Chapter 6

Pricing and Revenue Management

Slide 2004 by Christopher Lovelock and Jochen Wirtz

Services Marketing 5/E

6- 1

What Makes Service Pricing Strategy Different (and Difficult)?

 No ownership of services--hard for firms to calculate

financial costs of creating an intangible performance unit of service and establish basis for pricing? are they getting in return for their money? value to customers when delivered faster

 Variability of inputs and outputs--how can firms define a  Many services hard for customers to evaluate--what  Importance of time factor--same service may have more  Delivery through physical or electronic channels--may
create differences in perceived value

Slide 2004 by Christopher Lovelock and Jochen Wirtz

Services Marketing 5/E

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Objectives of Pricing Strategies

 Revenue and profit objectives

 Seek profit  Cover costs

 Patronage and user base-related objectives

 Build demand  Build a user base

Slide 2004 by Christopher Lovelock and Jochen Wirtz

Services Marketing 5/E

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The Pricing Tripod (Fig. 6.1)

Pricing Strategy

Competition Costs
Slide 2004 by Christopher Lovelock and Jochen Wirtz Services Marketing 5/E

Value to customer
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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

Slide 2004 by Christopher Lovelock and Jochen Wirtz

Services Marketing 5/E

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Activity-Based Costing: Relating Activities to the Resources They Consume

 Managers need to see costs as an integral part of a firms

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?)
 variety of products produced  complexity of products  demands made by individual customers
Services Marketing 5/E

 Must link resource expenses to:

Slide 2004 by Christopher Lovelock and Jochen Wirtz

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Net Value = (Benefits Outlays)

(Fig. 6.3)

Effort Time

Perceived Benefits

Perceived Outlays

Slide 2004 by Christopher Lovelock and Jochen Wirtz

Services Marketing 5/E

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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

Slide 2004 by Christopher Lovelock and Jochen Wirtz

Services Marketing 5/E

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Paying for Service: The Customers 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)

Slide 2004 by Christopher Lovelock and Jochen Wirtz

Services Marketing 5/E

6- 9

Determining the Total Costs of a Service to the Consumer (Fig. 6.4)

Search Costs Price Related Monetary Costs Time Costs Purchase and Use Costs Physical Costs Psychological Costs Sensory Costs Necessary follow-up Problem solving
Slide 2004 by Christopher Lovelock and Jochen Wirtz Services Marketing 5/E

Operating Costs Incidental Expenses

After Costs

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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
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

Clinic B
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 C
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
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Slide 2004 by Christopher Lovelock and Jochen Wirtz

Services Marketing 5/E

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

Slide 2004 by Christopher Lovelock and Jochen Wirtz

Services Marketing 5/E

6 - 12

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

and real time information to determine  what prices to charge within each price bucket  how many service units) to allocate to each bucket

segment from purchasing more cheaply than willing to pay

 RM uses mathematical models to examine historical data

Slide 2004 by Christopher Lovelock and Jochen Wirtz

Services Marketing 5/E

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The Strategic Levers of Revenue (Yield) Management

Price Fixed Duration
Quadrant 1: Predictable
Movies Stadiums/Arenas Function Space

Variable
Quadrant 2:
Hotel Rooms Airline Seats Rental Cars Cruise Lines

Quadrant 3: Unpredictable
Restaurants Golf Courses

Quadrant 4:
Continuing Care Hospitals

Slide 2004 by Christopher Lovelock and Jochen Wirtz

Services Marketing 5/E

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Dealing with Common Customer Conflicts Arising from Revenue Management

Customer conflict can arise from: Perceived Unfairness & Perceived Financial Risk Associated with Multi-Tier Pricing and Selective Inventory Availability Unfulfilled Inventory Commitment Unfulfilled Demand of Regular Customers Unfulfilled Price Expectation of Group Customers Change in the Nature of the Service Marketing tools to reduce customer conflicts: 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

Slide 2004 by Christopher Lovelock and Jochen Wirtz

Services Marketing 5/E

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Price Elasticity (Fig. 6.6)

Price per unit of service

Di De

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.

Slide 2004 by Christopher Lovelock and Jochen Wirtz

Services Marketing 5/E

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Key Categories of Rate Fences (Table 6.2)

Rate Fences Examples

Physical (Product-related) Fences Basic Product

Amenities Service Level

Class of travel (Business/Economy class) Size and furnishing of a hotel room Seat location in a theatre Free breakfast at a hotel, airport pick up etc. Free golf cart at a golf course Priority wait listing Increase in baggage allowances Dedicated service hotlines Dedicated account management team

Slide 2004 by Christopher Lovelock and Jochen Wirtz

Services Marketing 5/E

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Key Categories of Rate Fences (Table 6.2 contd)

Non Physical Fences Transaction Characteristics Time of booking or reservation Location of booking or reservation Flexibility of ticket usage

 Requirements for advance purchase  Must pay full fare two weeks before departure  Passengers booking air tickets for an
identical route in different countries are charged different prices

 Fees/penalties for canceling or changing a reservation (up to loss of entire ticket price)  Non refundable reservation fees

Slide 2004 by Christopher Lovelock and Jochen Wirtz

Services Marketing 5/E

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Key Categories of Rate Fences (Table 6.2 contd)

Non Physical Fences (contd) 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  Price depends on departure location, esp in international travel  Prices vary by location (between cities, city
centre versus edges of city)

Location of consumption

Slide 2004 by Christopher Lovelock and Jochen Wirtz

Services Marketing 5/E

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Key Categories of Rate Fences (Table 6.2 contd)

Non Physical Fences (contd) Buyer Characteristics Frequency or volume of consumption Group membership

 Member of certain loyalty-tier with the firm get

priority pricing, discounts or loyalty benefits

 Child, student, senior citizen discounts  Affiliation with certain groups (e.g. Alumni)  Group discounts based on size of group

Size of customer group

Slide 2004 by Christopher Lovelock and Jochen Wirtz

Services Marketing 5/E

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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 of 1st-class Cabin

Capacity of Aircraft

No. of Seats Demanded

Services Marketing 5/E

Slide 2004 by Christopher Lovelock and Jochen Wirtz

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Ethical Concerns in Pricing

 Customers are vulnerable when service is hard to evaluate

or they dont observe work

 Many services have complex pricing schedules

 hard to understand  difficult to calculate full costs in advance of service  misleading advertising  hidden charges

 Unfairness and misrepresentation in price promotions  Too many rules and regulations
 customers feel constrained, exploited  customers unfairly penalized when plans change

Slide 2004 by Christopher Lovelock and Jochen Wirtz

Services Marketing 5/E

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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?
Slide 2004 by Christopher Lovelock and Jochen Wirtz Services Marketing 5/E

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(Research Insight 6.1)

Consumption follows the Timing of Payments

Frequency of Health Club Visits

Annual Payment Plan

Quarterly Payment Plan

Frequency of Health Club Visits

Semiannual Payment Plan

Monthly Payment Plan

Time Line
Source: John Gourville and Dilip Soman, Pricing and the Psychology of Consumption, Harvard Business Review, September 2002, 90-96.

Time Line

Slide 2004 by Christopher Lovelock and Jochen Wirtz

Services Marketing 5/E

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