The Pricing and Revenue Management of Services: A Strategic Approach

Citation

Cappiello, G. (2008), "The Pricing and Revenue Management of Services: A Strategic Approach", International Journal of Service Industry Management, Vol. 19 No. 2, pp. 271-274. https://doi.org/10.1108/09564230810869775

With the continued rise in the pressure of competition, pricing policies have now reached a level of critical importance.

In the service sphere, the well known characteristics of output (such as intangibility, perishability, etc.) have increased the importance of price in terms of both the composition of final revenue and the signalling function played by exchange price. At the same time, the problem faced by service firms of defining a price policy has also become considerably more complex.

In her book, Irene Ng highlights this situation immediately: […] we live in a world today where a cinema ticket can be obtained for 20p, a flight ticket at £1, songs at 5 p and where even the most discerning marketer might wonder if the pricing of services has gone mad, or if not, perhaps a little out of control (p. 1).

Moreover, when we use the word “services” what we are referring to is a wide variety of contexts, ranging from professional services to transport to tourism, all of which can be interpreted with an equally wide variety of focuses (marketing, operation, financial analysis, etc.).

So how then can we judge whether a company has adopted a correct pricing strategy or not?

Studies on revenue management, i.e. “the practice of obtaining the highest possible revenue in the selling of a service firm's capacity” (p. 108), have existed since the 1970s (see Chapter 6) thanks to the contribution of operation research (OR), but “the scope was limited to capacity planning and allocation for a given set of prices” (p. 114); and the question was only tackled later from other viewpoints.

In practice, the consolidated logics of price discrimination were reutilized to extract what economists define as “consumer surplus,” and this was done by fixing the price of the product or service as near to the customer's “willingness to pay” as possible. Applying a revenue management strategy, to use a concise expression that has since become extremely popular, means “selling the right place, to the right customer at the right price” (Kimes, 1989).

However, what was noted immediately was that, given the increasingly competitive world we live in, offering a price that is close to the customer's willingness to pay, does not necessarily mean the customer will buy.

As these practices became more widespread, researchers soon realized that analysing the optimal allocation of service capacity could not be divorced from an understanding of the fixed price level and therefore from the response of buyers to variations in price: OR‐centred revenue management problems dealt primarily with supply issues of overbooking, capacity allocation and demand forecasting […] in contrast other disciplines were framed to revenue management problems to deal with maximizing profit through pricing or consumer choice models (p. 155).

Irene Ng's book plays a significant role in the progress made in revenue management studies, as the author states that it was written in order to “integrate the theory and the practice aspects of the subject” (p. xvi): There is a need to understand what motivates a buyer to purchase at a given price, i.e. buyer's choice and, second, to determine what influences the buyer's willingness to pay (p. 23).

What the author actually does is not only to collect contributions from all the various previous works, but also, in my humble opinion, she adds something completely new.

The text is split into two parts: the first looks at the question of pricing for service firms from the point of view of the customer: “the buyer as an individual.”

And this is the book's first innovation, the concept of expected net value (ENV): ENV is the expected net value that drives the price (and non‐price) outlays that buyers are willing to pay. Buyers purchase a service at a particular price based on expectations because services are experiential – there are very few ways you can tell if the service you purchase will be good for you unless you have already purchased and experienced it (p. 62).

The key strategic value for decision making is the ENV, how the ENV is affected by the expected benefit and outlays, and the construction of the pricing policy within the framework (p. 66)

The book continues by describing all the factors that can influence the ENV, with regard to the customer, the firm and other external factors. Particular emphasis is then put on the perception of the risk involved in the purchase “at each point in time” another extremely interesting point.

The ENV framework suggests seven strategies for attaining higher revenues to:

1. 1.

   price on value, not cost;

2. 2.

   convert Pareto loss into revenue;

3. 3.

   decouple purchase (exchange) and consumption;

4. 4.

   mitigate risk in valuation for advance purchases;

5. 5.

   change benefits;

6. 6.

   use customer effort to yield higher revenue; and

7. 7.

   find the highest end‐value in intermediating services.

The second part of the book focuses on the issue of the “buyer as an aggregate,” i.e. “how do we go from one buyer to many buyers” (p. 91) and here we come to what I regard as the book's second innovative concept.

Dynamic price strategies have become very popular with companies, who now adopt business formulas, which are so innovative, the services themselves are designed on the basis of price discrimination.

At this point, the author suggests a step forward: Revenue management needs to embrace e new era where operation management, operation research, marketing, economics and technology all play an important role. Indeed, revenue management is challenged to organise the end‐to‐end solutions, from the supply and capacity of the firm to the value and demand for the service by buyers (p. 130).

In my opinion, the really original idea here is that of laying such emphasis on the customer, who segments the firm's various offers through a process of self selection.

This suggests four further strategies:

• (8) re‐segmenting, re‐resigning and re‐pricing;

• (9) segmenting and pricing through self‐selection;

• (10) managing demand and supply through re‐sales and refunds; and

• (11) selling availability of the service.

When I finished this book, and given that I have been studying the question of pricing policies for some years now, since my PhD thesis in fact, I could not help thinking, “Wow! This is really impressive. This is a book I would have liked to have written myself!”

This is why I have tried to quote straight from the book, the sections that strike me as being most important, in order to keep the work as intact as possible and to invite anyone dealing with pricing strategies to read it.

As I too have been reflecting on these matters, I would like to take advantage of this opportunity to put a question to both the author of this book and the whole community of economists studying pricing: if Irene Ng has analysed the situation correctly, and I think she has, are we sure then that we can still use the term “segments”? As perhaps it would be more up‐to‐date to speak of “market bubbles” that is to say, temporary demand groups? I also have a second question. Is it an exaggeration to suggest that nowadays it is the customer who decides the price?