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_________________________________Pricing the service 8. Pricing the service 8.1 Pricing issues Price is a key element in the airline strategy, it must be acceptable for targeted customers and must reflect accurately the other marketing mix elements. The value of the service is the value attached to it by the service provider and it must correspond with the customer’s perception of value. Airlines offer a range of products at various price levels to meet the needs of different target segments who have different needs and spending power. The business segment commands a higher price as passengers pay for more flexibility, comfort and self-fulfilment. But even in this segment where passengers due value good service costs increasingly matter when the choice is so wide and there is a recession in sight. Every company adopts different pricing strategies. British Airways has a pricing policy which is geared mostly to market conditions. Virgin Atlantic follow its pursuit of offering a superior service undercutting competitors fares. All the airlines have official published fares and these tend to be pretty close to each other, especially in business class where they are usually identical. The price eventually established for a service will be subject to different elements, notably costs, pricing strategy, organisational objectives, the structure of the market, the life cycle stage, prices charged by the competition etc. (see Illustration 8.1). Target segment Pricing strategy Organisational objectives and positioning Life cycle stage Market structure and regulation Price Product X Demand level and elasticity Competitors’ price Costs Illustration 8.1 - Establishing a price Fabio Emanuele Noia, London March 1996 66 _________________________________Pricing the service Break even analysis and price elasticity A good starting point for pricing a product is a break even analysis to take account of fixed, variable costs and overheads. Price elasticity of demand in relation to actual revenue is another key element to consider. Demand levels vary continually during the year and in years depending on economic conditions, the product life cycle, peak periods, marketing and promotional effort and degree of substitutability of the product. Regulatory constraints Regulatory measures imposed by government and other bodies can also affect pricing decisions. Safety requirements can increase costs and therefore be passed onto the customers. The Civil Aviation Authority together with single market legislation supervise fares charged by airlines on European routes. In 1995 for example the CAA has prevented 8 proposed fare increases for long-haul carriers flying from British airports. CAA position however is that flexible economy fares should be cost related but it is up to each airline to charge what it wishes for business class. Competitor pricing Competitor pricing is a focal point in pricing a product. The airline industry however is one where very slight differences exist on the same routes among different carriers. Competitors tend to keep prices in line with others trying to avoid price wars, especially in the premium passenger markets. If airlines see opportunities for keeping prices high they take them. When filling capacity becomes difficult because of over supply then a price war is likely to start, but hardly on the premium segments. Virgin Atlantic is an exception to this rule as the airline’s disclosed objective is to benefit passengers through lower fares on those routes where other airlines take advantage of bilateral agreements or absence of competition to keep prices artificially high. In addition indirect competition on short hauls is increasingly becoming a matter of concern as seen with the Channel Tunnel with fares down to compete with trains and ferries competitive prices. Fabio Emanuele Noia, London March 1996 67 _________________________________Pricing the service Organisational objectives Organisational objectives affect pricing strategies. British Airways for example, which being a floated company feels more than Virgin Atlantic the pressure of shareholders and the stock exchange on its decision making, tend to maximise current profit. Virgin Atlantic instead goes for a more Japanese approach to the market in an attempt to maximise growth. Other objectives which will affect the pricing strategy might be enhancing the image of the organisation as a price leader or position it high in consumer perception as a company offering high quality, high price products. Positioning This relates to the way consumers perceive and evaluate the product. Price can convey the feeling that a certain brand stands out of other competitors’ brands. Different target will have different perception of price and some will be more sensitive than others (leisure market). Fabio Emanuele Noia, London March 1996 68 _________________________________Pricing the service 8.2 Pricing strategies There are different strategies an airline can adopt. Some examples related two the two airlines will give an idea of the main differences. Price skimming It consists in skimming the cream off the market by offering a product at a high price on a low volume basis. This can be easily referred to premium passenger markets for products such as British Airways Concorde, First, and business classes, and Virgin Atlantic Upper Class and Premium Economy. Penetration pricing In this case the price is set at a low level in order to attract high volumes of sales and build up market share, this strategy can help establishing a strong market position. The strategy is specially suitable when entering highly competitive markets such as international airlines. Virgin Atlantic used the attractiveness of superior service at lower prices to enter the North Atlantic market in open competition with the well established British Airways. Cost plus pricing This is based on adding a required margin or mark up on the total costs. Even if used as a suitable starting point it is not the best criterion to determine a price as it doesn’t take in consideration key factors shown in Illustration 8.1. Marginal pricing This is based on the cost of the last unit of output, for example the cost of carrying an extra passenger on a plane; this will be probably equal to the cost of the meal and drinks served on board and very low in comparison with the overall costs of fuel, maintenance, staffing and so on. Therefore where there is spare capacity reduced fare passengers are preferable to empty seats, provided the price charged is at least equal to the cost implied by the marginal passenger. This concept is at the basis of British Airways and Virgin Atlantic discounted fares, special offers in off peak times and stand by (see Table 81). Fabio Emanuele Noia, London March 1996 69 _________________________________Pricing the service Promotional pricing Promotional pricing in the airline industry is a well known tactical tool consisting in pricing reduction to match seasonal variations in demand or fill in spare capacity. Neither BA nor Virgin sells discounted fares for business class, though some travel agents sometimes offer modest discounts by splitting their commissions. Differential pricing Airlines also adopt differential pricing offering the same service at different prices depending on traffic peaks or other characteristics such age (pensioners) or being in education (students). Fabio Emanuele Noia, London March 1996 70 _________________________________Pricing the service 8.3 Fares comparison The two airlines tend to compete with each other on the basis of service and network provided with Virgin Atlantic slightly advantaged in the first field and British Airways dominating in the second. Prices tend to be matched to each other even if there’s no precise correspondence between BA and Virgin class structures. BA and Virgin have started their competition on transatlantic routes engaging in transatlantic price wars. The first shots were fired by BA (with a significant reduction on 50 routes) to pre-empt Virgin’s penetration strategy. Virgin’s response was to reduce fares to NY and LA by over £ 100 resulting in fares £1 below BA’s ones on those routes. With time Virgin has extended its network bringing competition on the most profitable routes. Now Virgin is about to bring the price war in the European market where airlines still overcharge their premium passengers on many routes. Some fares are reported below to give an idea of the two airlines approach to pricing strategy. British Airways charges £5,660 for a return ticket on its unique Concorde from London to New York. 80% of Concorders (about 500,000 passengers) are loyal repeat travellers. Virgin Upper Class better compare with BA First in terms of service. But BA £4,188 for a return ticket from London to New York in First is well above Virgin Upper Class price. Upper Class and Club World charge the same £1181 for a one way ticket from London to New York but with the already stated difference in service. BA unrestricted economy fare is £678 for World Traveller for a round trip to New York, while Virgin’s Premium Economy fare is £ 856 and Virgin’s Economy class fare is £678. Fabio Emanuele Noia, London March 1996 71 _________________________________Pricing the service Differences in prices charged for different classes are better shown in Table 8.1. British Airways London -NY Virgin Atlantic London-NY Class return (1993) Class return (1995) First Class £3,900 Upper Class £2408 World Club £2614 Premium Economy £870 World Traveller £700 Economy Saver £688 Apex £288 7 day Apex £588 Special promotion £200 21 day Apex £448 Special promotion £179 Table 8.1 - Fares comparison Fabio Emanuele Noia, London March 1996 72