A Revolution Is Brewing in Pricing
Yield management--or revenue enhancement, as some call it--has captured the travel industry, and its application is spreading into a variety of other industries, including utilities, radio, television and entertainment.
What exactly is yield management? Essentially, it’s value-based pricing. A product’s worth generally varies among different groups of people--business travelers versus vacation travelers, avid baseball fans versus those just looking for something to do on a Tuesday night. By characterizing a group whose members value a product similarly, but differently from other groups, a company can generally establish pricing mechanisms tailored to each customer group’s values.
Rudimentary applications of yield management abound. People who eat dinner after 6:30 p.m. are willing to pay more than those who eat earlier, so restaurants have “early-bird” specials. USC adjusts its football ticket prices depending on the popularity of the opponent, charging a premium for games against Penn State and Notre Dame. At a gas station in Maine, only tourists pay posted prices; the locals pay less. Such pricing actions are static: They reflect only broad and obvious demand patterns.
Yield enhancement techniques are more dynamic. They allow a company to profitably manipulate, and respond to, demand for its products. For example, hospitals may schedule elective surgery when their scarce resources are more readily available. Or, if such surgery restricts the hospital’s ability to accept other patients, a differential pricing structure may allow it to operate more effectively and efficiently. A two-day car rental may be more expensive when high rental demand is expected on the second day, because the car cannot be re-rented.
Most consumers, when planning a purchase, are concerned with how much value a product gives them. Manufacturers and retailers generally set a product’s price on the basis of its production or acquisition cost, plus profit. But there is a gap: Price-setting is not exactly aligned with the consumer’s purchasing criteria.
This gap creates an opportunity for the seller in terms of realigning prices to reflect the individual consumer’s value for the product. The traditional argument against this approach is that it is difficult or impossible, depending on competitive reaction, for one company to set prices to achieve an abnormally high profit margin. But this argument assumes that only a single price can be charged when, in fact, with many products, multiple, value-based prices generating higher profits are possible.
As the magnitude of these profits receives greater recognition (revenue increases of 3% to 6% are typically cited), value-based pricing is beginning to replace cost-based pricing. Use of yield management techniques is indeed spreading. Distribution systems are being established that make prices consistent with the multiple ways that customers value products.
Business travelers, for example, generally value air travel more than vacation travelers. Airlines thus place such restrictions as advance purchase and Saturday night stay-over on extraordinarily low fares to prevent business travelers from using them. At the same time, business travelers, who are willing to pay more, continue to do so.
Those who value a product highly pay more but, in turn, receive easier access to it. Those who value the product less are able to acquire it more cheaply, though not so easily. As a result, travelers willing to pay $529 for full-fare coach can obtain airline tickets far easier than travelers insisting on a $279 discount fare.
Current yield management programs are designed to increase company profitability, but this leaves customers out of the equation. After all, customers do offer a product to companies--their patronage--and, as such, should be able to dictate conditions for this patronage. Until now, a lack of enabling mechanisms has largely prevented this from happening. But all this may change.
Work is in progress that will allow a person to provide a travel agent with a travel “bid” describing the conditions (including fare level) that will earn the traveler’s patronage. Travel providers such as airlines and hotels may receive, review and respond to a bid. If the bid is accepted, a reservation (possibly nonrefundable) is made.
Such a system may dramatically affect the way travel arrangements are made and how travel providers price their product. Customers and travel agents who best understand yield management will likely be most successful at submitting the lowest acceptable bids--a strong incentive for understanding this pricing technique.
But there is a cautionary note: In the extreme, yield management could become discriminatory. While it can produce great benefits for both businesses and consumers, applying it too narrowly or arbitrarily could reduce profitability or be illegal.
Yield management promotes choice, as products and services are unbundled, rebundled and priced according to customer and company values. Today, it is revolutionizing the travel industry. Tomorrow’s applications appear limitless, as more and more industries look to reap the benefits of value-based pricing.
