Late fees – what’s better, percentage or flat amount?
Which is the better method of assessing a late payment penalty – a flat amount or a percentage of the past due amount?
Purpose of a late fee
Charging a late fee serves two purposes – to compensate the utility for the loss of operating cash and potential interest income because your customer didn’t pay on time and, secondly, to serve as a punitive measure (which is why some utilities call the late fee a penalty) to entice your customer to pay on time.
Flat amount late fees
A flat amount is the most straightforward and easiest way to charge late fees. It’s easy for your customers to remember, if they don’t pay their bill on time, to add $5 when they do pay.
However, flat amount late fees disproportionately impact your customers with low bills. A senior citizen living alone who receives a minimum bill every month pays the same late penalty as a large industrial user.
Percentage late fees
Charging a late fee as a percentage of the unpaid balance is a more equitable approach, ensuring that customers with lower bills are assessed a lower penalty. However, if the late fee is too low, it may not serve the purpose of motivating your customers to pay on time.
Back to the original question – which is better, flat amount or percentage? What if the answer to that question is “neither”?
The most creative solution to the flat amount vs. percentage dilemma is a hybrid of the two options. In this case the utility charges a percentage with a minimum amount, for example 10% with a minimum of $5.
Many times, this is expressed as “10% of the balance due or $5, whichever is greater” or “$5 on balances of $50 or less, 10% on balances of more than $50”.
The advantage of the hybrid method is it maintains the punitive aspect of the late penalty for customers with low bills while ensuring that customers with larger bills pay a larger late fee.