CHAPTER 6: Setting Prices and Implementing Revenue Management

Effective Pricing

It is Central to Financial Success

What makes Service Pricing Different and Difficult?

Harder to calculate financial costs of creating a service process or performance than a manufactured good

Variability of inputs and outputs: 

• How can firms define a “unit of service” and establish basis for pricing?

• Customers find service pricing difficult to understand, risky, and sometimes even unethical

• Importance of time factor – same service may have more value to customers when delivered faster

Importance of time factor

Same service may have more value to customers when delivered faster

Revenue and Profit Objectives

• Seek profit

• Cover costs

Patronage and User-Based Objectives

• Build demand

  • Demand maximization

  • Full capacity utilization

• Build a user base

  • Stimulate trial and adoption of new service

  • Build market share/large user base

Build Demanf

• Demand maximization

• Full capacity utilization

Build a user base

• Stimulate trial and adoption of new service

• Build market share/large user base

The pricing tripod

Pricing strategy = Costs, Competition, Value to customers

Three Main Approches to Pricing

Cost-Based Pricing, Value- Based Pricing, Competition-Based Pricing

Traditional costing approach

• Emphasizes expense categories (arbitrary overheads allocation)

• May result in reducing value generated for customers

ABC (Activity-Based Costing) Management system

• Link resource expenses to variety and complexity of goods/services produced

• Yields accurate cost information

Net Value Pricing

• Perceived Benefits to Customer (Gross Value) minus All Perceived Outlays (Money, Time, Mental/Physical Effort)

Consumer surplus

Difference between price paid and amount customer would have been willing to pay in absence of other options

Competing services

Are then evaluated via comparison of net value

Strategies for Enhancing Net Value

Enhance gross value - benefits delivered
Reduce costs incurred

Enhance gross value – benefits delivered

• Add benefits to core product

• Enhance supplementary service

• Manage perceptions of benefits delivered

Reduce costs incurred by

• Reducing monetary costs of acquisition and usage

• Cutting amount of time required to evaluate, buy, use service

• Lowering effort associated with purchase and use

Purchase and Service Encounter Costs

Money
Time
Physical Effort
Psychological Burdens
Sensory Burdens

Post Purchase Costs

Necessary Follow-Up
Problem Solving

Price competition increases due to:

• Increasing competition

• Increase in substituting offers

• Wider distribution of competitor

• Increasing surplus capacity in the industry

However under these circumstances, price competition can decrease:

• High non-price-related costs of using alternatives

• Personal relationships matter

• Switching costs are high

• Time and location specificity reduces choice

• Managers should examine all related financial and non-monetary costs

Revenue management (RM)

Is price customization 

• Charge different value segments different prices for same product based on price sensitivity

Maximizing Revenue from Available Capacity at a Given Time

• High fixed cost structure

• Relatively fixed capacity

• Perishable inventory

• Variable and uncertain demand

• Varying customer price sensitivity

Rate fences

Deter customers willing to pay more from trading down to lower prices (minimize consumer surplus)

Price Elasticity

Percentage change in demand/ Percentage change in price

Product-Related Fences

Basic Product
Amenities
Service Level

Transaction Characteristics

Time-bookking or reservation
Location of booking or reservation
Flexibility of ticket usage

Consumption Characteristics

Time or duration of use
Location of consumption

Buyer Characteristics

Frequency or volume of consumption
Group membership
Size of customer group

Ethical Concerns in Service Pricing

• 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

Putting Service Pricing into Practice

1. How much to charge?

2. What basis for pricing?

3. Who should collect payment?

4. Where should payment be made?

5. When should be payment be made?"

6. How should payment be made?

7. How to communicate price?

Pricing objectives can include

Generating revenues and profit, building demand, and developing user base

Three main foundations to pricing a service

• Cost-based pricing

• Competition-based pricing

• Value-based pricing
  
  Firm must be aware of competitive pricing but may be harder to compare for services than for goods

Revenue management

• Maximizes revenue from a given capacity at a point in time

• Manage demand and set prices for each segment closer to perceived value

• Use of rate fences

Ethical issues in pricing

• Complex pricing schedules

• Unfairness and misrepresentation in advertising 

• Hidden charges

• Too many rules and regulations