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November 09, 2006

Bad Profits Dissected

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According to Frederick Reicheld’s THE ULTIMATE QUESTION, there are bad profits and good profits which companies can earn from customers. Reicheld writes, “… bad profits are earned at the expense of customers, good profits are earned with customers’ enthusiastic cooperation.” In other words, bad profits result in creating customer detractors while the result of good profits is the creation of customer promoters. Detractors talk bad to others about companies while promoters talk good things to others about companies.

An example of a bad profit, which turns customers into detractors, is when an airline charges its customers $5 to use a blanket. Good profits happen every day at places like Whole Foods Market where customers gladly pay more for their groceries because they enjoy the shopping experience and the food quality enough to pay more for it.

In a special section on “Customer Service” (free access from AOL), the Wall Street Journal shared a few answers to why companies make the case for generating bad profits off good customers. One such answer involved rental car companies, who are notorious for finding ways to gouge its customers to earn bad profits.

For example ... if you fail to return a rental car with a full tank of gas, the company will charge you anywhere between 3 to 5 times more than the local price per gallon rate to fill the tank. I recently rented a car and noticed the refueling charge was $8.79 a gallon while the going rate in town was close to $2.75 a gallon. (Yikes.)

So … why do rental car companies charge such a high refueling fee? Here’s what the Wall Street Journal found out …

"You aren't paying for fuel," says Neil Abrams, president of the car-rental consultancy Abrams Consulting Group Inc. in Atlanta. Rental agencies set the price high to deter clients from bringing back vehicles with an empty tank and thus offset the steep cost of refueling.

Rental agencies don't have efficient systems for shipping and storing fuel and gassing up vehicles en masse, says Mr. Abrams. Some companies don't even keep gas on site, so an employee has to drive the car to another location to fill it up. And a rental agency's goal is to get the car out to the next customer as quickly as possible; if the agency has to take time to refuel a car, the lost revenue and labor costs are huge, Mr. Abrams says.

Still, most rental agencies do offer a pre-pay refuel option at the time of rental so the customer can bring back the car empty and pay for a tank of gas at a price close to local market rates. Those few additional cents on each gallon can help to offset labor costs, since the average renter never brings back a tank bone dry, says Michael Kane, president of Vehicle Replacement Consulting Group Inc. in Royal Oak, Mich.

Hmm ... seems like an opportunity exists for a rental car company to distinguish itself from its competitors by solving for how it can profit by not charging customers such a high refueling fee. That’s what I would do if I was a marketer for a rental car company.

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Comments

"Hmm ... seems like an opportunity exists for a rental car company to distinguish itself from its competitors by solving for how it can profit by not charging customers such a high refueling fee. That’s what I would do if I was a marketer for a rental car company."

That's a rental car company that won't last long. An economist would tell you that sometimes you have to create an incentive for human beings to act like, well ... like human beings. In this case, it is in a person's best interest NOT to refuel the card if there is no incentive to do so. Our time is valuable, and despite the fact that it's simply a crappy thing to do, economically speaking it's the right thing to do.

You have these sorts of charges all over the place, and I think in this case, one could argue that this isn't a bad profit, per se, but simply an inconvenience charge (they probably don't profit on the gas for the exact reasons they gave you).

What they really need to do if they want to differentiate is to parter/co-locate with a major fuel company. Offer discounts on fuel when you rent a car, and make it more convenient for the company to refuel when a customer fails to. Plus, the fuel company gets a guaranteed flow of customers. It's win-win-win.

The comment that the rental company won't last long doesn't ring true to me because I've found that the great majority of them do the same thing.

It would be a great differentiator to get a system in place to handle this negative treating of the customer. If a national company could do it could, they could really win some more market share I believe.

Rob ... then help me understand how Southwest Airlines and JetBlue have been able to carve out success by not relying on bad profits to drive profits in an industry that is notorious for inflicting bad profits on customers.

Your partnership program idea with a gas company is brilliant.

John,

Good post. I think it's possible that both you and Rob are correct. Economics can force us to create bad profits. But they are only bad if perceived that way.

The partnership idea may be a solution. Another solution may be to eliminate the surprise.

You experienced a bad profit from the rental car company becuause you were surprised by what seemed to be an unfair charge per gallon. Would it still have been a bad experience if when you rented the car the person who served you explained that you have a choice: Return the car with a full tank of gas or be charged a service fee of x dollars?

Lewis ... I wasn't surprised by the high refueling charge as that's normal rental car behavior. It's something I've come to expect. And in my book, a bad profit is a bad profit no matter if its explained to the customer or not. It's a good thing we as consumers have a choice with rental car refueliong charges. And I choose to refuel the car so as not to be exposed to a bad profit.

"Rob ... then help me understand how Southwest Airlines and JetBlue have been able to carve out success by not relying on bad profits to drive profits in an industry that is notorious for inflicting bad profits on customers."

OK, so let me clarify. The airlines, by not telling you that a blanket costs $5 until you're already trapped on a plane and freezing ... yes, that is clearly a bad profit. I don't think that the inconvenience charge of quadruple the rate for gas if you fail to bring it back fueled is quite the same thing.

Yes, Southwest and JetBlue are doing a great job, but their business model (as a low-cost carrier) reflects that. When it's part of the model, you can make it work for you.
For the other airlines who have costs that Southwest and JetBlue don't, they're struggling to find a way to add value, and unfortunately, that results in boneheaded mistakes like charging $5 to rent a toddler blanket.

In your example, assuming for a moment that the high refueling charge is indeed a bad profit, simply deciding not to make that charge doesn't immediately differentiate them. First, you have to publicize it, since it's not something most people see anyway. Then you have to deal with what will happen when people abuse it (which will happen, and was the reason for the charge to begin with). There are costs associated with all of that. As I said originally, a rental car agency that decides to simply drop that charge without making changes to their business model (as I suggested) won't survive.

Eliminating the surprise is part of the solution, especially since in this case, it's supposed to be a deterrent (and you can't deter if you don't tell them up-front). A better solution than a disincentive would be a pure incentive ... offer them a discount on their next rental, or something along those lines. The problem there is that it cuts into profits. Better to have the onus on the customer, at least from the business's perspective.

Of course, the best solution would be if we all acted like courteous and conscientious citizens, but that just won't happen. :)

The worse case of bad profits is the 'concert & entertainment' business. A venue here in Kansas City called the Uptown Theater charges $10 for a 20 ounce beer. TEN DOLLARS... come on.

Yeah know Rob ... some might be quick to say charging 4x the going rate for gas is "price gouging" while others might say its appropriate. Depends on the consumer.

This consumer isn't gonna sound the alarm and say charging 4x the going rate for gas is price gouging. However, I will say it seems to be a "bad profit" to me. There are other ways rental car companies should be able to drive profit than by charging customers what could be perceieved as an excessive fee.

OK, here's a flip side to the argument --

Your rental car company needs to communicate WHY it charges to much to refuel and WHY they ask you to do what they ask you to do -- all in the name of lowering their costs so they can pass savings along to YOU, the customer.

Walmart (and Sam's, Costco, and others) does this.

If everyone brings the car back half-full, the rental agency racks up higher expenses and passes them along to prudent, thoughtful consumers like you, who have to pay for others' inconsiderate behavior.

This is a BRANDING OPPORTUNITY along the lines of EasyJet, EastCar, etc. See http://www.easy.com/.

"What we have here... is a failure to communicate..."

I have an idea. Bring back the car with the right amount of fuel. If you don't have time to run to the gas station, why would you think the rental agency does?

The last time I rented a car, I had to wait for about 20 minutes. Do you know why? They were getting gas in the car because the previous customer returned it empty.

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