2003 Simchi-Levi, Kaminsky, Simchi-Levi. Outline. Custome

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Pricing and Customer Value
David Simchi-Levi Philip Kaminsky Edith
Simchi-Levi
Phil Kaminskykaminsky_at_ieor.berkeley.edu
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Outline

• Customer Value
• The Fundamentals of Pricing Strategies
• Revenue Management Customized Pricing
• Mail-in-Rebate strategies
• Dynamic Pricing in SCM
• Delayed Pricing vs. Delayed Production

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Customer Value

• How should a company measure the value of its
  products or services?
• The emphasis has moved from internal measures
  such as quality to customer satisfaction
  measures.
• The supply chain has a huge impact on perceived
  customer value
• Prices vs. service?
• Delivery speed vs. price?
• Specialization or one-stop shopping?
• Recall that responding to customer requirements
  is a basic part of supply chain management.
• Customer value drives changes in the supply
  chain, and is a critical input in determining the
  type of supply chain for a particular product
• Large inventories
• High level of customization

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The Dimensions of Customer Value

• Conformance to requirements
• Offer what the customer wants
• Demand impacts the supply chain
• Product Selection
• A proliferation of options makes the supply chain
  difficult to manage
• Three trends
• Specialty stores (Starbucks, Subway)
• Megastores (Wal-Mart, Target)
• Specialized Megastores (Home Depot, OfficeMax)
• Dealing with the proliferation
• Build-to-order
• Centralized inventories
• A fixed set of options

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The Dimensions of Customer Value

• Price and Brand
• Pricing is a key part of the customer experience
• The correct supply chain supports the correct
  price
• Wal-mart
• Brand works hand in hand with price
• As the number of salespeople decreases, the value
  of brand increases
• This is particularly true on the internet
• Value Added Services
• It is hard to compete on price alone
• Value added services are on the rise due to
• Commoditization of products
• The need to get closer to the customer
• Improving information technology
• Relationships and Experiences
• An increased connection between the firm and its
  customers
• Dell manages the PCs of large customers
• 3PL
• The Sony store

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Smart Pricing?

• Dell
• Same product is sold at a different price to
  different consumers (private/small or large
  business/government/academia/health care)
• Price of the same product for the same industry
  varies
• Amazon
• Books.com had a lower price than Amazon 99 of
  the time, yet Amazon had 80 of the market in
  2000 while Books.com only 2
• Nikon, Sharp
• Mail-In-Rebate
• Boise Cascade office
• Prices of 12,000 items sold on-line may change as
  often as daily

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Revenue Management

• Example
• A cruise ship with C400 identical cabins
• The Price-Quantity relationship

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Revenue Management
2000
Price
P2000-2Q
1000
No. seats
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Revenue Management

• Example
• A cruise ship with C400 identical cabins
• The Price-Quantity relationship
• What is the price that the company should charge
  to maximize revenue?

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Revenue Management
Price
Revenue480,000
P01200
C400
No. seats
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Revenue Management
Price
Money on the Table160,000
P01200
C400
No. seats
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Revenue Management
Price
P21600
Q2200
No. seats
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Revenue Management
Price
P11200
No. seats
C400
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Revenue Management
Price
Revenue1600(200) 1200(400-200)560,000
P21600
P11200
Q2200
No. seats
Q1 400
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Revenue Management

• Can we increase revenue more?

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Revenue Management
Price
P31800
Revenue1800(100) 1600(200-100)
1200(400-200)580,000
P21600
P11200
Q2200
No. seats
Q1 400
Q3100
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How can the firm prevent customers from moving
from one class to another?

Leisure Travelers
No Demand
Business Travelers
No Offer
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Revenue Management

• Allocating the right type of capacity to the
  right kind of customer at the right price so as
  to maximize revenue or yield
• Traditional Industries
• Airlines
• Hotels
• Rental Car Agencies
• Retail Industry

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Traditional Requirements

• Perishable inventory
• Limited capacity
• Ability to segment markets
• early-bird booking
• over the weekend
• Product sold in advance
• Fluctuating demand

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Airline Revenue Management

• Two components of airline revenue maximization
• Customized Pricing
• Various fare products offered at different
  prices for travel in the same O-D market
• Yield Management (YM)
• Determines the number of seats available to each
  fare class on a flight, by setting booking
  limits on low fare seats

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Revenue ManagementYield Management

• There are only two price classes
• Leisure (f2) 100 per ticket
• Business (f1) 250 per ticket
• Total available capacity 80 seats
• Distribution of demand for business class is known

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Business Class Demand Distribution
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Revenue ManagementCapacity Allocation

• There are only two price classes
• Leisure (f2) 100 per ticket
• Business (f1) 250 per ticket
• Total available capacity 80 seats
• Distribution of demand for business class is
  known
• Enough demand for the leisure class

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Revenue ManagementCapacity Allocation

• Objective How many seats to allocate to the
  business class to maximize expected revenue

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Expected Revenue
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Expected Revenue
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Revenue ManagementCapacity Allocation

• Optimality Condition Choose the number of seats
  for the business class such that marginal revenue
  from each class is the same

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Optimality Condition
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Optimality Condition
Marginal Revenue Leisure
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Optimality Condition
Marginal Revenue Leisure
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Benefits of Revenue Management in the Airline
Industry

• Evidence of airline revenue increases of 4 to 6
  percent
• With effectively no increase in flight operating
  costs
• RM allows for tactical matching of demand vs.
  supply
• Booking limits can help channel low-fare demand
  to empty flights
• Protect seats for highest fare passengers on
  forecast full flights

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Mail-in-Rebate

• What is the manufacturer trying to achieve with
  the rebate?
• Why the manufacturer and not the retailer?
• Should the manufacturer reduce the wholesale
  price instead of the rebate?
• Are there other strategies that can be used to
  achieve the same effect?

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Mail-in-Rebate

• A Retailer and a manufacturer.
• Retailer faces customer demand.
• Retailer orders from manufacturer.

Variable Production Cost200
Selling Price?
Manufacturer
Retailer
Wholesale Price900
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Demand-Price Relationship
10000
Demand
P2000-0.2Q
2000
Price
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Retailer Expected Profit (No Rebate)
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Retailer Expected Profit (No Rebate)
1,370,096
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Manufacturer Profit (No Rebate)
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Manufacturer Profit (No Rebate)
1,750,000
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Retailer Expected Profit (100 Rebate)
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Retailer Expected Profit (100 Rebate)
1,644,115
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Manufacturer Profit (100 Rebate)
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Manufacturer Profit (100 Rebate)
1,810,392
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Retailer Expected Profit (Reduced Wholesale
Price 100 )
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Retailer Expected Profit (Reduced Wholesale
Price 100 )
1,654,508
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Manufacturer Profit (Reduced Wholesale Price
100)
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Manufacturer Profit (Reduced Wholesale Price
100)
1,800,000
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Mail-in-Rebate
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Mail-in-Rebate
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Managerial Insights

• Mail in Rebate allows supply chain partners to
  move away from sequential strategies toward
  global optimization
• Provides retailers with upside incentive
• Mail in Rebate outperforms wholesale price
  discount for manufacturer
• Other advantages of rebates
• Not all customers will remember to mail them in
• Gives manufacturer better control of pricing

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Smart Pricing

• Customized Pricing
• Revenue Management Techniques
• Distinguish between customers according to their
  price sensitivity
• Influence retailer pricing strategies
• Move supply chain partners toward global
  optimization

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Smart Pricing

• Dynamic Pricing
• Changing prices over time without necessarily
  distinguishing between different customers
• Find the optimal trade-off between high price and
  low demand versus low price and high demand

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When does Dynamic Pricing Provide Significant
Profit Benefit?

• Limited Capacity
• Demand Variability
• Seasonality in Demand Pattern
• Short Planning Horizon

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The Internet makes Smart Pricing Possible

• Low Menu Cost
• Low Buyer Search Cost
• Visibility
• To the back-end of the supply chain allows to
  coordinate pricing, production and distribution
• Customer Segmentation
• Difficult in conventional stores and easier on
  the Internet
• Testing Capability

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A Word of Caution

• Amazon.com experimented with dynamic pricing
  customers responded negatively
• Coca-Cola distributors rebelled against a
  seasonal pricing scheme
• Opaque fares (priceline.com, hotwire.com)
• Determining the correct mix of opaque and regular
  fares is difficult.