1. Chapter 10 Pricing and Customer Value
Qi Xu
Professor of Donghua University
Tel:

2. Outline Customer Value The Fundamentals of Pricing Strategies
Revenue Management & Customized Pricing
Mail-in-Rebate strategies
Dynamic Pricing in SCM
Delayed Pricing vs. Delayed Production

3. Customer Value
How should a company measure the value of its products or services?
The emphasis has moved from internal measures such as quality to customer satisfaction measures.
The supply chain has a huge impact on perceived customer value:
Prices vs. service?
Delivery speed vs. price?
Specialization or one-stop shopping?
Recall that responding to customer requirements is a basic part of supply chain management.
Customer value drives changes in the supply chain, and is a critical input in determining the type of supply chain for a particular product
Large inventories
High level of customization

4. The Dimensions of Customer Value
Conformance to requirements
Offer what the customer wants
Demand impacts the supply chain
Product Selection
A proliferation of options makes the supply chain difficult to manage
Three trends
Specialty stores (Starbucks, Subway)
Megastores (Wal-Mart, Target)
Specialized Megastores (Home Depot, OfficeMax)
Dealing with the proliferation:
Build-to-order
Centralized inventories
A fixed set of options

5. The Dimensions of Customer Value
Price and Brand
Pricing is a key part of the customer experience
The correct supply chain supports the correct price
Wal-mart
Brand works hand in hand with price
As the number of salespeople decreases, the value of brand increases
This is particularly true on the internet
Value Added Services
It is hard to compete on price alone
Value added services are on the rise due to
Commoditization of products
The need to get closer to the customer
Improving information technology
Relationships and Experiences
An increased connection between the firm and its customers
Dell manages the PC’s of large customers
3PL
The Sony store

6. Smart Pricing? Dell: Amazon Nikon, Sharp… Boise Cascade office
Same product is sold at a different price to different consumers (private/small or large business/government/academia/health care)
Price of the same product for the same industry varies
Amazon
Books.com had a lower price than Amazon 99% of the time, yet Amazon had 80% of the market in 2000 while Books.com only 2%
Nikon, Sharp…
Mail-In-Rebate
Boise Cascade office
Prices of 12,000 items sold on-line may change as often as daily

7. Revenue Management Example: A cruise ship with C=400 identical cabins
The Price-Quantity relationship

8. Revenue Management
2000
Price
P=2000-2Q
1000
No. seats

9. Revenue Management Example:
A cruise ship with C=400 identical cabins
The Price-Quantity relationship
What is the price that the company should charge to maximize revenue?

10. Revenue Management
Price
Revenue=480,000
P0=1200
C=400
No. seats

11. Revenue Management Money on the Table=160,000 P0=1200 C=400 Price
No. seats

12. Revenue Management
Price
P2=1600
Q2=200
No. seats

13. Revenue Management
Price
P1=1200
C=400
No. seats

14. Revenue Management Revenue=1600(200) + 1200(400-200)=560,000 P2=1600
Price
Revenue=1600(200) ( )=560,000
P2=1600
P1=1200
Q2=200
Q1 =400
No. seats

15. Revenue Management
Can we increase revenue more?

16. Revenue Management
Price
P3=1800
Revenue=1800(100) ( ) ( )=580,000
P2=1600
P1=1200
Q2=200
Q3=100
Q1 =400
No. seats

17. Sensitivity to Duration Sensitivity to Flexibility
How can the firm prevent customers from moving from one class to another?
Sensitivity to
Price
Sensitivity to Duration
Sensitivity to Flexibility
High Low
Low
High
Leisure
Travelers No
Demand No
Offer
Business
Travelers

18. Revenue Management
“Allocating the right type of capacity to the right kind of customer at the right price so as to maximize revenue or yield”
Traditional Industries:
Airlines
Hotels
Rental Car Agencies
Retail Industry

19. Traditional Requirements
Perishable inventory
Limited capacity
Ability to segment markets
early-bird booking
over the weekend
Product sold in advance
Fluctuating demand

20. Airline Revenue Management
Two components of airline revenue maximization:
Customized Pricing:
Various “fare products” offered at different prices for travel in the same O-D market
Yield Management (YM):
Determines the number of seats available to each “fare class” on a flight, by setting booking limits on low fare seats

21. Revenue Management: Yield Management
There are only two price classes
Leisure: (f2) $100 per ticket
Business: (f1) $250 per ticket
Total available capacity= 80 seats
Distribution of demand for business class is known

22. Business Class: Demand Distribution

23. Revenue Management: Capacity Allocation
There are only two price classes
Leisure: (f2) $100 per ticket
Business: (f1) $250 per ticket
Total available capacity= 80 seats
Distribution of demand for business class is known
Enough demand for the leisure class

24. Revenue Management: Capacity Allocation
Objective: How many seats to allocate to the business class to maximize expected revenue

25. Expected Revenue

26. Expected Revenue

27. Revenue Management: Capacity Allocation
Optimality Condition: Choose the number of seats for the business class such that marginal revenue from each class is the same

28. Optimality Condition

29. Optimality Condition
Marginal Revenue Leisure

30. Optimality Condition
Marginal Revenue Leisure

31. Benefits of Revenue Management in the Airline Industry
Evidence of airline revenue increases of 4 to 6 percent:
With effectively no increase in flight operating costs
RM allows for tactical matching of demand vs. supply:
Booking limits can help channel low-fare demand to empty flights
Protect seats for highest fare passengers on forecast full flights

34. Mail-in-Rebate
What is the manufacturer trying to achieve with the rebate?
Why the manufacturer and not the retailer?
Should the manufacturer reduce the wholesale price instead of the rebate?
Are there other strategies that can be used to achieve the same effect?

35. Mail-in-Rebate A Retailer and a manufacturer.
Retailer faces customer demand.
Retailer orders from manufacturer.
Variable Production Cost=$200
Selling Price=?
Retailer
Manufacturer
Wholesale Price=$900

36. Demand-Price Relationship
10000
Demand
P= Q
2000
Price

37. Retailer Expected Profit (No Rebate)

38. Retailer Expected Profit (No Rebate)
$1,370,096

39. Manufacturer Profit (No Rebate)

40. Manufacturer Profit (No Rebate)
$1,750,000

41. Retailer Expected Profit ($100 Rebate)

42. Retailer Expected Profit ($100 Rebate)
$1,644,115

43. Manufacturer Profit ($100 Rebate)

44. Manufacturer Profit ($100 Rebate)
$1,810,392

45. Retailer Expected Profit (Reduced Wholesale Price $100 )

46. Retailer Expected Profit (Reduced Wholesale Price $100 )
$1,654,508

47. Manufacturer Profit (Reduced Wholesale Price $100)

48. Manufacturer Profit (Reduced Wholesale Price $100)
$1,800,000

49. Mail-in-Rebate

50. Mail-in-Rebate

51. Managerial Insights
Mail in Rebate allows supply chain partners to move away from sequential strategies toward global optimization
Provides retailers with upside incentive
Mail in Rebate outperforms wholesale price discount for manufacturer
Other advantages of rebates:
Not all customers will remember to mail them in
Gives manufacturer better control of pricing

52. Smart Pricing Customized Pricing Revenue Management Techniques
Distinguish between customers according to their price sensitivity
Influence retailer pricing strategies
Move supply chain partners toward global optimization

53. Smart Pricing Dynamic Pricing
Changing prices over time without necessarily distinguishing between different customers
Find the optimal trade-off between high price and low demand versus low price and high demand

54. When does Dynamic Pricing Provide Significant Profit Benefit?
Limited Capacity
Demand Variability
Seasonality in Demand Pattern
Short Planning Horizon

55. The Internet makes Smart Pricing Possible
Low Menu Cost
Low Buyer Search Cost
Visibility
To the back-end of the supply chain allows to coordinate pricing, production and distribution
Customer Segmentation
Difficult in conventional stores and easier on the Internet
Testing Capability

56. A Word of Caution
Amazon.com experimented with dynamic pricing – customers responded negatively
Coca-Cola distributors rebelled against a seasonal pricing scheme
Opaque fares (priceline.com, hotwire.com)
Determining the correct mix of opaque and regular fares is difficult.