In Praise of Honest Pricing

Most video rental stores offer a midweek two-for-one special — an apparently good deal to entice people in on a slow day. The catch is that the offer does not extend to late fees: When customers are late in returning the videos, they have to pay a fee on each one. That second video isn’t really free after all. And those late fees add up, constituting up to 20% of Blockbuster Inc.’s revenue, for example.

Similarly, cell-phone operators, rental car companies and many others announce one “low” price for their offerings while hiding various charges in the fine print. And in a way reminiscent of a price war, once some companies are pricing this way, others feel they have no choice but to follow suit.

The conventional wisdom is that such tactics are a good idea; after all, they allow companies to boost profits while seeming to price competitively. But hidden pricing can be harmful not only for consumers who can’t figure out what something really costs but also for the businesses that engage in it. And as examples from the appliance industry and restaurant business demonstrate, companies that engage in honest pricing can enjoy important benefits — happier customers, clearer product differentiation and, consequently, higher profits. In short, telling people what things really cost can make more business sense than racing downward against competitors to an artificially low price.

Is Talk Cheap?

The cell phone business provides a striking example of hidden pricing. Consider a typical offer from Sprint PCS of 4,000 calling minutes for $39.99 per month. At first glance, the cost would seem to be a penny per minute. The rub is that only 350 of those minutes are “anytime”; the other 3,650 minutes are restricted to evening and weekend usage. If a subscriber goes over the allotted time on either segment, he is charged 35 cents per minute, and unused minutes from the month are forfeited. So what is the true cost per minute?

Since few people would use all the night and weekend minutes, let’s say that off-peak usage is essentially free and that all the cost is based on calls made during peak times. For a subscriber who uses the 350 minutes exactly, the cost works out to a little more than 11 cents per minute. But assume that the subscriber uses 200 peak minutes in some months and 500 in others.