Pricing and Customer Value

1. Pricing and Customer Value Phil Kaminskykaminsky@ieor.berkeley.edu David Simchi-Levi Philip Kaminsky Edith Simchi-Levi

2. 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

3. 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

4. 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

5. 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

6. Smart Pricing? • Dell: • 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

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

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

9. 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?

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

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

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

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

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

15. Revenue Management • Can we increase revenue more?

16. 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

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

18. 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

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

20. 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

21. 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

22. Business Class: Demand Distribution

23. 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

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

25. Expected Revenue

26. Expected Revenue

27. 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

28. Optimality Condition

29. Optimality Condition Marginal Revenue Leisure

30. Optimality Condition Marginal Revenue Leisure

31. 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

34. 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?

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

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

37. Retailer Expected Profit (No Rebate)

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

39. Manufacturer Profit (No Rebate)

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

41. Retailer Expected Profit ($100 Rebate)

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

43. Manufacturer Profit ($100 Rebate)

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

45. Retailer Expected Profit (Reduced Wholesale Price $100 )

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

47. Manufacturer Profit (Reduced Wholesale Price $100)

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

49. Mail-in-Rebate

50. Mail-in-Rebate