pricing
Post on 13-May-2015
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Exploring Business Models: Pricing and Revenue Management
Learning Objectives
Determine three foundations to pricing a service
Compare cost based to activity based pricing
Manage customer perceptions of non-monetary costs of obtaining service
Examine how revenue management can improve profitability
Reflect on the key ethical concerns in service pricing
Study seven key questions for price schedule design
Background Pricing of services is complicated Eg diff fare schedules for a full price aircraft,
tuition fees etc Key goal is to manage revenues in certain
way that supports firms profitability objectives Real challenges are to price services for
which calculating unit costs are difficult and allocating fixed costs is complex
Increasingly customers complain of pricing schedules which are confusing and unfair
Effective Pricing Is Central to Financial Success
What Makes Service Pricing Strategy Different and Difficult?
Marketing- depends upon good business model and brings revenue
Harder to calculate financial costs than a manufactured good- no ownership of services
Difficulty in defining a “unit of service”
Services hard to evaluate
Customers may be prepared to pay more for faster delivery
Delivery through physical or electronic channels—may create differences in perceived value
Alternative Objectives for Pricing
Revenue and profit objectives Seek profit Make largest possible cont or profit Achieve specific target level but no max profit Cover costsCover fully allocated costs, incremental costs
Patronage and user-based objectives Build demand-maximize demand, full capacity
utilization Build a user base- stimulate trial and adoption of
service, build market share or large user base
Pricing Strategy Stands on Three Legs
The Pricing Tripod
Pricing strategy
CostsCompetition
Value to customer
The Pricing Tripod
Costs: A firm needs to recover usually impose
a min price for a specific service offering and
the customers perceived value of the offering
sets a maximum or ceiling
Price: charged by competitors for similar or
substitute services typically determines where
the price should be set
Objectives : determine where actual prices
should be set given the feasible range
provided by the tripod analysis
Cost-Based Pricing: Traditional vs. Activity-Based Costing
Traditional costing approach Labour and infrastructure costs are considered fixed costs Service firms have higher ratio of fixed to variable costs
found in manufacturing Cost reduction decisions often cut these costs which leads
to reduced service levels and unhappy customers Activity-based costing (ABC)
Sets of delivery activities and related costs Firms can pinpoint profitability of different services,
channels etc When looking at prices, customers care about value
to themselves, not what service production costs the firm
Competition-Based Pricing When customers don’t see a difference between
competitive offerings, they choose the cheapest Price competition is reduced when
Non- price related costs of using competing alternatives are high
Personal relationships matter Eg hairdresser, family medical care
Switching costs are high Time and location specificity reduce choice
When competing on price take into account the entire cost to customers including: All related financial and non-monetary costs PLUS
switching costs Compare this cost to the competition
Value-Based PricingUnderstanding Net Value
Customers evaluate competition by comparing their perceived benefits to their perceived outlays
Net value= Perceived benefits-Perceived costs,+ve diff= greater value
Service pricing strategies should enhance perceived value by: Reducing uncertainty Relationship enhancement Low cost leadership Manage value perception
Perceived benefits
Time e
Effort
Perceived outlays
Service pricing strategy- enhance value by
• If customers unsure of value- they will remain with the same supplier or not change at all
• Benefit driven pricing and flat rate pricing
Reducing uncertainty
• Discounts: for new customers ,not very attractive
• Creative schemes: price and non price reqd, give vol discounts, pricing when two or more is bought together
Relationship enhancement
• Low priced services- appeal to customers with budget issues
• Should convince customers that low price not means poor quality but good value. Eg SpiceJet,Jetlite
Cost leadership
• Value is subjective, customers lack expertise to assess the quality and value they receive
• Credence services for which – diff to assess quality of service ,consultants must communicate time, research, professional expertise and attention
Managing value perception
Reduce Related Monetary and Non-Monetary Costs
Incremental financial outlays Includes the price of purchasing service and other
expenses Expenses associated with search, purchase activity,
usage E.g. Two theatre tickets also requires the cost of parking,
babysitters etc.
Non-monetary costs Time costs: time usage Physical costs: fatigue and discomfort Psychological (mental) costs: mental effort, perceived
risk, cognitive dissonance, fear etc Sensory costs (unpleasant sights, sounds, feel, tastes, smells)
Defining Total User Costs
Physical effort
Psychological burdens
Sensory burdens
Necessary follow-up
Problemsolving
Incidental expenses
Operating costs
Purchase
Time
Money
* Includes all five cost categories
Search costs*
Purchase and service encounter costs
After costs*
Trading Off Monetary and Non-monetary Costs
Revenue Management: What It Is and How It Works
Revenue Management (RM)
Sophisticated approach to manage supply and demand under varying degrees of constraint- sets prices according to predicted demand levels among different market segments
RM charges more for customers booking service closer to time of consumption instead of on a first come first served basis Charge different value segments different prices for same product
Predicts how many customers will use a given service at a specific time at each of several different price levels and then allocates capacity at each level or price bucket
If booking pace for a higher-paying segment is stronger than expected, additional capacity is allocated to this segment and taken away from the lowest- paying segment
Rate fences allow customers to self segment on the basis of service characteristics and willingness to pay.
This helps companies restrict lower prices to customers willing to accept certain restrictions
Key Categories of Rate Fences
Rate Fences 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 pickup, etc.
Free golf cart at a golf course
Service level Priority wait-listing
Increase in baggage allowances
Dedicated service hotlines
Dedicated account management team
Key Categories of Rate Fences (2)Table 5.2
Nonphysical 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)
Nonrefundable reservation fees
Key Categories of Rate Fences
Nonphysical Fences (cont’d)
Consumption Characteristics
Time or duration of use
Early-bird special in restaurant before 6PM
Must stay over on Saturday for airline, hotel
Must stay at least 5 days
Location of consumption
Price depends on departure location, especially in international travel
Prices vary by location (between cities, city centre versus edges of city)
Key Categories of Rate Fences Table 5.2
Nonphysical 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
Relating Price Buckets and Fences toDemand Curve
Price per seat
Capacity of 1st class cabin
Capacity of aircraft
No. of seats demanded
1st class
Full fare economy (no restrictions)
1 - week advance purchase
1 - week advance purchase, Saturday night stay
3 - week advance purchase, Saturday night stay
Specified flights, book on Internet, no changes/refunds
Late sales through consolidators/Internet, no refunds
3-week advance purchase, Saturday night stay, $100 for changes
* Dark areas denote amount of consumer surplus (goal of segmented pricing is to reduce this)
Ethical Concerns in Service Pricing
Designing Fairness into Revenue Management Design clear, logical, and fair price schedules and
fences
Use high published prices and present fences as opportunities for discounts rather than quoting lower prices and using fence as basis to impose surcharges
Communicate consumer benefits of revenue management
Use bundling to “hide” discounts
Take care of loyal customers
Use service recovery to compensate for overbooking
Putting Service Pricing into Practice
Pricing Issues: Putting Strategy into Practice
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?
Summary
The three foundations to pricing a service are costs, competition and value to customer
Activity based pricing is better than traditional pricing approaches
Incremental financial outlays and non-monetary such as physical effort play a role in customers price perception
Revenue management can improve profitability by allocating service capacity to high paying customers and creating restrictions for low paying customers
Key ethical concerns in service pricing rest on clear, logical and fair pricing
There are seven key questions for price schedule design
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