Limits to Differential Pricing

If different customers place different values on the same products and services, and if differential pricing is such a powerful tool, why don’t all sellers aggressively practice it? The answer is simple: It is not easy.

If RMs recognize that different customers value their products differently, and are willing to pay different amounts for them, it follows that prices should refl ect these buyer differences. Despite the diffi culties involved, those RMs working in the hospitality industry and who seek to maximize profits must learn to practice differential pricing by overcomingfour pricing-related challenges:

1. Imperfect knowledge. Unfortunately, it simply isn’t always possible to know precisely what buyers are willing to pay for what they want to buy. Professional buyers can get very good at hiding their actual intention. As a result, RMs often must base the prices for the products and services they sell on their estimate of the average willingness of customer segments to pay.

2. Cannibalization. A signifi cant threat to the implementation of profi table price differentiation strategies is the tendency for “high willingness buyers” to masquerade as “low willingness buyers” and thus avoid paying higher prices. Any time an RM designs a differential pricing strategy there must be an effective way to accurately identify those who qualify for the differentiated price.

3. Arbitrage. If some buyers are willing to pay more than others for the same item, what would keep those buyers who are allowed to purchase at a low price from reselling to those buyers willing to pay a higher price? In many cases, the answer is nothing. It is easy to see, however,that arbitrage has a negative effect on an RM’s ability to effectively maintain differential prices.

4. Questions of legality or ethics. Some observers of differential pricing ask a question that is both fundamental and important: How can an organization charge different prices for what is the same, or essentially the same, product or service? A related question is: Is it fair to do so? Even within the hospitality industry, there may not be universal agreement on an answer. Recall, however, that differential pricing means offering different prices to different customers based on a customer’s willingness to buy.

Applying Differential Pricing

One of the greatest drawbacks of a fi xed pricing strategy is that it assumes all customers are the same. Although it might seem very fair and even egalitarian to treat each customer as an average customer, good businesses don’t do that. Instead, they treat their customers as individuals. Not all customers are the same. Some are high value. They eat in your restaurant on a regular basis or reserve a room at your hotel every time they come into town. These customers do not expect to be treated like everyone else nor should they be.

It is for that reason hospitality businesses commonly seek to identify and repay their best customers by planning andimplementing sophisticated rewards programs.

Product versioning offers talented RMs many chances to employ creativity and fl exibility. Those considering versioning as a way of instituting differential pricing may choose to do one or more of the following:

Add features: This may include increasing quality, quantity, or the service levels provided to customers.

Subtract features: Doing so may allow the product or service to appeal to new customers while leaving current customers unaffected.

Add a service to a product: In some cases, the service may be permitting the customer to save time by avoiding a wait, or to feel pampered, or even to circumvent having to perform a less-than-pleasant task related to the purchase.

Offer a menu of choices: In many cases, product alternatives can be easily mixed and matched by the customer. Allowing guests to create their own defi nition of good, better, and best maximizes the chances of offering a product that is a perfect

fi t for its buyer.