both consumers’ perceptions of the attractiveness of store prices as well as their buying behavior. In Study 1, we created our own “membership club” in which we asked some participants to pay a fee before making any purchases from our store, in order to document the potential increased spending that results from fees. We examined the underlying causes of the basic finding more directly in Studies 2 and 3, assessing consumers’ price perceptions of goods at stores that charge fees or not. Using the same “membership club” paradigm as in Study 1, we assessed both price perceptions and spending concurrently in Study 4. Finally, Study 5 suggests a practical implementation of our results, varying the fees displayed on store advertisements and demonstrating the impact of such fees on consumer preferences for retail outlets. Study 1: Real Spending as a Function of Membership Fees The purpose of Study 1 was to examine consumers’ spending patterns when they shop at a store that charges a fee or not. To do this, we created our own stores in which we assigned participants to either a fee condition or a no fee condition, and recorded their willingness to shop and the total amount that they spent. Method Participants (N = 80) were approached after they participated in a one-hour session of unrelated experiments. Participants were told on a sheet of paper that they were invited to shop The “Fees Savings” Link 8 from a variety of products at discounted prices. Several of each of the following products were displayed on a table with their prices clearly visible: Gum (2 for $0.25), Candy Bar ($0.25), Pen printed with the university’s logo ($1.00), Beanie Baby ($2.00), Compact Disc Carrying Case ($5.00). Participants were assigned randomly to either the fee condition or the no fee condition. Participants in the fee condition were told they were required to pay a $0.50 fee in order to purchase anything from the store, while participants in the no fee condition were allowed to buy whatever they wished without any mention of a fee. Importantly, participants saw all of the products – and the prices we were charging for those products – before deciding whether or not to pay the fee, such that the fee was paid simultaneously with any purchases. Thus our results are unlikely to be driven by a sunk cost explanation, in which consumers justify having paid a fee by increasing subsequent consumption (Arkes and Blumer 1985; Staw 1981); we return to this issue in the General Discussion. Results The results revealed that there was no significant difference in purchase likelihood between our two stores: 58% of participants in the fee condition chose to pay the fee and buy at least one item, while 55% of participants in the no fee condition did so, χ < 1. However, as predicted, participants in the fee condition (M = $1.17, SD = $1.78) spent significantly more than those in the no fee condition (M = $0.51, SD = $1.01), t(78) = 2.05, p < .05. We can further compare the implied profitability of the two conditions by calculating the expected value per customer – multiplying average spending by the percentage of those who bought something in each condition, and adding in revenues from fees. We found that expected value per customer The “Fees Savings” Link 9 was three times higher in the fee condition (M = $0.97) than in the no fee condition (M = $0.28) (see Table 1). Examining the data from a different perspective, only 30% of participants in the no fee condition spent $0.50 or more (since 45% of participants in that condition did not buy anything and an additional 25% spent only $0.25.) Any rational account would therefore posit that no more than 30% of participants in the no fee condition would have been willing to pay a $0.50 fee if we had required them to do so, since 70% had a total willingness-to-pay of less than $0.50. However, results showed that in the fee condition, 58% of participants (i.e., nearly double this 30%) actually paid the fee and purchased at least one item, suggesting that the presence of the fee changed consumers’ total budgets despite the fact that the goods and prices were exactly the same across our two stores. In addition, these results appear to run against consumers’ intuitions about the impact of fees. We showed a different set of participants (N = 76) pictures of the same products used in Study 1 at the same price points, and asked them to predict their buying behavior. Though fees had little impact on the actual number of people who made a purchase in Study 1, participants predicted that fees would serve to dissuade them from purchasing, as only half as many participants predicted they would make a purchase if asked to pay a $0.50 fee as those participants who did not have to pay a fee (44% vs. 80%), χ (1) = 10.29, p < .01. Unlike with real spending, in which the presence of fees spurred additional purchasing, participants did not predict in the abstract that the presence of fees would change their total budget, as estimates of spending did not vary between the fee (M = $2.54, SD = $4.48) and no fee conditions (M = $2.99, SD = $4.32), t < 1. Thus people predicted that the expected value per customer in the no fee condition was nearly double that in the fee condition, $2.39 versus $1.39, in direct contrast to The “Fees Savings” Link 10 our actual spending results from Study 1 in which our store made three times more when we charged fees. Despite people’s intuitions to the contrary, Study 1 demonstrated that consumers were not dissuaded by the presence of our fees when they chose to enter our store, and, having paid the entry fee, actually spent more money in that store. We propose that this effect can be explained by an implicit “fees savings” norm that consumers infer when shopping in stores that charge fees. In the next two studies, we tested this premise directly by assessing how consumers perceive prices at stores that either charge fees or not. Study 2: Consumer Perceptions of Discounts at Wal-Mart and Costco In the introduction, we suggested that consumers may have difficulty understanding that at least some of the savings they receive at stores that charge fees are due merely to volume discounts, rather than to savings offered specifically by stores that charge fees. In this study, we wanted to show that people believe that Costco offers a discount over and above a regular volume discount they might get at a store like Wal-Mart, offering evidence that people may believe that stores that charge fees offer better deals than similar stores which do not. Method A nationally representative sample of participants (N = 368, 53% female, Mage = 40.3) – drawn from a pool maintained by an online survey company – completed the survey as part of a block of unrelated surveys. We showed participants five products, with actual prices listed for the regular size of that product at Wal-Mart (see Table 2), and asked them to estimate how much each product would The “Fees Savings” Link 11 cost in a bulk package size at Wal-Mart, then asked them to estimate how much each product would cost in that same bulk package size at Costco. Results For each product, participants estimated a lower price for the bulk package size at Costco than at Wal-Mart: Opti-Free (MCostco = $12.80, MWal-Mart = $13.63, t(361) = 5.37, p < .001), Vitamins (MCostco = $11.96, MWal-Mart = $13.10, t(365) = 6.62, p < .001), Kleenex (MCostco = $8.39, MWal-Mart = $8.73, t(365) = 1.91, p = .056), Listerine (MCostco = $6.15, MWal-Mart = $6.52, t(365) = 4.61, p < .001), M&Ms (MCostco = $5.23, MWal-Mart = $5.48, t(366) = 3.31, p < .01). Table 2 shows the imputed percent discounts implied by these price estimates. First, consumers did understand that larger package sizes lead to volume discounts at both Wal-Mart and Costco; averaging across all five products, they estimated a 24.8% volume discount at WalMart and a 29.3% volume discount at Costco. Most importantly for our account, however, they felt that Costco offered a 4.5% discount over and above the discount offered by Wal-Mart. Thus participants endorse the notion that Costco offers savings over and above Wal-Mart even for the exact same items available in the exact same package size. Study 3: Consumer Perceptions of Discounts Solely as a Function of Fees Of course, it may well be the case that Costco does in fact offer greater savings than WalMart in those cases when they do offer the same products in the same size. As we mentioned in the introduction, Costco may offer better deals than Wal-Mart over and above a volume discount due to other factors that differentiate the two retailers (most obviously, Costco’s lower overhead due to its bare-bones approach reflected in its concrete-floored warehouses). Our contention is not that Costco never offers better prices than Wal-Mart, but that consumers overgeneralize the The “Fees Savings” Link 12 “fees savings” link even to situations in which fees do not actually signal savings, such that even stores which do not in fact offer additional savings are perceived as doing so, provided they charge a fee. To test this proposition, we controlled for any additional differences between existing stores like Costco and Wal-Mart by simply asking consumers in Study 3 about their general intuitions about the prices of stores that charged fees or not. Method Participants (N = 49; 24 male, Mage = 19.7, SD = 2.5) were approached at the student center of a large northeastern university to complete a short survey. They read a description of two stores which offered goods at discounted prices, and were told that at one store membership was free while the other store charged a $100 yearly membership fee. We then asked participants to choose which store they thought offered more discounted prices/better savings. Additionally, we showed them pictures of two products (a 10-pack of gum and an MP3 player), gave them the manufacturer’s suggested retail prices of these products ($4.40 and $249.00, respectively), and asked them to indicate the price they thought each store (no fee or $100 fee) would charge. Results The vast majority of participants (88%) thought the $100 fee store offered better prices than the no fee store, χ (1) = 27.94, p < .001. While both stores were perceived as offering significant discounts on both items (one-sample ts comparing estimated price to the given actual retail price, all ps < .001), our prediction of perceptions of relatively better prices at the $100 fee store was borne out. Participants predicted lower prices at the $100 fee store than the no fee store on both the MP3 player ($211.28 and $229.08, SDs = $36.65 and $25.11), paired t(48) = 4.88, p < .001, and the 10-pack of gum ($3.28 and $3.92, SDs = $1.10 and $0.70), paired t(48) = 5.93, p < .001. The “Fees Savings” Link 13 These results suggest that participants inferred the level of price discounts from the presence or absence of membership fees, perceiving stores that charge a fee to have more attractive prices than those that do not. These reductions mapped onto an 8% discount on the MP3 player and a 16% discount on the gum, even larger than the 4.5% discount we observed for predictions between Wal-Mart and Costco for the same-sized goods in Study 2, suggesting that fees have an impact on price perceptions independent of factors specific to particular retailers. Study 4: Real Spending and Price Perceptions Studies 2 and 3 suggested that consumers inferred a “fees savings” link when stores charge fees, while Study 1 demonstrated that the presence of fees drove increased consumer spending. In Study 4, we combined the paradigm from Study 1 with the insights from Studies 2 and 3, once again creating our own stores which either did or did not charge fees, and allowing participants to shop while also assessing their perceptions of the quality of our prices. In addition, Study 4 allowed us to further isolate the impact of fees on price perceptions independent of other differences that might be associated with cost savings – such as concrete floors or less lighting – between real-world retailers like Costco and Wal-Mart which vary in their fee levels: As in Study 1, the only difference between our “fee” and “no fee” stores was the fee itself.