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  1. 1. Exploring Business Models: Pricing and Revenue Management
  2. 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. 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. 4. Effective Pricing Is Central to Financial Success
  5. 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. 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. 7. Pricing Strategy Stands on Three Legs
  8. 8. The Pricing Tripod Pricing strategy Costs Competition Value to customer
  9. 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. 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. 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. 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. 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. 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. 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. 16. Trading Off Monetary and Non-monetary Costs
  17. 17. Revenue Management: What It Is and How It Works
  18. 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. 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. 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. 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. 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. 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. 24. Ethical Concerns in Service Pricing
  25. 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. 26. Putting Service Pricing into Practice
  27. 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. 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