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Pricing and Revenue Management

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1 Pricing and Revenue Management
Chapter 6 Pricing and Revenue Management

2 What Makes Service Pricing Strategy Different (and Difficult)?
No ownership of services--hard for firms to calculate financial costs of creating an intangible performance Variability of inputs and outputs--how can firms define a “unit of service” and establish basis for pricing? Many services hard for customers to evaluate--what are they getting in return for their money? Importance of time factor--same service may have more value to customers when delivered faster Delivery through physical or electronic channels--may create differences in perceived value

3 Objectives of Pricing Strategies
Revenue and profit objectives Seek profit Cover costs Patronage and user base-related objectives Build demand Build a user base

4 The Pricing Tripod (Fig. 6.1)
Strategy Costs Competition Value to customer

5 Three Main Approaches to Pricing
Cost-Based Pricing Set prices relative to financial costs (problem: defining costs) Competition-Based Pricing Monitor competitors’ pricing strategy (especially if service lacks differentiation) Who is the price leader? (one firm sets the pace) Value-Based Relate price to value perceived by customer

6 Activity-Based Costing: Relating Activities to the Resources They Consume
Managers need to see costs as an integral part of a firm’s effort to create value for customers When looking at prices, customers care about value to themselves, not what production costs the firm Traditional cost accounting emphasizes expense categories, with arbitrary allocation of overheads ABC management systems examine activities needed to create and deliver service (do they add value?) Must link resource expenses to: variety of products produced complexity of products demands made by individual customers

7 Net Value = (Benefits – Outlays) (Fig. 6.3)
Effort Time e Perceived Outlays Perceived Benefits

8 Enhancing Gross Value Pricing Strategies to Reduce Uncertainty
service guarantees benefit-driven (pricing that aspect of service that creates value) flat rate (quoting a fixed price in advance) Relationship Pricing non-price incentives discounts for volume purchases discounts for purchasing multiple services Low-cost Leadership Convince customers not to equate price with quality Must keep economic costs low to ensure profitability at low price

9 Paying for Service: The Customer’s Perspective
Customer “expenditures” on service comprise both financial and non-financial outlays Financial costs: price of purchasing service expenses associated with search, purchase activity, usage Time expenditures Physical effort (e.g., fatigue, discomfort) Psychological burdens (mental effort, negative feelings) Negative sensory burdens (unpleasant sensations affecting any of the five senses)

10 Determining the Total Costs of a Service to the Consumer (Fig. 6.4)
Search Costs Price Operating Costs Related Monetary Costs Incidental Expenses Time Costs Purchase and Use Costs Physical Costs Psychological Costs Sensory Costs Necessary follow-up After Costs Problem solving

11 Trading off Monetary and Non- Monetary Costs (Fig. 6.5)
Which clinic would you patronize if you needed a chest x-ray (assuming all three clinics offer good quality) ? Clinic A Clinic B Clinic C Price $45 Located 1 hour away by car or transit Next available appointment is in 3 weeks Hours: Monday – Friday, 9am – 5pm Estimated wait at clinic is about 2 hours Price $85 Located 15 min away by car or transit Next available appointment is in 1 week Hours: Monday – Friday, 8am – 10pm Estimated wait at clinic is about minutes Price $125 Located next to your office or college Next appointment is in 1 day Hours: Mo –Sat, 8am – 10pm By appointment - estimated wait at clinic is about 0 to 15 minutes

12 Increasing Net Value by Reducing Non-financial Costs of Service
Reduce time costs of service at each stage Minimize unwanted psychological costs of service Eliminate unwanted physical costs of service Decrease unpleasant sensory costs of service

13 Revenue Management: Maximizing Revenue from Available Capacity at a Given Time
Based on price customization - charging different customers (value segments) different prices for same product Useful in dynamic markets where demand can be divided into different price buckets according to price sensitivity Requires rate fences to prevent customers in one value segment from purchasing more cheaply than willing to pay RM uses mathematical models to examine historical data and real time information to determine what prices to charge within each price bucket how many service units) to allocate to each bucket

14 The Strategic Levers of Revenue (Yield) Management
Quadrant 4: Continuing Care Hospitals Quadrant 3: Restaurants Golf Courses Unpredictable Quadrant 2: Hotel Rooms Airline Seats Rental Cars Cruise Lines Quadrant 1: Movies Stadiums/Arenas Function Space Predictable Duration Variable Fixed Price

15 Dealing with Common Customer Conflicts Arising from Revenue Management
Perceived Unfairness & Perceived Financial Risk Associated with Multi-Tier Pricing and Selective Inventory Availability Customer conflict can arise from: Marketing tools to reduce customer conflicts: Unfulfilled Inventory Commitment Unfulfilled Demand of Regular Customers Unfulfilled Price Expectation of Group Customers Change in the Nature of the Service Fenced Pricing Bundling Categorising High Published Price Well designed Customer Recovery Programme for Oversale Preferred Availability Policies Offer Lower Displacement Cost Alternatives Physical Segregation & Perceptible Extra Service Set Optimal Capacity Utilisation Level

16 Price Elasticity (Fig. 6.6)
De Di Price per unit of service Quantity of Units Demanded De : Demand is price elastic. Small changes in price lead to big changes in demand. Di : Demand for service is price inelastic. Big changes have little impact on demand.

17 Key Categories of Rate Fences (Table 6.2)
Examples Physical (Product-related) Fences Basic Product Class of travel (Business/Economy class) Size and furnishing of a hotel room Seat location in a theatre Amenities Free breakfast at a hotel, airport pick up etc. Free golf cart at a golf course Service Level Priority wait listing Increase in baggage allowances Dedicated service hotlines Dedicated account management team

18 Key Categories of Rate Fences (Table 6.2 cont’d)
Non Physical Fences Transaction Characteristics Time of booking or reservation Requirements for advance purchase Must pay full fare two weeks before departure Location of booking or reservation Passengers booking air tickets for an identical route in different countries are charged different prices Flexibility of ticket usage Fees/penalties for canceling or changing a reservation (up to loss of entire ticket price) Non refundable reservation fees

19 Key Categories of Rate Fences (Table 6.2 cont’d)
Non Physical Fences (cont’d) Consumption Characteristics Time or duration of use Early bird special in restaurant before 6pm Must stay over on Sat for airline, hotel Must stay at least five days Location of consumption Price depends on departure location, esp in international travel Prices vary by location (between cities, city centre versus edges of city)

20 Key Categories of Rate Fences (Table 6.2 cont’d)
Non Physical Fences (cont’d) Buyer Characteristics Frequency or volume of consumption Member of certain loyalty-tier with the firm get priority pricing, discounts or loyalty benefits Group membership Child, student, senior citizen discounts Affiliation with certain groups (e.g. Alumni) Size of customer group Group discounts based on size of group

21 Relating Price Buckets and Fences to the Demand Curve (Fig. 6.7)
First Class Full Fare Economy (No Restrictions) One-Week Advance Purchase One-Week Advance Purchase, Saturday Night Stayover 3-Week Advance Purchase, Saturday Night Stayover 3-Wk Adv. Prchs, Sat. Night Stay, No changes/refunds 3-Week Adv. Prchs, Sat. Night Stay., $100 for Changes Late Sales through Consolidators/ Internet, no refunds Capacity of Aircraft No. of Seats Demanded of 1st-class Cabin Price per Seat

22 Ethical Concerns in Pricing
Customers are vulnerable when service is hard to evaluate or they don’t observe work Many services have complex pricing schedules hard to understand difficult to calculate full costs in advance of service Unfairness and misrepresentation in price promotions misleading advertising hidden charges Too many rules and regulations customers feel constrained, exploited customers unfairly penalized when plans change

23 Pricing Issues: Putting Strategy into Practice (Table 6.3)
How much to charge? What basis for pricing? Who should collect payment? Where should payment be made? When should payment be made? How should payment be made? How to communicate prices?

24 Consumption follows the Timing of Payments (Research Insight 6.1)
Frequency of Health Club Visits Annual Payment Plan Semiannual Payment Plan Time Line Quarterly Payment Plan Monthly Payment Plan Source: John Gourville and Dilip Soman, “Pricing and the Psychology of Consumption,” Harvard Business Review, September 2002,

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