There are a number of things in business that really make you scratch your head if you stop to think about them.
Annual fees, in most cases, are just a nutty thing that we have come to accept in certain industries, and this article by Virginia Heffernan talking about Amazon Prime is a good one (I will get to Amazon in a bit).
When I say annual fee, the first thing that may come to mind is credit cards. The credit card business, as far as I can tell, has nine of the ten characteristics of organized crime, the tenth being the “crime” part. How on earth they get away with charging annual fees is not only a mystery to me, as far as I can tell it’s really just a relic from another time. 20-30 years ago it was hard to get credit cards. People would actually get rejected on their applications. Cards like American Express literally advertised themselves as a “membership” such that paying an annual fee was like club dues that for all practical purposes are a privilege. Fast forward to today and credit card companies throw themselves at us in the mail and on TV, and yet in most cases they still charge an annual fee. It’s just nutty, and it really doesn’t have anything to do with their operating model or their brand to do it.
What is their operating model? The business model of the credit card company is pretty sound and simple, they charge merchants a fee for every transaction. In most cases they charge a percentage, and that seems a little bit like organized crime because in this day and age, they don’t really have a choice and the use of cash in most industries is all but gone (a friend of mine was in an AT&T store the other day and was paying cash and the people in the store literally didn’t know how to process a cash transaction). Beyond that money they make because of our buying decisions (so in that sense we are already putting money in their pockets), they charge insane interest rates on the cards when we are late making a payment. Why they don’t just charge bank interest rates is really odd to me. Unfortunately it seems a lot of people are bad about planning spending, and/or bad at math and the average American runs a balance over $6,000, and at about 20% interest that’s $1200 a year in interest (probably at least $900 of that is profit) which is a million dollars a year for every 1,000 credit card holder. . . so why the devil do they charge an annual fee? And why do people pay them?
Costco is a company that charges an annual fee to shop at their stores, which might sound as cuckoo as a credit card annual feel, but in their case it is entirely sane. How so? Costco, by choice, doesn’t profit from the goods it sells, and I have blogged about this before, but it’s not their goal to make money selling their products, which in general are a great deal. All of their profits come from their membership dues – that IS their operating model and it works for everyone. it makes a lot of sense and I am not surprised they have been so successful.
Amazon Prime is a little different.
Amazon Prime’s fee is a little bit like paying for an upgrade on a flight when you don’t have enough miles or awards to do it for free. If you buy enough from amazon, you get free two day shipping for everything you buy, which is GREAT. If you don’t have enough purchases, they will charge you for the service. In my case, I rarely care whether the products arrive in two days or ten days, so I would never pay for Prime. It would be one thing if I were buying perishable goods or if I were a last minute gift shopper or something like that, but I would never pay to be a Prime customer. Having said that, it makes sense to me that Amazon charges people for this if they don’t “earn” it, but there is an actual cost to shipping, and I wonder how they calculate how much to charge? They must crunch the numbers to look at the total actual cost and then divide that by some number of customers that don’t earn it. You could also do it based on the number of packages, but because of the wide range of quantities purchased by customers, that’s probably not as good a metric. Anyway . . . I would be curious to know where the number comes from.
So annual fees for credit cards make no sense, Costco’s makes a lot of sense, and Amazon Prime’s also makes some sense, but I would love to know how they calculate the fee. These are all good examples of rethinking where you need to be really clear about what your customer cares about and what they don’t care about, and based on that you should be able to make good decisions about when and where, and for what, you are going to charge your customer. I do think/hope it’s just a matter of time before the credit card business gets a major overhaul or gets put out of business by some mobile version of PayPal.
-Ric
P.S. As an aside, speaking of the actual cost of things, I saw in the paper yesterday that Netflix paid about a billion dollars for digital movie rights for some of the big movie houses so they can stream the most popular movies. A billion sounded like a gigantic amount until I read further in the article that they spend about $600 million a year on postage, so that makes the billion seem like a bargain when you look at it that way, and combine it with the enormous growth of streaming video at Netflix.
Ric,
The credit card companies will continue to charge the annual fees as long as consumers sign-up for the service and pay them. For the percentage of the population that regularly carries a balance or doesn’t manage their activity, they probably don’t even know the fee is there.
Regarding Costco, I thought I read somewhere that they do make a profit on much of the merchandise they sell, but the margins are capped at a certain percentage. The membership dues are almost 100% profit (some expense to manage the renewals) for them and where they make most of their money.
Bob