What Is A Fair Price? - And Who Gets to Decide? What Customer-centric Revenue Managers Know About Guest Perceptions of Price By Dr. David Hayes and Allisha Miller November 15, 2010 - In the lodging industry Revenue Managers set and manage prices. Customer-centric revenue managers make sure their prices are fair. The difficulty for them; and for you if you influence pricing, comes in deciding exactly what constitutes a fair price. The question is important for a variety of reasons including: Buyers must be convinced the prices they are paying are fair if they are to become repeat customers. Employees of a hotel must be convinced the prices charged by their employers are fair if they are to be effective salespersons for the business. Regulatory agencies must be convinced prices charged are fair or they will be motivated to increase their oversight and control Actually, while the issue of what constitutes a fair price is interesting, even more interesting is the question of who decides when a price is fair. Sellers initially set what they believe to be fair prices for what they sell, but in the long run it is always the buyer, not the seller, who determines the fairness of a price. That is so because buyers will not repeatedly and willingly pay more for a product than they believe it is truly worth. Interestingly, 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 sellers that lead to accusations of price gouging or unconscionable selling prices (and that can result in bad press for an industry or invite government regulation). 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, they sometimes have a tendency to project an attitude that nearly any price is “too high”. That is, their preference, much like your own, is always to pay a lower price for all of the things they want to buy. Experienced Revenue Managers understand this natural tendency but they also know that the fact that a potential customer feels a price is too high is not a legitimate reason for granting that customer a price reduction. They, like you, also know that the issue of a too high a 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!). Revenue Managers have little control over the inherent tendency of buyers to seek low prices. They have a great deal of control, however, over buyer perceptions of price fairness. It is extremely important to recognize that most buyers believe it is unfair for sellers to charge excessively high prices, even if the majority of buyers are willing to pay those prices. This is so because, overwhelmingly, consumers feel they have a right to a reasonable price, just as 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 must pay the prices charged. Ignoring this customer viewpoint can be the cause of pricing fiascos brought about by those who honestly (but erroneously) believe a fair price is ultimately defined by “what the market will bear”. To see why, consider the upstate New York hardware store normally selling snow shovels for $ 25.99. The morning after a major snowstorm, the store knows it will sell all the snow shovels it has in stock so it raises the price on its five remaining snow shovels to $ 39.99. Is such an action on the part of the store owner and the resulting new snow shovel price “fair”? When posed with this question, an overwhelming majority of buyers (over 82% of respondents in one study) found such an action to be inherently unfair. You probably do as well. 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 demand increased while supply was constant) to be “fair”; a pretty good indicator that unless buyers’ views are more fully considered, pricing debacles and the strong consumer reactions they generate will not disappear in the foreseeable future. Interestingly, the same business students were not asked if they thought the store’s pricing decision would serve to build repeat customers (maybe because the answer to that question was too self-evident?) The fact is that most buyers will sympathize with a seller’s cost increases much more than with the seller’s supply shortages. Thus a seller who finds they have only a few of an extremely popular item in stock (for example, this Christmas season’s most popular new video game release or 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. This is so because buyers use a variety of information to establish their reference price; or the price perceived by them to be the normal (and fair) price for a product or a service. They will 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 those normal prices that are set very high, are popular with buyers. Experienced sellers know it pays to keep reference prices (rack rates in the hotel industry) high, and when it is advantageous to them, offer discounts from those regular prices. Reducing rack rates across the board and then advertising the reduced prices widely makes little 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 manipulation of forecast data to set prices. It is 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. The best Revenue Managers always remember that it is their customers’ perceptions of pricing fairness, not their own, which matters most. 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 operate Panda Professionals (www.pandapros.com) where they create and deliver innovative and practical educational materials and programming exclusively for those in the hospitality industry. Contact: Allisha Miller Panda Professionals 1715 Jolly Road Okemos, MI 48864 amiller@pandapros.com . .