When Does Providing Free Extras Pay Off?

Roland T. Rust, Rebecca W. Hamilton, Chekitan S. Dev, and Michel Wedel
AMA Scholarly Insights
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Key Takeaways

​What? Service providers often give free extras to enhance the customer’s overall service experience. For example, hotels may provide free Wi-Fi, free bottled water, or free fitness center access. But do these added amenities pay off in terms of ROI?

So What? If free extras do not pay off, then service providers should discontinue them, not initiate them in the first place, or outsource to third parties with a different business model that makes it financially feasible to provide these extras.

Now What? Firms need to rigorously measure the ROI of their free extras. A more accurate picture can be obtained via a deeper understanding of costs and revenues and by calculating these for each amenity on a case-by-case basis.

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When you stay in a hotel room, the bed is not the only thing that matters. Some other amenities also tend to be standard—a shower, a TV, a telephone. Virtually all competing hotels will typically have those. Then, there are extras that may differentiate the stay. For example, free Wi-Fi is an amenity that has become popular in recent years. Providing extras like Wi-Fi costs money, though, so it is important to know whether the investment pays off.

This problem is not restricted to hotels. An airline may consider providing free food and drink, a car repair shop may offer free coffee, or a retirement home may provide a free shuttle service. Any firm considering whether to provide free extras to better satisfy its customers and differentiate itself in the marketplace must consider whether those extras are worth it.

Our Journal of Marketin​g Research​​ article, “Return on Service Amenities,” addresses this issue and shows how a firm can model ROI from investments in free extras (see our related article in the MIT Sloan Management Review, “Which Features Increase Customer Retention?”).


More on Customer Perceptions and ROI:


Calculating ROI: Revenues and Costs

Figuring out the ROI from free extras requires thinking very carefully about revenue and costs. Essentially, the added contribution to profit needs to be a large enough percentage of the added costs, just as for any investment. 

Understanding Revenues

Additional revenue comes from two sources:

  • Increasing initial purchases: More first-time buyers may choose the company if the free extras matter to them.

  • Increasing customer retention: Customers may be more likely to return to the company if they have taken advantage of the free extras.

​The increase in initial purchases can be estimated from traditional methods such as discrete choice models and/or conjoint analysis. The added revenue from customer retention, however, is somewhat more difficult to understand, requiring surveys (to find out whether the customer used the free extra) and customer database analysis (to track the customer’s subsequent purchases). We provide explicit details of how to perform this analysis in our JMR article.

It is important to understand that simply computing the increase in initial purchases using a discrete choice or conjoint model is not enough. Customers may feel differently about extras after actually using a good or service (see the 2005 JMR article, “Feature Fatigue: When Product Capabilities Become Too Much of a Good Thing”). If initial purchases increase but customers never buy again, the free extras may not actually increase total revenue. Thus, the customer retention effect must be modeled separately. 

Understanding Costs

The cost side must also be considered. Costs may be separated into:

  • Initial investment (e.g., buying all the equipment for a hotel fitness center),

  • Subsequent maintenance (e.g., regular upkeep and repair of the fitness equipment), and

  • Per-use cost (e.g., cost of towels for each individual user of the fitness center).

The ROI is then obtained from the added revenue minus these added costs, summed over all of the firm’s customers who use the amenities, and then divided by the initial investment. Again, our JMR article provides the details of the model for calculating ROI.

Implementing the Model

There are two cases to consider. In the first case, the firm has already implemented the free extras. In this case, the analysis proceeds as described above. In the second case, the firm has not yet implemented the free extras. In this case, the firm can roll out a test implementation (e.g., a hotel chain may test free amenities in some of its hotels) and then conduct the analysis described above.

In our article, we describe the application of our model at a major multibrand global hotel firm. We estimated ROI for three free amenities—bottled water, Wi-Fi, and fitness center—at 33 North American properties across 6 brands, ranging from upscale to luxury. We find that for some brands and amenities, the benefit was largely driven by initial choice, whereas for other brands and amenities, the benefit was driven more by customer retention. Thus, companies interested in implementing our model are advised not to generalize across brands and amenities. It is important to do the statistical modeling on a case-by-case basis to find out what the return on amenities will be.

Calculating the ROI, we found that all three amenities we studied were profitable for at least some of the brands, even when we used a conservative one-year payback window to calculate the ROI. The ROI would be even greater if we had used a longer window. Free bottled water and free Wi-Fi were profitable for almost all the brands, while the fitness center was profitable for only one brand (though it would likely be profitable for several of the brands, given a longer payback window). It is clear that a large initial investment makes it difficult to achieve an attractive short-term ROI, but then again, such large investments do not usually anticipate a short-term payback. 

The ROI for some amenities, such as free bottled water, was driven more by the increase in customer retention it generated than by its effect on initial purchase. However, the reverse was true for free Wi-Fi: While the availability of free Wi-Fi had a strong effect on initial purchase, using it had little incremental effect on customer retention. 

Adding extras can make money for a service provider, but a favorable ROI is not guaranteed. For best results, a firm should rigorously calculate the ROI from its service extras. A more holistic picture can be obtained only by considering a costs (initial investment + subsequent maintenance + per-use cost) and revenues (from both initial purchases and subsequent retention) and by calculating these for each amenity on a case-by-case basis. The model we describe in our paper​ can be used to do this.

Figure: Comparison of Revenues from Initial Choice and Repeat Purchase



Article Citation
Rebecca W. Hamilton, Roland T. Rust, Michel Wedel, and Chekitan S. Dev (2017), “Return on Service Amenities,” Journal of Marketing Research, 54 (1), 96-110.
doi: http://dx.doi.org/10.1509/jmr.14.0364

Rebecca W. Hamilton is Michael G. and Robin Psaros Chair in Business Administration and Professor of Marketing, McDonough School of Business, Georgetown University (e-mail: rebecca.hamilton@georgetown.edu).


Roland T. Rust is Distinguished University Professor and David Bruce Smith Chair in Marketing, and Executive Director of the Center for Excellence in Service, Robert H. Smith School of Business, University of Maryland (e-mail: rrust@rhsmith.umd.edu).


Michel Wedel is PepsiCo Chair in Consumer Science, Robert H. Smith School of Business, University of Maryland (e-mail: mwedel@rhsmith.umd.edu).


Chekitan S. Dev is Associate Professor of Strategic Marketing and Brand Management, School of Hotel Administration, Cornell University (e-mail: chekitan.dev@cornell.edu).


Author Bio:

 
Roland T. Rust, Rebecca W. Hamilton, Chekitan S. Dev, and Michel Wedel
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