Why Small Firms Take a Pass on Profitable Opportunities

Higgins, a Kellogg associate professor of finance, was consulting with a Mexico-based fintech company that charged merchants a fee for credit-card-payment processing. When a competitor had begun offering a lower fee, the fintech company wanted to test lowering its own fee as well. The goal was twofold: to retain its merchant customers in the face of competition and to encourage its customers to accept credit cards—versus cash—for more transactions.

“The idea was to shift some customers to card payments by making those payments cheap enough to offset the indirect costs of using cash, like having to handle it and go to the bank frequently,” Higgins says.

Logical enough. But there was just one problem: when Higgins helped the company run a pilot study that offered the lower fee to about 11,000 merchants, only about 15 percent opted in. “We were surprised,” Higgins says. “It takes just a couple minutes to fill out the form and activate the lower fee.”

That result motivated Higgins and collaborators Paul Gertler and Ulrike Malmendier of UC Berkeley and Waldo Ojeda of Columbia to study why small businesses hesitate to act.

“Past studies have shown it can be constraints like information frictions, if the firm just doesn’t know about a profitable opportunity or technology, or credit constraints, when a firm doesn’t have the money to pay for a new technology and can’t get access to a loan,” Higgins says. “But those didn’t really apply here because the businesses got an email telling them about the lower fee, and they opened it. And this opportunity was free to adopt.”

So the researchers designed an experiment to test whether behavioral frictions (such as forgetfulness or failing to think long term) could explain why businesses were resistant to taking certain actions that might benefit them. They ran a randomized controlled trial offering lower fees to thousands of the fintech company’s merchant customers. Then they tested whether certain tools like deadlines and reminders could reduce behavioral frictions and, in turn, help encourage customers to opt in.

They found that several tools significantly increased customers’ likelihood of accepting the offer. Above all, “pre-announced reminders had the largest impact,” Higgins says.

Moreover, they identified a common thread among the tools that were most effective at shifting behavior. “In the end, factors that had the biggest impact were those that increased trust [in the fintech company] the most,” Higgins says.

The value of reminders

For their study, Higgins and colleagues worked with the fintech company to offer nearly 34,000 Mexico-based small businesses the ability to opt in for lower payment-processing fees.

They extended some of the merchants a one-percentage-point reduction in the processing fee (from 3.75 percent to 2.75 percent), while they offered others a 0.75-percentage-point reduction (from 3.75 percent to 3 percent). As expected, there was higher uptake among merchants who received the larger reduction (29.4 percent of these merchants opted in), compared with those who received the smaller reduction (25.9 percent opted in)—a difference of 3.5 percentage points.

But the researchers also varied several other factors to test how they would affect firms’ likelihood of accepting the offer.

For example, they sent some of the merchants a reminder of the offer about a week after the initial notification. This allowed the researchers to assess how mere forgetfulness might be influencing merchants’ decision to accept the offer.

Uptake for the no-reminder group (who received no follow-up communication) was about 26 percent. In comparison, uptake among those who received a reminder was 4.7 percentage points higher, with most of this effect occurring the day the reminder was sent out.

In other words, reminders were more effective at shifting merchant behavior than a larger reduction in the fee.

Increasing uptake

But announcing this reminder ahead of time made it even more effective, the researchers found.

A subset of the merchants who received the reminder also received a note in the initial notification that they would be receiving a reminder in the future—what the researchers referred to as a pre-announced reminder. Uptake among merchants in this subset was 2 percentage points higher than for those who received only the reminder.

“The economic model we had going into the study didn’t predict this,” Higgins says. “We believed that if you’re confident about your memory, hearing there will be a reminder should have no impact on whether you accept the offer because you would think you were going to remember anyway.”

“On the other hand, if you’re worried about forgetting, announcing the reminder could actually reduce uptake on day one,” he adds, “because once the fintech company tells you they will send a reminder, you don’t have to worry about forgetting anymore and can put off accepting the offer until the day you receive the reminder.”

So the researchers conducted a post-study survey to understand why the announced reminder boosted uptake so much and found that it stemmed from an increase in trust.

“It has something to do with the fintech company telling merchants on day one that the company is going to do something,” Higgins says, “and then following through and actually doing it.”

Indeed, 39 percent of managers who were told in advance that they would receive a reminder said that the reminder changed their perception of the offer’s value, versus 23 percent of those who weren’t told in advance.

The announced reminder had an especially pronounced effect on merchants who were most hesitant to trust in the fintech company at the outset, including merchants who had a newer relationship with the company.

These results “reassure us that it’s really trust that’s driving this,” Higgins says.

Trust, in fact, also helped explain a counterintuitive finding in the research: that giving merchants a deadline caused a decrease in uptake on day one. “The deadline caused people to be less likely to trust the offer at first, maybe in part because we’re used to getting all these anti-phishing messages warning us that if someone’s trying to get you to do something quickly, it’s probably a scam,” Higgins says.

Though having a deadline did not increase uptake (by the time of the deadline) across firms overall, it did increase uptake among the smallest firms. Uptake was 2 percentage points higher among small firms that received the deadline, compared with small firms that didn’t receive one.

Try for trust

The findings demonstrate the value of building trust with customers, including when offering them benefits.

“Announcing and then sending reminders can be an important way to build trust, as we’ve shown,” Higgins says. “But you may not want to send a million of them. Sending just one can have big impact.”

But what about the other side of the equation—that of the consumer? Consumers could also be missing out on valuable opportunities due to uncertainty fueled by a lack of trust.

“It’s been shown in other research that how well you do in life is a function of trust,” Higgins says. “But it’s an inverted-U shape such that if you don’t trust at all, you’ll do poorly, and the same if you trust too much. It’s not just black-and-white; there’s some optimal middle ground.”

Higgins notes that regulators in various countries are currently developing technologies to help consumers find that middle ground and to understand which financial offers—like common ads about low interest rates for personal loans—are legitimate: “It will help people understand which offers are true offers to trust and which are scams.”