Price Fairness: How to maximize revenues without gouging the guest
By Kelly McGuire Vice President, Advanced Analytics, Wyndham Destination Network | June 12, 2011
It is clear that revenue management practices can help hotels increase revenue, but successful revenue management counts on consumers being willing to pay different prices for essentially the same product, based on the hotel's expectation of demand. Hotel managers have good reason to be concerned about negative consumer reaction to demand-based pricing. Research has shown that consumers will punish firms that they perceive to be acting unfairly in their pricing strategies by refusing to patronize them in the future(i). So, how can hotels balance the risk of negative consumer reactions with the benefits of variable pricing?
In a previous article in the HotelExecutive.com June 2011 Feature Focus series on 'Revenue Management: Maintain Rates & Avoid Price Wars', I alluded to research in my article "Private vs. Public Rates: How to Discount Without Starting a Price War " that provides advice for structuring pricing practices to minimize negative consumer reaction, while allowing the hotel to take advantage of revenue generating opportunities. The underlying theory about consumers' reactions to pricing practices comes from Behavioral Economics, which is a branch of economics where researchers use social, cognitive and emotional factors to understand the economic decisions of individuals and institutions. These economists have determined the factors that influence consumer reaction to pricing practices and developed theories to explain consumer behavior in financial decision making. I'll apply this theory to the revenue management pricing problem, and give some tips for hotel managers to avoid negative consumer reactions to pricing strategies.
Principle of Dual Entitlement
Consumers believe that they are entitled to a reasonable price, but that firms are also entitled to a reasonable profit(ii). They understand that the airlines may have to raise ticket prices when fuel prices increase or restaurants may have to charge more for lettuce when there is a drought in California. These are considered necessary for firms to maintain that "reasonable" profit. However, they react negatively to firms who try to take actions that result in "unreasonable" profits, seeing these as firms unfairly taking advantage of consumers. For example, raising the price of snow shovels during a major snow storm, or raising the price of a coke with the outdoor temperature would be considered "unreasonable" profit seeking.
Dual entitlement is the most dangerous principle for hoteliers that are looking to maximize revenue. Any unexplainable price increases run the risk of violating consumers' sense of a "fair profit", resulting in perceptions of price gouging. Hoteliers can combat this by providing a reasonable justification for any price that the consumer is asked to pay. In revenue management terms, this means creating rate fences, which offer consumers discounted prices but impose rules and regulations at each level of discount to balance the perceived value for the different market segments(iii). For example, the ability to cancel without penalty has value for a business traveler, but not for a leisure traveler who is less likely to cancel. The leisure traveler pays a lower price, but must pay ahead. To be perceived as fair, the fences need to be logical, transparent, upfront and fixed so that they cannot be circumvented.