Variable-Pricing Models March 2015
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Variable-pricing strategies are fairly common in certain industries and generally accepted by consumers in those cases. Examples include the variable pricing of airline tickets, variable interest rates in lending, and seasonal variations in prices for certain foods. Also commonly accepted by consumers is the idea that some people pay less simply because of selectively timed and distributed price promotions. This article examines novel developments in variable-pricing strategies that extend beyond the traditional variable-pricing models above. In some cases, variable-pricing schemes form the core of new business models. Will consumers be willing to accept variable-pricing schemes in situations in which fixed prices have been the norm?
Will consumers be willing to accept variable-pricing schemes in situations in which fixed prices have been the norm?
Developments in technology and the integration of large amounts of consumer data into companies' day-to-day operations are beginning to enable individual-level price-discrimination schemes. Analytics firm Freshplum (TellApart; Burlingame, California) has developed an algorithm that provides consumer segments with discounts according to geographic region, repeat purchases, or likelihood to buy. The algorithm apparently takes into account a customer's location in a city, the weather in that area, and various other types of data. Freshplum cofounder Sam Odio claims that clients that use the algorithm in their online stores see an average margin increase of 6.4%. But according to Harvard Business School (Harvard University; Cambridge, Massachusetts) professor John Gourville, the notion that some customers pay less for a product than others do because of factors such as where they live, weather conditions where they live, and their willingness to pay likely will anger many customers if the scheme becomes common knowledge. The success of differential pricing may therefore depend in part on a company's ability to target individuals without increasing common knowledge of these tactics—a difficult proposition in the age of social media.
Psychologists at Harvard University used role-playing experiments to examine the effects of common knowledge on pricing. In the experiments, participants assumed the roles of a butcher and a baker. Working independently, each merchant can make a profit; however, if the two merchants coordinate and sell hot dogs, they could make more profit. Consumers will not buy buns or hot-dog meat alone, so the two merchants risk making no profit if they fail to coordinate properly. The price of hot dogs fluctuates daily, which makes selling them sometimes profitable and sometimes not. The experiments revealed that shared-knowledge scenarios—those in which each merchant has the same information but is uncertain about what information the other merchant has—were less likely to result in cooperation than were common-knowledge scenarios in which each merchant has the same information and is fully aware of what information the other merchant has. Common knowledge of variable pricing among consumers may fuel resistance to such pricing schemes, whereas common knowledge of variable pricing among suppliers increases the likelihood of coordination and improves organizational effectiveness. The careful management of information flow is necessary to support variable-pricing strategies and will be an increasingly important consideration for companies acting in the variable-pricing space.
Recent research indicates that in combination with the pay-it-forward (PIF) pricing scheme—an adaptation of the pay-what-you-want (PWYW) pricing scheme—a consumer's not knowing what other consumers pay for a good or service increases the amount that the one consumer is willing to pay for the good or service. Researchers from the University of California, Berkeley (Berkeley, California), and the University of California, San Diego (La Jolla, California), compared PWYW schemes with PIF schemes in the context of museum admissions. In the PIF-pricing scenario, researchers told customers that another person had already paid their admission and gave them the opportunity to pay the admission of the next visitor. The PWYW-pricing scenario produced an average payment of $1.82 per person, whereas the PIF-pricing scenario produced an average payment of $2.67 per person. This effect appears to be the result of people's overestimating the kindness of others: People in the PIF-pricing groups typically tried to match but systematically overestimated the unknown amount paid by the person who bought their ticket. If nonprofits, artists, and for-profit organizations engaged in social-outreach programs can limit information flow among consumers, they may be able to use PIF pricing to elicit higher average donation amounts.
A similarly consumer-driven pricing scheme recently saw implementation at the Teatreneu (Barcelona, Spain) comedy club. The club has replaced its usual cover charge with a technology-enabled pay-per-laugh business model. Entry into the club is free, but patrons must agree to pay the club €0.30 ($0.34) each time they laugh, up to a maximum of €24 ($27) per visit. The club uses specialized machine-vision software to detect when individual patrons laugh. The software apparently runs on tablets that are mounted in such a way that each tablet's built-in camera images a single patron. Since the club implemented this model, average ticket revenue per patron has increased by €6 ($6.70), inspiring other comedy clubs in Spain to begin implementing the model.
Variable-pricing schemes that are built into business models that emphasize consumer experience and control likely will see less resistance from consumers than will variable pricing surreptitiously imposed on consumers through data mining. Cafe Ziferblat (London, England) charges customers £0.03 ($0.05) for every minute they spend inside. That price also covers drinks, biscuits, and Wi-Fi access. To track their time, customers take a clock from the cupboard and keep it with them the whole time they are in the café. They also have to make their own drinks and, occasionally, wash up after themselves. Whether fundamentally switching the consumption focus from products to ambiance can be sustainable for service businesses remains uncertain, and making that switch requires a deeper understanding of consumer segments that value primarily nonconsumptive aspects of services.
Variable pricing can take various forms, ranging from data-focused individual-targeting techniques to fundamental changes to the ways that products and services see consumption. Some variable-pricing models are under direct consumer control and some are not, creating friction points around perceptions of fairness. Managerial considerations in variable-pricing models center on information flows and, ultimately, customers' willingness to pay and customers' satisfaction.