Chapter 6

1. 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) Pricing Strategy Competition Costs 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) Price Search Costs 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 30 - 45 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 bucketsaccording to price sensitivity • Requires rate fencesto 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 Price Duration Fixed Variable Quadrant 1: Movies Stadiums/Arenas Function Space Quadrant 2: Hotel Rooms Airline Seats Rental Cars Cruise Lines Predictable Quadrant 3: Restaurants Golf Courses Quadrant 4: Continuing Care Hospitals Unpredictable

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

16. Price Elasticity (Fig. 6.6) Price per unit of service Di De De Di 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)

18. Key Categories of Rate Fences (Table 6.2 cont’d)

19. Key Categories of Rate Fences (Table 6.2 cont’d)

20. Key Categories of Rate Fences (Table 6.2 cont’d)

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

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. 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? Pricing Issues: Putting Strategy into Practice (Table 6.3)

24. Consumption follows the Timing of Payments (Research Insight 6.1) Quarterly Payment Plan Annual Payment Plan Frequency of Health Club Visits Semiannual Payment Plan Monthly Payment Plan Frequency of Health Club Visits Time Line Time Line Source: John Gourville and Dilip Soman, “Pricing and the Psychology of Consumption,” Harvard Business Review, September 2002, 90-96.