News for the Hospitality Executive
By Dr. David Hayes and Allisha Miller
November 15, 2010 - In the lodging industry revenue managers set prices. Customer-centric revenue managers, go further. They make sure their prices are fair.
The difficulty for them, and for you if you are responsible for setting prices in your organization, comes in deciding exactly what constitutes a fair price. The question is important for several reasons because:
Actually, while the issue of what constitutes a fair price is pretty interesting, even more interesting is the question of who decides when a price is fair.Sellers tend to think fair prices reflect their cost of doing business and their profit objectives. Sounds reasonable, but its backwards. That’s because in the long run it is always the buyer, not the seller, who determines the fairness of a price.
Buyers will not repeatedly and willingly pay more for a product than they believe it is truly worth. And buyers are notoriously unconcerned with a seller’s costs or profits when buying an item. In fact, if you ask them, they are happiest when buying at a price they think is below a seller’s actual costs. And, when you buy, so are you.
Fortunately, in most cases, it is not the actual price charged for an item that makes buyers question its fairness. Rather, it is the perception of the potential profit made by the seller that is most important.
Accusations of price gouging or unconscionable selling prices that can result in bad press for an industry (think baggage fees and airlines!) or invite government regulations are always the result of thinking that profit, not price, is too high.
Are My Prices Perceived As Fair By My Customers?
The question; “Are my prices perceived as fair by customers?” calls for thoughtful consideration. Because all customers naturally seek to pay low prices, sometimes it seems every customer thinks every price charged is “too high”. That’s because their preference, much like your own, is that it’s always best to pay the lowest price possible for all of the things they want to buy.
Experienced revenue managers understand this natural tendency but they also know that the fact a potential customer feels a price is too high is not a legitimate reason for granting that customer a price reduction. They recognize that the issue of a too high price is vastly different from that of an unfair price. Prices can easily be too high for a potential buyer, but still be perceived as fair (just ask your local Mercedes Benz dealer!).
The truth is revenue managers have little control over the inherent tendency of buyers to seek low prices. They have a great deal of control, however, over their buyer’s perceptions of price fairness.
Most customers feel it is unfair for sellers to charge excessively high prices, even if the majority of buyers are willing to pay those prices. Overwhelmingly, consumers feel they have a right to a reasonable price, and that sellers have a right to a reasonable profit. Prices that appear to customers as having been established to increase profits beyond reasonable levels will always be viewed as being unfair, even when those customers pay the prices charged.
Ignoring this critical customer viewpoint can be the cause of pricing fiascos brought about by some who honestly (but erroneously) believe a fair price is ultimately defined by “what the market will bear”.
To see why that is such an appealing but dangerous position, consider the example of an upstate New York hardware store that normally sells snow shovels for $ 25.99. The morning after a major snowstorm, the hardware store knows it will sell all of the snow shovels it still has in stock so it raises the price on its five remaining shovels to $ 39.99.
Question: Is the new price for snow shovels fair?
When posed with this actual question, an overwhelming majority of buyers (over 82% of respondents in one study) found such an action to be inherently unfair. You might think so too.
Interestingly, in an identical study, 76% of the economics students in one of the nation’s leading business schools found raising the prices of the shovels (because of increased demand and limited product supply) to be inherently fair. They understood supply and demand curves better than they understood buyers. Interestingly, the same business students were not asked if they thought the store’s pricing decision would serve to build its repeat customer base (maybe because the answer to that question was too self-evident!) As long as buyers’ and sellers’ perceptions of fairness vary so much, it is likely pricing debacles and the strong consumer reactions they generate will not disappear in the foreseeable future.
The fact is that most buyers will sympathize with a seller’s cost increases much more than with a seller’s supply shortages. As a result, sellers who find they have only a few of an extremely popular item in stock (for example, this Christmas season’s most popular video game release, newest iPhone or even hotel rooms) must be careful. While the price of the item could, of course, be raised significantly, or even auctioned to the highest bidder, doing so would certainly be perceived as unfair by the majority of consumers. The result might be short term revenue maximization, but it would not be long term revenue optimization.
Researchers have found that buyers use a variety of information sources to establish their reference price; the price perceived by them to be the normal (and fair) price for a product or a service. They then evaluate all other prices for that same item in comparison to that reference price.
It is for this reason that discounts from normal prices, even when those normal prices are set very high to begin with, are so popular with buyers.
The lesson for hoteliers is clear if often unheeded. Namely, it pays to keep reference prices (rack rates in the hotel industry) high, and when it is advantageous to do so, offer targeted discounts from those reference prices. Reducing rack rates across the board and then advertising the reduced prices widely makes no long-term pricing sense because it simply drives down the guest’s reference price.
What Does It All Mean?
Customer-centric revenue management is about much more than the use of sophisticated data to set prices. It is also about using pricing to capture and retain market share. While data is important in helping to determine prices, understanding buyers’ perceptions of price fairness is more important if price is to be the effective and powerful tool it can be for expanding a hotel’s customer base and building loyalty.
The best revenue managers always remember that it is their customers’ perceptions of pricing fairness, not their own, which matters most. Are your prices fair? Just ask your customers.
About this Article: This article is based on information in Revenue Management for the Hospitality Industry by David K. Hayes and Allisha A. Miller. © 2011 John Wiley & Sons, Inc. All rights reserved. To purchase this book, visit www.wiley.com.
About the Authors: Dr. David K. Hayes and Allisha A. Miller manage Panda Professionals (www.pandapros.com) Hospitality Education and Training where they create and deliver innovative and practical educational materials and training for those in the hospitality industry.
More Information Contact:
Allisha A. Miller
Panda Professional Hospitality Education and Training
1715 E Jolly Road
Okemos, MI 48864