Differential Pricing and Segmentation on the International Hotel

Differential pricing and segmentation on the Internet: the case of hotels Rama Yelkur Assistant Professor of Marketing, University of Wisconsin-Eau Claire, Eau Claire, USA Maria Manuela Neveda DaCosta A Professor of Economics, University of Wisconsin-Eau Claire, Eau Claire, USA Hotels, Service industries, Pricing, Segmentation, Loyalty, Internet Keywords Introduction In the 1950s, marketers discovered that, if they gave their customers what they wanted Abstract and did it better than the competition, their In the ever-changing electronic sales grew.With the advent of the Internet, environment of the twenty-first marketers have access to the technology to century, price is one of the key customize products and communicate strategic elements that is often overlooked by firms. The paper directly with smaller target markets. The addresses differential pricing in Internet is now firmly established as a business-to-consumer electronic marketing tool. It serves as an integral part commerce, in particular of the marketing mix, serving as a digital differential pricing for hotel services sold on the Internet. istribution channel as well as an electronic Hotels are able to take advantage storefront. of differential pricing for various When a firm establishes a presence on the segments because the market for Internet, its marketing activities, including hotels can be divided into narrow customer segments. An overview advertising, pricing, and distribution, should of e-commerce and Internet reflect characteristics unique to the medium marketing is provided. The to help consumers realize the value added characteristics of products sold over traditional methods. online and differential pricing are discussed.Pricing policies for onConsumers in the Internet medium are line marketing are examined with more than just passive recipients in the a special emphasis on differential marketing process (Hoffman et al. , 1995). The pricing, customer loyalty and Internet is an interactive medium as opposed segmentation. With the help of secondary data, online pricing to traditional marketing which usually strategies used by hotels on the allows only one-way communication (Peters, Internet are evaluated.Finally, 1998; Sandelands, 1997) from marketer to conclusions are drawn and implications for the hotel industry consumer. re discussed. Many diverse vendors, from florists to manufacturers of durable goods, as well as service providers such as airlines and hotels have rushed to do business on the Internet. In order to effectively market on the World Wide Web (the Web), companies need to evaluate the basic components of the marketing mix: product, price, place, and promotion. In the ever-changing electronic environment of the twenty-first century, firms must identify and sustain competitive advantage in order to survive. Price is one of the key strategic elements that is often overlooked by firms (Yelkur and Herbig, 1997).In the on-line setting, companies have the oppo rtunity to utilize price to build competitive advantage by enhancing customer satisfaction and loyalty by meeting Management Decision 39/4 [2001] 252 ±261 # MCB University Press [ISSN 0025-1747] The current issue and full text archive of this journal is available at http://www. emerald-library. com/ft the demands of specific segments which have the potential to improve the firm's profit position. How much impact is the Internet really having on the market mix, especially pricing?Is it changing the approach to pricing or is it merely complementing traditional pricing practices? Our paper addresses differential pricing and segmentation in business-to-consumer electronic commerce, in particular differential pricing for hotel services sold online. The consumer segments in the hotel industry are based on usage, situation, and frequency of use. Hotels are able to take advantage of differential pricing for various segments because the market for hotels can be divided into specific custom er segments (Awh, 1998; Yelkur and Herbig, 1997).The more specific the segment, the easier it is to estimate demand; the knowledge of demand is essential to adopting a differential pricing strategy. This paper is organized as follows: An overview of e-commerce and Internet marketing is provided. The characteristics of products sold online and differential pricing are discussed. Pricing policies for online marketing are examined with a special emphasis on differential pricing. The importance of customer loyalty and segmentation and their relationship to differential pricing on the Internet are emphasized.With the help of secondary data, online pricing strategies used by hotels on the Internet are evaluated. Finally, conclusions are drawn and implications for the hotel industry are discussed. The growth of e-commerce Business conducted over the Internet is commonly referred to as electronic commerce or e-commerce. E-commerce is changing the way firms do business. In 1999, e-commerce t ransactions accounted for over $150 billion in sales and it is predicted that this amount will increase to $3 trillion by the year 2003 (The Economist, 2000). E-commerce [ 252 ]Rama Yelkur and Maria Manuela Neveda A DaCosta Differential pricing and segmentation on the Internet: the case of hotels Management Decision 39/4 [2001] 252 ±261 transactions come in many forms. Table I displays an e-commerce matrix that illustrates the difference among these various types of transactions by giving examples: Business-to-business transactions still account for 80 percent of all e-commerce business but consumer-to-consumer, consumer-to-business, and business-toconsumer (the object of this study) transactions are expected to grow astronomically in the next decade.According to an Internet consulting firm (Forrester Research, as cited in The Economist (2000)), business-to-consumer trade in the USA amounted to about $20 billion in 1999 and could reach $184 billion by 2004, which is about 5 percen t of USA's retail trade. Product characteristics that facilitate Internet marketing Some areas of retailing and commerce may be particularly well suited for the Internet, given certain characteristics (see Table II). For business-to-consumer marketing, as proposed by Peterson et al. 1997), products and services in the context of the Internet can be classified on the basis of: . cost and frequency of purchase; . value proposition; and . differentiability. Products can vary from low cost, frequently purchased goods (ex: coffee), to high-cost, infrequently purchased goods (ex: car). In general, for goods for which purchase fulfillment requires physical delivery in a short time, the Internet is not an appropriate mode of delivery (Peterson et al. , 1997).For an industry such as hotels, where a transaction can be completed without physical delivery of the product and the frequency of purchase is relatively low and the cost is relatively high (when compared with consumables such as coffee ), the Internet is a more efficient medium for firms to use to conduct business. The suitability of the Internet also depends on the tangibility of the product. Internet marketing is practically well suited for certain types of services. For example, it is now widely used for banking and other financial services.When the value proposition is intangible and the frequency of use higher, the greater is the advantage of the Internet as a transaction and distribution medium. The transport and delivery of the goods are an important consideration. Clearly, it is easier to sell lighter goods over the Internet than bulky and heavy ones. Then, there are those that can be delivered electronically like software, music, and certain services like banking, insurance, travel and hotels. The 1999 top-ranking products in the US market in terms of online transactions were computer hardware/ software, travel, financial brokerages, and collectables.In fact, intangible or symbolic information products su ch as airline tickets or hotel reservations gain tangibility on the Internet medium. Internet marketing can result in extreme price competition when products are similar, because other factors that moderate competition (ex: store location) are absent. However, when products and services are capable of significant differentiation, the Internet can serve as a method of segmenting consumers and directing them toward the appropriate product or service, as is the case Characteristics of Internet marketingThe Internet represents an extremely efficient medium for accessing, organizing, and communicating information. As such, the Internet subsumes communication technologies ranging from the written and spoken word to visual images. Internet marketing is one of the newest distribution channels marketers use to reach the customer. It is different from traditional channels in that it is also a communication network. Like all communication networks, the Internet is all about establishing and re inforcing connections between people.The Internet has been growing rapidly in the second half of the 1990s and today it is available in approximately 38 percent of US households (Nielsen Media Research, 2000). No medium including television has reached the 50 million-user mark in four years (Strauss and Frost, 1999). The integration of the Internet as a technological tool as well as a delivery medium with traditional marketing has transformed the processes firms use with which to conduct business. Table I The e-commerce matrix Business Business B2B GM/Ford EDI networks C2B Priceline Accompany Consumer B2C Amazon E*trade C2C EBay QXLConsumer Source: The Economist, 2000 [ 253 ] Rama Yelkur and Maria Manuela Neveda A DaCosta Differential pricing and segmentation on the Internet: the case of hotels Management Decision 39/4 [2001] 252 ±261 in the hotel industry. The â€Å"hotel† product is relatively expensive, infrequently purchased, has an intangible value proposition, and rat es high on differentiation from competing products. As a result, sellers are able to charge a higher price based on the match between the buyer's needs and the nature of the product offering.In a traditional setting, such personalization would turn out to be relatively expensive. Yelkur and Herbig (1997), are explained below: Select a target market The broad target market for a business is already chosen when the product is positioned. The firm needs to divide its broad target market into smaller segments. Differential pricing The model of price discrimination or differential pricing used by Cannon and Morgan (1990) provides an important analytical insight into many discriminatory pricing practices.The prices charged by a firm practicing differential pricing are usually not proportional to the marginal costs incurred in producing the service. When firms adjust their prices according to customer, location or product, they are said to follow the strategy of segmented pricing or differ ential pricing (Strauss and Frost, 1999). It is not unusual for businesses to offer varying prices for consumers by age group, for example, senior citizen discounts. In addition, customers can be differentiated based on customer type, for example, the business customer versus the individual customer.Businesses can also offer different prices for products based on location; for example, the pricing of a hotel room in San Francisco, California, would be different from a similar room in Phoenix, Arizona. Finally, firms frequently price products differently not necessarily based on cost, but rather on the willingness to pay. For example, firstclass airline tickets are always priced much higher than economy fares (Strauss and Frost, 1999). In summary, segmented pricing can be based on three major factors: customer type, location of product or service, and product or service offering.It is also possible to customize prices based on the profile provided by the customer, as is the case for hotel services sold online. The five steps a firm must take to achieve a differential pricing policy, as illustrated by The essence of any customer service strategy is to segment the customer to be served. It is important to differentiate between market segmentation and customer service segmentation. Customer service segments differ from traditional market segments in significant ways. Customer service segments tend to be narrower (Davidow and Uttal, as cited in Yelkur and Herbig (1997).In addition, the narrower the segments, the more homogeneous they tend to be, making it easier to estimate consumer demand for each segment. Another factor that cannot be overlooked is the usage situation. Segmentation needs to take into account the what, where, how and why of demand. As demand is a result of the interaction of a person with the environment, a segmentation perspective that includes both the person and the situation is needed to explain the demand. In service industries such as hotels , distinct lines can be drawn, say, to divide different types of customers such as the vacationer or the business traveler.The usage situation thus gives the firm a guideline for customer service segmentation. Once customer segments are identified, the next step is to estimate the demand for each of these segments. Divide the target market into smaller customer service segments Steps for differential pricing Table II Product characteristics matrix for hotels Cost and frequency of purchase Relatively high cost Infrequently purchased Value proposition Intangible Service-related good Degree of differentiation Significant differentiation possible Source: Based on the Peterson et al. (1997) model [ 254 ]Customer demand can be estimated by a method suggested by Oren et al. (1984), which proposes that there are many customers in a target market, each with different characteristics summarized in an index, say, t, indicating customer type (based on the customer service type). Assuming that t here is a continuum of types with indices in the interval t0 t t1. The fraction of the population whose types are less than an index t is given by a distribution function H(t) (which forms the customer segment as described in the previous section) that is assumed to be continuous and strictly increasing. It implifies notation to let s = H(t) be this fraction so that t = H(s), and s is uniformly distributed on the interval 0 s 1. One can use s to denote a customer rank or customer type. Although this method is more suited to physical goods markets, it can be applied to service markets as well. In Estimate demand for each customer segment Rama Yelkur and Maria Manuela Neveda A DaCosta Differential pricing and segmentation on the Internet: the case of hotels Management Decision 39/4 [2001] 252 ±261 practice such estimations should be substantiated with both historical and estimated market data.Reservation price indicates the maximum amount a customer is willing to pay for a good or s ervice (Guiltinan, 1987). The reservation price of the customer indicates her willingness to pay and is the underlying benchmark for setting different prices for different customer segments. Classifying customers by the value they place on the service provides a rough estimate of the cost of satisfying them as well as the price they are willing to pay. Firms operating in service industries can use differential pricing only if they can estimate the distributions of the reservation prices.The amount by which the reservation price exceeds the actual price is the consumer surplus. The reservation price (Rp) would therefore depend on the value the customer places on the service (V) and the number of different firms offering the service (N). That is, Rp = f(V,N). The greater the number of firms offering the service, the lower will be the reservation price of the consumer. Whereas, if the customer has only a limited number of choices (substitutes), then her reservation price becomes higher ; that is her willingness to pay increases (her demand becomes more inelastic).The final price is determined for each customer segment based on customer type, location and product/service offering. Thus, though there is no change in marginal cost, different prices are charged depending on the type of customer segment and the reservation prices for each segment. Among the goods and services that are sold online, hotel services appear to be particularly well suited for differential pricing because of the ease of segmenting customers at a relatively low marginal cost. Determine reservation prices (which indicate willingness to pay) for each segmentRosen and Howard (2000) provides examples of improved transaction efficiency for service industries such as banking, travel, and stock brokerage. Table III illustrates the reduction in transaction costs for service firms because of delivery via the Internet. Traditional pricing strategies such as differential pricing, discussed in the previou s section, are particularly well suited to ecommerce. We will focus primarily on differential pricing for online services, also referred to as segmented pricing.A new and unique method of pricing called dynamic pricing, which is easily facilitated by the electronic medium, enhances differential pricing for online services. The Internet enables marketing managers to update product databases instantly and continuously, as new product features are developed and price adjustments are made (Strauss and Frost, 1999). Dynamic pricing allows Internet customers to receive up-todate price information on demand from product databases. This information changes with time and by user.For example business customers may receive different prices than individual customers. Business customers may receive different price information based on volume ordered. Thus, dynamic pricing allows further customization by target customer and further enhances the traditional segmented or differential pricing in the online environment. Determine prices for each segment Online presence of hotels Hotel services seem to be particularly suited to sale on the Internet. They can be delivered online and, once in place, benefit from tremendous economies of scale and scope.One firm can design a Web site and then just differentiate from locale to locale and from hotel to hotel at very low cost. In fact, the marginal cost of adding one more line to the Web site or another site for a new hotel is practically negligible. Despite these advantages, the hotel industry seems to have been relatively slow at â€Å"going digital† and using the Internet as a marketing tool. Hotel transactions in the USA account for less than 5 percent of the US total volume of e-business transactions. However, there is some indication that this is likely to increase significantly in the near future.Table IV shows that online travel business transactions increased from $2. 2 billion in 1998 to $6. 5 billion in 1999, a 200 pe rcent increase. Furthermore, when we disaggregate the total online travel bookings by travel product, it is interesting to note that lodging Pricing policies on the Internet E-commerce is likely to have a significant impact on pricing, as it creates a more competitive environment in which firms may sell. The Internet is able to generate different pricing mechanisms, particularly by allowing customers to make instant price and product comparisons.The Internet offers significant opportunity for reducing operating costs, particularly for service firms (Rosen and Howard, 2000). A study by Andersen Consulting (as cited in [ 255 ] Rama Yelkur and Maria Manuela Neveda A DaCosta Differential pricing and segmentation on the Internet: the case of hotels Management Decision 39/4 [2001] 252 ±261 increased from 13 percent in 1998 to 16 percent in 1999, a trend that is likely to continue. Table IV Total online travel bookings by travel product 1998 $2. 2 billion market (%) Air Lodging Car Cruis e/tour 80 13 7