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A Demand based Model for the Advanced and Spot Pricing of Services

A Demand based Model for the Advanced and Spot Pricing of Services. Irene Ng Associate Professor of Marketing and Director, Centre for Service Research University of Exeter Business School, UK. Separation of Purchase and Consumption.

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A Demand based Model for the Advanced and Spot Pricing of Services

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  1. A Demand based Model for the Advanced and Spot Pricing of Services Irene Ng Associate Professor of Marketing and Director, Centre for Service Research University of Exeter Business School, UK

  2. Separation of Purchase and Consumption • Normative Economics and marketing literature assumes that a consumer obtains utility upon purchase • When there is separation between purchase and consumption, the valuation of the service is uncertain (state dependency utility) (Ng, 2007, 2008; Shugan & Xie 2000, 2001) • Stylized Fact: Due to the inseparability of productions and consumption, and the separation of purchase and consumption, the (advanced) pricing of services would need to take into account the valuation risk faced by buyers

  3. Capacity Constraint • Service Firms usually operate with fixed short term capacity constraint • Stylized Fact: Short-term capacity constraints result in buyers facing uncertainty in the service being available, if they choose to buy at consumption time. The pricing of services would need to take into account the unavailability risk faced by buyers Ng (2008), The Pricing & Revenue Management of Services: A Strategic Approach, Routledge Advances in Business & Management Studies

  4. Demand Distribution across a Service’s Valuable Life • Trade off between the buyer’s unavailability risk and valuation risk • the distribution of demand across the valuable life of the service becomes important in the firm’s pricing decision • firm faces uncertainty in demand distribution across time – the revenue management problem (accurate demand forecasting, coupled with dynamic optimization algorithms across time)

  5. Buyers’ erratic arrival times Buyers perceptual differences Probabilistic Stochastic Deterministic Buyers’ behaviour from firm’s pricing policy Nature of Advanced Demand

  6. Inter-dependence between demand at different times • Assume that there exists only two times in the service’s valuable life to sell – advanced time, denoting selling the service far in advance and spot time, denoting the selling of the service at a time close to consumption • If the advanced price is low, the discount from spot price might outweigh the valuation risk faced by spot buyers and similarly, if the spot price is low, advanced buyers might wait till spot to buy • Firm’s decision on price would also have an effect on the buyers (cf yms systems) • Extrapolate across multiple time periods – complex pricing decision

  7. Non-consumption Factor • the existence of a non-zero probability of non-consumption by advanced buyers provides a service firm with a unique opportunity not presented to goods firm i.e. the ability to sell the capacity that was already sold in advance – again at spot OR oversell in advance • Separation of purchase and consumption due to the inseparability of services result in a non-zero probability of advanced buyers not consuming, thus freeing up of capacity to be re-sold at spot. Pricing decisions have to take into account the non-consumption effect.

  8. Non-consumption Factor • The implications on the pricing decision are enormous. • Depending on • the demand distribution across time • the level of non-consumption • Capacity of the firm firms might be prepared to manipulate advanced and spot prices to optimize profits.

  9. The Simple Theoretical Model

  10. Model Assumptions • Perfect information. • The marginal cost of providing the service is negligible • The capacity has no salvage value after production/consumption. • The service under study is a pure service (with no attributes of a good), so the consumer, after consumption, has no ownership of anything tangible. • The firm will only sell if prices at spot and in advance are positive i.e. . • The firm can credibly commit to spot prices in advance (cf. Xie and Shugan 2001) • Buyers who buy in advance are guaranteed the availability of capacity at the time of consumption. • Capacity relinquished by advance buyers can be fully re-sold at spot (this assumption is relaxed in the next section). • The service is not transferable. • The firm is a monopoly.

  11. Impact on Price, Quantities and Profits

  12. Impact of Capacity Constraints

  13. Refunds • Two types of refunds • Seller Failure • Buyer Failure • Why offer buyer failure refund? • Png (1989), Shugan and Xie (2001) – obtain higher prices

  14. Model Extension with Refund

  15. Discussion • Offering Buyer-failure refund may be more profitable to the firm • Advanced prices may be lower, with a refund offer • Offering buyer-failure refund may be pareto optimal i.e. full insurance for capacity unavailability, full insurance against valuation AND at a lower price

  16. Conclusion • Study aims to provide a stylized model for service pricing for advanced demand • Platform for a more thorough understanding of pricing in services, across various service industries.

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