Segmentation, Revenue Management and Pricing Analytics

Tudor Bodea, Mark Ferguson

• Editorial: Routledge
• Año: 2014
• ISBN:
  9781136624834
• Edición: 1
• Categoría: Negocios y empresa
• Categoría: Previsiones

The practices of revenue management and pricing analytics have transformed the transportation and hospitality industries, and are increasingly important in industries as diverse as retail, telecommunications, banking, health care and manufacturing. Segmentation, Revenue Management and Pricing Analytics guides students and professionals on how to identify and exploit revenue management and pricing opportunities in different business contexts.

Bodea and Ferguson introduce concepts and quantitative methods for improving profit through capacity allocation and pricing. Whereas most marketing textbooks cover more traditional, qualitative methods for determining customer segments and prices, this book uses historical sales data with mathematical optimization to make those decisions. With hands-on practice and a fundamental understanding of some of the most common analytical models, readers will be able to make smarter business decisions and higher profits.

This book will be a useful and enlightening read for MBA students in pricing and revenue management, marketing, and service operations.

1

THE IDEAS BEHIND CUSTOMER SEGMENTATION

The practices of Revenue Management and Pricing Analytics use historical sales data to analytically estimate demand forecasts that are then used in optimization models to set and update capacity (or prices) offered through various channels to specific customer segments in order to maximize profit. A familiar example is the passenger airline industry, where a carrier may sell the same type of seats (e.g., coach) on the same flight to different customer segments (typically business and leisure travelers) at different prices. These practices have transformed the transportation and hospitality industries and are increasingly important in industries as diverse as retail, telecommunications, banking, health care, and manufacturing. While capacity-constrained industries such as airlines and hotels typically optimize on the capacity to make available to each customer segment, price optimization is more frequently used for less capacity-constrained industries such as retailing and banking. The key denominator for successful implementations of either a revenue management or pricing analytics solution is a customer population that is diverse (at some level) in how different groups of customers value a company’s products. The process of identifying these different groups of customers is commonly referred to as customer segmentation.

To better understand the idea behind customer segmentation, consider your own buying behavior. If someone asked you what is the maximum price that you would be willing to pay for a bottle of your favorite brand of purified water, it is unlikely that you would give a price more than $1. We are unlikely to assign a higher value to the bottle of water because we know of many retail outlets where we can purchase this product in bulk, most likely at a per bottle price that is significantly less than $1. If someone could magically search our entire buying history, however, he or she would probably find instances where we have paid much more than $1 for a bottle of water (ball games, fancy restaurants, and hotel mini-bars to name just a few). We are still the same person with the same valuations, yet we purchase the same product at very different prices depending on the time and location when the purchase is made. Even though it is the same person who may not pay more than $0.20 for a bottle of water at a grocery store and then pays $4 for the same brand bottle of water at a restaurant, he or she is considered to belong to two different segments of customers, depending on the time and location where the purchase is made. The customer at the grocery store is typically buying in bulk and primarily concerned with meeting their basic needs, while the customer at the fancy restaurant is buying a luxury experience and no alternatives are easily available. Thus, it would be a very costly mistake to use the same customer pricing policy in all of the distribution channels as a $4 price per bottle will not sell in a grocery store while a $0.20 per bottle price will leave unrealized revenue at a fancy restaurant.

In the example above, the products were sold at two completely different locations so an argument can be made that the price difference is purely due to cost; the cost of supplying the product to the grocery store is much less expensive than the cost of supplying the product to the fancy restaurant. This argument has some truth as there is some difference in distribution costs to the two locations, although it is very unlikely that the difference is large enough to justify such an extreme price difference. A follow-up question is then: Are there cases where customers pay very different prices for the same exact product at the same exact location? In fact, there are many examples where this is the case. It is a high probability that two people sitting beside each other on an airplane paid significantly different prices for their fares (business/leisure-based segmentation). It is also common practice for two different customers purchasing the exact same make and model car from the same dealership to have paid different prices (informed consumer-based segmentation) or for men and women to pay different cover charges to enter the same popular night club at the same time (gender-based segmentation). Student discount rates at some tourist attractions and senior discounts at some retailers and restaurants (membership- or age-based segmentation) are other examples.

Once you start looking for it, you will notice that segmentation-based pricing is practically everywhere, as it has been since the very beginning of human commerce. While there may be debates on which of these practices is ethical, or even legal in some cases, most consumers have come to accept a certain degree of segmentation-based pricing as a fact of life. We will cover the aspect of segmentation-based pricing that is more or less acceptable to customers in a latter chapter. For now, our focus is on identifying these different segments and designing products that are targeted for each one.

CUSTOMER SEGMENTATION VERSUS PRODUCT SEGMENTATION

The two major (but nonexclusive) segmentation strategies are customer based and product based. Customer-based segmentation is when a firm offers exactly the same product to two or more different customers at different prices, based on certain customer attributes such as age, gender, or nationality. Ladies’ night at a club and senior discounts for a meal are examples of customer-based segmentation. While there does not appear to be any legal issues with these types of segmentation schemes, legal issues may arise if there is any perception that customers are segmented based on more sensitive attributes such as race or physical disabilities (imagine the public reaction to a surcharge for blind people, for example). While race-based segmentation is illegal in many countries, nationality is sometimes used. One of the authors experienced this first hand when attempting to rent a car in Spain. When the author’s U.S. address was entered on the car rental company’s website, a much higher price was quoted than when the address of the local hotel was entered. While customer-based segmentation is common, it typically places major limitations on how refined you can make your segments. A senior discount, for example, does not differentiate between a very affluent (and less price sensitive) older tourist and a less affluent (and very price sensitive) retiree who is barely getting by. To achieve this level of segmentation, firms typically have to move to product-based segmentation.

Product-based segmentation involves creating either superior or inferior versions of a product so that each version can be priced differently but that cannibalization of sales from the higher priced versions to the lower priced versions is minimized. The latter is the most critical part for successful product-based segmentation, as there needs to be some incentives or restrictions to keep the higher willingness-to-pay customers from purchasing the lower priced versions of the product. Customer acceptance of these restrictions is typically higher when the version choice is a conscious decision of the customer rather than a true restriction on a particular class of customer from purchasing a particular version of the product.

It should be noted that different versions of a product do not necessarily mean actual physical differences in the product. For segmentation purposes, the exact same seat on an airline flight can be sold as different products; either a fully refundable or a nonrefundable ticket for example. Here, airlines create inferior versions of their base product (a fully refundable no advance purchase airline seat), placing various levels of restrictions on it. This allows the airlines to charge lower prices to their more price-sensitive customer segments while still having a “fence” in place to keep their less price-sensitive customers from paying the lower prices. In the case of airline tickets, business travelers are typically less price sensitive than leisure travelers (as business travelers are typically reimbursed for their travel expenses through their employer). The restriction here for the lower priced version of the product is that it is nonrefundable and/or has an advance purchase requirement. Since business travelers often have to make last-minute travel decisions (or, changes in their current travel plans), they often self-select the more expensive airline tickets. This versioning practice is typically accepted by the business travelers because they are not excluded from purchasing the lower-priced (and more restricted) versions of the airline tickets. The science behind the allocation of these different product versions to their respective customer segments is discussed in Chapter 4.

Compare the product versioning practice of the airlines to those of the previously mentioned rental car company in Spain that charges native Spanish residents lower prices than customers from other countries. Most foreign visitors would be upset if they knew that they were paying a significantly higher price, for exactly the same service, than native residents. To try to diminish this customer dissatisfaction, the rental car company only provides the final price once a customer puts in their credit card address information, thus minimizing the likelihood that the customers will observe the differential pricing. This practice of trying to hide or disguise the final prices is also a common practice of auto dealerships and repair shops, which frequently rank very low in cross-industry customer satisfaction surveys.

We are not claiming by any means that all customers are happy with the airlines’ current pricing practices. As a general rule, customers commonly feel dissatisfied when they learn that they are paying more for what they perceive to be the same product than another customer. Businesses (the ones actually paying the travel bills) often revolt when they feel that the airline price differentials become excessive, slashing travel budgets and encouraging their employees to meet via tele-presence. This dissatisfaction has been successfully exploited by the “low-cost” airlines that have entered the industry over the last 30 years. Many of the low-cost airlines advertise their “simpler” fare structures and lighter restrictions on purchasing the lower fare classes. Thus, as in any market, there are constant price adjustments taking place as the airlines try to find the prices that best match supply with demand. Despite the frequent complaints, however, most leisure travelers are happy to give up some travel flexibility for an (often) lower total cost ticket price while most business travelers appreciate the ability to find seats still available for last-minute flight changes. Examples of product-based segmentation methods outside of the airline industry are provided in the next section.

EXAMPLES OF PRODUCT-BASED SEGMENTATION

Recall that the most successful product-based segmentation schemes often involve restrictions placed on a product to create inferior versions of the product where the customers self-select which version (and thus price) they want. You may already be familiar with how this practice works in an industry that has an expiring capacity such as airlines (once a plane leaves with an empty seat, the opportunity to sell that seat on that flight is lost forever), but how is it practiced in industries without expiring capacity? Examples abound, especially in the retail sector. At first glance, retail products appear to have opposite characteristics than do products in the travel industry: a retail product tends to depreciate in value as it sits on a shelf while a travel product tends to appreciate in value as the time of consumption approaches. Thus, the common revenue management practices of reserving capacity for higher paying (and later arriving) customers cannot be directly applied in the retail sector. In its place is a myriad of methods designed to offer customer segment specific prices for what is, essentially, the same product. Some of the more common methods are listed below.

1. Seasonal time-based pricing.

2. Package-based pricing.

3. Channel-based pricing.

4. Coupons, mail-in rebates, and promotion codes.

Seasonal time-based pricing refers to when a retailer sells a seasonal product at a list price at the beginning of the season and then discounts or “marks-down” the product’s price as the season progresses. This practice is very common in the apparel retail sector, where a winter coat that was priced at $200 in September may be marked down to $80 the following March. While this practice is sometimes simply an act by the retailer to make up for an ordering mistake (perhaps the coat was assorted in a very unpopular color), it is often a conscious decision by the retailer to exploit two different customer segments. The customer segmentation that occurs here is between the highly fashion-conscious customers who gain a lot of satisfaction from wearing the latest fashions in the season that the fashions are first introduced and the less fashion-conscious customers who are willing to trade-off a slightly out-of-fashion garment (a coat bought at the end of the current season will mostly be worn the following winter) for a lower price. The practice of markdown pricing is described in Chapter 7.

Package-based pricing is a broad term that refers to several segmentation strategies in the consumer goods industry. One strategy is to simply package the product in different sizes, with the smaller package typically commanding the higher per-unit price. In the bottled water example at the beginning of this chapter, a gallon-sized bottle of water typically sells for a lower price per ounce than does a 20 ounce bottle of the same brand. While there are typically economies of scale and a reduction in per-unit packaging cost for larger quantity package sizes, these cost savings rarely explain the full price differential between the two package sizes. Thus, this pricing strategy is intended to segment customers who are looking for an immediate and convenient package size from the customers who are looking to meet the needs of themselves (and perhaps others) over a longer span of time. This same reasoning applies when the packaging involves the aggregation of multiple units of the same size (i.e. bulk purchases). A 25-pack of 20 ounce bottles, for example, is priced at a lower per-bottle price than an individual 20 ounce bottle (see Chapter 8 for an example where customers are segmented based on the quantity size they purchase in a B2B environment).

Channel-based pricing refers to the differential pricing of the same product depending on which channel the product is sold through. Referring back to the bottled water example, a bottle of water sold by a vendor in the stands at a sporting event is a different product (by our definition) than the same brand bottle of water sold at a grocery store. The segmentation in this case is mainly driven by the amount of alternative options available to the buyer at the time of purchase. A buyer considering a purchase in a grocery store may have many alternative beverages easily available to them, as well as a number of alternative grocery stores to shop from. Thus, a large price increase of a particular brand of bottled water will result in many consumers switching to another brand of bottled water, to some other type of beverage, or even to deferring their purchase until they can purchase their preferred brand of water at another retail location. Compare this scenario to the pricing of bottled water at a stadium during a sporting event. The owner of the stadium typically operates as a local monopoly of all concessions, controlling the pricing of all beverages that are sold there. Thus, the availability to the consumer of significantly lower priced options is very limited in this situation. This is the reason we typically see much higher per-unit prices for products sold in restaurants, theatres, and theme parks; or basically anywhere a localized monopoly can control the availability of outside alternatives.

While it is typically easy to identify the channel-based pricing opportunities described in the examples above, there are many other channel-based pricing opportunities that are less understood. Internet retail sales is an example of an area where companies are still struggling to understand exactly what customer segment this buying sub-population represents. On the one hand, the internet makes it extremely easy to price comparison shop compared to when consumers had to physically travel to different retail locations to compare prices. On the other hand, active users of the internet typically have higher discretionary income than do consumers who do not have home access to high-speed internet service. Thus, an argument can be made that internet shoppers are less price sensitive than noninternet shoppers. When internet retail sales was still in its infancy, there were several notable pronouncements that the increased price transparency of the internet would lead, within a few years, to only a few dominant internet retailers who would basically charge the same price as the other major retailers for all of the products they sold. A quick search on almost any product today, however, shows that there still exists a wide variety of internet retailers selling a product along with a wide variety of selling prices between them. Thus, it is now becoming clear that attempts to group all internet buyers into a single purchasing behavior segment is misguided and a more nuanced approach is needed.

Some firms who primarily advertise their prices on the internet (where the search cost is low) have found that using a portfolio of pricing strategies can significantly increase profits. Rental car companies are a good example of this group, as they typically price their base daily rental rates very competitively and, subsequently, command very low margins on actually renting their cars. One reason could be that the search cost is very low for this industry, as most customers use a third-party search engine such as Expedia or Travelocity to compare the daily prices of all the available rental companies for a particular location. After a customer has reserved a car and is picking it up at the rental car counter, however, he or she is often encouraged to buy extras such as insurance, pre-paid gas or GPS units. Since the search cost for these products is much higher (the customer is already at the counter), the corresponding margins on the products are much higher as well.

The last of the common segmentation-based pricing strategies involves the use of effort-based discounts such as coupons, mail-in rebates or promotion codes. The consumers segmented through this strategy are the group who are willing to take the time and effort (and have the organizational skills) required to claim the discount versus those who do not. The use of coupons seems to be more popular for lower-priced products sold in grocery and convenience stores while mail-in rebates are more popular for higher-priced items such as consumer electronics. In internet retailing, promotion codes appear to be the most popular way to employ this strategy, as a way to offer lower prices to customers who are more price-sensitive and willing to search for these codes. We discuss aspects of this type of pricing in Chapter 3.

MAJOR CHALLENGES OF PRODUCT-BASED SEGMENTATION

An advantage of customer-based segmentation versus product-based segmentation is that it is typically easier to identify which consumers belong to each segment. Simply checking the birthdate on a person’s driver’s license, for example, can confirm whether or not the person is eligible for a senior discount. As previously discussed, however, product-based segmentation has a lot of advantages over customer-based se...