Customer-Centric Pricing: Myth or Reality?
As revenue management has developed in hospitality and gaming organizations, hotels and casinos have become increasingly sophisticated at pricing. Today, pricing is carefully managed by most gaming resorts on a daily basis – and even intra-day as arrival dates approach.
These revenue management decisions are complex, as they must consider a variety of rates, segments, and disparate channels for sales. In addition, we have seen gaming companies invest significantly in developing customer data warehouses, and in using this information to improve guest services, and market to customers. Yet, while hotels and gaming resorts are sophisticated in managing published rates, and have developed sophisticated capabilities for serving the individual customer, the industry lags in bringing these two capabilities together in the form of customer-centric pricing techniques.
Many commercial banks, credit firms, and telecommunications companies rely substantially on customer-centric pricing as a core element in their pricing strategies. In these industries, customer-centric pricing is not a “part time” practice, but rather something that is considered as a regular practice whenever pricing is presented to customers.
Looking to open a checking account, get a new credit card, or open a new cellular account? The chances are that you will be presented with pricing for these services that have been tailored to you as a customer – regardless of how you shop. Conversely, while we have seen tremendous gains in terms of how revenue management and marketing work together, customer-centricity continues to be largely relegated to the role of promotional pricing opportunities in the hospitality industry. This is unfortunate, since customer-centric pricing has particular value in hospitality for a number of reasons:
- A customer-centric strategy allows us to create a private channel conversation with the customer, thereby avoiding rate parity agreements that commoditize distribution and drive up distribution costs.
- A customer-centric strategy that incorporates customer-tailored products and pricing improves our ability to retain ownership of our customers (as opposed to allowing our distribution agents to own them) – which then improves our ability to continue to provide unique and relevant offers to them.
- Optimizing revenues across the property can only be fully realized when the full value of a customer’s expected spend (including room and ancillary spends) can be assessed at the time that the first purchase decision is made (i.e. a room is reserved). We have seen some movement in this area around gaming spend, but when one considers food and beverage revenues, spa, retail spends, and show tickets, customer-centricity offers significant potential beyond what has typically been explored.
Debunking the Myths of customer-centric Pricing
One of the difficulties in applying customer-centric principles is simply getting clarity on what is customer-centric revenue management, and what the goals of such an approach should be. As Table 1 below shows, there are a number of common myths about customer-centricity that need to be overcome.
The most common (and unfortunate) myth or misconception is that customer-centric pricing should somehow be treated according to rules that are different from standard revenue management practices. Nothing could be further from the truth. Personnel that are familiar with customer-centric approaches, but unfamiliar with hospitality and travel revenue management, often feed this unfortunate mis-belief. One of the core tenets of revenue management says, “Don’t sell a room to this customer at this rate if you know that you could sell the same room to another customer (or even the same customer) at a higher rate.” This philosophy stems from the reality that our inventory of rooms is fixed – rooms are not widgets that we can produce more of in the short term. The same philosophy applies to customer-centric pricing – we should not make offers that dilute revenue (or if we do, we should account for, and budget for such investment – more on that later).
A second misconception is that customer-centric pricing is something that only applies when creating promotions and promotional pricing. While customer-centric approaches are common and useful in promotions, a customer-centric approach can be effective at every customer touch point – website, reservations call center, front desk, and so on. Further, by incorporating a consistent, customer-centric practice at each touch point, we can improve both the quality and consistency of our service at each point in the customers’ experience.
A third misconception is that customer-centricity is just about pricing. In a typical gaming resort, we have a very wide variety of rooms and services to offer (including show tickets, restaurant reservations, dining coupons, or spa services for example). If we are going to maximize the opportunity to sell at any given interaction point, it is critical to get the right offer in front of the customer the right room type, the right bundle of ancillary products and services, and so on. In today’s travel environment, customers have many, many options for where to book travel, so overwhelming the customer with choices that they aren’t interested in is a sure way to lose a sale. This is why companies like Amazon and Google (and yes, Expedia does it too), invest in customer-centric approaches. This is not to say that pricing doesn’t play a role in customer-centricity – it clearly does – the point is that customer-centricity is not just about pricing, it’s also about maximizing the rate of sale by maximizing the relevancy of offers every time we interact with the customer.
Typically, revenue managers (and revenue management systems) take a short-term approach to maximizing profitability. As noted above, this takes the form of managing rates such that if the value of a particular rate is lower than what we can otherwise expect to receive from the market on any particular date, that rate should be made unavailable.
In a customer-centric environment, considering which products a particular customer is most likely to purchase – based, of course, on understanding this customer’s historical behavior, as well as the purchasing behavior of similar customers can enhance revenue management. Both order of offering (e.g., the positioning of offers on our website, or order in which reservations agents present options to the customer) and pricing can be managed to maximize the expected profitability contribution of this customer. As with any good revenue management decision, a short-term, profit-maximizing, customer-centric offer should account for both current levels of availability, as well as expected future demand for the rooms and inventory-constrained services, as well as this customer’s expected spend on ancillaries that are not inventory-constrained.
Booking engine websites (as well as web pages utilized by reservations staff to manage reservations for customers), offer a rich source of information to drive information regarding customer preferences. By collecting information regarding customer visits to a web page, the options and offers reviewed by the customer, and the bookings that are generated (or not), it is possible to extract a great deal of information about customer preferences. Once behaviors and preferences are understood, offers and display can be managed to maximize revenues through these channels. This type of analysis and real-time processing is a great example of a “big data” problem, to which modern technical infrastructure and analytics are well suited.
It is important to note that firms should not be looking to extract extra value by increasing pricing above published levels – even when it is believed that a particular customer is highly price-insensitive. Customers are extremely wary of being “taken advantage of,” and the long-term publicity costs from appearing to gauge customers can be very high – as Amazon learned in the past, and as Orbitz learned last year. Published pricing is readily available from any number of distribution outlets, so customers are certain to become aware if that sort of approach is taken.
Rather, we are considering which product the customer is most likely to buy, and positioning that to the customer first. If overall demand is low relative to available capacity, we can also consider a targeted discount. Finally, we are enhancing our offer to the customer with custom-configured bundles that are attractive to that particular customer. Since these bundles are custom configured, and can consider the demand for each individual element of the offer, the pricing of the bundles can be managed to provide the appearance of significant discounts, even while the overall profitability of the offer is maintained.
Avoiding the Discount Trap
Unfortunately, many firms focus too much on the targeted discounting approach. Of course, from a marketing perspective, these discounts are often seen as the rewards of loyalty. But, from a revenue management perspective such discounting is often counter-intuitive – many a revenue manager has asked “why are we constantly throwing discounts at our most loyal customers? They have the lowest elasticity and the highest willingness to pay!”
Interestingly, while I’m sure that many of us can point to specific instances that show just how inelastic the typical loyal customer is, it wasn’t until recently that there was enough data to back up the revenue manager’s position – or fully explain it. Recently, Michael Norton, Daniel Mochon, and Dan Ariely published their study on the “IKEA Effect” [The IKEA Effect: When Labor Leads to Love, Harvard Business School. http://hbr.org/web/2009/hbr-list/ikea-effect-whenlaborleads-to-love]. This study, in which participants were asked to build IKEA furniture, and then judge the value of their creations relative to professionally built pieces, shows that consumers judge an “increase in valuation to self-made products.” The application in the context of loyalty programs is neither hard to conceive or observe: loyal customers that are rewarded with status as a result of their efforts over time will tend to value this relationship and its benefits highly – their labor in producing the relationship through their loyalty.
Given that our most loyal customers are often our least price-sensitive, how should they be rewarded? If discounts to them are both hurtful to the bottom line and unappreciated by the customer (an important point to consider when thinking about giving discounts to price-insensitive customers), then how do we reward them? By expanding the relationship that they value! Rather than offering giveaways and discounts that de-value product, offer your best customers limited-availability offerings. Do you have a new show or restaurant opening? Make these available to your loyal customers before they are generally available. Limited-availability offerings and bundles designed for loyal customers enhance customer satisfaction without the negative impacts that discounts have on both profitability and value perception.
Thinking Long Term
While consideration of traditional revenue management philosophies is important in applying customer-centric approaches, customer-centric pricing allows us to take into account concerns that are outside of the bounds of normal hospitality revenue management. In particular, as noted above, traditional revenue management approaches focus on short-term profitability. This short-term focus can lead to insufficient consideration of long-term development for the business: in short, maximizing the value of a single transaction in the short term can cost us profitability in the long run. But how do we know when to sacrifice a short-term investment in profit for a long-term payoff?
Customer-centricity provides a means to understand these trade-offs – by understanding customer life cycles and customer lifetime value. Of course, there are a wide variety of models for customer life cycles, and they can differ by industry. For the purposes of hospitality, and looking just from the perspective of pricing, we can simplify the phases of a customer life cycle, as shown in the chart below.
During the Acquisition phase of the customer relationship, we should be focused on gaining the customer, and encouraging the customer to experience our property. During the Loyalty phase of the relationship, we should be expanding and deepening the relationship – learning about the customer to ensure that each interaction is relevant and maximizes the potential from each stay. Finally, during the Retention and Win Back phases, we are dealing with customers whose loyalty appears to be at risk, or whom we have already lost. During this phase, we should be looking to re-invigorate the relationship, determining if the relationship can be saved and if it should be saved.
From a pricing perspective, it is during the Acquisition, Retention, and Win Back periods that we may need to take aggressive steps to capture or retain loyalty. During these periods it may be profitable, depending on the expected value of the customer, to make an investment in the customer by taking a short-term loss (relative to what could be expected from the market) in revenue in order to accept a reservation. This type of investment should consider the potential value of developing a particular customer vs. the revenue differential given up. It is a best practice to limit the amount of such investments by budgeting for them – thereby ensuring that not all of our business is predicated on future value.
Building a customer-centric revenue management approach has tremendous value – but it isn’t easy. It’s a long journey that will not be accomplished in a single step. Start by building up your customer data. Make sure that you are capturing the transactions from every possible interaction with your customers, so that you understand the full value of each one. Also, make sure that you take every step to ensure quality data – it’s very easy to lose the connection between transactions to a single customer if care is not taken to ensure consistency at each transaction point. Data is the foundation of every customer-centric program, and incomplete or poor quality d a t a will damage the value of the entire program. Once you develop your data, take steps to slowly integrate more customer-centric principles at every customer touch point: your reservations center, your website, and your front desk for example. Look for ways to enhance service, drive revenue, and expand your knowledge of the customer at each step of their relationship with you.
Customer-centric revenue management is a very real possibility for hotels and casinos. If you can push past the misinformation and myths about how to manage this approach, loyal customers and better revenue awaits you.
Alex Dietz is the Principal Industry Consultant for the SAS Hospitality and Travel Practice. Dietz is a 25year veteran of pricing and revenue management solutions development and consulting in hospitality, travel, and retail. Before joining the Hospitality and Travel Practice, he worked as the Product Manager for SAS Markdown Optimization – a price optimization solution used by leading fashion retailers – a position he held with SAS for five years. Prior to joining SAS, he was Vice President of Revenue Management and Marketing for Raleigh-Durham based Midway Airlines from 1998 to 2002, reporting directly to CEO Robert Ferguson. Dietz began his career with American Airlines, where he managed the development of American’s industry-leading yield management systems. Following his time with American, he joined SABRE where he acted as product manager for SABRE’s airline revenue management solution and also led SABRE’s pricing and revenue management global consulting practice. In his various roles as consultant and solution developer, Alex has worked with leading airline, hospitality and retail customers around the globe. Dietz earned his MBA and BS (Industrial Engineering / Operations Research) degrees from Syracuse University.