Pricing and Revenue Management

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
• Managers need toConsume an integral part of a
see costs as
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 Perceived
Benefits Outlays

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)
Search Costs Price Operating Costs
Related Monetary
Costs Incidental
Expenses
Time Costs
Purchase and Physical Costs
Use 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  Price $85  Price $125
 Located 1 hour away  Located 15 min away  Located next to your
by car or transit by car or transit office or college
 Next available  Next available  Next appointment is
appointment is in 3 appointment is in 1 in 1 day
weeks week  Hours: Mo –Sat, 8am
 Hours: Monday –  Hours: Monday – – 10pm
Friday, 9am – 5pm Friday, 8am – 10pm  By appointment -
 Estimated wait at  Estimated wait at estimated wait at
clinic is about 2 hours clinic is about 30 - 45 clinic is about 0 to 15
minutes 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 buckets according
to price sensitivity
• Requires rate fences to prevent customers in one
value segment from purchasing more cheaply
than willing to pay
• RM uses mathematical models to examine

14. The Strategic Levers of
Revenue (Yield) Management
Price
Fixed Variable
Quadrant 1: Quadrant 2:
Duration
Predictable Movies Hotel Rooms
Stadiums/Arenas Airline Seats
Function Space Rental Cars
Cruise Lines
Quadrant 3: Quadrant 4:
Unpredictable Restaurants Continuing Care
Golf Courses Hospitals

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

16. Price Elasticity (Fig. 6.6)
Price per Di
unit of De
service
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)
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 pick up etc.
Free golf cart at a golf course
Service Level Priority wait listing
Increase in baggage allowances
Dedicated service hotlines
Dedicated account management team

18. Key Categories of Rate Fences (Table 6.2
cont’d)
Non Physical Fences
Transaction Characteristics
Time of booking or  Requirements for advance purchase
reservation  Must pay full fare two weeks before departure
Location of booking or  Passengers booking air tickets for an
reservation identical route in different countries are
charged different prices
Flexibility of ticket  Fees/penalties for canceling or changing a
usage reservation (up to loss of entire ticket price)
 Non refundable reservation fees

19. Key Categories of Rate Fences (Table 6.2
cont’d)
Non Physical Fences (cont’d)
Consumption Characteristics
Time or duration of  Early bird special in restaurant before 6pm
use  Must stay over on Sat for airline, hotel
 Must stay at least five days
Location of  Price depends on departure location, esp in
consumption international travel
 Prices vary by location (between cities, city
centre versus edges of city)

20. Key Categories of Rate Fences (Table 6.2
cont’d)
Non Physical Fences (cont’d)
Buyer Characteristics
Frequency or volume  Member of certain loyalty-tier with the firm get
of consumption priority pricing, discounts or loyalty benefits
Group membership  Child, student, senior citizen discounts
 Affiliation with certain groups (e.g. Alumni)
Size of customer  Group discounts based on size of group
group

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
of 1st-class of Aircraft
Cabin
No. of Seats Demanded

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

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

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