6 pricing and revenue management.ppt

Slide ©2004 by Christopher Lovelock and Jochen Wirtz Services Marketing 5/E 6 - 1
Chapter 6
Pricing and Revenue
Management

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

Objectives of Pricing Strategies
 Revenue and profit objectives
 Seek profit
 Cover costs
 Patronage and user base-related objectives
 Build demand
 Build a user base

The Pricing Tripod (Fig. 6.1)
Pricing Strategy
Costs
Competition
Value to customer

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

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

Perceived
Benefits
Time
e
Effort
Net Value = (Benefits – Outlays)
(Fig. 6.3)
Perceived
Outlays

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

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)

Determining the Total Costs of a Service
to the Consumer (Fig. 6.4)
Price
Related Monetary
Costs
Time Costs
Physical Costs
Psychological
Costs
Sensory Costs
Necessary
follow-up
Problem
solving
Operating Costs
Incidental
Expenses
Purchase and
Use Costs
Search Costs
After Costs

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) ?
 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
Clinic B
 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
Clinic C
Clinic A
 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

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

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 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

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

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

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

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

Key Categories of Rate Fences (Table 6.2 cont’d)
Non Physical 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)
Non refundable reservation fees

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

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

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

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?

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

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