Customers don't all value your product or service equally. Why charge them identically?
Many companies would love to raise prices across the board--but fear losing business. When the Washington Opera Co., located in the nation's capital, was considering increasing ticket prices after a difficult season, ticket-services manager Jimmy Legarreta decided there had to be a better way. He found one after carefully reviewing opera economics. Legarreta knew--and his computer system confirmed--that the company routinely turned away people for Friday and Saturday night performances, particularly for prime seats. Meanwhile, midweek tickets went begging.
Legarreta also knew that not all seats were equal, even in the sought-after orchestra section. So the ticket manager and his staff sat in every one of the opera house's 2,200 seats and gave each a value according to the view and the acoustics. With his revenue goal in mind, Legarreta played with ticket prices until he arrived at nine levels, up from five. In the end, the opera raised prices for its most coveted seats by as much as 50% but also dropped the prices of some 600 seats. The gamble paid off in a 9% revenue increase during the next season, 199495.
Legarreta didn't know at the time that his unusual approach to pricing has a name. Airlines call it "yield management" and practice it religiously. Robert Cross, a longtime consultant to the airlines, calls it "revenue management." In a new book by that name, Cross argues that all companies should apply revenue-management concepts, which emphasize an aggressive micromarket approach to maximizing sales. "Revenue management," Cross writes, "assures that companies will sell the right product to the right consumer at the right time for the right price."
Cross's underlying premise: no two customers value a product or service exactly the same way. Furthermore, the "perceived value" of a product results from many variables that change over time. Some of Cross's clients use sophisticated simulation modeling to predict sales at different price levels, but his technique doesn't have to be rocket science. If you understand your customers' motivation for buying and you keep careful sales records, it's possible to adjust prices to remedy supply-and-demand imbalances. Legarreta, for example, ended his midweek slump by making opera affordable for more people, yet he accurately predicted that the Washington in crowd would pay higher prices for the best weekend seats.
Probably the simplest form of "revenue management" is off-peak pricing, common in the entertainment and travel industries. Marc Epstein, owner of the $3-million Milk Street Cafe, in Boston, discovered that technique more than 10 years ago, when he noticed he had lines out the door at noon but a near-empty restaurant around his 3 p.m. closing time. After some experimentation, Epstein settled on a 20% discount for the hours just before noon and after 2--and he's pleased with the results. "If we didn't offer this, our overall revenue would be less," he argues. Epstein did not feel he could simultaneously raise prices during the lunch rush; instead, he has grown the corporate-catering side of his business, where he can charge more per sandwich because "the perceived value of a catered lunch is higher."
Many other companies could conceivably segment their prices to increase revenues and profits. Cross cites examples ranging from a one-chair barbershop, to an accounting firm, to a health center. But there are risks. When you establish a range of prices, customers who pay the higher ones may feel cheated. "It can't be a secret that you're charging different prices for the same service," Cross advises. "Customers must know, so they can choose when to use a service."
Even so, promotions designed to shift customer traffic to off-peak times can backfire. Rick Johnson, owner of Madison Car Wash, in Montgomery, Ala., describes his experience with a "Wonderful Wednesday" special: "The incentive was too good. It took away from the rest of the week and made Wednesday a monster day; it was a horrible strain on my facility and my people. I played around with the discount, but it was still a problem. So I finally dropped it." Likewise, Jimmy Branch, owner of Speedy Car Wash in Panama City, Fla., tried "Men's Monday" and "Women's Wednesday" specials but discovered that when people wash their cars wasn't important because they were washing them so infrequently. Branch started tracking customers by computer two years ago. "Forty-nine percent of my customers come in once a year," he says. "Only 18% wash every two weeks, and that 18% is a changing group." So he stopped doing specials. Instead, Branch raised prices and created a clean-car program that rewards frequent washers. Meanwhile, Rick Johnson found that the year-end holidays were a good time to raise prices without encountering much customer resistance. "These weren't regular customers by any stretch of the imagination," he says. "These were real dirty cars."
The moral of the story? You can never know too much about your customers. With that customer knowledge comes power--to make the best pricing decisions.
Checklist: Revenue Management 101
Could revenue management benefit your business? Robert Cross offers some questions to consider:
- Sell a perishable product or a time-sensitive opportunity? That could be anything from apples that will rot to Super Bowl sweatshirts whose appeal will fade.
- Experience seasonal or other peaks in demand? Variable pricing might help.
- Have multiple market segments for your product? Different groups of customers may value your product differently. Price accordingly.
- Have to decide whether to sell individually or in bulk? Sports teams, performing-arts organizations, and TV networks, for example, try to sell in bulk to bring in revenues. But the inventory could be sold later to individual buyers at a higher unit price. Is it worth the risk to wait?
- Discount to meet competition? You should question how much to discount, how many discounts to offer, and how much to sell at what price.
- Operate in a rapidly changing industry? That means the value of your products is changing just as fast--and that it's crucial to be able to forecast and react quickly at the micromarket level.
Before changing your pricing, be sure to get feedback from advisers, especially your lawyer. The antitrust laws governing pricing can be confusing; for example, while volume discounts are common in many fields, they are illegal in some instances.
Susan Greco is Inc.'s articles editor.