Chapter 5: Exploring Business Models: Pricing and Revenue Management:

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Chapter 5 Exploring Business Models Pricing and
Revenue Management

• What is a business model?
• What Makes Service Pricing Strategy Different and
  Difficult?
• How can the pricing tripod be integrated to
  arrive at a good pricing point?
• How do we reduce non-price related costs to the
  consumer?
• What is revenue management (RM)?
• Why are ethical concerns and fairness perception
  important issues when designing service fee
  schedules and RM strategies?
• What are the seven key decisions managers need to
  make when designing an effective pricing
  schedules?

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What Is a Business Model?

• Why is marketing the only function that brings
  operating revenue into the organization, while
  all other management functions insure costs?
• Marketing is an activity engaged in pursuing
  value innovation by looking systematically across
  all elements of a business model. It
• analyzes trends, drivers and emerging behaviors
• creates needs in particular customer segment(s)
• identifies profitable customer segment(s) and
  stimulates demand
• develops value propositions for particular
  customer segment(s)
• ensures the value chain and processes are
  designed to create viable value propositions for
  specific customer segments in a sustainable and
  profitable manner
• Identifies the companys core capabilities to
  create the value and ensures people are marketing
  oriented rather than cost oriented
• devises price mechanisms that require customers
  pay a price with reference to costs, competition
  and value that ensures long term sustainability
  and profitability of the company.

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What Is a Business Model?

• Aligns and Integrates all key components and
  activities of a particular business, and converts
  the inputs into an effective pricing mechanism
  to
• Transform sales into revenues
• Recover costs
• Create value for owners of business
• Must clarify business logic that explains how
  firm can deliver value to customers at an
  appropriate cost
• Not all business models require end user of
  specific service to pay full costconsider
  third-party payers
• Advertisers
• Health insurers
• Donors to nonprofit organizations
• Tax subsidies for public services

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What Is a Business Model?

• Business logic
• Expresses the dynamic relationship (consistent
  cause and effect relationships) of key components
  of a particular business which reinforce each
  other to create value to the companys particular
  customer segment in a manner that generates
  profitable and sustainable revenue streams.

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What Makes Service Pricing Strategy Different and
Difficult?

• Harder to calculate financial costs of creating a
  service process or performance than a
  manufactured good
• Variability of inputs and outputshow can firms
  define a unit of service and establish basis
  for pricing?
• Customers find many services hard to
  evaluatewhat are they getting in return for
  their money?
• Importance of time factorsame service may have
  more value to customers when delivered faster
• Delivery through physical or electronic
  channelsmay create differences in perceived value

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What is the role of pricing and revenue
management in a business model? (Table 5.1)

• Revenue and profit objectives
• Ensures sustainability and growth by setting
  targets
• Cover costs
• Build demand
• Demand maximization
• Full-capacity utilization
• Build a user base
• Stimulate trial and adoption of new service
• New gym, movie
• Build market share/large user base (critical
  mass)
• Network effect the purchase of a service product
  by one customers indirectly benefits others who
  use the service
• Network externalities economies arising from
  network effects are known as network
  externalities

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How can the pricing tripod be integrated to
arrive at a good pricing point? Fig 5.1

• Competition-based pricing
• Monitor competitors pricing strategy
  (especially if service lacks differentiation)
• Who is the price leader? Does competition always
  matter?
• Location and time factors
• Personal relationship
• Switching costs
• Rapid change of prices

• Cost-based pricing
• Set prices relative to financial costs (problem
  defining costs)

• Value-based pricing
• Relate price to value perceived by customer

Price leadership
Loss leaders
Determinant
Floor
Ceiling
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Cost-based Pricing Traditional vs.
Activity-based Costing

• Traditional costing approach
• Fixed
• Variable
• Semi-variable
• Contribution
• Break-even
• Emphasizes expense categories (arbitrary overhead
  allocation)
• May result in reducing value generated for
  customers
• ABC management systems
• Each step in a value chain constitutes an
  activity to be accounted for
• Link resource expenses to variety and complexity
  of goods/services produced
• Yields accurate cost information
• Pricing implications of cost analysis
• Recover costs
• Negligible variable costs sunk costs loss
  leaders
• Outsourcing avoids the misperception of
  negligible variable costs
• The final analysis costs have nothing to do with
  value

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Value-based pricing How do marketers enhance the
gross value delivered through value-based pricing?
From a customer perspective, what serves to
define value in a legal firm, a hairdresser, a
nightclub?

• Net value 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
• Marketers can enhance gross value
• Reduce uncertainty
• Relationship pricing
• Low-cost leadership
• Value perception management (see Figure 5.3)

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Why is the purchase price often not the most
important component of the total cost to the
consumer? (Fig 5.4)
Purchase
Money
Search costs
Time
Operating costs
Physical effort
Incidental expenses
Purchase and service encounter costs
Psychological burdens

• How do we reduce non-price related costs to the
  consumer?

• Reduce time
• Minimize unwanted psychological costs
• Eliminate unwanted physical effort
• Decrease unpleasant sensory
• Suggest ways to decrease monetary costs

Sensory burdens
Necessary follow-up
After costs
Problem solving
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What is the role of non-monetary costs in a
business model, and how do they relate to the
consumer's perception of the offered value
exchange? (Fig 5.5)

• Which clinic would you patronize if you needed a
  chest x-ray (assuming all three clinics offer
  good quality)?

Clinic A
Clinic B
Clinic C

• Price 85
• Located 15 mins away by car or transit
• Next available appointment is in 1 week
• Hours Mon-Fri, 8AM-10PM
• Estimated wait at clinic is about 30 to 45 mins

• Price 125
• Located next to your office or college
• Next appointment is in 1 day
• Hours Mon-Fri, 8AM-10PM
• By appointment estimated wait at clinic is 0 to
  15 mins

• Price 45
• Located 1 hour away by car or transit
• Next available appointment is in 3 weeks
• Hours Mon-Fri, 9AM-5PM
• Estimated wait at clinic is about 2 hours

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Revenue Management (RM)

• What is RM (yield management)?
• managing the four Cs of perishable service
• Calendar (how far in advance booking is made)
• Clock (the time of day service is offered)
• Capacity (the inventory of service resources),
  and
• Cost (the price of the service)
• to manage the customer demand in order to
  maximize profit.
• To sell the right capacity to the right customer
  at the right prices.
• When is RM effective?
• Businesses have relatively fixed capacity
• High fixed cost structure
• Perishable inventory
• Demand that is variable and uncertain
• Varying customer price sensitivity

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Maximizing Revenue from Available Capacity at a
Given Time

• Price customization
• Charge different value segments different prices
  for same product according to predicted demand
  levels among different segments
• Useful in dynamic markets
• Different price buckets based on price
  sensitivity to different usage times,
  flexibility, other factors
• RM uses mathematical models to examine historical
  data and real-time information to determine
• What prices to charge within each price bucket
• How many service units to allocate to each bucket
• Rate fences deter customers willing to pay more
  from trading down to lower prices (minimize
  consumer surplus) (See Table 5.2 p. 140)
• Physical fences
• Non-physical fences
• Transaction characteristics
• Consumption characteristics
• Buyer characteristics

In your research, explore how successful business
models employ innovative service pricing and
revenue management strategies and compare with
their competitors.
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How might RM be applied in different industries?
Price
Fixed
Variable

• Quadrant 1
• Movies
• Stadiums/arenas
• Function space

• Quadrant 2
• Hotel rooms
• Airline seats
• Rental cars
• Cruise lines

Predictable
Duration

• Quadrant 3
• Restaurants
• Golf courses

• Quadrant 4
• Health care
• Hospitals

Unpredictable
Source The Strategic Levels of Revenue (Yield)
Management (Fig 1 from Kimes and Chase (p. 212)
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Price Elasticity (Fig 5.6)
Price per unit of service

Di
De
Price elasticity Percentage change in
demand Percentage change in price
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
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Relating Price Buckets and Fences toDemand Curve
(Fig 5.7)
Price per seat
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
3-week advance purchase, Saturday night stay,
100 for changes
Specified flights, book on Internet, no
changes/refunds
Late sales through consolidators/Internet, no
refunds
Capacity of 1st class cabin
No. of seats demanded
Capacity of aircraft
Dark areas denote amount of consumer surplus
(goal of segmented pricing is to reduce this)
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Why are ethical concerns and fairness perception
important issues when designing service fee
schedules and RM strategies?

• Customers are vulnerable when service is hard to
  evaluate or they dont observe performance of
  work
• 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 The car is free, the keys are
  extra
• Too many rules and regulations
• Customers feel constrained, exploited
• Customers unfairly penalized when plans change

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Ethical issues

• Do you think there is true competition on price
  between MTN, Vodacom and CellC?
• Yes 4
• No 89
• Uncertain 7
• Source http//www.mybroadband.co.za/nephp/?optpo
  llsactshow_pollid116disable2

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Service perspectives 5.3 (P.143) Needless
complexity in phone service pricing

• Confusopolicies (p. 142)
• Peak and off-peak minutes
• Over time roaming minutes charged at higher
  prices
• Unlimited off-peak calling, free incoming calls
• Varying charges calls per second, per 6-second
  block, per minute block
• Family plans subject to monthly quota
• Virgin mobile
• Per-second billing and the lowest all-day prepaid
  rate
• Fees! Fees! Fees! (pp 220-224)
• America used to be the land of the free. Now
  its the land of the fee.
• Hidden costs Harder for customers to compare
  prices
• Inflation is understated when fees are hidden.

Review recent bills that you have received from
services businesses and evaluate them from
ethical perspectives.
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How can perceptions of unfairness be mitigated
and perceptions of fairness created? (p. 144)
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What are the seven key decisions managers need to
make when designing an effective pricing
schedules? (p. 147 Table 5.3)

• How much to charge?
• The pricing tripod model
• What should be the specified basis for pricing?
• Completing a task, Time based, Commission
• Who should collect payment?
• Service provider or specialist intermediaries
• Where should payment be made?
• Conveniently located intermediaries
• Mail/bank transfer
• When should payment be made?
• Before or after
• How should payment be made?
• Cash, Check, Token
• Stored value card, Electronic fund transfer
• Charge card (debit/credit), Vouchers
• Third-party payment
• How to communicate prices?
• Relate the price to that of competing products
• Ensure price is accurate and intelligible

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Chases Blink Service (Fig 5.10)

• Chase advertises its fast new credit card
  scanning service, Blink
• Blink can be read by a point-of-sale terminal
  without being physically touched
• Simplifies and speeds payment transaction, saves
  customer time and effort

Courtesy of JP Morgan Chase Company
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Frequency of Health Club Use Relates to Timing
of Payments (RI 6.1)
Source John Gourville and Dilip Soman, Pricing
and the Psychology of Consumption, Harvard
Business Review, September 2002, 90-96.
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Summary of Chapter 5 Exploring Business Models

• Pricing objectives can include
• Generating revenues and profit
• Building demand
• Developing user base
• Three main foundations to pricing a service
• Cost-based pricing
• Competition-based pricing
• Value-based pricing
• Revenue management
• Maximizes revenue from a given capacity at a
  point in time
• Helps manage demand and set prices for each
  segment closer to perceived value
• Involves use of rate fences to deter segments
  willing to pay more from trading down to lower
  prices
• Ethical issues in pricing
• Unfairness and misrepresentation in price
  promotions and advertising
• Designing fairness into revenue management
• The 7 key decisions managers need when putting
  service pricing into practice