Pricing and Revenue Management

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• Pricing and Revenue Management

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Les Miserables

• The duty of the innkeeper is to sell to the first
  comer, food, rest, light, fire, dirty linen,
  servants, fleas, and smiles to charge for the
  open window, the closed window, the chimney
  corner, the sofa, the chair, the stool, the
  bench, the feather bed, the mattress, and the
  straw bed to know how much the mirror is worn
  and to tax that and by five hundred thousand
  devils, to make the traveler pay for everything,
  even the fleas that is dog eats.

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Objective of this section

• Understand steps to better pricing
• Understand Competitive Value Analysis
• Review basics of revenue management
• Understand price customization
• Understand Value

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The Challenge of PricingTaxi
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There is no easy way to find out what the actual
true price of any car is. Oh sure, there is a
sticker price, but only a very naïve fungal
creature just arrived from a distant galaxy
would dream of paying this. In fact, federal
law now requires that the following statement
appear directly under the sticker price
WARNING TO STUPID PEOPLE DO NOT PAY THIS AMOUNT
-- Dave Barry
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Assume that you go to make a reservation at the
luxury hotel you are loyal to and you find out
that they are charging you 50 per night more
than they usually do because they have only a few
rooms left. Please answer each of the questions
based on this knowledge.

• 60.3 claimed they definitely would ask about the
  room rate the next time they made a reservation
• 35.7 claimed they would definitely check rates
  at other properties the next time they planned to
  visit this hotel

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Steps to Better Pricing

• Assess what value your customers place on a
  product or service
• How to create value
• What is the economic value of this product or
  service to customers
• Case study on Coca-Cola
• Look for variation in the way customers value the
  product
• Do customers vary in their intensity of use
• Do customers use the product differently
• Does product performance matter more to some
  customers, even if the application is the same

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Steps to Better Pricing

• Look for variation in the way customers value the
  product - continued
• How do differences in both perceived value and
  non value factors influence price sensitivity and
  divide customers into market segments
• How can members of different segments be
  identified prior to purchase
• How can fences between segments be established
• How can the firm avoid violating legal constraints

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Steps to Better Pricing

• Assess customers price sensitivity
• - How could an effective marketing and
  positioning strategy influence the
  customers willingness to pay
• - Market research techniques using Excel
• - Behavioral aspects of pricing
• Identify an optimal pricing structure
• Bundle pricing

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Steps to Better Pricing

• Consider competitors reactions
• Who are key current and potential competitors
• If competitors are currently in this market, what
  actual transactional prices do they charge
• Given competitors past behavior, personalities,
  and organization structures, what is their goal
  in pricing

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Steps to Better Pricing

• Consider competitors reactions - continued
• What are competitors strengths and weaknesses
  relative to the firm
• How might a firm use information to influence
  competitors behavior in ways that would make its
  goals more achievable or profitable

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Steps to Better Pricing

• Monitor prices realized at the transaction level
• - pricing across different channels
• Assess customers emotional response
• Analyze whether the returns are worth the cost to
  serve

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Steps to Better Pricing

• Understand costs
• What is the incremental variable cost of sales
• At what levels of output will additional
  expenditures on semi-fixed costs be required, and
  how much will they be
• What are the avoidable (not yet sunk) fixed costs
  involved to offer this product at the proposed
  price

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Steps to Better Pricing

• Understand Supply
• Cost structure
• Capacity utilization
• Product perishability
• Extent of product differentiation
• Number and diversity of competitors
• Impact of sales volume on cost

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Steps to Better Pricing

• Understand Demand
• Price sensitivity of selective demand
• Efficiency of price shopping
• Degree of brand loyalty
• Industry growth rate
• Buyer concentration
• Complementary product

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Steps to Better Pricing

• Understand Distribution Channels

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• Competitor Analysis and Positioning Key to
  Pricing

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Index of Competitive Strength
The competitive advantages and disadvantages
which are shown in the matrix of competitive
advantages can be condensed into one single
index, the index of competitive strength. All
relative performances of the product on the
individual factors are weighted with their
importance and summed up.
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Example Importance Question

• Next, please think for a moment about the reason
  for visiting a specific hotel in Las Vegas for
  gambling. Please tell me how important each
  reason is for you in your decision to visit one
  specific property over another. Please use a 1
  to 10 scale, where a 1 means the reason is not
  at all important and a 10 means the reason is
  very important in your decision to choose one
  establishment over another for gambling. You may
  use any number on this 1 to 10 scale.
• Ask questions in random order
• How important is_______________in your decision
  to choose one place to visit over another?
• It is a place my friends like to go

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Example Attitude Question

• Now I am going to read you a list of features
  that may or may not describe some of the hotels
  in the Las Vegas area. Well use a 1 to 10
  scale, where a 1 means it does not describe the
  hotel at all and a 10 means describes the hotel
  perfectly. If you have not been to the hotel
  personally, please base your answers on what you
  have heard, or what you believe to be true.
• Ask questions in random order
• How well does this feature describe(brand to be
  rated)?
• It is a place my friends like to go

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Calculation of Competitive Index

• Sum the importance ratings for all features and
  multiply by the number of scale points. (The
  numbers are in column A in Table on next page)
• For each attribute, multiple average importance x
  average performance. Answers in Column C
• Sum all numbers in column C
• Calculate the CSI as -- Total C/Total in A
• Repeat steps for competitor's see columns D and
  E

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Calculation of Competitive Index
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Matrix of Competitive Advantages
Example Casino
high
Slot Club
Friendly Staff
Value of Promotions
Brand
Feel Safe
Service
Package
Level of Importance
Price
Good Entertainment
Non Smoking
low
Relative Performance
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Steps to Developing a Positioning Strategy

• Identify the competitors
• From customers point of view
• Different competitors in different segments

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Best Way to Define True Competitors

• Ask 50 100 customers at check-in, If you did
  not stay here tonight, where would you stay?
• Those hotels who, if they took a pricing action,
  would force you to take a pricing action
• Where do you currently walk guests?

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Best Way to Define True Competitors

• Based upon a definition of the core customer
  different competitors for different segments
• Avoid emotional opinions

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Steps to Developing a Positioning Strategy

• Determine how the competitors are perceived and
  evaluated
• Determine the competitors positions
• Critical to also have reference points for data
  analysis

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• Identify competitive set
• Upper tier member of competitive market with a
  rate premium above our hotel
• Direct tier member of our competitive market,
  with a rate price point approximately equal to
  our hotel
• Lower tier member of our competitive market,
  with a rate price point below our hotel

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• Calculate for your three core customers in all
  three competitive tiers a total of nine analysis
• Three core customers
• Business transient
• Pleasure transient
• Group customer
• Thee competitive tiers
• Upper tier
• Direct tier
• Lower tier

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• Conduct competitive pricing analysis
• Shops for
• Local hotel reservations office
• Hotel 800 number
• GDS system
• Internet
• Shop for leisure peak, leisure non-peak, business
  peak, business non-peak, group peak, and group
  non-peak

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• Use chart to plot each competitors overall value
• Horizontal axis plot each competitors overall
  value assessment
• Vertical axis plot each competitors lowest
  available retail rate obtained via blind shop
• Center axis your hotel with rate equal to lowest
  available retail price point

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53.16 Caesar
189
47.91 Bally
185
180
179
59.97 Rio
63.92 Boulder
43.41 Circus Circus
159
54.3 Fiesta
155
52.07 Excalibur
140
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Creating Loyalty (44)
Process
Exit
Exit
Exit
Value (Added and Recovery)
Communication
Exit
Fluid
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Value-Based Pricing

• Involves choosing a price after developing
  estimates of market demand based on how potential
  customers perceive the value of the product or
  service.
• Can satisfy diverse product strategies,
  including, for example, market penetration or
  profit maximization.
• Should be the preferred pricing methodology

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Question Where Would You Buy Gas?
Station A Sells gasoline for 2.30 per gallon,
and gives a 0.10 discount if the buyer pays
with cash. Station B Sells gasoline for 2.20
per gallon, and charges a 0.10 surcharge if
the buyer pays with a credit card.
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Examples

• Which do you choose? A____ or B____
• A. Receive 50
• B. 55 chance of receiving 100 45 chance of
  earning nothing

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Examples

• Which do you choose? C____ or D____
• C. Loose 20
• D. 20 chance of loosing 100 80
• chance of losing nothing

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Answer to Previous Question Pertains to Prospect
Theory
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Daniel Kahneman Toasting Noble Prize
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Prospect Theory Basic Idea

• Value is associated not with actual levels of
  consumption, but with anticipated changes in well
  being
• Buyer assesses prospective decision outcomes
  (prospects) by mentally categorizing them as
  either gains or losses relative to reference point

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Explanation

• Station A sets reference point at 2.30 and then
  rewards buyers who pay cash that is a gain
  relative to the reference point
• Station B first establishes a reference point at
  
• 2.20 and then penalizes buyers who use credit
  cards a loss relative to the reference point
• This is in contrast to economic theory that
  predicts that gains and losses of equal size are
  valued the same

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Positive Value
Value Function
Station A (2.30 0.10)
1.0
Gains
Losses
1.6
Reference Point (state of well being)
Station B (2.20 .10)
Negative Value
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Examples

• Which do you choose? A____ or B____
• A. Receive 50
• B. 55 chance of receiving 100 45 chance of
  earning nothing
• Which do you choose? C____ or D____
• C. Loose 20
• D. 20 chance of loosing 100 80
• chance of loosing nothing

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Answer

• If you chose A in Question 1, then you should
  choose C in Question 2
• If you chose B in Question 1, then you should
  choose D in Question 2
• How many had a reversal?

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Rationale for Answers

• Prospect theory states that people are risk
  adverse (e.g., conservative) when considering
  gains in contrast, more naturally inclined to
  risk a loss than to pay even the expected value
  of avoiding it.

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Positive Value
Value Function
Gains
Losses
Reference Point (state of well being)
Negative Value
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Economic Theory versus Prospect Theory

• Economic Theory
• Gains and losses of equal size treated the same
  (e.g., 100 gain to 100 loss)

• Prospect Theory
• loss judged more painful than a gain of equal
  value (e.g., loss of 100 more painful than a
  gain of 100)

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Economic Theory versus Prospect Theory

• Economic Theory
• People are consistent in their decision making

• Prospect Theory
• If people perceive they are in the gain domain,
  they will act conservatively
• If people are in the loss domain, they will tend
  to take more risks

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Economic Theory versus Prospect Theory

• Economic
• Expected utility of uncertain outcome is weighted
  by its probability

• Prospect
• Expected utility of uncertain outcome is
  multiplied by a decision weight ?(p) where ?
• 1.      Impossible events are discarded ?(0)0
• 2.      Low probabilities are over weighted while
  moderate and high probabilities are under
  weighted (e.g., odds of being involved in an
  airline crash versus car accident)

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Prospect Theory Implications

• Increasingly larger gains are incrementally less
  pleasurable (10 to 20 great 110 to 120 not as
  great)
• Increasingly larger losses are incrementally less
  painful (and smaller losses are almost as painful
  as slightly larger losses)
• The displeasure associated with losing a certain
  amount (e.g., of money) is generally greater than
  the pleasure associated with winning the same
  amount (e.g., of money)

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Implications

• Once consumers have agreed to spend a certain
  amount of money, getting to pay more is easier
  than one would think
• Goal for is to move the reference point beyond
  price to something that can gain a competitive
  advantage e.g., brand, type of ingredients,
  service, etc.

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Positive Value
Value Function
Gains
Losses
Reference Point (state of well being)
Negative Value
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Prospect Theory Leads to Framing
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Framing
Buyers frequently form frames of reference when
making buying decisions, and these frames of
reference in turn influence how buyers respond to
price and product information.
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Goal of Understanding Frames of Reference
1. Change the relationship between
what customers perceive they pay and what they
perceive they get in return. And manage this
relationship
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Example -1 Change the relationship between what
customers perceive they pay and what they
perceive they get in return.

• Option 1 Oliva Cameroon Cigar for 15
• Option 2 Oliva Cameroon (Figurado, 6 ½ inch x 60
  ring) made by Oliva Cigar Co. Nicaragua
• The Authentic Cameroon Wrapper gives this boxed
  pressed figurado a pronounced aroma of nuts, with
  hints of cocoa and coffee.
• It is medium-bodied, but not exceedingly
  strong. 15

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Example-2 Change the relationship between what
customers perceive they pay and what they
perceive they get in return.

• Option 1 Selection of teas from wooden box 1.95
  
• Option 2 Fresh pot of Lapsang Souchong
  black-smoked tea
• From the Fujian province of China, this black
  tea is full ancient history and flavor! Smoky
  smooth character is achieved through the smoking
  process over pine and oak fires. 3.95

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Example-3 Change the relationship between what
customers perceive they pay and what they
perceive they get in return.

• Option 1 Our standard room for 240
• Option 2 Or, an upgrade to superior from for
  only 15 more.

How is a better way to write this?
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Example-4 Change the relationship between what
customers perceive they pay and what they
perceive they get in return.

• Research shows that a significant number of
  consumers DO place a value on the X brand e.g.,
  for a 10 premium 56 of business travelers and
  38 leisure travelers are very likely to choose
  Brand A
• Goal is to concentrate not on the price, but the
  components of the brand that consumers desire
• Give customer choice

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Example-5 Change the relationship between what
customers perceive they pay and what they
perceive they get in return.

• Focus on the features of the menu item that are
  different from what consumer can buy at home
  e.g., Kobe beef

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Ways To Frame Purchase Decisions

• Structure transactions to reflect gains and
  avoid losses
• Present price last after descriptions
• endow potential buyers

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2 Change Way Frame Decisions
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Example 1

• Let customer know the cost of not booking and
  paying now that is, give the difference between
  current booking class and the next level up

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Examine How We Quote Rates

• We always quote low to high, which sets reference
  point low and the other prices a loss
• If we quote high price first, then other prices
  are a gain

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Example 2

• Make it simple for customer to see options and
  trade-offs

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This slide shows how prices change depending upon
day of flight key here is that customer sees the
options and can make choices
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Figure 3
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Note departure and return are bundled Customers
knows price but has to buy prepackaged schedule
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Customer chooses by schedule but does not know
price
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Customer can easily get both price and schedule
and therefore it is easy to make choice
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Example 3

• Frame decision outcomes in terms of gains or
  losses
• do not discuss benefits of buying the product,
  but discuss the consequences of not buying the
  product

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Example 4

• Frame by Bundling Gains and Losses
• un-bundle gains
• bundle losses

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Frame by Un-bundle Gains

• Packages such as London for Free use of free
  bundles gain list all the components separately
• Ability to purchase upgrades by segment (e.g.,
  seat on UK to USA different utility than seat on
  USA to UK)
• Check-in time use of lounge

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Frame by bundle losses

• Should we quote rates that include all taxes and
  airport fees?
• What losses that can be bundled?

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Hotel Examples?
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Example of Research Study Undertaking

• Test Condition Bundling Added
• Utilize proper opening dialogue
• Listen to callers requests
• Ask repeat guest question and determine reason
  for stay
• Provide normal sales strategy
• At time of purchase, ask the following

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Example of Research Study Undertaking

• For an extra 15 we can offer an amenities
  package that includes
• no phone access charge,
• 10 free local phone calls,
• free received faxes,
• free sent faxes,
• free internet access,
• one 3-minute call to call home (may call anywhere
  in the world).

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Examples of current research

• Test Condition Willingness to Pay for
  Guaranteed Bed Type
• At time of purchase, read the following
• As you are probably aware, hotels only guarantee
  a room, they never guarantee what the bed type in
  the room will be. The reason for this pertains
  to the fact that the bed inventory is limited and
  fixed. Since guests arrive at different
  intervals, room assignments are made on a first
  come first serve basis. This means that the bed
  type you would like to have may not be available.
  For an extra 20 we can guarantee that no matter
  what time you arrive, the bed type you requested
  will be available. 

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Examples of current research

• Test Condition Willingness to Pay for
  Guaranteed Bed Type 
• Other test conditions
• At what price would this guarantee service be so
  expensive that you would not consider purchasing
  this service?
•  At what price would this guarantee service be
  expensive, but you still would consider
  purchasing this service?
•  What price would you expect this hotel to charge
  for the guarantee of a bed type?

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Framing and Reference Price Formation
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Hotel Example Would You Choose?

• Staying at the Venetian Hotel in Las Vegas for a
  vacation Staying two nights 3036 rooms
• Which Would You Choose?
• A Luxury suite room at 159 and then for an
  additional 30 you get guaranteed room on a high
  floor with a strip view
• B Luxury suite room with guaranteed room on a
  high floor for 189, or room for 30 less
  anywhere in the hotel

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Hotel Example

• Venetian Hotel in Las Vegas
• Manipulation
• Quote 159 first (option A previous slide)
• Quote 189 first (option B previous slide)
• Two Teams
• Team 1 conversion 21.9 calls 1813
• Team 2 conversion 21.2 calls 1654

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Hotel Example

• Upgrades
• 159 quoted first 13.59 upgraded (option A)
• 189 quoted first 20.55 upgraded (option B)
• Translates 31,878 extra revenue for the month to
  the bottom line

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Restaurant Study
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Study Design

• Eight different menus
• Type of description
• Modest/Detailed
• Number of items
• Three per category/Two per category
• Prices
• High prices/Low prices

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Spinach and Feta Dip

• Modest Description
• Spinach and Feta Cheese with Tomatoes and
  Pinenuts
• Detailed Description
• Organic Spinach Sautéed in Garlic and Combined
  with Authentic Athenian Feta Cheese, Sun Ripened
  Yellow Tomatoes and Toasted Pinenuts

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MENU DESIGN
Menu One Detailed Menu Descriptions, High
Price, 3 Choices Menu Two Detailed Menu
Descriptions, Low Price, 3 Choices Menu
Three Detailed Menu Descriptions, High Price, 2
Choices Menu Four Detailed Menu Descriptions,
Low Price, 2 Choices Menu Five Modest Menu
Description, High Price, 3 Choices Menu
Six Modest Menu Description, Low Price, 3
Choices Menu Seven Modest Menu Description,
High Price, 2 Choices Menu Eight Modest Menu
Description, Low Price, 2 Choices
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Hypothesis Two Items Each Menu Category
Ho1 X value (high price with detailed description) X value (high price with modest description) Mean 4.74 4.26 p.083
Ho2 X value (low price with detailed description) X value (low price with modest description) Mean 4.99 4.74 P.369
Ho3 X value (high price with detailed description) X value (low price with detailed description) Mean 4.74 4.99 P.315
Ho4 X value (high price with modest description) X value (low price with modest description) Mean 4.26 4.74 p.113
Ho5 X value (high price with detailed description) X value (low price with modest description) Mean 4.74 4.74 p1.00
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What Influence Buyers Reference Prices

• Current Price Influences
• Past Price Influences
• Purchase Context Influences
• Prices of similar items
• Price considering cost of making item yourself

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1. Current Price Influences

• Product-Line Pricing
• Adding a premium product to the product line may
  not necessarily result in overwhelming sales of
  the premium product itself. It does, however,
  enhance buyers perceptions of lower-priced
  products in the product line and influences
  low-end buyers to trade up to higher-priced items

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Product Line Pricing Example Wine

• 38
• 48

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Product Line Pricing Example Wine

• 38
• 48
• 58

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Anchoring

• The idea is that when a person must make a
  judgment, he or she starts with an initial,
  approximate judgment - an anchor. This
  judgment gets the person in the ball-park.
  Then, in view of other considerations, the person
  arrives at a final judgment by adjusting away
  from that initial assessment

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Our top room is a Park Avenue Suite decorated
with an elegant European accent. This suite is
900 Sq. Ft. The suite is designed with the
business traveler in mind. Suites feature a
separate parlor with a wet bar and refreshment
center, an oversized working desk, 2 multi-line
speaker phones with call waiting, voicemail,
data-port, fax machines, Lodgenet Entertainment
System with movies and CD Library. These rooms
overlook 56th street or the city view of 57th
street. The bedroom can be closed off from the
living room. The king size bed includes five down
pillows with satin-banded Egyptian cotton
Pillowcases. Suites sell for 995.00.   Position
following second   Our 2nd room type is the
Metropolitan Suite. This suite is 700 Sq. Ft.
  Position following third   Our 3rd room type
is the Executive Suite. This suite is 600 Sq. Ft.

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Current Price Influences - continued

• Suggested Reference Prices
• State a price charged previously
• State a price charged by a competitor
• State suggested retail price

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Example of item being tested

• If consumers are always told the normal rate, and
  then provided with a discount from that rate,
  they will remember the normal rate, not the
  discount rate.  In addition, when the invoice is
  provided to the client at check-out, the normal
  price will be printed. At the end the discount
  will be subtracted. We should see a rise in
  "overall price value" compared to when customer
  only sees the price paid.

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Current Price Influences - continued

• Consider the following airline prices seen on
  Internet for round-trip
• London to Paris 310
• Paris to Prague 288
• Nice to Prague 289
• London to Nice 310
• Given above prices, answer following questions
• 1. What price would you expect to pay to fly
  from London to Prague _____
• 2. What is the most you would pay _____
• 3. What is a fair price _____

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2. Past Price Influences

• Past price paid has a particularly strong
  influence on the reference price because it is
  more likely to be recalled as a frame of
  reference than past prices that were observed in
  advertising

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2. Past Price Influences - continued

• Implications of Previous Slide
• Numerous small price increases for frequently
  purchased items more likely to be accepted than
  are infrequent large increases
• Need to always state actual price and discount
  from that otherwise, low promotional prices can
  establish low reference prices for judging the
  value of later purchases

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3. Purchase Context Influences

• You are lying on the beach on a hot day. All you
  have to drink is warm water. For the last hour
  you have been thinking about how much you would
  enjoy a nice cold bottle of your favorite
  imported beer. A companion gets up to make a
  phone call and offers to bring back a beer. The
  only near by place where beer is sold is a small,
  run-down grocery store. He asks what the maximum
  price you are willing to pay. If the price is
  higher, he will not buy it.
• What price do you tell him? _____

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3. Purchase Context Influences

• You are lying on the beach on a hot day. All you
  have to drink is warm water. For the last hour
  you have been thinking about how much you would
  enjoy a nice cold bottle of your favorite
  imported beer. A companion gets up to make a
  phone call and offers to bring back a beer. The
  only near by place where beer is sold is a resort
  hotel. He asks what the maximum price you are
  willing to pay. If the price is higher, he will
  not buy it.
• What price do you tell him? _____

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3. Purchase Context Influences continued

• Use context as a frame of reference that makes
  the price seem fair or reasonable
• e.g., 8 hours tossing and turning trying to get
  comfortable, versus good night sleep
• e.g., a day at the office
• e.g., What is your time worth to drive versus
• to fly to airport that is not
  convenient?

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4. Prices of similar items (e.g., if consumers
think there is no difference, then there is a
problem)5. Price considering cost of making
it yourself
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6. Price Differentials

• Scenario A You are a purchasing agent for a
  large organization. You have ordered for your
  own use a new electric typewriter with special
  features, which will cost 1,000. A friend
  discovers that the identical typewriter is
  available from another vendor for 600. Would
  you cancel the current order and switch to the
  other vendor? (Assume that canceling the current
  order and initiating a new one will take one of
  the purchasing clerks who works for you about
  one-half day. Assume that there are no other
  costs such as a loss of good will or delay in
  delivery.)
• Would you cancel the current order and switch
  to the other vendor?
• Yes _______ No _________

108

• Scenario B You are a purchasing agent for a
  large organization. You have ordered a new word
  processor with special features, which will cost
  20,000. Your purchasing department discovers
  that the identical word processor is available
  from another vendor for 19,600. Would you
  cancel the current order and switch to the other
  vendor? (Assume that canceling the current order
  and initiating a new one will take one of the
  purchasing clerks who works for you about
  one-half day. Assume that there are no other
  costs such as a loss of good will or delay in
  delivery.)
• Would you cancel the current order and switch
  to the other vendor?
• Yes _______ No _________

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• Scenario A the difference is 40, whereas in
  Scenario B the difference is 2, even though the
  absolute difference in both is 400
• Implications
• the perception of a price change depends on the
  percentage, not on the absolute difference
• there is a threshold above and below a products
  price at which price changes are ignored

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• When quoting rates, quote price differences
  instead of whole rate e.g., 320 versus 290.
  For 30 less get.

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7. Framing Price Differences

• Look at the two pairs of prices below and quickly
  answer the question For which pair of prices is
  the lower price more of a bargain?
• Higher Price Lower Price
• First Pair 0.89 0.75
• Second Pair 0.93 0.79
• Your answer _____

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• Perceptions of Odd Price Endings
• Buyers use left most digits in a price and round
  up to form a quick reference point to evaluate
  the actual price against.
• Previous example second pair seems to have
  better discount.
• (first pair 8-7 1 second pair 9-7 2 if
  figure same in first column, then look at second
  column)
• In reality, difference is a greater percentage
  of the price in the first pair (18.6 vs. 17.7)

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Objective of this section

• Understand steps to better pricing
• Understand Competitive Value Analysis
• Review basics of revenue management
• Understand price customization
• Understand Value