Chapter 10 Pricing and Customer Value Qi Xu Professor of Donghua University Tel: 021-62378860 E-mail: xuqi@dhu.edu.cn

Outline Customer Value The Fundamentals of Pricing Strategies Revenue Management & Customized Pricing Mail-in-Rebate strategies Dynamic Pricing in SCM Delayed Pricing vs. Delayed Production

Customer Value How should a company measure the value of its products or services? The emphasis has moved from internal measures such as quality to customer satisfaction measures. The supply chain has a huge impact on perceived customer value: Prices vs. service? Delivery speed vs. price? Specialization or one-stop shopping? Recall that responding to customer requirements is a basic part of supply chain management. Customer value drives changes in the supply chain, and is a critical input in determining the type of supply chain for a particular product Large inventories High level of customization

The Dimensions of Customer Value Conformance to requirements Offer what the customer wants Demand impacts the supply chain Product Selection A proliferation of options makes the supply chain difficult to manage Three trends Specialty stores (Starbucks, Subway) Megastores (Wal-Mart, Target) Specialized Megastores (Home Depot, OfficeMax) Dealing with the proliferation: Build-to-order Centralized inventories A fixed set of options

The Dimensions of Customer Value Price and Brand Pricing is a key part of the customer experience The correct supply chain supports the correct price Wal-mart Brand works hand in hand with price As the number of salespeople decreases, the value of brand increases This is particularly true on the internet Value Added Services It is hard to compete on price alone Value added services are on the rise due to Commoditization of products The need to get closer to the customer Improving information technology Relationships and Experiences An increased connection between the firm and its customers Dell manages the PC’s of large customers 3PL The Sony store

Smart Pricing? Dell: Amazon Nikon, Sharp… Boise Cascade office Same product is sold at a different price to different consumers (private/small or large business/government/academia/health care) Price of the same product for the same industry varies Amazon Books.com had a lower price than Amazon 99% of the time, yet Amazon had 80% of the market in 2000 while Books.com only 2% Nikon, Sharp… Mail-In-Rebate Boise Cascade office Prices of 12,000 items sold on-line may change as often as daily

Revenue Management Example: A cruise ship with C=400 identical cabins The Price-Quantity relationship

Revenue Management 2000 Price P=2000-2Q 1000 No. seats

Revenue Management Example: A cruise ship with C=400 identical cabins The Price-Quantity relationship What is the price that the company should charge to maximize revenue?

Revenue Management Price Revenue=480,000 P0=1200 C=400 No. seats

Revenue Management Money on the Table=160,000 P0=1200 C=400 Price No. seats

Revenue Management Price P2=1600 Q2=200 No. seats

Revenue Management Price P1=1200 C=400 No. seats

Revenue Management Revenue=1600(200) + 1200(400-200)=560,000 P2=1600 Price Revenue=1600(200) + 1200(400-200)=560,000 P2=1600 P1=1200 Q2=200 Q1 =400 No. seats

Revenue Management Can we increase revenue more?

Revenue Management Price P3=1800 Revenue=1800(100) + 1600(200-100) + 1200(400-200)=580,000 P2=1600 P1=1200 Q2=200 Q3=100 Q1 =400 No. seats

Sensitivity to Duration Sensitivity to Flexibility How can the firm prevent customers from moving from one class to another? Sensitivity to Price Sensitivity to Duration Sensitivity to Flexibility High Low Low High Leisure Travelers No Demand No Offer Business Travelers

Revenue Management “Allocating the right type of capacity to the right kind of customer at the right price so as to maximize revenue or yield” Traditional Industries: Airlines Hotels Rental Car Agencies Retail Industry

Traditional Requirements Perishable inventory Limited capacity Ability to segment markets early-bird booking over the weekend Product sold in advance Fluctuating demand

Airline Revenue Management Two components of airline revenue maximization: Customized Pricing: Various “fare products” offered at different prices for travel in the same O-D market Yield Management (YM): Determines the number of seats available to each “fare class” on a flight, by setting booking limits on low fare seats

Revenue Management: Yield Management There are only two price classes Leisure: (f2) $100 per ticket Business: (f1) $250 per ticket Total available capacity= 80 seats Distribution of demand for business class is known

Business Class: Demand Distribution

Revenue Management: Capacity Allocation There are only two price classes Leisure: (f2) $100 per ticket Business: (f1) $250 per ticket Total available capacity= 80 seats Distribution of demand for business class is known Enough demand for the leisure class

Revenue Management: Capacity Allocation Objective: How many seats to allocate to the business class to maximize expected revenue

Expected Revenue

Expected Revenue

Revenue Management: Capacity Allocation Optimality Condition: Choose the number of seats for the business class such that marginal revenue from each class is the same

Optimality Condition

Optimality Condition Marginal Revenue Leisure

Optimality Condition Marginal Revenue Leisure

Benefits of Revenue Management in the Airline Industry Evidence of airline revenue increases of 4 to 6 percent: With effectively no increase in flight operating costs RM allows for tactical matching of demand vs. supply: Booking limits can help channel low-fare demand to empty flights Protect seats for highest fare passengers on forecast full flights

Mail-in-Rebate What is the manufacturer trying to achieve with the rebate? Why the manufacturer and not the retailer? Should the manufacturer reduce the wholesale price instead of the rebate? Are there other strategies that can be used to achieve the same effect?

Mail-in-Rebate A Retailer and a manufacturer. Retailer faces customer demand. Retailer orders from manufacturer. Variable Production Cost=$200 Selling Price=? Retailer Manufacturer Wholesale Price=$900

Demand-Price Relationship 10000 Demand P=2000-0.2Q 2000 Price

Retailer Expected Profit (No Rebate)

Retailer Expected Profit (No Rebate) $1,370,096

Manufacturer Profit (No Rebate)

Manufacturer Profit (No Rebate) $1,750,000

Retailer Expected Profit ($100 Rebate)

Retailer Expected Profit ($100 Rebate) $1,644,115

Manufacturer Profit ($100 Rebate)

Manufacturer Profit ($100 Rebate) $1,810,392

Retailer Expected Profit (Reduced Wholesale Price $100 )

Retailer Expected Profit (Reduced Wholesale Price $100 ) $1,654,508

Manufacturer Profit (Reduced Wholesale Price $100)

Manufacturer Profit (Reduced Wholesale Price $100) $1,800,000

Mail-in-Rebate

Mail-in-Rebate

Managerial Insights Mail in Rebate allows supply chain partners to move away from sequential strategies toward global optimization Provides retailers with upside incentive Mail in Rebate outperforms wholesale price discount for manufacturer Other advantages of rebates: Not all customers will remember to mail them in Gives manufacturer better control of pricing

Smart Pricing Customized Pricing Revenue Management Techniques Distinguish between customers according to their price sensitivity Influence retailer pricing strategies Move supply chain partners toward global optimization

Smart Pricing Dynamic Pricing Changing prices over time without necessarily distinguishing between different customers Find the optimal trade-off between high price and low demand versus low price and high demand

When does Dynamic Pricing Provide Significant Profit Benefit? Limited Capacity Demand Variability Seasonality in Demand Pattern Short Planning Horizon

The Internet makes Smart Pricing Possible Low Menu Cost Low Buyer Search Cost Visibility To the back-end of the supply chain allows to coordinate pricing, production and distribution Customer Segmentation Difficult in conventional stores and easier on the Internet Testing Capability

A Word of Caution Amazon.com experimented with dynamic pricing – customers responded negatively Coca-Cola distributors rebelled against a seasonal pricing scheme Opaque fares (priceline.com, hotwire.com) Determining the correct mix of opaque and regular fares is difficult.