- 20 Nov 2007
- Working Paper Summaries
The “Fees → Savings” Link, or Purchasing Fifty Pounds of Pasta
Overview — 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, and warehouse clubs are estimated to be a $120 billion industry today in the United States alone. As a result, many 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. One rational reason for such behavior is that membership clubs do offer lower prices than other retailers. However, Norton and Lee offer a counterintuitive explanation for such buying behavior. They 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." Norton and Lee explore this phenomenon by setting up their own "membership clubs" and comparing profits across stores with varying membership fees. Key concepts include:
- Consumers behave irrationally in response to membership fees.
- When stores charge membership fees, consumers infer a "fees → savings" link due to their belief that stores that charge fees do so because they offer better prices.
- The presence of fees leads to increased spending.
- Consumers in the study were more likely to express a desire to shop at stores that charged fees than those that did not, even when products and savings were similar.
- With exceptions, there may be a curvilinear relationship between fees and savings: fees that are too low serve as a hook to make people pay more later; medium fees indicate good prices and decent quality and service; and high fees signal exclusivity and high prices.
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.