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