Forgoing immediate revenue in order to provide
customers with a more satisfying experience may be an optimal decision for a
firm if dissatisfaction reduces customer lifetime value. This paper estimates the long-run effects of
paying late fees, a leading cause of dissatisfaction in the video-rental
market, on lifetime value. Using
administrative data from an independent video store, we empirically examine the
effect of penalizing customers on future spending per visit, visit frequency,
and customer retention. We use a
semiparametric identification strategy designed to analyze dynamic binary responses
in panel data and find that late fees have a significant effect on future
profit. Specifically, we find that
customers respond to paying a late fee on all three dimensions – expected
spending temporarily falls by 0.8% (mostly in the form of reduced future late
fees), average wait time between visits increases by 1.4 days, and customers
are 27% more likely not to return.
Expensive late fee payments have a larger effect on future behavior than
inexpensive late fee payments. We also
find that late fee payments that are taken directly from a prepaid account have
less of an effect on future behavior than those collected in cash at the
register. We discuss the managerial
implications that these results have regarding late fee policies as well as the
effects of dissatisfaction more generally.