Ch.10PricingValue

Pricing and Customer Value

Phil [email protected]

David Simchi-LeviPhilip Kaminsky

Edith Simchi-Levi

McGraw-Hill/Irwin © 2003 Simchi-Levi, Kaminsky, Simchi-Levi

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:

– 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

Price

No. seats

2000

1000

P=2000-2Q


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 ManagementPrice

No. seats

P0=1200

C=400

Revenue=480,000



No. seats

P0=1200

C=400

Money on the Table=160,000



No. seats

P2=1600

Q2=200



No. seatsC=400

P1=1200



No. seatsQ1 =400

P1=1200

Q2=200

P2=1600

Revenue=1600(200) + 1200(400-200)=560,000


Revenue Management Can we increase revenue more?



No. seatsQ1 =400

P1=1200

Q2=200

P2=1600

P3=1800

Q3=100

Revenue=1800(100) + 1600(200-100) + 1200(400-200)=580,000


How can the firm prevent customers from moving from one class to another?

Leisure

Travelers

Business

TravelersNo

Offer

NoDemand

Sensitivity to Price

Sensitivity to DurationSensitivity to Flexibility

High Low

Low

High


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

Probability

0

0.05

0.1

0.15

0.2

0.25

0.3

0 5 10 15 20 25 30

Demand for Business Class


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



Objective: How many seats to allocate to the business class to maximize expected revenue


Expected Revenue

Expected Revenue

7500

8000

8500

9000

9500

10000

0 5 10 15 20 25 30 35

Business Class


Expected Revenue

Expected Revenue

7500

8000

8500

9000

9500

10000

0 5 10 15 20 25 30 35

Business Class



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


Optimality Condition

Margina Revenue Business

0

50

100

150

200

250

300

0 5 10 15 20 25 30 35




0

50

100

150

200

250

300

0 5 10 15 20 25 30 35

Marginal Revenue Leisure




0

50

100

150

200

250

300

0 5 10 15 20 25 30 35

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.

Selling Price=?

Wholesale Price=$900

Retailer Manufacturer

Variable Production Cost=$200


Demand-Price Relationship

Demand

Price

10000

2000

P=2000-0.2Q


Retailer Expected Profit (No Rebate)

0

200,000

400,000

600,000

800,000

1,000,000

1,200,000

1,400,000

1,600,000

500 1,000 1,500 2,000 2,500 3,000 3,500 3,654 4,110 4,567 4,547

Order

Reta

iler E

xpec

ted

Prof

it


Retailer Expected Profit (No Rebate)

0

200,000

400,000

600,000

800,000

1,000,000

1,200,000

1,400,000

1,600,000

500 1,000 1,500 2,000 2,500 3,000 3,500 3,654 4,110 4,567 4,547

Order

Reta

iler E

xpec

ted

Prof

it

$1,370,096


Manufacturer Profit (No Rebate)

0

1,000,000

2,000,000

3,000,000

4,000,000

5,000,000

6,000,000

500

1,000

1,500

2,000

2,500

3,000

3,500

3,654

4,110

4,567

4,547

4,961

5,374

5,788

6,201

6,614

7,028

7,441

7,855

Order

Man

ufac

ture

r Pr

ofit


Manufacturer Profit (No Rebate)

0

1,000,000

2,000,000

3,000,000

4,000,000

5,000,000

6,000,000

500

1,000

1,500

2,000

2,500

3,000

3,500

3,654

4,110

4,567

4,547

4,961

5,374

5,788

6,201

6,614

7,028

7,441

7,855

Order

Man

ufac

ture

r Pr

ofit

$1,750,000


Retailer Expected Profit ($100 Rebate)

0

200,000

400,000

600,000

800,000

1,000,000

1,200,000

1,400,000

1,600,000

1,800,000

1,000 1,500 2,000 2,500 3,000 3,500 4,000 4,110 4,567 4,547 4,961

Order

Ret

aile

r Exp

ecte

d Pr

ofit


Retailer Expected Profit ($100 Rebate)

0

200,000

400,000

600,000

800,000

1,000,000

1,200,000

1,400,000

1,600,000

1,800,000

1,000 1,500 2,000 2,500 3,000 3,500 4,000 4,110 4,567 4,547 4,961

Order

Ret

aile

r Exp

ecte

d Pr

ofit

$1,644,115


Manufacturer Profit ($100 Rebate)

0

1,000,000

2,000,000

3,000,000

4,000,000

5,000,000

6,000,000

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,110

4,567

4,547

4,961

5,374

5,788

6,201

6,614

7,028

7,441

7,855

8,268

Order

Man

ufac

ture

r Pr

ofit


Manufacturer Profit ($100 Rebate)

0

1,000,000

2,000,000

3,000,000

4,000,000

5,000,000

6,000,000

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,110

4,567

4,547

4,961

5,374

5,788

6,201

6,614

7,028

7,441

7,855

8,268

Order

Man

ufac

ture

r Pr

ofit

$1,810,392


Retailer Expected Profit (Reduced Wholesale Price $100 )

0

200,000

400,000

600,000

800,000

1,000,000

1,200,000

1,400,000

1,600,000

1,800,000

500 1,000 1,500 2,000 2,500 3,000 3,500 4,000 4,110 4,567 5,024

Order

Ret

aile

r E

xpec

ted

Pro

fit


Retailer Expected Profit (Reduced Wholesale Price $100 )

0

200,000

400,000

600,000

800,000

1,000,000

1,200,000

1,400,000

1,600,000

1,800,000

500 1,000 1,500 2,000 2,500 3,000 3,500 4,000 4,110 4,567 5,024

Order

Ret

aile

r E

xpec

ted

Pro

fit

$1,654,508


Manufacturer Profit (Reduced Wholesale Price $100)

0

500,000

1,000,000

1,500,000

2,000,000

2,500,000

3,000,000

3,500,000

4,000,000

4,500,000

5,000,000

500 1,000 1,500 2,000 2,500 3,000 3,500 4,000 4,110 4,567 5,024 4,961 5,374 5,788 6,201 6,614 7,028 7,441 7,855

Order

Man

ufac

ture

r Pro

fit


Manufacturer Profit (Reduced Wholesale Price $100)

0

500,000

1,000,000

1,500,000

2,000,000

2,500,000

3,000,000

3,500,000

4,000,000

4,500,000

5,000,000

500 1,000 1,500 2,000 2,500 3,000 3,500 4,000 4,110 4,567 5,024 4,961 5,374 5,788 6,201 6,614 7,028 7,441 7,855

Order

Man

ufac

ture

r Pro

fit

$1,800,000


Mail-in-Rebate

Strategy Retailer Manufacturer TotalNo Rebate 1,370,096 1,750,000 3,120,096 With Rebate ($100) 1,644,115 1,810,392 3,454,507 Reduce Wholesale P ($100) 1,654,508 1,800,000 3,454,508


Mail-in-Rebate

Strategy Retailer Manufacturer TotalNo Rebate 1,370,096 1,750,000 3,120,096 With Rebate ($100) 1,644,115 1,810,392 3,454,507 Reduce Wholesale P ($100) 1,654,508 1,800,000 3,454,508 Global Optimization 3,929,189


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.

Documents

Ch.10PricingValue