How to change customer behaviour: Incentivise or penalise?

Which works best at changing behaviours - incentivising or penalising? It’s about using positive and negative reinforcements and it also largely depends on how you emotionally frame the situation as a gain or a loss.

Whilst I was recently in New York City staying with friends, I noticed that many people were getting very worked up that shops and restaurants were now charging them a 4% - 5% surcharge for using their credit cards. I was used to this situation when I was living in Sydney a few years ago. But this practice was banned in the UK in 2018, where previously it was used extensively in the travel & leisure sector especially amongst low cost airlines.

I do understand that many businesses are operating on very small margins and so feel they need to pass on the charges they get from the credit card companies. However, how they do this will really impact how customers feel about them.

Most retail establishments offer people the option to pay by card to make it easy and convenient for customers. Many of these New York merchants established their pricing to include the extra costs for people paying by card, but as of 2019, they can make an additional surcharge to customers and get a bit more money to offset these costs.  

If they charge you 4% more for using a credit card and often people don’t know they are going to do this until the bill arrives, customers wind up feeling angry, annoyed and taken advantage of. And many will actually not come back and end up taking their business elsewhere.

So, what’s the alternative?

Reward customers for paying cash by giving them a 4% discount. Retailers can do this if they price their goods and services as if people were going to pay by plastic. This enables retailers to offer customers a cash discount and still protect their margins.

By offering a customer a discount, they feel they are then in control and can make a conscious choice to pay cash and so walk away happy. Plus, the retailer gets instant access to their money.

Mexican restaurant Spanglish got a lot of customer complaints when they introduced the 4% surcharge. Many customers said that they wouldn’t be returning there because of the fee. So, they quickly discontinued the surcharge and instead offers a 4% discount off the menu’s prices for paying cash, and customers were much happier.

For the past year a Thai restaurant in Brooklyn have been offering a 10% discount for using cash in an effort to persuade customers to give up plastic. 

Offering a cash discount achieves the same results; the business gets to keep more money helping them to maintain their margins but more importantly customers would welcome a discount as opposed to paying a surcharge. By offering a cash discount business are rewarding customers for using cash as opposed to punishing them for using plastic. It also helps to avoid upsetting or even losing customers.

Positive reinforcement or punishment avoidance

So, which works best at changing behaviours, incentivising or penalising? It’s about using positive and negative reinforcements and it also largely depends on how you emotionally frame the situation as a gain or a loss.

If a customer is told that they getting a discount price compared to the regular price, they will feel that they are gaining in that situation creating a positive reinforcement of a behaviour. Whereas a customer having to pay a surcharge will view it as a penalty and will feel they are losing out in the exchange, because they will be paying more, so negatively reinforcing them to change their behaviour.

Many of those in the field of behavioural economics will argue that surcharges are more effective at changing behaviours because customers tend to have a lose aversion bias. The theory is that more customers will actively decide to pay with cash if faced with an imposed surcharge and the subsequent loss of money than the gain of the cash discount. 

Research done almost 20 years ago in the Netherlands showed that 75% of cardholders thought that it was very bad for retailers to ask for a fee, just to use their cards. When told about the discount they would get when not using their cards 43% paid by other means, thus changing their normal behaviour based on the way the situation was framed. So, this approach of positioning it as “cash = discount vs. credit card = surcharge” impacts the decisions that customers make and is likely to motivate them to pay by cash.

Many of those in the field of behavioural economics will argue that surcharges are more effective at changing behaviours because customers tend to have a lose aversion bias

Although this would appeal to customers on lower priced purchases it could be a big attraction for customers on higher priced items because the gain would be much larger and so could help to attract more customers, engender greater loyalty and increase word of mouth.

If you want to change behaviour it really is all about how you frame the situation, a case of not what you say but how you say it. As Daniel Kahneman & Amos Tversky showed in their research in the 1980’s, people don’t behave rationally. Instead they rely on numerous mental shortcuts to speed up their reasoning which means they are really susceptible to how things are framed. And messages that include both positive gains and negative losses are the most effective in prompting behavioural change.

So, in the example of cash discounts vs. credit card surcharges in New York, my friends and other people felt happier being offered a discount as opposed to being surcharged. This improves the customer experience and customer lifetime value by rewarding behaviours you want as opposed to penalising ones you don’t.

A balanced use of the carrot & stick works best, but always begin with the carrot, keeping the stick in the background.  If you start off by imposing a surcharge, you risk alienating your customers and damaging your business. It is always more difficult to reverse a decision, because customers have long memories and it’s hard to change a negative perception, especially one that can impact on trust.