Chapter 6

Pricing and Revenue

Management

Slide ©2004 by Christopher Lovelock and Jochen Wirtz Services Marketing 5/E 6- 1
 What Makes Service Pricing Strategy Different
(and Difficult)?

 No ownership of services--hard for firms to calculate

financial costs of creating an intangible performance
 Variability of inputs and outputs--how can firms define a
“unit of service” and establish basis for pricing?
 Many services hard for customers to evaluate--what
are they getting in return for their money?
 Importance of time factor--same service may have more
value to customers when delivered faster
 Delivery through physical or electronic channels--may
create differences in perceived value

Slide ©2004 by Christopher Lovelock and Jochen Wirtz Services Marketing 5/E 6- 2
 Objectives of Pricing Strategies

 Revenue and profit objectives

 Seek profit
 Cover costs

 Patronage and user base-related objectives

 Build demand
 Build a user base

Slide ©2004 by Christopher Lovelock and Jochen Wirtz Services Marketing 5/E 6- 3
 The Pricing Tripod (Fig. 6.1)

Pricing Strategy

Competition
Costs Value to customer

Slide ©2004 by Christopher Lovelock and Jochen Wirtz Services Marketing 5/E 6- 4
 Three Main Approaches to Pricing

 Cost-Based Pricing
 Set prices relative to financial costs
(problem: defining costs)

 Competition-Based Pricing
 Monitor competitors’ pricing strategy
(especially if service lacks differentiation)
 Who is the price leader? (one firm sets the pace)

 Value-Based
 Relate price to value perceived by customer

Slide ©2004 by Christopher Lovelock and Jochen Wirtz Services Marketing 5/E 6- 5
 Activity-Based Costing: Relating Activities to
the Resources They Consume

 Managers need to see costs as an integral part of a firm’s

effort to create value for customers
 When looking at prices, customers care about value to
themselves, not what production costs the firm
 Traditional cost accounting emphasizes expense
categories, with arbitrary allocation of overheads
 ABC management systems examine activities needed to
create and deliver service (do they add value?)
 Must link resource expenses to:
 variety of products produced
 complexity of products
 demands made by individual customers

Slide ©2004 by Christopher Lovelock and Jochen Wirtz Services Marketing 5/E 6- 6
 Net Value = (Benefits – Outlays)
(Fig. 6.3)

Effort Time
e
Perceived Perceived
Benefits Outlays

Slide ©2004 by Christopher Lovelock and Jochen Wirtz Services Marketing 5/E 6- 7
 Enhancing Gross Value

 Pricing Strategies to Reduce Uncertainty

 service guarantees
 benefit-driven (pricing that aspect of service that creates value)
 flat rate (quoting a fixed price in advance)

 Relationship Pricing
 non-price incentives
 discounts for volume purchases
 discounts for purchasing multiple services

 Low-cost Leadership
 Convince customers not to equate price with quality
 Must keep economic costs low to ensure profitability at low price

Slide ©2004 by Christopher Lovelock and Jochen Wirtz Services Marketing 5/E 6- 8
 Paying for Service:
The Customer’s Perspective

Customer “expenditures” on service comprise both

financial and non-financial outlays

 Financial costs:
 price of purchasing service
 expenses associated with search, purchase activity, usage

 Time expenditures
 Physical effort (e.g., fatigue, discomfort)
 Psychological burdens (mental effort, negative feelings)
 Negative sensory burdens (unpleasant sensations affecting any
of the five senses)

Slide ©2004 by Christopher Lovelock and Jochen Wirtz Services Marketing 5/E 6- 9
 Determining the Total Costs of a Service
to the Consumer (Fig. 6.4)

Search Costs Price Operating Costs

Related Monetary
Costs Incidental
Expenses
Time Costs
Purchase and
Physical Costs
Use Costs
Psychological
Costs

Sensory Costs

Necessary
After Costs follow-up
Problem
solving
Slide ©2004 by Christopher Lovelock and Jochen Wirtz Services Marketing 5/E 6 - 10
 Trading off Monetary and Non- Monetary Costs
(Fig. 6.5)

Which clinic would you patronize if you needed a chest

x-ray (assuming all three clinics offer good quality) ?
Clinic
ClinicAA Clinic
ClinicBB Clinic
ClinicCC
Price
 Price$45
$45 Price
 Price$85
$85 Price
 Price$125
$125
Located
 Located11hourhouraway
away Located
 Located15 15min
min Located
 Locatednext
nexttoto
by
bycar
carorortransit
transit away
awayby bycar
caror
or your
youroffice
officeor
or
Next
 Nextavailable
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transit college
college
appointment
appointmentis isin
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 Nextavailable
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 Nextappointment
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weeks
weeks appointment
appointmentis isin
in11 is
isin
in11day
day
Hours:
 Hours:Monday
Monday–– week
week Hours:
 Hours:Mo Mo–Sat,
–Sat,
Friday,
Friday,9am9am––5pm
5pm Hours:
 Hours:Monday
Monday–– 8am
8am––10pm
10pm
Estimated
 Estimatedwait waitat
at Friday,
Friday,8am8am––10pm
10pm By
 Byappointment
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clinic
clinicisisabout
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 Estimatedwaitwaitatat estimated
estimatedwait
waitatat
hours
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clinicisisabout
about3030-- clinic
clinicis
isabout
about00toto
45
45minutes
minutes 15
15minutes
minutes

Slide ©2004 by Christopher Lovelock and Jochen Wirtz Services Marketing 5/E 6 - 11
 Increasing Net Value by Reducing
Non-financial Costs of Service

 Reduce time costs of service at each stage

 Minimize unwanted psychological costs of service
 Eliminate unwanted physical costs of service
 Decrease unpleasant sensory costs of service

Slide ©2004 by Christopher Lovelock and Jochen Wirtz Services Marketing 5/E 6 - 12
 Revenue Management: Maximizing Revenue
from Available Capacity at a Given Time

 Based on price customization - charging different customers

(value segments) different prices for same product

 Useful in dynamic markets where demand can be divided

into different price buckets according to price sensitivity

 Requires rate fences to prevent customers in one value

segment from purchasing more cheaply than willing to pay

 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

Slide ©2004 by Christopher Lovelock and Jochen Wirtz Services Marketing 5/E 6 - 13
 The Strategic Levers of
Revenue (Yield) Management

Price

Fixed Variable

Quadrant 1: Quadrant 2:
Duration

Predictable Movies Hotel Rooms

Stadiums/Arenas Airline Seats
Function Space Rental Cars
Cruise Lines

Quadrant 3: Quadrant 4:
Unpredictable Restaurants Continuing Care
Golf Courses Hospitals

Slide ©2004 by Christopher Lovelock and Jochen Wirtz Services Marketing 5/E 6 - 14
 Dealing with Common Customer Conflicts
Arising from Revenue Management

Customer conflict can arise from: Marketing tools to reduce

customer conflicts:
 Perceived Unfairness & Perceived  Fenced Pricing
Financial Risk Associated with  Bundling
Multi-Tier Pricing and Selective  Categorising
Inventory Availability  High Published Price
 Unfulfilled Inventory Commitment  Well designed Customer Recovery
Programme for Oversale
 Unfulfilled Demand of Regular  Preferred Availability Policies
Customers
 Unfulfilled Price Expectation of  Offer Lower Displacement Cost
Group Customers Alternatives
 Change in the Nature of the  Physical Segregation & Perceptible
Service Extra Service
 Set Optimal Capacity Utilisation Level

Slide ©2004 by Christopher Lovelock and Jochen Wirtz Services Marketing 5/E 6 - 15
 Price Elasticity (Fig. 6.6)

Price per Di
unit of De
service

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.

Slide ©2004 by Christopher Lovelock and Jochen Wirtz Services Marketing 5/E 6 - 16
 Key Categories of Rate Fences (Table 6.2)

Rate Fences Examples

Physical (Product-related) Fences
Basic Product Class of travel (Business/Economy class)
Size and furnishing of a hotel room
Seat location in a theatre
Amenities Free breakfast at a hotel, airport pick up etc.
Free golf cart at a golf course
Service Level Priority wait listing
Increase in baggage allowances
Dedicated service hotlines
Dedicated account management team

Slide ©2004 by Christopher Lovelock and Jochen Wirtz Services Marketing 5/E 6 - 17
 Key Categories of Rate Fences (Table 6.2 cont’d)

Non Physical Fences

Transaction Characteristics
Time of booking or  Requirements for advance purchase
reservation  Must pay full fare two weeks before departure
Location of booking or  Passengers booking air tickets for an
reservation identical route in different countries are
charged different prices
Flexibility of ticket  Fees/penalties for canceling or changing a
usage reservation (up to loss of entire ticket price)
 Non refundable reservation fees

Slide ©2004 by Christopher Lovelock and Jochen Wirtz Services Marketing 5/E 6 - 18
 Key Categories of Rate Fences (Table 6.2 cont’d)

Non Physical Fences (cont’d)

Consumption Characteristics
Time or duration of  Early bird special in restaurant before 6pm
use  Must stay over on Sat for airline, hotel
 Must stay at least five days

Location of  Price depends on departure location, esp in

consumption international travel
 Prices vary by location (between cities, city
centre versus edges of city)

Slide ©2004 by Christopher Lovelock and Jochen Wirtz Services Marketing 5/E 6 - 19
 Key Categories of Rate Fences (Table 6.2 cont’d)

Non Physical Fences (cont’d)

Buyer Characteristics
Frequency or volume  Member of certain loyalty-tier with the firm get
of consumption priority pricing, discounts or loyalty benefits

Group membership  Child, student, senior citizen discounts

 Affiliation with certain groups (e.g. Alumni)
Size of customer  Group discounts based on size of group
group

Slide ©2004 by Christopher Lovelock and Jochen Wirtz Services Marketing 5/E 6 - 20
 Relating Price Buckets and Fences to the
Demand Curve (Fig. 6.7)

Price per
Seat

First Class
Full Fare Economy (No Restrictions)

One-Week Advance Purchase

One-Week Advance Purchase, Saturday Night Stayover
3-Week Advance Purchase, Saturday Night Stayover
3-Week Adv. Prchs, Sat. Night Stay., $100 for Changes
3-Wk Adv. Prchs, Sat. Night Stay, No changes/refunds
Late Sales through Consolidators/
Internet, no refunds

Capacity Capacity
of 1st-class of Aircraft
Cabin
No. of Seats Demanded

Slide ©2004 by Christopher Lovelock and Jochen Wirtz Services Marketing 5/E 6 - 21
 Ethical Concerns in Pricing

 Customers are vulnerable when service is hard to evaluate

or they don’t observe 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

 Too many rules and regulations

 customers feel constrained, exploited
 customers unfairly penalized when plans change

Slide ©2004 by Christopher Lovelock and Jochen Wirtz Services Marketing 5/E 6 - 22
 Pricing Issues:
Putting Strategy into Practice (Table 6.3)

 How much to charge?

 What basis for pricing?

 Who should collect payment?

 Where should payment be

made?

 When should payment be

made?

 How should payment be

made?

 How to communicate prices?

Slide ©2004 by Christopher Lovelock and Jochen Wirtz Services Marketing 5/E 6 - 23
 Consumption follows the Timing of Payments
(Research Insight 6.1)

Annual Payment Plan Quarterly Payment Plan

Health Club Visits
Frequency of

Semiannual Payment Plan Monthly Payment Plan

Health Club Visits
Frequency of

Time Line Time Line

Source: John Gourville and Dilip Soman, “Pricing and the Psychology of Consumption,”
Harvard Business Review, September 2002, 90-96.

Slide ©2004 by Christopher Lovelock and Jochen Wirtz Services Marketing 5/E 6 - 24