The Mysteries of Fixing a Price

How much should you pay for an item – any item? If you asked the majority of consumers they would say that a fair price would cover the cost of manufacture plus a little extra for profit.

However in reality, pricing is not that simple, in fact it can be pretty complicated. You really can't charge the same for everybody and this is quite clearly exemplified in the airline and insurance industries.

What has to be taken into account is the following:

Time of day, time of year
Is the customer a regular one?
How much are they buying?
Do they want the product or service now, straight away?
In the case of insurance, what is the risk?

Here are a few examples of companies tackling this issue:

Easyjet

Easyjet is the UK's largest short-haul airline. Their average fare is around £59.00 including taxes. The average profit margin is around £7.00 per seat. 55% of their fares are less than £50. In order to make a decent profit each plane must be full. Their use of benchmark pricing is nothing new.

Easyjet looks at the historical performance of a flight to implement their pricing. How did a particular flight do last year on the same day, same time? Each flight has its own price profile. The starting price is decided a year in advance and closer to departure the price will be more.

Easyjet has 12 pricing managers who can override the system if no-one is using a particular route (for whatever reason). Easyjet doesn't want flights to sell out too far in advance because they need to accommodate last-minute passengers (the day before the flight) who will be prepared to pay more.

Of course airlines also add "frills" where there are good margins to be made; these include hold baggage, allocated seat, fast track security etc. Much of these extras will appeal to business travellers who are less price sensitive because they are not paying for themselves.

January is the peak month for booking summer holidays. 200,000 seats are sold on planes by 10.00 am on the first day of January.

Easyjet says that they could not possibly have one published price for every seat because if the price was always the same a competitor would just come along offering a cheaper seat.

Because each flight has its own profile there is a misconception about differing prices, particularly when customers are booking multiple seats. The price of a seat will fluctuate over the course of a day, which often antagonises customers.

Aviva

Aviva is the largest general insurer in the UK, with 16 million customers. £30billion was paid out last year in claims.

Insurers look at a potential customer's claims history and assess their risk attributes. In the case of motoring insurance, age is the biggest risk because on average younger drivers have more accidents than older ones. Insurers look at how long the driver has been driving, what vehicle they drive and assess how much this customer is potentially going to cost them.

It's true that insurers assess where their potential customer lives, what property they reside in and the value of the car they drive but Aviva is ultimately looking for loyalty. There is always a "cooling off" period after a policy has been purchased when a customer can decide to go elsewhere for insurance.

One thing that really angers customers is renewal notices on insurance policies. These are so often higher than what they paid originally, even if a claim has not been made. Customers often consider this a "rip-off"; they feel that insurance companies are banking on them not bothering to 'phone and complain about the hike and just paying up the new premium.

Also, if the customer does call in and complain often the insurance company is able to offer them a better deal straight away. So, why can't the insurance companies get this right first time?

Drivers can have a telematic box installed in their cars to measure various aspects of how, when and where they drive. The information gathered from this box is fed back to the insurance company and they can assess how safely you drive. If your driving is safe you will get a cheaper insurance renewal.

Aviva and other motoring insurance companies already segment/differentiate their customers by the choice of insurance (fully comprehensive, third party, excess).

Price Discrimination

Price Discrimination is nothing new – we've had first, second (and even third) classes on railways for over 150 years.

Is it a good or bad thing? Well, the airline and insurance industries think it is fair. Easyjet believes that the higher prices close to departure pays for the cheaper, early prices. This makes air travel accessible to more people.

Aviva believe that customers should pay more for home insurance if they are living on a flood-plain for example. People choose to live next to a river, why shouldn't they pay more? If you drive unsafely and make accident claims then you should pay more than a safe driver.

In the case of making a claim, insurers are able to access any public social media that might shed light on a potential fraudulent claim. If you are claiming for a whiplash injury for example but are competing in a 10K run then the insurance company is unlikely to pay out.

The big pharmaceutical companies for instance charge more for drugs in the USA/Western Europe than they do in the developing world because these poorer countries would not be able to afford the higher prices. If the pharmaceutical companies weren't allowed to charge more in richer countries they might stop selling in poorer countries altogether.

Increasingly companies are able to access the browsing histories of their potential customers and assess how price conscious this customer will be. Prices are becoming personalised, tailored to a particular customer.

First-degree price discrimination is a special case of price discrimination, which involves a seller offering different prices to different buyers for the same good or service. The key differentiating feature of first-degree price discrimination is that prices are determined at the level of individual buyers and how much they are willing to pay, rather than through group-targeting (second-degree price discrimination) or volume-based targeting (third-degree price discrimination).

Charging some individuals extra money for a product because they seem to want it more is seen as unpopular. However, special, personalised discounts are often viewed favourably by those receiving the discounts.

The Future of Pricing

Big Data is a holistic strategy for capturing, storing, analysing, visualising and sharing enormous amounts of information – and could be considered quite scary. This will provide statistical links and correlations to provide perfect information regarding what prices are best in what situations. Companies who adopt this approach will be able to stay ahead of their competition.

Related Posts

Why Do Companies Price Discriminate?

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The Power of Differential Pricing