Imagine that this month your business is at full capacity. What would you charge if someone begged you to do one more project? Alternatively what would you be willing to accept if you had no business at all booked for this month? Now, answer the same questions for a project six months from now. It’s not easy, is it? Yet, airlines and hotels do this every day. Where am I gong with this? Pricing based on capacity has some interesting implications for my readers.
Most rental-stagers and systems integrators assess the value of a given opportunity in project terms. Integrators typically determine the price of the project based on the sum of the parts plus a profit margin. Stagers are more likely to use a retail price and then deduct a discount to calculate the project price. Too often, the amount of profit the seller is willing to accept is based on the perception of the customer’s price tolerance. Margins or discounts are manipulated to generate the negotiated price. In other words, sellers play a guessing game that asks, “What is the customer willing to pay?”
Neither pricing method takes into account the project’s impact on other projects that might occur at the same time or vice versa. True, some managers will apply instinctual pricing strategies to an individual order based on how busy the time period is expected to be. However, most are not consistent in how they assess the situation, and this leads to confusion in the sales process and hence, customer perceptions. In fact, even industries that are highly effective in setting dynamic prices – such as the airline or hotel segments, run the risk of confusing their customers.
Primer on Dynamic Pricing
This idea of fluctuating prices seemingly runs counter to issues that owners and managers face every day, such as, “We are totally max’d out. We cannot fit another job in.” to “I just hope some work of any kind comes in.” In between feast and famine are many opportunities to leverage the firm’s capacity to better returns. Let’s look at the hotel business as an example. A given hotel has a finite number of rooms and the same 365 day calendar as the rest of us. The manager’s goal is to maximize the utilization of that inventory in terms of revenue received and cost spent. The hotel has competitors with the exact same problem.
Based on history and the local event calendar, hotels can roughly predict demand in the future. This is called forecasting and any company can do this with varying degrees of accuracy. The hotelier then sets the ceiling price for a room for a given day or set one master rate for the year. Like rental companies or resellers with margin expectations, they rarely receive that rate. Instead the room price is discounted depending on demand and capacity. Big hotels actually have a person that monitors room rates at least daily if not hourly. Airlines have computer algorithms that do this too. Have you ever shopped for airfare on an airlines website and found the price you selected was no longer available by the time you got to checkout? This frequently happens to me if I shop too long looking for the best fare.
A hotel or airline will also oversell a given night or flight. Why? Because they are betting that someone won’t show up. And if even if they do arrive, the last couple of seats or rooms probably sold for as much as five times the price of the designated oversold customer. The hotelier will find a comparable room for the guest at a nearby hotel and may even have to pay that hotel’s last minute rates, but that cost goes against the price of the last room sold (probably retail or higher), not the price the displaced guest paid through a discounter such as Hotels.com. An airlines may have to buy a seat from another airline, but years ago they came up with a better solution: vouchers. The airline simply asks other passengers to give up their seat in exchange for a guaranteed seat on a later flight (an unsold seat!) plus a voucher that can be used another trip (guarantees future travel!). Airlines and hotels win when they oversell.
Right now you are grumbling about customer service, loyalty, and this is why everyone hates airlines – except that this is NOT what the best customers experience. Getting bumped is what happens to non-frequent travelers. Elite flyers and hotel guests are rarely affected by oversold capacity. And, well-trained customer service reps can usually find a solution that the displaced traveler can live with (such as an upgrade, free meals, or spa treatments). In other words, they have mitigated most of the downside of overbooking and are reaping maximum price for their capacity.
And what is that capacity worth? Dynamic pricing formulas can be extremely complex, in its simplest form the rate of the room goes up as capacity decreases. In the follow chart, Scenario A represents the typical two-rate system. High volume buyers (Groups) get the lower rate. The rest of us pay the higher transient rate. In Scenario B, the Group customer that probably guaranteed rooms months in advance pays the same rate of $90. The next groups or early bookers pay a higher rate. As the number of rooms booked increases, the rate goes up. The last 20% of capacity pays the retail rate of $150. Furthermore, the hotel may change its retail rate by season, which affects the entire sliding rate scale for that period. Most importantly, hotels have an absolute bottom rate, which is based on the incremental cost of servicing the room. A business hotel in a city spends roughly $30-40 to clean and supply a room for one night. Longer stays are slightly less. Therefore the best rate for an unsold room is any price you can get above that cost. However, hotels also know that when they are full so are other hotels and therefore they can demand a higher rate for an unsold room.
Most significantly, the total revenue of the dynamically-priced hotel is higher for the same number of rooms. Hoteliers have to learn to be indifferent about whether they could have charged more or if they lost a customer on price as long as they reach capacity. If the expected capacity for a slow month is only 50% of the rooms, the dynamic price is based on 50% occupancy. In other words, the first room may only sell for $50 instead of $90. If the hotel reached 100% of that 50% goal, then the rate for the remaining rooms can go up even higher. Likewise, an oversold room rate – like the guaranteed reservations that top-tier elite customers earn – might be more than the highest rate to date. In Scenario B, the over-capacity rate might be $175. Even if the hotel has to buy one customer a room at another hotel for $150, they hotel makes money and the elite customer gets a room at their hotel of choice (the online broker customer will get bumped!).
At this point you are wondering how dynamic pricing affects an installation or live event. We can’t bump customers or issue vouchers. Let’s look at the basics for each:
Dynamic Pricing in Systems Integration
The most challenging aspect of SI is that project timelines have a nasty habit of moving around. Construction delays and client scheduling throw off the best-laid plans. Nonetheless dynamic pricing in SI typically only affects costs related to labor, as product costs are relatively constant or at least can be locked-in in advance. The exceptions are last-minute projects, which should intuitively cost the customer more than planned projects and delayed projects, which may incur holding costs for products that have already been received by the seller.
Dynamic pricing offers two potential methods that can apply to Systems Integration.
Schedule-Dependent Pricing in SI
The price the customer pays for a fixed schedule with agreed upon completion dates is higher than having a choice of finish dates. In basic terms, if the customer or project dictates the schedule then the potential costs for the Integrator are higher and should be passed on. If the Integrator can select the time line based on their availability, then costs are lower and the savings can be extended to the customer. In other words, planning and advance scheduling reduce overtime and the need for subcontractors. Just like hotels, when a customer moves the date the price is entitled to change. Let’s set aside how to effectively sell this and focus on the reality of job cost: When building a project budget, having control over the schedule and delivery date is worth a lot to an Integrator. Having to follow a construction timeline with all the inherent delays is potentially more expensive. This directly affects the labor rates you need to charge and Terms and Conditions will describe how to assess a change order when the project dates move.
In terms of selling, you may not be able to convince the customer that labor rates have to change based on timing, but it makes sense. A plumber costs more on Sunday than Monday. However, you can factor timing in to your job cost estimates when determining the project price and set a higher expected net margin for such projects. Alternatively, you might specify penalties (not the recommended terminology BTW) that come in to play when timing issues occur that are outside the Integrator’s control.
Seasonal Pricing in SI
Seasonal pricing can be in addition to or in place of the Two-Tier system. Seasonal pricing says that labor rates in peak installation seasons are higher than slower periods. For instance, Summer is a high demand time in many regions as schools and colleges schedule projects to occur while students are away. The end of the year may be peak time for businesses to use up annual budgets. Seasonal pricing may also come into play when the Integrator knows that a major, resource-sapping project will be ongoing. Each additional project during that period will incur higher costs through overtime and sub-contracting.
You may not be able to charge schools a higher rate, but you can choose to dedicate your capacity to lower margin projects. Additional projects therefore warrant not only a higher cost, but higher margins as the Integrator’s risk increases when all crews are booked and the company is then at the mercy of the sub-contractor channel.
Dynamic Pricing in Live Events
Rental-Stagers have a pricing opportunity that is much more akin to the hotel and airline pricing scenario. There are clear busy seasons and slow seasons, plus customers book projects or place orders at an irregular pace. Capacity pricing scenarios also clearly apply as the cost for staging an event in a busy week will invariably be higher than in a slow one. Sub-rental costs increase as availability wanes as do labor rates for sub-contractors, which are both critical and unavoidable expenses in Live Events.
Seasonal Pricing Scenario:
The advantage that Rental-Stagers have in dynamic pricing strategies is that the timing of the demand is specific. Shows tend to stay on schedule. Event dates rarely move and when they do, customers expect the price to fluctuate somewhat. Stagers also have a fairly good sense of which months will be busy and which won’t. Therefore it is relatively simple to adopt either a dynamic discount or dynamic retail price based on seasons. However, the marketplace has become accustomed to transparency in pricing through itemization on proposals – making it difficult to sell seasonal rates.
For instance, let’s assume that May is the busiest month for your Staging business. You know you will reach maximum capacity at various times, have higher than normal sub-rental needs, and keep a lot of freelancers and sub-contractors busy. Most stagers have a fixed price list and alter the discount or duration multiplier (ie: “number of days”) to reach the target price. The only real math involved is dropping the price until the customer says, yes. A hard-nosed buyer may hold out for a two-day week and 40% discount, while a customer that values your services might pay considerably more.
In a seasonal pricing plan, management might dictate a maximum discount that is lower than what some customers expect. The fear is of course that repeat customers will feel slighted if their perceived value (ie: the discount) changes. An alternative is to maintain discounts by customer, supposedly based on things like volume, loyalty, or some other negotiation. Seasonal pricing in that case involves better adherence to retail pricing, labor rates, and duration multipliers. In other words, basic pricing discipline.
The second and much more revolutionary approach to seasonal pricing would be to change the retail prices of equipment and labor according to the period. However, it is unlikely that anyone could convince repeat customers that raising the cost of a projector during peak time is anything other than gouging. Changing the wording to say that the price is discounted more in slow times won’t convince many more buyers to accept this approach. And even when this method is implemented, the tendency it to simply increase discounts or make other concessions that drive the net price back down. Seasonal pricing is a good idea, but difficult to sell without major changes in customer expectations.
The first step towards adopting dynamic pricing in rental is to reduce the pricing variables to one. Discount on rental rates is the logical variable as it is the one thing that doesn’t affect COGS dramatically. What this means for most stagers is that retail rental rates, duration multipliers, labor rates, and rates for expenses such as trucking and travel are not negotiable. What can change is the discount against equipment costs. By eliminating all other variables, the sales process can isolate the pricing discussion to timing and the volume of business that client represents.
In practice, a client would be assigned a range of discounts that are affected seasonally. In high season that rate might only be 20%, but in low season it could go as high as 60% or more. Labor rates and markups on things like travel remain constant year round. More sophisticated sellers with robust ERP systems could also apply dynamic pricing to products and services besides rental discounts, but let’s focus on the basic concepts for now.
By introducing the concept of busy vs slow times early in the negotiation, the customer has an added incentive to make a decision. Hesitation could lead to higher rates and the buyer will either have to accept the new price or start their buying process over again with alternate suppliers. Capacity Pricing sellers will also have stiff competition from other companies that will pretend to be more flexible about their pricing and therefore appear more loyal to repeat customers. Overcoming this simple objection is not difficult if the seller has established a strong value proposition and also demonstrated that their services are in demand, as witnessed by their busy schedule. In other words, the application of dynamic pricing can actually create demand from customers that want the security of your services guaranteed far in advance.
Capacity Pricing Scenario:
Capacity pricing has the most potential for acceptance in Rental-Staging applications. However, most Rental-Stagers struggle with determining demand, a problem which is compounded by the long amount of time between when projects are quoted and confirmed. What price do you quote six months’ in advance if confirmation won’t come until one month in advance? Placing “good until <date>” language can help drive the customer towards a decision, but the reality of the business is that budgets often evolve over time and are not confirmed until much closer to the project dates.
Determining how much capacity is committed based on confirmed orders alone is problematic. Therefore, Stagers need to include potential orders in the planning. Most rental management software provides a coding system that allows jobs to be tagged as Confirmed, Tentative, or Quote or something to this effect. Simply adding a statistical weight to each of these then applying that to available inventory can prove effective. For instance, confirmed jobs reserve 100% of the items in the order while Tentative jobs only reserve 50%. Again, more sophisticated ERP systems can utilize more complex formulas, but the net result is an indication of how much capacity is potentially promised, perhaps even with a standard deviation to indicate overall certainty.
Much more probable is a the method in which the stager simply looks at the dollar volume for a given period or the number of technicians booked to set a marker for busy or not busy.
Regardless of how the pricing is manipulated from the customer’s point of view, what matters most is how gross profit is affected from the seller’s position. In slow periods, Stagers can afford to accept a lower margin because their overall risk is lower. Specifically, if there is excess capacity then changes in demand are less likely to require sub-rentals or booking of outside labor to fulfill the order. When companies are extremely busy, the margin sold needs to be as high as possible because circumstance are more likely to require unplanned costs, reducing actual gross profit.
Capacity pricing would then dictate that the earliest confirmed projects can have the lowest margins as-sold. As capacity is used up, the margin as sold needs to increase. The simplest means to accomplish this is to discount the job less as capacity dwindles. Longtime customer relationships can make this difficult. Therefore, Rental-Stagers need to learn to sell differently and retrain customers on what to expect in terms of pricing options.
One final note on dynamic pricing, the posted prices do not have one trajectory. They can go up or down depending on outcomes. For instance, a manager may set a low rate to entice early customers to confirm. As other projects commit, he continues to raise the rates as planned. If the pipeline stalls, the manager could just as easily loosen the rates to drive more confirmations. Once the sales pipeline is back on track, he would resume the upward price adjustments.
Changing the Conversation from Price to Value
Clearly the traditional approach to quoting projects needs to change in order to apply any kind of dynamic pricing methodology. Customers have become comfortable discussing price and asking for concessions. Helping customers understand how to control costs on a project is a key part of the selling process. Furthermore, if you can reduce the pricing negotiating points to one variable, then you increase opportunities to focus on value. Even the perception of multiple variables will cause the customer to focus more on price. Consider hotel or airline rates when those companies introduce a la carte pricing for checked bags, included breakfast, or internet access. All inclusive pricing (Virgin Air for example or business-class hotels) attracts a more exclusive buyer than cut-rate suppliers do. The seller in effect weighs the value of being completely sold out versus a higher margin per guest.
Your goal is to earn the most margin for your available capacity. How to do that is, as we have seen, complex; but given the potential returns, solving this dilemma is critical to the survival of your business as customer continue to see you and your competitors as commoditized services. The first step is to recognize the opportunity to increase effective utilization while earning a higher overall margin.
Are you fighting commoditization? Could be the problem lies in your inability to price dynamically. To learn how Stimson Group can help your business reap more profit from existing business, visit our website.
Tom Stimson, MBA, CTS, is president of Stimson Group LLC, a Dallas-based management consulting firm specializing in strategy, process improvement, and market research for the Audiovisual Industry. Tom is a Past-President of InfoComm International and a current member of InfoComm’s Adjunct Faculty.