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  • 1. Exploring Business Models: Pricing and Revenue Management
  • 2. 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
  • 3. 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
  • 4. Effective Pricing Is Central to Financial Success
  • 5. 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
  • 6. 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 costs Cover 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
  • 7. Pricing Strategy Stands on Three Legs
  • 8. The Pricing Tripod Pricing strategy Costs Competition Value to customer
  • 9. 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
  • 10. 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
  • 11. 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
  • 12. Value-Based Pricing Understanding 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
  • 13. 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
  • 14. 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)
  • 15. Defining Total User Costs Physical effort Psychological burdens Sensory burdens Necessary follow-up Problem solving Incidental expenses Operating costs Purchase Time Money * Includes all five cost categories Search costs* Purchase and service encounter costs After costs*
  • 16. Trading Off Monetary and Non-monetary Costs
  • 17. Revenue Management: What It Is and How It Works
  • 18. 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
  • 19. 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
  • 20. 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
  • 21. 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)
  • 22. 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
  • 23. Relating Price Buckets and Fences to Demand Curve Price per seat Capacity of 1st class cabin Capacity of aircraftNo. 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)
  • 24. Ethical Concerns in Service Pricing
  • 25. 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
  • 26. Putting Service Pricing into Practice
  • 27. 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?
  • 28. 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