Executive Summary
As a frequent speaker at industry conferences, I fly more than 100,000 miles every year, which means I spend a lot of time interacting with airlines as a customer and buy a whole bunch of plane tickets… and have a lot of opportunity to experience the way airlines price their tickets, charge for their services, and try to attract my business (or retain my loyalty). And a look at the best practices in “what works” for the airline industry leads to some striking parallels – and contrasts – for financial planners.
For instance, while in the financial planning world, there is often a focus on trying to ensure that every client is equally profitable and avoid a situation where more profitable clients "subsidize" less profitable ones, yet airlines recognize that strictly trying to equalize profitability can have harmful unintended consequences (the cost to travel is highly sensitive to weight, but does anyone really think it’s a good business idea to charge heavy people more for airline tickets than thin passenger!?). Simply put, extreme efforts to equalize profitability across clients can actually be perceived unfavorably by them!
Similarly, airlines have also long since recognized that value is not based on what you pay for; value is intrinsic to the service/feature/benefit provided. Accordingly, charging separately for a service is not something you do to enhance its perceived value, it’s something you do to discourage people from using it (e.g., baggage fees)! In fact, the best use for some of the most highly valued services is not to charge for them at all, but to give them away for free as perks to attract and retain otherwise-high-value customers/clientele!
Ultimately, airlines have still struggled to bring down their costs to be economically viable businesses, given the significant costs involved. But that challenge has also forced them to recognize how important it is to establish clear and consistent tiers of service, and price them accordingly… not require phone calls, data gathering forms, and a meeting or two, just to find out what the service will cost in the first place, as financial planners are notorious for doing! In the end, customized pricing may be appealing for a business, but it can make the process so hard for consumers to buy a service, that transparent and simple pricing/service tiers win out in the end!
Not Every Customer Has To Be Equally Profitable
At the most basic level, the airlines are in the transportation business, and the inputs to the transportation business are pretty straightforward: the greater the distance and/or the greater the weight, the more expensive it is to move the object, because moving an object requires energy, and energy costs money. This is true whether you’re shipping a package, or flying a human being, and is the reason that fuel expenses alone are as much as 1/3rd of the cost of a plane ticket. To be profitable as a business, you need to ensure that the cost to move a certain amount of weight over a certain distance is less than what you’re charging for the service.
In the context of shipping packages, these metrics are incorporated quite directly into the pricing structure; the further you’re shipping a package, and/or the greater its weight, the more it will cost. This allows shipping companies like UPS and FedEx to earn a somewhat consistent profit on any object they transport, and their business grows as the volume of what we ship increases.
By contrast, with airlines there are some constraints to this kind of pricing model – to put it mildly, it would not be considered “good taste” to actually charge fliers based on their weight, with thin people paying lower ticket prices than those who are obese. While theoretically it could be done (just step on the scale before you purchase your plane ticket!), in situations like this we can clearly acknowledge that it’s better to accept an imperfect model based on the average weight of a passenger, than making the pricing model too “perfect” (so that you can make the exact same profit per passenger by adjusting their plane ticket price for their body weight).
Fortunately, though, that’s not necessarily crucial to the business model to be effective; the good news is that airlines fly a large number of passengers, have good information on the average weight of an individual person, and as a result can price tickets in a manner that technically means some (lighter) passengers will be more profitable than other (heavier) ones, but that the profitability averages out overall. And the airlines can manage the extremes by having some reasonable limitations (e.g., checked bags limited to 50 lbs, carry-ons limited to one per person, and people of a certain size must buy a second seat).
In the context of the financial planning business, this similarly means that sometimes, it might be better to just have a standardized retainer fee or AUM fee schedule, and recognize that yes, sometimes a few clients will be less profitable (more time-demanding), while others will be more profitable (less time demanding). As long as the utilization of your services averages out overall relative to your pricing model and cost structure, and you have reasonable minimums and some maximum service levels built in, there’s no reason that every client has to be precisely equivalently profitable. Yes, it’s important to know how much revenue you’re generating from each client relative to the time you spend servicing each, but that doesn’t necessarily mean clients will appreciate paying for every service by the hour and always feeling like they’re on the clock (any more than they want to pay for airline tickets by the pound and have to step on a scale before buying a ticket).
A precisely priced fee can work for a finite service – whether it’s a pay-by-the-weight shipping fee for a package or an hourly fee for a specific financial planning issue – but trying to ensure consistent profitability for every client/customer for a complex holistic service, whether it’s flying a passenger across the country or helping them plan their financial life, may cause more harm than good. In some cases, it’s better to just accept that a big customer is indirectly “subsidizing” a smaller one (or vice versa in the case of an airline!).
Value Is Not Determined By What You Pay A Fee For
In the financial planning world there has been an increasing focus on the virtues of serving clients on a fee-only basis because of the elimination of some potentially severe conflicts of interest surrounding certain types of commission-based products. Accordingly, many advisors have been increasingly focused on promoting the fee-only nature of their business. Yet while there may be some benefits to consumers for being served on a fee-only basis, that doesn’t necessarily mean it’s a good way to market and communicate those services.
For instance, while technically you might say that you pay a “fee” to get on a flight, the airlines don’t focus on the fee that you pay, they focus on what you get – a ticket, that gives you access to that flight, its destination, and the opportunities/adventures that lay at the other end. Airlines may be a fee-only business, but they don’t market that you pay fees to get their services; they market the services that you get, and the benefit of getting them.
In fact, to the extent that the airlines charge “fees”, the context is almost entirely negative (fees are so disliked, airlines try to hide many of them, leading to recent legislative proposals to force greater upfront fee transparency!)! The most prominent in recent years has been the dramatic rise in baggage fees, which racked up an estimated $3.35B of additional revenue for airlines in 2013. Their primary reason for being there: as a means to ensure passengers who are less profitable (by bringing more bags that take up more space and add more weight) pay up to become more profitable for the airline. And since no one celebrates the extent of the fees they have the privilege of paying, just to fly somewhere, the reality is that the secondary effect of baggage fees is even more significant: it discourages people from bringing bags so they won’t have to pay the fees.
This has some striking parallels in the context of financial planning, where the recent mantra has been “people don’t value something unless they pay for it” which has been used as a justification for charging separate (and/or additional) standalone financial planning fees. Yet as the airlines have clearly demonstrated, charging a separate fee for an “additional service” doesn’t necessarily make people value it more; it makes people resent the fee and want to utilize the service less, and only pay if they absolutely have to!
By contrast, for frequent fliers, airlines often give a series of perks, from accumulating loyalty points (frequent flier miles), to waiving those extra baggage fees, to shortened security lines, to potential seat upgrades. As a busy conference traveler, I know that one of the “perks” I value most as a top tier flier is the fact that if there’s a travel disruption, I can switch onto an alternative flight, and get bumped immediately to the top of the standby list, to ensure that I make it to the conference and podium on time.
Yet this, too, draws some striking parallels – or rather, contrasts – with financial planning. As the airlines have found, the highest value services are actually some of the best ones to give away for free to the highest value customers! In other words, the reality is that customer don’t determine what’s valuable by what they pay for; they value what’s valuable to them, period. As a business, once you identify what those valued services are, the goal isn’t necessarily to charge every customer/client the maximum value for them; sometimes, the best thing you can do is either attach a fee to them (to discourage/manage their use if they’re expensive to deliver), give them away for free (as a perk to retain otherwise high-value clients), or create a form of loyalty points with perks attached to incentivize client loyalty (yet any form of ‘wealth management loyalty points’ is exceptionally rare in financial planning firms!).
Don’t Make It Hard To Be A Customer; Standardize Service Tiers And Let Clients Choose
If airlines were run like a financial planning business, this would be the process of buying a plane ticket:
1) Contact the airline, indicate your desire to purchase a plane ticket, and be put in touch with someone with whom you can schedule a 1-hour “get to know you” meeting to better understand your travel needs and goals. The meeting would be scheduled for 1-2 weeks out.
2) Prior to the meeting, you would be asked to fill out a data gathering form, indicating: your travel goals; the time horizon to complete your trip; your tolerance for the risk of flight delays; your willingness to trade off a faster flight for a higher fee or a longer flight for a lower fee; your preferences for inflight food and beverages, inflight entertainment, and legroom for seating; your financial wherewithal to pay for a ticket; and the details of your height and weight (along with the typical bags you use for travel and whether you tend to pack heavy or light).
3) Assuming you still wanted to go through with the process after #1 and #2, you would now follow-up with your one-hour meeting with the “travel consultant” who would discuss your responses in the travel data form, further delve into understanding your needs and goals around your trip, culminating in a promise to craft an individualized travel plan for your needs.
4) Schedule a follow-up meeting 2-3 weeks out, where you make another trip to see the travel consultant to finally find out for the first time what the cost of your trip will actually be, after having taken into account all of your goals and concerns. At this point, you can decide whether or not you want to buy your ticket.
5) If you don’t like the outcome of the trip/price you received at the end of #4, you will have to repeat steps #1-#4 all over again with a new airline.
While technically, this process really would be highly likely to ensure that virtually every passenger on the airplane got a wonderfully individualized, customized experience, priced directly to their needs, ability to pay, and in a manner that is profitable for the airline, it’s so unbelievably arduous and inhospitable for most consumers, it’s not at all viable. In fact, this was essentially the business model of most travel agents, a career that has experienced a tremendous decline in the past decade with the rise of the internet.
Instead, what airlines learned is that the best approach is to craft a relatively limited number of standard service tiers (e.g., economy, economy plus, and first/business class), articulate what features/benefits/value is receive at those tiers, the price points of each, and let consumers choose for themselves what they want. While this inevitably means that a few high-value customers may not quite find the right quote for themselves and move on to a competitor, it more than makes up for the losses in both the sheer efficiency and savers for the airline in taking on customers, not to mention the enhanced client experience of not needing to spend hours and hours of time just to find out the cost of the service they’re considering buying in the first place! And while travel agents do still exist – albeit in small numbers – such truly deep-customization individualized services are used primarily just for unique or complex circumstances that dictate their need.
Yet in the financial planning realm, we still cling to this painfully inefficient method of taking on clients. It’s still surprisingly rare for firms to articulate their fees on their website, and is similarly rare for firms to state their minimums, and virtually no firms clearly explain their breadth of services with a series of clearly defined service tiers with different price points so that consumers can choose which offering best meets their needs. Instead, clients are forced to go through a high-stakes, opaque, time-consuming process just to find out whether what they’re going to get offered at the end even really meets their goals and desires and is something they can afford and want to pay for, failing to recognize the incredible undue burden it places on prospective clients who may even want to work with us but aren’t enthusiastic to go through the pain of trying to find out what we offer in the first place. In other words, we make it very hard to become a financial planning client, even for someone who wants to become one!
Of course, in the end the reality is that airlines, too, have had their struggles over the years; it is a service for which most consumers can only afford a certain limited price point, and that price point if difficult to deliver upon for an industry with as much cost and overhead as the airline industry. Nonetheless, while airlines have struggled for years to figure out how to manage their costs – with some doing far better than others, and consolidation aiming to improve the situation, albeit slowly and with its own challenges – the fact remains that large airlines that service tens of millions of customers a year have been forced to figure out how to price services appropriately and efficiency… with some striking parallels and lessons for financial planners as well.
So what do you think? Should financial planners draw on these lessons from the airlines about how to appropriately price and communicate services and value? Are the industries too different for the parallels to be relevant? Or do some of these key aspects of airline pricing resonate for you and your business?
All valid points. Two points about aligning with airline strategies:
One, airlines are notorious for their OWN financial performance. A relative handful of domestic airlines have NOT gone bankrupt at least once (Southwest and…..er, maybe only one). A hurdle to overcome will be the ability to project professionalism without having to say “Do as I say, not as I do.”
Two, airlines are notorious for logistical mistakes. Alan King made a career out of a basic joke about requiring an airline to sell him a ticket to Cleveland and sending his bags to Miami, just like last time. Today, six years later, retirees and near retirees remember 2008 and just how the best laid plans of mice and men played out. We need to be offering predictable strategies and happily overdelivering with a better than illustrated performance. Brokers and agents that vastly oversold the projection performance of stocks, mutual funds, and variable products were left to explain why the illustration (the ticket to Cleveland) and the actual performance (the suitcase in Miami) wasn’t avoidable, or even predictable.
As a software consultant (not a financial planner) I am well aware of how hard it is to gain a long-term loyal client. It is worthwhile for me reduce my margin on an initial (serious) engagement to position myself to win over the client with the quality of services that we can deliver. As we proceed further into the relationship there is less price resistance and hopefully less overhead to the service so we both win in ways that we care about.
As I search for financial planners my observation is that many do very little to differentiate their services (display no competitive difference) other show their portfolio management fees (hardly compelling).
Agree with you Carl about FAs doing little to differentiate their services. They harp on features and their background instead of benefits, what they offer, and that they’re credible.
So here’s a dumb question. How do we differentiate? i’m assuming it shouldn’t be on cost/price. We all say we serve people well and do wealth management/financial planning/investment management. Is the only way to differentiate by having niche for client base? A few may differentiate on investment process, but that’s usually hard for most to do and claim. What other options are there?
Airlines, way to often, nickel and dime riders. I really don’t see them caring enough about the people who use their services. Instead, they seem to care more about their (ever increasing) bottom line.
One airline that unfortunately is not around, was Midway, based out of Chicago. They were great. If there was a way for me to fly through their service, I took it. Even if I had to switch planes (which I hate doing)
Michael, thanks for another thought-provoking post, I absolutely agree with you that financial planning firms could do a better job with pricing transparency.
One major difference between airlines and the planning profession is that consumers who book a flight already know where they want to fly from and where they want to go — i.e., from Chicago to New York, Boston to LA, etc. — while most individuals who want financial guidance don’t know either of these!
No airline or travel website that I’m aware of provides fare information until the consumer provides basic departure and arrival locations as well as approximate travel dates.
Good stuff, thanks again.
I agree with Michael B that the reason financial planning tends to be a time-consuming process is because it takes awhile to help/ figure out what a client needs. It’s more detailed than just locations/ times/ and costs. Financial planning is also a lot more high stakes than the airline industry of having a long-term impact on the client’s life.
However, it does raise an interesting conversation of what the role of commissions vs. fees should be. Are commissions given to advisors strictly to help articulate features/ benefits and value about products to a client? Should fees than be used to monitor the discovery process and uncover needs for financial products as part of a comprehensive plan? It would seem that clients who already have knowledge about what they want will be less time consuming from the advisors perspective and could be charged less in fees because they want to jump right to implementation where commissions are the reward. The key seems to be setting the expectation up front about whether a comprehensive or tactical approach is needed. To use the airline anology, are we trying to help the client with one flight or are we trying to help them understand how much allocation of their money should be spent on travel? Obviously the second is more time consuming.