Pricing and Revenue Optimization

2017 – 2018 – Mohali Campus

Professor Nishant Mihra

Case Study/Homework Name – HW1

Group Number - 14

No. Student’s Name PGID Number

1 Smriti Gupta 61810804
2 Preetham Murthy
3 Gundeep Singh Saini 61810330
4 Surbhi Wadhwa 61811028
Q1. When is dynamic pricing efficient market practice and when is it fleecing?
“Fleecing” is a frequent term used nowadays to describe when a customer is being over priced by
the company. A lot of companies have resort to fluctuating prices over time which is called
dynamic pricing. In dynamic pricing the firm calculates the prices periodically based on different
factors like time, market conditions, availability etc. Dynamic pricing is being commonly used in
industries like hospitality, airline, entertainment etc.

Dynamic pricing is used by companies in order to maximize their profits from each customer. It
helps the companies to price their product based on the demand in the market. Dynamic pricing is
efficient market practice in the following scenarios:

1. Peak / Non Peak hours – Dynamic pricing helps to regulate the traffic during the peak
hours. Companies charge higher price from consumers during peak hours as the demand
for the product/service is greater. During non-peak hours companies provide discounts in
order to attract customers. For example, happy hours are provided in restaurants during
non-peak hours.
2. Perishable goods/services – Companies in the service industry like hotels, airlines apply
dynamic pricing as their services are perishable. If a room remains unsold one night, it is a
lost revenue for the hotel. Hence, companies use dynamic pricing.
3. Limited stock – Companies tend to charge different prices to consumers with time. As the
stock of the product is limited, consumers are charged higher when low level of stock is
available. For examples, vegetables prices increase as the supply of vegetable decreases.
Dynamic pricing is now being exploited by companies. Companies have begun to charge
consumers higher prices thus fleecing customers. In the name of “surge pricing” companies
overprice their product/service because they are aware that consumers will be willing to pay higher
price in the time of need.

For example, products like water are heavily priced in multiplexes and restaurants. This is fleecing
consumers and charging a higher price as consumers who want water will be willing to pay.

Q2 a. Amazon Prime
Amazon Prime initially started in 2005 where prime members were provided free expedited
shipping and nothing else for $79. This concept didn’t work as consumers felt they were paying
additional only for delivery. Amazon then brought in additional services for its prime members.

Currently by purchasing the Amazon prime subscription a consumer receives the benefit of free
Two-Day Shipping, unlimited streaming of movies and TV shows with Prime Video, and the
ability to borrow books from the Kindle Owners' Lending Library for $99 a year or $10.99 a month.
Amazon segments its customers as Prime and non-prime members.
Prime members pay an additional fee to get access to a bundle of services i.e. delivery and videos.
This is an additional income for Amazon and at the same time these perks help to build customer
loyalty and helps retain customers. Due to Prime membership, Amazon has created a segment of
customers who are easily identifiable as having high lifetime value. These customers spend almost
three times than non-Prime customers spend per year. Hence, this segmentation has proved to be
a success for Amazon.

The fences created by Amazon are fierce as non-prime members do not enjoy fast delivery, early
sales and the entertainment on Prime Video. Hence, the fierce fences effectively separate the
customers based on their usability of the application. The prime members feel a sense of loyalty
to the company and abort from using other online shopping applications. Their usual behavior is
impacted. Earlier the first step was price comparison and now is direct purchase from Amazon.
Amazon has been able to reach revenue maximization with this pricing strategy. The customer
segmentation Amazon has achieved has helped Amazon is giving priority service to those
customers who need it and value it. The customers for whom the priority delivery service is not
valuable are unaffected as they are not forced to pay the premium.

Q2 b. Groupon coupons
Groupon, an American e-commerce marketplace, offers coupons of activities, services and goods
by liaising with local merchants and subscribers. Groupon earns a share of the revenue on every
sale as commission, which is pre-set. Before 2012, Groupon was failing to deliver a solution to
restaurants and losing out revenue on restaurant business segment. While Groupon couldn’t
succeed in restraint business segment, Savored spread its mark in dining category. The acquisition
of Savored help Groupon expand into dining category.

Groupon was not able to make a consistent and deep relationship with restaurants, which
demanded a steady channel to control their sale of tables. Groupon was a daily deal provider.
Restaurants, a fixed cost heavy business, volume of customers is crucial for profits. Savored
provided a platform to restaurants that could be tweaked to suit their needs. Restaurants could sell
their perishable inventory through Savored. Groupon, a generic platform, could not fulfil this need
as it needed a group selling to offer deals and hence, fine dining world became Anti-Groupon.
Through Savored’s growth in restaurant partner community, consumers’ experienced also
improved and Savored was able to quickly fill tables at those restaurants. As Savored did not need
a group to make a deal valid, it made it easy for customers to use it.

After acquisition, Groupon could now manage its revenue by having 2 different products for 2
different types of customers. First set of customers were those who were happy with deals sold by
Groupon at cheaper rates as it helped increase customers without much hassle. Second set became
the fine dining restaurants that needed a deeper and consistent relationship with the platform, and
a market favorable ability to increase sale volume. The overall revenue of Groupon was hence
maximized.

The fences thus created between the two customer segments separated the customers based on
their demand of relationship type in order to restrict their usage. The fence was effective enough
to segregate the customers that needed consistent relationship and the customers that needed daily
deals. Thus, this revenue management technique helped Groupon increase its revenue.

Q2 c. Another Example – Travel Industry (Airlines)

Airlines sell same seats to different customer segments at different prices. The two customer
segments are business class and economy class. Airlines assign capacities to both the segments.
The fences are created either by enforcing some rules such as a mandatory Saturday-night stay or
a 15-day advance purchase on economy tickets. Such fences restrict business class customers to
book in economy class as they are schedule sensitive. The enforced fare rules discourage business
class customers to purchase economy tickets. Along with such rules, airlines provide some
additional services to business class customers such as early check-in, early baggage, food and
beverage.

The sales restrictions in this case help airlines manage revenue effectively as it charges for almost
same product differently to different customer segments. This strategy helps the companies fill its
seats with maximum revenue.

Apart from this segmentation, airlines do dynamic pricing. As the date of travel comes closer, the
airlines increase its seats’ prices because of capacity constraint they have. As the capacity keeps
filling, airlines try to maximize revenue by increasing price for the same seat. This segmentation
is justified because here pricing is directly dependent on supply chain equation. There isn’t a clear
fence in this type of segregation as there is no restrictions on usage. This is just a pricing strategy
that works because of limited capacity in airlines.

The pricing in airline industry is set in order to fill the seats and recover cost of every trip by high
occupancy rate. This model needs effective revenue maximization as it is also a fixed cost heavy
business. The customer segmentation and dynamic pricing combined helps airlines to manage its
revenue to maximum possible. Further loyalty programs of airlines also connect with frequent
travelers by providing the free lounge and spa services at airports to enhance their overall travel
journey.

The pricing model of airlines is hence successful. Such strategies can also work for restaurants and
hotels.
Q3 Vertigo Case
Member Demand, Dm = 10000 – 125p ; Member Revenue, Rm = Dm * p = 10000p – 125p2
Non-member Demand, Dg = 40000 – 200p ; Non-member revenue, Rg = Dg * p = 40000p – 200p2

The maximum revenue that can be generated for individual categories can be found by
differentiating the equations. Therefore, the maximum revenue is generated at p=40 for members
and p=100 for non-members, the combined max revenue is generated at p=100.
a) Therefore, if a discount needs to be given to the members, the final price of the tickets
should be $40 in order to maximize the revenue from members. Discounts are used to
increase the volume of sales and the same principle is being followed here. In order to fill
more seats, a discount is being given across categories that will attract people as the
discounted prices will be within the WTP of the segments.
b) In case a single price is to be charged, it should maximize the total revenue, therefore a
price of $100 should be charged. But at this price, the U2 members will not attend as it is
greater than their willingness to pay (WTP). It is therefore imperative to offer differential
pricing based on the WTP of different customer segments since they do not have the same
WTP. In this case, the U2 members will benefit the most if a differential pricing is put in
place. A price of $40 for members and a price of $100 for non-members will maximize the
revenues as well.
c) In order to restrict the discount to $30, the prices can be set at $50 for the members and
$80 for the non-members, this way the revenue is reduced than the optimal but the
constraint is satisfied.

Seated Demand, Dm = 22000 – 100p ; Member Revenue, Rm = Dm * p = 22000p – 100p2

Non-seated Demand, Dg = 20000 – 100p ; Non-member revenue, Rg = Dg * p = 20000p – 100p2

The maximum revenue that can be generated for individual categories can be found by
differentiating the equations. Therefore, the maximum revenue is generated at p=110 for seated
and p=100 for non-seated. The problem in achieving the optimal solution is that the GA area is
best suited for U2 members whose WTP is $80 but the optimal solution price is not in line with
the WTP.

Also, the fact that 2 seats displace 3 non seated members, we will lose non seated member volumes
at a rate 1.5 times the seated members are added. Since the U2 member’s revenues were primarily
based on volumes, this is not a good move. Also, this seating arrangement can attract customers
from other categories which might lead to loss of revenue in those segments.

In order to improve this, the discount offered to the non-seated guests can be removed and the
seating can be a full priced ticket for U2 members. This will ensure that the member volume does
not reduce and at the same time, the members who want a seat will be able to secure it.