Pricing Models: The secret to how great businesses make more money
Pricing models: The secret to how great businesses make more money
If you are small business owner, pricing manager or CEO of a large corporate and you are thinking of ways to make more fast cash, review your pricing model today.
How you generate money (i.e., your revenue stream) is inextricably linked to your pricing model. If you want to make more money and are finding it difficult to find revenue opportunities, maybe it’s time to re-think your pricing model.
The type of pricing models you develop for your business can have a huge impact on the revenues you generate. Develop the wrong pricing model and soon find yourself justifying unsustainable and sporadic cash flow statements to the accountant, CFO, board or shareholders.
In this article, I will go through how airline pricing models work to make more money. I will explain how and why there is such a strong connection between a businesses’ revenue stream and their pricing models.
I will then lay out two common types of pricing models – fixed pricing models and dynamic pricing models – and show the key differences and usages of the two very popular pricing models.
Throughout the article, I will show how leading B2B and B2C businesses make more money by carefully thinking about how their pricing models can yield more revenue and margin opportunities.
What is a pricing model?
A pricing model is based on a series of pricing mechanisms and mathematical formulae that calibrate fare prices using logic, rules and constraints. An airlines pricing model, for instance, considers things like: route, time of day, season, demand, supply and other factors because fare pricing and airline revenues are largely dependent on inventory and time of purchase.
How do airline pricing models generate more revenue and margin?
Pretty much every successful airline business hires a large team of pricing and revenue managers and analysts. These teams make small adjusts to airfares throughout the day (tactical pricing) to boost revenue and (hopefully) create better customer experiences.
The team loads fares into their pricing models at different times of the day and every day. The pricing and revenue management team may also do some level of forecasting to determine the best times of the day or week to optimise prices based on supply and demand.
Depending on the strategic pricing approach and sub-strategies defined in the teams’ playbook, the revenue manager may choose to adjust prices or hold prices as a tactic (or sub-strategy) to compete under highly competitive market conditions i.e., a competitive bidding strategy or bounce strategy to win market share etc.
What pricing models make most money?
Revenue managers like to use algorithmic pricing models to maximise profitability.
For example, the picture above on the Cranky Flier blog above shows a simple method that airlines have discovered to make more money out of individual passengers. (Remember this the next time you’re sitting in economy with knees scrunched up under your chin). This is a seat-to-leg room ratio / calculated using an algorithmic pricing model to make more money for the airline.
Advanced pricing models are fairly flexible models that enable pricing and revenue managers to continually refine additional calculations, business rules and constraints within each segment and as the team learns more about the market and consumer behaviour.
Understanding more about how your competitors and consumers behave is the secret to generating more revenue while protecting volume.
How advanced pricing models make money for large corporates
Fares in airline pricing models are dynamic because they are set by the market and focus on the consumer i.e., the number of passengers booked on a flight varies at any one time and this will trigger alternative valued based pricing logic and value fences embed within in the pricing model that will in turn optimise revenue and margin against set volume requirements by flight, schedule and customer segment.
Many airlines announce sales at the beginning of the week and this can often create some kind of reaction in the market or price response. Some airlines, for instance, may try and match certain fare prices the following day because this is their competitive strategy while others may choose to hold their fare prices after calculating competitive responses using advanced Game theory modelling and/or scenario planning sessions.
Airlines tend to have technologies and price software to automate their pricing models to speed up routine pricing tasks for better pricing outcomes. Airlines, for instance, develop pricing models for pricing systems that are commonly made up of pricing algorithms (or mathematical formulae), which at a very basic level are calculated using regressions and price volume elasticities for the business and their key competitors.
The output from these pricing models shows key price volume differentials which the team interpret as leading indicators of growth and profitability.
How “Smart pricing” strategies drive price optimisation
Airlines tend to automate their pricing models using “smart pricing” or algorithmic pricing. Algorithmic pricing coupled with technology and price software reduces the time it takes to review prices across multiple customer segments.
Think for a moment about the complexity of a flight network and the huge array of fares, discounts and specials (or price files) in their SAP system. A pretty daunting and time consuming task right?
It would be very difficult for revenue managers and their teams to manually go through every price point for every flight and adjust prices for optimal revenues. Most airlines choose to buy pricing software to automate price reviews for predictable flight schedules.
Automation has also been found to reduce human error and save time. Price software does not provide solutions for unpredictable pricing situations. This has to be programmed into the system as an additional rule and constraint.
Opportunities to making more money with smarter pricing models
The complexity of algorithmic pricing models is dependent on the continual development of carefully selected business rules and constraints / or conditions that have been pre-programmed into pricing model.
Algorithmic pricing models can simultaneously boost revenue and maximises profitability. They help teams to make more informed decisions.
Algorithmic pricing models produce real time data analytics and visualisations to help teams understand market dynamics in a glance using price, volume graphs, histograms, price waterfalls and charts.
Revenue managers like to use algorithmic pricing models to boost revenue and maximise profitability.
Advanced pricing models are designed to be flexible and enable pricing and revenue managers to generate more revenue for the business while protecting volume.
|Pricing model options|
|1. Fixed pricing models|
(largely used by B2B businesses)
|2. Dynamic pricing models|
(commonly used by B2C businesses)
|List price||§ Fixed prices for individual products, services or other value propositions||Negotiation|
|§ Price negotiated between two or more partners depending on negotiation power and/or negotiation skills|
|Product feature dependent||§ Price depends on the number or quality of value proposition features||Yield management||§ Price depends on inventory and time of purchase (normally used for perishable resources such as hotel rooms or airline seats)|
|Customer segment dependent||§ Price depends on the type and characteristic of a Customer segment||Real-time-market||§ Price is established dynamically based on supply and demand|
|Volume dependent||§ Price as a function of the quantity purchased||Auctions||§ Price determined by outcome of competitive bidding strategy|
|*Based on Pricing Mechanisms table written in Business Model Generation – Alex Osterwalder & Yves Pigneur|