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Pricing for Hotels: Revenue Management Through Pricing

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Title: Strategic Pricing Cornell 2006 Author: Stowe Shoemaker Last modified by: Stowe Shoemaker Created Date: 6/3/2008 9:29:49 PM Document presentation format – PowerPoint PPT presentation

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Title: Pricing for Hotels: Revenue Management Through Pricing


1
Pricing for Hotels Revenue Management Through
Pricing
  • Stowe Shoemaker
  • Cornell University Executive Education Faculty
  • University of Houston
  • sshoemaker_at_uh.edu
  • www.stoweshoemaker.net

2
The Pricing Process A Blue Print for Class
  1. Understand the steps to better pricing.
  2. Understand what is price and consider the two
    mail ways to price
  3. Investigate different pricing strategies
  4. Understand why we should have multiple prices
  5. Understand customer psychology and how to use
    this information to increase revenue

3
The Pricing Process A Blue Print for Class -
continued
  1. Understand competitor analysis especially
    segmentation and positioning (competitive value
    analysis)
  2. Understand methods to determine price thresholds
    (e.g., willingness to pay)
  3. Examine decision making and how it impacts the
    prices we offer the customer.
  4. Understand how to use pricing tools to maximize
    revenue (e.g., bundling group forecasting
    statistics to predict proper bookings)

4
The Pricing Process A Blue Print for Class -
continued
  1. Review basic math for pricing

5
Pricing As Strategy
The corporate strategy is the way a company
creates value through the configuration and
coordination of its multi-market activities.
The objective is to create value for the various
stakeholders of the company, i.e. employees and
stockholders.
The marketing strategy defines the way to create
value for the customers by means of products,
distribution, communication, and service.
The pricing strategy is the part of the marketing
strategy that defines the way to extract value
from the customers based on their willingness
to pay for the value they get.
This slide from Stephan Butscher
sbutscher_at_simon-kucher.com
6
Price and the Customer
  • Price is the economic sacrifice a customer makes
    to acquire a product or service
  • In essence, a customer buys a product or service
    only if its perceived value is greater than the
    price.
  • For example, see chart on next slide.

7
Atomic Building Stone of Pricing
Sales Volume
1.5
Reservation Price
1.0
0.5
Price
1.00
0
Variable cost
Individual Maximum Price
8
Section A
  • Pricing Audit and Challenge of Pricing

9
Objectives of Section
  • Provide you with a pricing audit that will help
    you understanding your pricing decisions better
  • Discuss where pricing fits into an organization
  • Introduce the challenge of pricing
  • Provide a framework for where pricing is moving
  • Introduce the 11 steps to better pricing that
    will be the foundation of the class

10
The Pricing Audit
  • Complete the table on the next page
  • Use following scale
  • Relevance High, Medium, Low
  • Performance Poor 1 2 3 4 5 Excellent

11
Pricing Audit
  • Our pricing process
  • Complements the overall marketing strategy
  • ______
  • Is coordinated and holistic _____

Relevance High, Medium, Low Performance
Poor 1 2 3 4 5 6 7 Excellent
12
Pricing Audit - continued
  • Our pricing process
  • Assesses value customers place on our product
    ________
  • Considers variation between customers in their
    perceived product value ____
  • Assesses consumer price sensitivity _____
  • Identifies an optimal structure _____
  • Considers competitive reaction _____

Relevance High, Medium, Low Performance
Poor 1 2 3 4 5 6 7 Excellent
13
Pricing Audit - continued
  • Monitors the transaction level_____
  • Considers the customers emotional response____
  • Analyzes revenue versus costs to serve____
  • Treats our loyal customers differently than
    one-time customers____
  • Is based on consumer input _____

Relevance High, Medium, Low Performance
Poor 1 2 3 4 5 6 7 Excellent
14
What did the pricing audit tell you about your
firm?
15
The Challenge of Pricing Taxi
16
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
17
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

18
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

19
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

20
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

21
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

22
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
  • Case study on Tweeter

23
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

24
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

25
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

26
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

27
Steps to Better Pricing
  • Understand Distribution Channels

28
The Evolution of Pricing Strategies In Hotels
Bundling and other techniques to change
perception of value
Profitability
Value Pricing
Revenue per Available Customer
Revenue per Available Room
Seasonal Rates
Strategic
Tactic
Revenue Management look at the total value of
the customer
Rates vary by season, some Measurement, Some DF
Yield Management Systems much DF
Pricing based upon value received, not cost to
produce consider loyalty
Pricing based on customer knowledge
29
Lessons from Research
  • Coming together of RM and CRM
  • Revenue management practices at this stage of
    the game do not take a great deal of relationship
    management into account, except for special
    corporate rates for volume accounts. -Tim
    Genovese of Intercontinental Hotel Group

30
Lessons from Research
  • Pricing is currently a commodity type of
    pricing, where a customer that has stayed 100
    nights is quoted the same rate as one that stays
    only one night over a peak time, argues Tim
    Genovese.

31
Lessons from Research
  • Importance of pricing for revenue maximization in
    addition to maximizing inventory allocation. RM
    should be called price optimization
  • You cant change rooms very fast but you can
    sure change the price. It gives you final
    control. John Riddel

32
Lessons from Research
  • Understanding consumers buying behavior and
    price elasticity to be able to charge the right
    price to each customer
  • Yield management opens and closes each rate.
    The key question is what the rate should be,
    highlights John Higbie with Revenue Analytics.

33
Lessons from Research
  • The finer we can segment our market, the better
    we can target and get the right product in front
    of the right customer in the right channel at the
    right price.
  • Tim Colemen

34
Lessons from Research
  • Dynamic packaging and pricing is a major future
    trend
  • Chris Bishop with Harrahs Entertainment
    explains In the near future, customers will be
    able to use drop-down menus to choose if they
    want a bottle of wine in their room, use the spa
    or attend a show.

35
Lessons from Research
  • One of the areas where group revenue management
    is likely to grow in the future is in the area of
    forecasting.
  • Group revenue management should get down to the
    same level of detail as transient yield
    management and group-acceptance decisions should
    be made based on alternative group displacement
    instead of only transient displacement, argues
    John Riddel.

36
Section B
  • What Is Price?
  • Generic Pricing Strategies

37
Objectives for this section
  • Introduce what is price
  • How to change price
  • Types of pricing strategies
  • Hear from you on the types of pricing strategies
    you are using and challenges you face.

38
What is price?
quantity of goods and services received by the
buyer versus
quantity of goods and services given by the seller
39
What is price? - continued
  • Way to change prices
  • Change the quantity of money or goods and
    services to be paid by buyer
  • Change the quantity of goods and services
    provided by seller
  • Change the quality of goods and services provided
  • Change the premiums or discounts to be applied
    for quantity variations

40
What is price? - continued
  • Way to change prices
  • Change the time and place of transfer of
    ownership
  • Change the place and time of payment
  • Change the acceptable form of payment

41
Ways to Price Products and Services
42
  • Two common approaches to pricing products and
    services
  • cost-based pricing,
  • value-based pricing,

43
Cost-Based Pricing
  • Involves adding a target margin to the cost of
    producing a product or service.
  • Satisfies no goal other than achieving the target
    margin (to the extent the target margin is chosen
    arbitrarily).

44
The Drivers of Profit
Profit
Costs
Sales Revenue
Variable Cost
Fixed Cost
Sales Volume (units)
Price
Variable Unit Cost
Sales Volume
45
Cost Based Product Definitions
  • Unit margin margin contribution margin
    unit revenue unit variable cost
  • Margin in terms unit margin/revenue per unit
    for example selling price is 65.35 and variable
    unit cost is 29.04 then the margin is
    29.04/65.35 or .444 or 44.4 percent margin

46
Cost Based Product Definitions
  • Selling price cost/(1 margin percentage/100)
  • 36.31/(1 (44.4/100))
  • Break even volume the number of units sold that
    just allows the organization to cover its fixed
    costs
  • (Fixed costs in euros)/(euros margin per unit)
  • If fixed costs are e 750,000 and margin per unit
    is e 3.50, how many units to break even?

47
Cost Based Product Definitions
  • Assume fixed costs increase by 175,000. How
    many additional units would we need to sell to
    cover these new fixed costs?
  • Assume we run a promotion that reduces unit
    margin from e 3.50 to e 2.50. How many units do
    we need to sell to make up the difference?

48
Effect of Price on Profit Figure 1
Sales Volume (millions)
1.5
Total contribution (always shown as rectangle))
1.0
0.5
50
60
100
Selling Price
Variable Unit Cost
49
Facts
  • Price is 100
  • Annual sales volume is 1 million units
  • Variable unit cost (marginal cost) is 60
  • Unit contribution margin the difference between
    the selling price and variable unit cost
  • Fixed costs 30 million
  • Total contribution unit contribution x sales
    volume
  • Profit total contribution fixed costs

50
Questions about Figure 1
  • Price is 100
  • Annual sales volume is 1 million units
  • Variable unit cost (marginal cost) is 60
  • What is the unit contribution margin?
  • What is the total contribution?
  • What is the profit?

51
Questions
  • Does current 100 yield highest profit?
  • What happens is we have a 20 price cut?
  • What happens if we have a 20 price increase?
  • Want to maintain the 10 million dollar profit
    so, how many units to sell in the above two
    situations?

52
Figure 2 Shows
  • What is the price cut?
  • What is the unit variable cost the same?
  • What is the unit contribution?
  • How many units do we need to achieve same total
    contribution and profit?
  • What is the total contribution?
  • What happens to the unit contribution when we
    reduce price?
  • Question? What is the cost of this additional
    volume?

53
Effect of Price on Profit Figure 2
Sales Volume (millions)
2.0
Necessary sales increase to get same profit
(100)
1.5
1.0
Shaded area is total contribution
0.5
Price
50
60
100
80
0
Variable Unit Cost
New Price
Old Price
54
Questions for Figure 3
  • What price increase do we have?
  • What is the variable unit cost?
  • What is the contribution margin?
  • How many units do we need to get a 10 million
    dollar profit?
  • What decrease in sales volume do we have?
  • A ___ increase in price is a ____ decrease in
    sales volume (fill in the blanks)
  • What is the cost of this decrease?

55
Effect of Price on Profit Figure 3
Sales Volume (millions)
2.0
Shaded area is total contribution
1.5
Acceptable sales reduction to get same profit
1.0
0.5
Price
50
60
100
80
120
Old Price
New Price
Variable Unit Cost
56
Figure 4 Summary Of previous slides
Price Response Curve
Sales Volume (million units)
Units
1.8
1.6
A at price of 80 sell 1.4 million units B at
price of 100 sell 1 million units C at price of
120 sell .6 million units D at price of 150
sell 0 units
A
1.4
1.2
B
1.0
0.8
C
0.6
0.4
0.2
0.2
D
0.0
0.0
20
40
60
80
100
120
140
160
Price ()
150
Variable unit cost
57
Question?
  • What price will yield the highest profit, if only
    one price can be charged?
  • Why? Discussed on next 2 slides

58
Figure 5
Sales Volume (million units)
C
1.8
Price response curve
1.6
1.4
1.2
1.0
0.8
0.6
0.4
0.2
0.2
A
B
0.0
0.0
20
40
60
80
100
120
140
160
Price ()
150
Variable unit cost
59
Figure 5 Notes
  • Feasible range is 60 to 150 at 60 sales 1.8
    million units but unit contribution sinks to 0.
    As price approaches 150, unit contribution
    becomes very large, but sales volume declines to
    0 want to find optimum trade off between volume
    and contribution
  • Recall, total contribution is represented by a
    rectangle with price on one side and volume on
    another
  • To find optimal tradeoff between volume and
    contribution, we want to maximize the rectangle
    within the boundaries of the price response curve
    -- within triangle ABC if the response curve is
    linear and the marginal cost is constant, then
    the optimal price is exactly in the middle
    between the maximum price of 150 and the
    marginal cost of 60. (15060)/2105)

60
Figure 6
Sales Volume (million units)
C
1.8
Price response curve
1.6
1.4
1.2
Optimal
Optimal Price is 105 Sell 900,000 units.
1.0
0.8
0.6
0.4
0.2
0.2
A
B
0.0
0.0
20
40
60
80
105
120
140
160
Price ()
150
Optimal Price 105
Variable unit cost
61
Figure 6 calculations
  • 105900,000 94,500,000
  • 60900,000 54,000,000
  • 40,500,000
    contribution margin
  • 30,000,000 fixed
    costs
  • 10,500,000 profit
  • Recall, that at price 100 we sold 1 million units
    but made profit of only 10 million
  • 1001,000,000 100,000,000
  • 601,000,000 60,000,000
  • 40,000,000
    contribution margin
  • -30,000,000 fixed
    costs
  • 10,000,000
    profit

62
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63
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.

64
Value-Based Pricing Key Benefits
  • It forces managers to review the objectives they
    have when marketing their product or service.
  • It generally will be superior to cost-based
    pricing in achieving any goals that might be
    implicit in the margin targets used in a
    cost-based pricing.
  • It requires managers to keep in touch with the
    needs and preferences of customers.

65
Creating Value
66
Differences between Up sell and Revenue
Opportunity
  • Up sell
  • Replace product with a better product
  • Force the need for better
  • E.g., H20 versus Avian
  • Revenue Opportunity
  • Find need customers have and then charge for that
    need
  • E.g., Virgin selling exit row for 50

67
Value Added
  • Financial
  • Temporal
  • Functional
  • Emotional/Psychological
  • Experiential
  • Social
  • Trust
  • Identification with organization

68
Factors that Impact Financial Value
  • Perceived substitute effect
  • buyers are more price sensitive the higher the
    products price relative to prices of perceived
    substitutes
  • Unique value effect
  • buyers are less sensitive to a products price
    the more they value any unique attributes that
    differentiate the offering from competing
    products
  • Switching cost effect
  • the greater the product-specific investment that
    a buyer must make to switch suppliers, the less
    price sensitive that buyer is

69
Factors that Impact Financial Value
  • Difficult comparison effect
  • buyers are less price sensitive to the price of a
    known or reputable supplier when they have
    difficulty comparing alternatives
  • Price quality effect
  • buyers are less sensitive to a products price to
    the extent that a higher price signals better
    quality
  • Expenditure effect
  • buyers are more price sensitive when the
    expenditure is larger, either in dollar terms or
    a a percentage of household income

70
Factors that Impact Financial Value
  • End-benefit effect
  • broken into two parts derived demand
    (relationship between the desired end benefit and
    buyers price sensitivity for something that
    contributes to achieving that benefit) share of
    total cost (cost of the specific item to total
    cost of the product)
  • Shared-cost effect
  • impact of partial or complete reimbursement on
    price sensitivity
  • Fairness effect
  • based on price previously paid, prices of similar
    products (includes location or situation), and if
    item is to avoid a loss versus achieve a gain

71
Value Added - continued
  • How much is one hour of your customers time
    worth?

72
Temporal
  • Time is money
  • 100 per hour
  • Advertisement

73
Functional
  • Does the product or service do what is suppose to
    do?
  • Do we convey the functional value to the
    consumer?
  • RATER SYSTEM

74
Dimensions of Service Quality
  • Reliability
  • Assurance
  • Tangible
  • Empathy
  • Responsiveness

75
RATER SYSTEM
  • Apply to every area of guest interaction
  • Part of plan your work
  • RATER system and room service

76
Emotional/Psychological
  • Need for recognition
  • Staff have your best interest in mind
  • Feeling of safety

77
Experiential
  • Guests active participants in the experience
    versus passive observers

78
Social
  • Similar to experiential
  • Pricing of friends (e.g., Southwest promotes
    friends fly free, free birthday entrees)

79
Experiential
  • Guests active participants in the experience
    versus passive observers

80
Social
  • Similar to experiential
  • Pricing of friends (e.g., Southwest promotes
    friends fly free, free birthday entrees)
  • Memories of people together (e.g., getting
    engaged at Brennans)

81
Trust
  • Integrity
  • 34.1 claimed that If I ask management or an
    employee a question, I feel they will be truthful
    with me.
  • Security
  • 37.8 claimed that I feel comfortable leaving
    business papers and valuables in my room at this
    hotel.

82
Identification with Organization (from article on
theater goers)
  • Dedication to the customer
  • Customer support groups
  • HOGS
  • Seattle Mariners
  • Manchester United

83
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84
Identification with Organization
  • Opportunities for public displays of association

85
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86
Identification with Organization
  • Active alignment with and support of social
    causes
  • Ronald McDonald House
  • Baseball team

87
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88
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89
Identification with Organization
  • Provide opportunities for contact

90
Fox Theater
91
Identification with Organization
  1. Dedication to the customer
  2. Customer support groups
  3. Opportunities for public displays of association
  4. Active alignment with and support of social
    causes
  5. Provide opportunities for contact
  6. Distinctive human resource policies

92
Case study on Coca Cola
  • Questions
  • Is selling Coke through interactive vending
    machines a good idea or a bad idea?
  • What is Coke? What does Coke mean to the average
    consumer?
  • Where, how, and for whom does this technology
    create/destroy value? For example, loyal Coke
    customers, switchers amongst cola products, loyal
    Pepsi customers, etc.?

93
Case study on Coca Cola
  • Questions
  • What did Coca-Cola do right? What did it do
    wrong? How would you have done it?
  • What is price discrimination and when does it
    work?
  • What do you think of Ivester and his comments?

94
Types of pricing strategies
95
Types of Pricing Strategies and What to Consider
Skim Penetration Neutral Match
Customers
Competition
Costs
Strategy
96
Skim Pricing
  • Strategy
  • Designed to capture high margins at the expense
    of high sales volume
  • Skim prices are high in relation to what most
    buyers are willing to pay

97
Skim Pricing-continued
  • Customers
  • price insensitive
  • place high value on a products differentiating
    attributes
  • costs are billed to someone else
  • importance attached to end-benefits
  • value prestige and exclusivity

98
Skim Pricing - continued
  • Costs
  • incremental unit costs represent a small share of
    products price, even a small price premium will
    generate a large percentage increase in the
    contribution margin

99
Skim Pricing - continued
  • Competition
  • Must have some source of competitive protection
    (e.g., patents, brand name, access to scarce
    resource, distribution channel, image)

100
Penetration Pricing
  • Strategy
  • Setting price far enough below economic value to
    attract and hold a large base of customers
  • Strategy designed to generate sales volume even
    at the expense of high margins
  • Penetration prices not necessarily cheap, but are
    low relative to others (e.g., Lexus)

101
Penetration Pricing
  • Customers
  • A large share of the market must be willing to
    change suppliers in response to a price
    differential
  • Not every market will respond
  • Will not attract buyers to products for which the
    price is a trivial expenditure
  • Will not attract buyers who look at other
    features beside price

102
Penetration Pricing
  • Costs
  • More favorable when variable costs represent a
    small share of the price so that each additional
    sale provides a large contribution margin
  • the lower the contribution per sale, the larger
    the sales gain required before penetration
    pricing is profitable
  • if firm can create variable cost economies (e.g.,
    warehouse clubs, Dell computer)

103
Penetration Pricing
  • Competition
  • Competitors lack the ability or incentive to
    match prices this will only happen when
  • 1. Firm has significant cost advantage and or
    resource advantage so competitors believe they
    will lose if they begin a price war
  • 2. When firm is small so that it will not effect
    sales of competitors

104
Neutral Pricing
  • Strategic decision not to use price to gain
    market share
  • Firm favors other marketing tools
  • Generally adopted by default, as unable to
    practice a skim or penetration strategy
  • Maintain coherent pricing strategy

105
Neutral Pricing
  • Customers
  • Maintain coherent pricing strategy
  • Competition
  • May or may not be concerned with competition
  • Costs
  • May or may not understand costs

106
Match Pricing
  • Strategy
  • Decision to directly match competitors price
  • Customers
  • Believe customer is concerned about price
  • Costs
  • No understanding of costs
  • Competition
  • Totally concerned with competition

107
Exercise
  • What are your hotels pricing objectives?
  • What are your competitors objectives?
  • How would you respond to a competitor that
    practices penetration pricing
  • Prepare report to class
  • Overall pricing objective
  • Variations by segment
  • Describe implementation

108
Types of Pricing Strategies and What to Consider
Skim Penetration Neutral Match
Customers
Competition
Costs
Strategy
109
Section C
  • Understanding Revenue Management and Strategic
    Pricing

110
Objective of this section
  • Review basics of revenue management
  • Suggest how revenue management is different from
    strategic pricing
  • Understand core concepts of strategic pricing
  • Understand price customization

111
What Is Revenue Management One Part of Strategic
Pricing
  • Is the application of disciplined tactics that
    predict consumer behavior at the micro-market
    level and optimize product availability and price
    to maximize revenue growth - Robert Cross

112
What Is Revenue Management
  • Objective is to sell the right product to the
    right customer at the right time for the right
    price.
  • How do we define product?

113
Revenue Management
  • Tell me when you want to arrive and I will tell
    you the price
  • Tell me the price and I will tell you when to
    arrive and what the room will include

114
RM Works Best for Industries with Following
Characteristics
  • Perishable products and opportunities
  • Seasonal and other demand peaks
  • The products value is different in different
    market segments
  • Product wastage
  • Competition between individuals and bulk
    purchasers
  • Discounting to meet competition

115
  • Strategic Pricing
  • Strategy
  • Types of Questions What market segments should
    we go after how should we price our rooms What
    do our customers value
  • Revenue Management
  • Tactic
  • Types of Questions Should I sell this room at a
    discount or should I take a chance on the future?
  • How many rooms should be available at each price
    point

116
Seven Concepts of Strategic Pricing
  • Focus on price rather than supply when balancing
    supply and demand
  • Replace cost-based pricing with value pricing
  • Sell to segmented micro markets, not mass markets
  • Save your products for your most valuable
    customers
  • Make decisions based on knowledge, not
    supposition
  • Exploit each products value cycle
  • Continually reevaluate your revenue opportunity

117
Price Customization
118
Price Customization
If I have 2000 customers on a given route and
400 different prices, I am obviously short 1600
prices.
-Robert L. Crandall Former CEO of American
Airlines
119
Airline Sales Response Curve Figure 7
Number of seats
Sales Response Curve
B
380
Price below variable unit cost
A
C
0.0
Sales Price
100
0.0
3900
Variable Unit Cost
120
What does the previous slide tell us?
121
Questions for Figure 7
  • If going to charge one price, what would it be?
  • What is the potential revenue in area ABC?
  • With one price, how much revenue would be
    generated?
  • With one price, what would be the of revenue
    captured?

122
Airline Sales Response Curve Figure 8
Sales Volume
Sales Response Curve
B
380
Price below variable unit cost
190
D
E
The Maximum Profit Rectangle for Single Price
(ADEF)
C
A
F
0.0
0.0
100
2000
3900
Variable Unit Cost
123
Airline Sales Response Curve Figure 9
Sales Response Curve
Sales Volume
Passed Up Profit because reservation price
under 2,000
380
B
The Maximum Profit Rectangle for Single Price
X
(25)
190 seats
Price below variable unit cost
Money Left on the Table people willing To pay
more but priced too cheap so people paid the
cheaper fare called consumer surplus.
50
Y (25)
C
A
0.0
0.0
100Cost
2000 Price
3900
124
Role of Revenue Management
  • Transfer Some of the in X and Y to the Firm
    Due This By Having Different Prices and different
    products

125
Airline Sales Response Curve Figure 10
Sales Volume
Sales Response Curve
380
B
X1
254
Price below variable unit cost
The Maximum Profit Rectangle for Price 1
Y1
127
The Maximum Profit Rectangle for Price 2
Y2
127
A
C
0.0
0.0
100
(1,367)
3900
(2,633)
Variable Unit Cost
126
Questions Re Figure 10
  • What is the area of triangle ABC?
  • What is maximum profit rectangle for economy
    class?
  • What is maximum profit rectangle for business
    class?
  • What is the area of X-1,Y-1, Y-2 combined? What
    of potential revenue is this?
  • What have you learned?

127
Airline Sales Response Curve Figure 11
Sales Volume
Sales Response Curve
B
380
X-1
285
Price 1 contribution
Price below variable unit cost
Y-3
190
Price 2
Y-2
95
A
Y-1
Price 3
C
0.0
0.0
100
2950 first
2000 business
1050 economy
3900
Variable Unit Cost
128
Questions Re Figure 11
  • What is the area of triangle ABC?
  • What is maximum profit rectangle for economy
    class?
  • What is maximum profit rectangle for business
    class?
  • What is maximum profit rectangle for first class?
  • What is the area of X-1,Y-1, Y-2, Y-3 combined?
  • What of revenue is left on the table?

129
Complete the Following Table 12
Single First Economy First Business
Economy Ticket Class Class Class Class
Class
Price 2,000 2,633 1,367 2,950
2,000 1,050 Sales Volume 190 127
127 95 95
95 Total Passengers _____
_________ __________ Increase Passenger
Count NA __________ ___________ Cont
ribution ________
__________ ___________ Money Left On
Table/Profit Passed Up __________
__________ ___________
130
Fences to Manage Segments
131
1. Product-line Sort As A Way to Build Fences
  • Develop a product line and have customers sort
    themselves among the various offerings based on
    their preference (e.g., room with view)
  • Can have vertical differentiation (good, better
    best)

132
Example 1 Same room/Different Product
  • Corporate rate
  • Always available if there is room to sell
  • A reservation can be changed anytime
  • The room can be cancelled up to 6 PM on the day
    of arrival with no penalty
  • Advance purchase rate
  • Available when the hotel needs business
  • Once a reservation is made, payment is processed
    and no changes can be made
  • Full payment is kept by the hotel is the guest
    cancels or no shows

133
2. Controlled Availability As A Way to Build
Fences
  • Coupons to certain customer groups
  • Geographic pricing (e.g., different prices for
    locals)
  • Weekday versus Weekend

134
3. Buyer Characteristics As A Way to Build Fences
  • Age e.g., children and senior discounts
  • User status e.g., loyal customer/non-loyal
    corporate traveler, etc.
  • Others?

135
4. Transaction Characteristics As A Way to Build
Fences
  • Refundability
  • Changeability
  • Advance requirement
  • Quantity sold

136
5. Method of Booking As A Way to Build Fences
  • Internet Rates
  • Brand Shield
  • Priceline
  • Hotwire

137
Potential Fences
Rule Type Advanced Requirement Refundability Changeability Must Stay
Advance Purchase 3- Day Non refundable No Changes WE
Advance Reservation 7-Day Partially refundable ( refund or fixed ) Change to dates of stay, but not number of rooms WD
14- Day Fully refundable Changes, but pay fee, must still meet rules
21-Day Full changes, non-refundable
30-Day Full changes allowed
138
How Do Other Industries Build Fences?
  • Theaters?
  • Phone companies?
  • Ski resorts?
  • Golf?
  • Restaurants?
  • Broadcasting?

139
The Biggest Mistakes in Price Customization
Companies aim mostly for the low-price triangle
(discounting), but not for the high-price
triangle.
Goal Price customization should not bring the
average price down!
From Simon Kucher Partner (sbutscher_at_simon-kuc
her.com)
140
What Did We Learn
  • The rationale for why we price the way we do
  • The importance of understanding a customers
    willingness to pay and their reservation price
  • The importance of fences and enforcing the use of
    fencing
  • Why we learned geometry in school

141
American Airline Cases
142
Section D
  • Understand methods to determine price thresholds.

143
Objectives of this section
  • Learn methods to calculate customers willingness
    to pay
  • Introduce more sophisticated methods of pricing
    research

144
Price Sensitivity
  • The price a customer could be expected to pay
    for a product or service usually expressed as a
    range of prices.
  • Although can be thought of as price elasticity.

145
When Doing Price Research
  • Obtain information about
  • buyers perceptions and knowledge of prices with
    product category
  • purchase and use experience with the product
    category

146
Methods for Collecting Price Response Data
  • Price experiments
  • Customer surveys direct questioning
  • Conjoint measurement
  • Historical market data

147
Price Experiments
Examine actual purchases
  • Uncontrolled experiments
  • Aggregate sales data
  • Consumer panel
  • Examination of call center reports (e.g., turn
    downs, demand booking patterns, etc.)
  • Venetian study

148
Types of Experimentally Controlled Studies
1 Pre-test Post-test with no control
01 Pre-test Test Group rate and
booking pattern before 02 Post-test Test Group
rate and booking pattern after TE Treatment
Effect change in wording
149
Hotel Example
  • Venetian Hotel in Las Vegas
  • Manipulation
  • Quote 159 first
  • Quote 189 first
  • Two Teams
  • Team 1 conversion 21.9 calls 1813
  • Team 2 conversion 21.2 calls 1654

150
Price Experiments
Examine actual purchases
  • Controlled
  • In-store experiments
  • Laboratory purchase experiments
  • Opportunity for no manipulation

151
Types of Experimentally Controlled Studies -
continued
2 Basic Form of Pre-test Post-test with Control
TE (02 - 01) - (04 - 03)
01 Pre-test Test Group ADR 120
02 Post-test Test Group ADR 150
03 Pre-test Control Group ADR
120 04 Post-test Control Group ADR 120
TE Treatment Effect change of
wording
TE ?
152
Direct Questioning of Consumers
  • Methods
  • Magnitude Scaling
  • Price Sensitivity Measurement
  • Lewis and Shoemaker article
  • Price Categorization

153
Magnitude Scaling
  • Directions Below are some pairs of brands of
    hotels. For each pair please indicate which
    hotel brand you would stay in by circling the
    number that corresponds most closely with the
    description of your choice. Assume you are
    interested in purchasing this hotel for a
    business trip and that the pair represents the
    only choice available.

154
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155
Price Difference Mean Rating (A versus B)
-40 1.3
-35 1.6
-30 1.9
-25 2.2
-20 2.4
-15 2.6
-10 2.9
-5 3.2
0 3.2
5 3.6
10 3.7
15 4
20 4.5
25 5
30 5.5
35 5.8
40 6
156
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157
Price Difference Mean Rating (A versus C)
-40 1.9
-35 2
-30 2.4
-25 3
-20 3.25
-15 3.3
-10 3.4
-5 3.5
0 3.5
5 4
10 4.5
15 5.75
20 5.9
25 6
30 6.1
35 6.3
40 6.3
158
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159
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160
Direct Questioning of Consumers Price
Sensitivity Measurement
161
5 Questions
  • At what price would you consider this hotel to be
    so inexpensive that you would have some doubts
    about the quality of accommodations?
  • Used to determine optimal price
  • At what price would you still feel this hotel was
    inexpensive, yet have no doubts about the quality
    of the accommodations?
  • Used to determine the indifference price

162
5 Questions - Continued
  • At what price would you begin to feel that this
    hotel is expensive, but still worth staying in
    because its quality (e.g., accommodations,
    location, etc.)?
  • Used to determine indifference price
  • At what price would you feel this hotel is so
    expensive that regardless of its quality (e.g.,
    accommodations, location, etc.) it is not worth
    purchasing this room?
  • To determine optimal price

163
5 Questions - Continued
  • Please state the price that you think you would
    expect to pay for __________?
  • Used to determine reference price

164
Examples of ways to measure responses
___ ___ ____ ____ ____ ____ ____ ____
____ ____ P1 P2 P3 P4 P5
P6 P7 P8 P9 P10
Price? _________
165
Steps In Analysis (Lewis and Shoemaker)
  • Type in data and put in one chart
  • Sort data by price point
  • Calculate frequency of each price point
  • Calculate Cumulative proportion of those who
    find price to be unacceptable because it is too
    low
  • Calculate Acceptable cumulative
  • Calculate Cumulative proportion of those who
    find price to be unacceptable because it is too
    high is labeled
  • Calculate Acceptable high
  • Add all data to one spreadsheet
  • Plot graphs

166
PSM ANALYSIS
See Handout
167
Conjoint Measurement
  • Assumption that value of a product is made up by
    the value of different components
  • The purchasing of a product/service involves
    trade-offs (e.g., the hotel is a little out of
    the way, but I want the frequency points)

168
Conjoint Measurement - example
  • Individual provides an overall preference
    judgment for various products and then researcher
    uses mathematical analysis to tease out the value
    of each level of the attribute
  • Example fitness facility sauna (yes, no) and
    locker size (small, medium, large)
  • 2 x 3 or 6 combinations

169
Conjoint Measurement - continued
Attribute sauna locker size
Level Yes, No S, M, L
Card small locker with a sauna
170
Conjoint Measurement - continued
  • 2 x 3 or 6 combinations
  • Sauna
  • Y
    N
  • Small rank 2 rank 4
  • Locker Med rank 1 rank 3
  • Large rank 5 rank 6

171
Conjoint Measurement - continued
  • change ranks to utility pts to capture
    preferences
  • 5 is highest 0 is lowest
    Y Sauna
    N
  • Small 4 2
    average 3
  • Locker Med 5 3
    average 4
  • Large 1
    0 average 0.5

average3.33 average1.67
172
Conjoint Measurement - continued
  • think of utility as average value so
  • sauna yes 3.33
  • no 1.67
  • locker small 3
  • medium 4
  • large 0.5
  • recall, 1 rating was medium locker with sauna
  • 3.33 4 7.33
  • recall, 2 rating was small with sauna
  • 3.33 3 6.33

173
Conjoint Measurement - continued
  • change ranks to utility pts to capture
    preferences
  • 5 is highest 0 is lowest Sauna

    Yes No
  • 4 (6.33) 2 (4.67)
  • Locker 5 (7.33) 3 (5.67)
  • 1
    (3.83) 0 (2.17)

S M L

174
Conjoint Measurement - continued
  • For problems with more than 2 features, calculate
    the averages using regression instead of looking
    at averages, we look at beta weights
  • Y a ß x were b is the beta weight

175
Conjoint Measurement - continued
  • Although not shown, it is possible to estimate
    utilities for all levels of all attributes even
    though respondent rates only a subset
  • e.g., product with 5 attributes (3 with 3
    levels, 2 with 2 levels) 3 x 3 x 3 x 2 x 2 108
  • fractional factorial design allows us to rate
  • 16 of the 108 combinations

176
Steps In Performing Conjoint Study
  • Determine Number of Factors (Benefits) and the
    level of each factor
  • Construct the cards via a design program (e.g.,
    SPSS)
  • Present cards to respondents and have them rate
    each card
  • Estimate utilities for each level
  • Construct ideal benefit profiles using calculated
    utilities

177
Conjoint Measurement - Example
  • Motor coach study
  • You are selecting a New England Fall Foliage
    Motorcoach tour. The total package price
    includes the following
  • Two dinners from a selected menu
  • 3 days and 2 nights
  • All taxes and gratuities
  • Room based on per person
  • Each of the 8 cards represents a package tour.
    Please rank order the cards in order in which
    tour you would most likely select, placing this
    card on top, down through your least likely
    selection (on the bottom of the pile.)

178
Conjoint Measurement - Example
  • Items Studied
  • Daytime activities
  • Some preplanned, some free time 1
  • All preplanned 0
  • Total package price
  • 159
    1
  • 179
    0
  • Tour company
  • You are not familiar with the companys
    reputation 1
  • You are familiar with the companys reputation
    0
  • Accommodations
  • Deluxe chain hotel 1
  • Historic Inn
    0
  • Meals
  • In hotel
    1
  • In host citys restaurant 0
  • After dinner entertainment
  • Preplanned activity 1
  • Evening free
    0

179
Conjoint Measurement - Example
  • Example of a card
  • Daytime activities
  • Some preplanned, some free time
  • Total package price
  • 159
  • Tour company
  • You are not familiar with the companys
    reputation
  • Accommodations
  • Deluxe hotel
  • Meals
  • In hotel
  • After dinner entertainment
  • Preplanned activity

180
Profile Number 1 Daytime activities all
preplanned 179 Tour Company Familiar type of
accommodations deluxe chain hotel Type of Meals
In hotel After Dinner Entertainment
Free     Profile Number 2 Daytime activities
some free time 179 Tour Company
Unfamiliar type of accommodations country
inn Type of Meals In hotel After Dinner
Entertainment Free     Profile Number 3 Daytime
activities some free time 159 Tour Company
Familiar type of accommodations deluxe chain
hotel Type of Meals In host city After Dinner
Entertainment Free
181
Profile Number 4 Daytime activities all
preplanned 179 Tour Company Unfamiliar type of
accommodations deluxe chain hotel Type of Meals
In host city After Dinner Entertainment
Preplanned     Profile Number 5 Daytime
activities some free time 159 Tour Company
Unfamiliar type of accommodations deluxe chain
hotel Type of Meals In hotel After Dinner
Entertainment Preplanned   Profile Number
6 Daytime activities some free time 179 Tour
Company Familiar type of accommodations country
inn Type of Meals In host city After Dinner
Entertainment Preplanned
182
Profile Number 7 Daytime activities all
preplanned 159 Tour Company Unfamiliar type of
accommodations country inn Type of Meals In
host city After Dinner Entertainment Free
    Profile Number 8 Daytime activities all
preplanned 159 Tour Company Familiar type of
accommodations country inn Type of Meals In
hotel After Dinner Entertainment
Preplanned      
183
Conjoint Model Tested
Y ß0 ß 1Price ß 2Meals ß
3Accommodations ß 4Company ß 5Daytime
ß 6After Dinner error
NOTE, ß ARE THE UTILITIES
184
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185
Interpretation of Analysis
FEATURE
BETA SIG. Tour Company (unfamiliar
with) More unfamiliar, the less they like it
-1.60 .00 Daytime (some
preplan/some free) 0.60
.00 More there is some planned/some free,
the more they like it Accommodations (deluxe
hotel) -0.35 .04
The less it is like a deluxe hotel, the more
they will like it After Dinner
0.22 .26 Price
0.19 .27 Meals -0.07
.71
186
Conjoint Measurement - Example
  • Items Studied
  • Daytime activities
  • Some preplanned, some free time .60
  • All preplanned
    -.60
  • Total package price
  • 159
    0
  • 179
    0
  • Tour company
  • You are not familiar with the companys
    reputation -1.60
  • You are familiar with the companys reputation
    1.60
  • Accommodations
  • Deluxe chain hotel
    -.35
  • Historic Inn
    .35
  • Meals
  • In hotel
    0
  • In host citys restaurant 0
  • After dinner entertainment
  • Preplanned activity 0
  • Evening free
    0

187
Exercise for Calculating Utilities
  • Given information on previous slide, calculate
    utilities for tour packages and create ideal
    tour.

188
Profile Number 1 Daytime activities all
preplanned 179 Tour Company Familiar type of
accommodations deluxe chain hotel Type of Meals
In hotel After Dinner Entertainment
Free     Profile Number 2 Daytime activities
some free time 179 Tour Company
Unfamiliar type of accommodations country
inn Type of Meals In hotel After Dinner
Entertainment Free     Profile Number 3 Daytime
activities some free time 159 Tour Company
Familiar type of accommodations deluxe chain
hotel Type of Meals In host city After Dinner
Entertainment Free
189
Profile Number 4 Daytime activities all
preplanned 179 Tour Company Unfamiliar type of
accommodations deluxe chain hotel Type of Meals
In host city After Dinner Entertainment
Preplanned     Profile Number 5 Daytime
activities some free time 159 Tour Company
Unfamiliar type of accommodations deluxe chain
hotel Type of Meals In hotel After Dinner
Entertainment Preplanned   Profile Number
6 Daytime activities some free time 179 Tour
Company Familiar type of accommodations country
inn Type of Meals In host city After Dinner
Entertainment Preplanned
190
Profile Number 7 Daytime activities all
preplanned 159 Tour Company Unfamiliar type of
accommodations country inn Type of Meals In
host city After Dinner Entertainment Free
    Profile Number 8 Daytime activities all
preplanned 159 Tour Company Familiar type of
accommodations country inn Type of Meals In
hotel After Dinner Entertainment
Preplanned      
191
Sampling
192
Six-Step Procedure for Drawing a Sample
  • Define the Population
  • Identify the Sampling Frame
  • Select a Sampling Procedure
  • Determine the Sample Size
  • Select the Sample Elements
  • Collect the Data from Designated Elements

193
Determinants of Sample Size
  • The importance of the decision (this relates to
    confidence intervals)
  • The nature of the research (exploratory vs.
    descriptive vs. causal)
  • The nature of the analysis (i.e., if plan to look
    at subgroups)
  • Incidence rates (this relates to cost)
  • Resource constraints

194
Sampling Techniques
  • Non Probability
  • Judgmental
  • Convenience
  • Quota
  • Snowball

195
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