Michigan State University Extension
Tourism Educational Materials - 33740097
06/06/02
Pricing Tourism Products & Services
Michigan State University
Holecek, Donald
33.74
E-1999
1987
Full Text
Filing Key
INTRODUCTION
In general, tourism businesses appear to be in a highly
competitive industry with limited flexibility to set
prices. Either they sell at or below the established
market price or see a rapid drop in sales. Establishing a
firm's price under such circumstances is straightforward,
although not always simple. All one needs to do is to
identify what the competition is charging and price one's
own product comparably.
Despite this apparent lack of flexibility, however, the
uniqueness of tourism/recreation goods and services
actually enables producers to establish prices. This
uniqueness stems from a number of product attributes,
including: business location, its natural environment,
the types of facilities offered, the personal
relationships that management and staff develop with
customers, and real and perceived differences in the
quality of the firm's products.
Because most tourism/recreation businesses have at least
some flexibility to establish prices, this bulletin will
address the key factors that should be considered in
making pricing decisions. Keep in mind, however, that the
same uniqueness which provides pricing flexibility also
precludes development of a universally applicable formula
for guiding pricing decisions. Furthermore, the goals of
businesses in this industry vary widely and, because
price is a major toot for achieving a business's goals,
identical businesses under identical circumstances may
logically establish different prices.
While it is not possible to prescribe a single formula
for all price-setting decisions, it is possible to
identify the primary components of a sound pricing
strategy. These "ingredients" can be found in textbooks
and by observing business pricing practices. Both sources
are drawn upon here to provide you with the ingredients
to make sound pricing decisions. Ultimately, you must fit
them to your business goals and circumstances to arrive
at the best prices for your products.
THE BASICS OF PRICING
Price theory is a keystone of economics. Because of this
central role, no economics text would be complete without
one or more chapters devoted to pricing. Many books have
been written on this single topic. Successful business
people, whether from books or practical experience, have
learned to use basic pricing concepts for their products
and services. These elements are introduced briefly
below.
Economists begin their introduction to pricing by
explaining the concept of demand. In simple terms, demand
means that consumers will purchase more of a good or
service at a low price than at a high price. Therefore,
demand is the economists' term to describe the
relationship between the varying quantities of a product
which can be sold over a range of prices. Demand can be
expressed in at least three ways: a) in tabular form; b)
as a mathematical relationship; or c) as a graph. We will
discuss demand as expressed in a graph, since that format
is the easiest to visualize.
Note that as the price charged decreases from $3 to $2,
the quantity which can be sold increases from five to ten
units. Based only on this information, the operator of
this particular business would maximize sales revenue by
establishing a price of $2 for the product. At that
price, gross revenue would equal $2 x 10 units = $20. At
a price of $3 or $1 gross revenue would equal only $15.
If the unit cost of producing these 5, 10 or 15 units was
identical--for example, $0.50 per unit, net revenue would
also be maximized by setting the price at $2. Net revenue
(gross revenue - production cost = net revenue) at a $2
price would equal $15. Note, however, that while gross
revenue is $15 at both the $1 and $3 unit price, net
revenue is not equal. At a$3 price, net revenue is $12.50
while at a $1 price net revenue is only $7.50. This
illustrates the need to account for both demand and cost
when setting prices.
In addition, unit costs contain both fixed and variable
elements. Fixed costs include such items as rent,
insurance and managerial costs which must be paid to be
in a particular business. The per unit fixed cost burden
declines as output increases. Doubling output, for
example, would reduce fixed costs per unit by half.
Variable costs, on the other hand, vary directly with
output. Examples of variable cost items include employee
wages, laundry costs and supplies. Total variable costs
increase as output increases but often will not be the
same across all levels of output. Per unit variable costs
typically are high at low levels of output and decline as
output level expands because of economies of scale (e.g.
volume discounts on large orders from suppliers).
With reasonably good projections of a business's fixed
and variable costs, it is possible to establish the
minimum price required in order for the business to earn
a profit. This is often referred to as a break-even
price. This is the price per unit for a given volume of
output at which total revenue is exactly equal to total
costs. This relationship can be expressed algebraically
as follows:
P X Q = F+ (V X Q)
where
P = price per unit sold
Q = quantity produced and sold
F = total fixed costs
V = variable cost per unit
Isolating price in the above expression yields the
following:
P=F + (V x Q)
Q
Even though fixed and variable costs and quantity may not
be known precisely, calculation of an appropriate range
of break-even prices can often be very revealing. Indeed,
use of this simple business technique could keep you from
inadvertently investing in products unlikely to be
purchased at the price required for you to break-even on
the quantity you could produce. Occasionally, however,
there are circumstances in which a rational business
person may deliberately establish a selling price below
the break-even point.
PRICING IN PRACTICE
The real world which the commercial recreation/tourism
business faces is far more complex than the highly
simplified theoretical economic models which we have been
discussing.
However, these models can help you to deal better with
your real-world pricing problems and are a firm
foundation upon which to build a more comprehensive
tourism/recreation pricing strategy. When economists
establish the price-quantity relationship which they
refer to as demand, they mean it to apply to a single
product which consumers perceive as being identical.
Billions of dollars are spent each year on advertising
with the single purpose of convincing consumers that
apparently identical products in fact possess important
differences. These advertising dollars aren't wasted. The
boom in sales of certain designer jeans, headache
remedies, soft drinks, and fast foods reflect consumer
perceptions of differences among the products available
to them, whether or not these differences actually exist.
Even without the influence of advertising, consumers'
perceptions of products and services in the tourism and
recreation industry do differ greatly. These differences
in perceptions are extremely important to a business's
pricing strategy. In essence, these perceptions define
the competition. From a prospective consumer's
perception, for example, the competition for a modern
campground along a major highway, may be nearby budget
motels, rather than less-developed campgrounds on the
same route. In such a setting, the modern campground
owner might be able to price a night of camping
considerably higher--near the level of nearby budget
motels-than would be feasible if the competition was
exclusively other campgrounds. Thus, a first step in
developing a pricing strategy is to establish from the
consumer's perspective what other products in your market
compete most directly with your offering. Be sure to
include all significant attributes of your product such
as: location, facilities and services you offer, and
significant attractions in the vicinity of your business.
Many tourism/recreation businesses offer multiple
products and/or services to the consumer. A marina, for
example, may rent boat slips, sell boats, fuel, and
equipment, offer maintenance and storage services, and
even operate a grocery/beverage outlet. In establishing a
pricing strategy, the marina must not only focus on
demand, production costs, and its competitors' prices,
but also must consider the impact of slip rental prices
on the attractiveness of its other products and services.
The objective is to maximize profit across its entire
product line. This might be achieved by charging slip
rental fees below the competition and even below the
break-even price. Grocery stores commonly employ such a
pricing strategy for turkeys at holiday seasons, since
all but the most conscientious shoppers are likely to
purchase the rest of the ingredients for the holiday meal
wherever the best price on turkeys is offered.
Restaurants with bars will often discount food prices in
order to attract customers who will purchase drinks,
which are a high profit product. Impact across a firm's
product line is an important consideration in
establishing pieces for an individual product offering.
Demand for tourism/recreation varies with the season and
the day of the week. In some cases, demand may also vary
across product offerings. For example, rooms with a
scenic view or campsites near the water are in greater
demand than others which a business may have to offer.
These differences can be exploited, since greater demand
provides an opportunity to charge higher prices.
Variations in demand also suggest that lowering prices
during non-peak periods can yield added revenue. As long
as the price discounts offered aren't excessive (i.e. the
established price covers all variable costs), offering
reduced rates can actually enhance a firm's profit. To
the extent that differences in demand can be identified,
differential pricing should be an ingredient in a firm's
overall pricing strategy.
Pricing is often employed to attract new customers, to
maintain good customer relations, to help a new business
to become known, and to "wage war" on competition. The
latter seldom makes sense for small businesses,
especially those with limited capital or lines of credit.
Offering price discounts, however, can be effective in
the other instances noted and is often feasible even for
small businesses. For example, offering a price discount
on occasion may yield more business than allocating an
equivalent sum for advertising. On the other hand, a
business in the hospitality industry must avoid the
appearance of price gouging or risk loss of customers
over the long haul.
SUMMARY
This approach to making pricing decisions draws upon the
concepts of demand and production costs. Break-even
analysis reveals the minimum price to be charged in order
for a firm to remain in business in the long run. In the
"pricing in practice" section, we highlighted the
importance of viewing your product from the consumer's
perspective. Knowing the consumer's perspective helps
identify your competitors. Assessing the impact of
pricing decisions across your entire product line and
using the concept of differential pricing were also noted
as considerations in developing pricing strategies.
Finally, the idea of discount pricing as a promotional
strategy to attract new customers or to maintain good
relations with old customers was noted as a possible use
of pricing strategy.
One point remains to be made. Regardless of how much you
read about pricing, both in theory and in practice, and
how much research you undertake to support your
decisions, it is necessary to monitor the results of your
pricing decisions. Only through monitoring can you
determine whether your pricing decisions are yielding the
anticipated results. It is far better to adjust your
strategy than it is to stick with a bad decision. Even
good business people occasionally make bad decisions
because of faulty information or incorrect analysis. The
only way to determine what price to charge is to
experiment. The ideas presented here should help you to
narrow the focus of your experiments so that you can more
quickly identify prices which are best for your business.
This information is for educational purposes only. References
to commercial products or trade names does not imply
endorsement by MSU Extension or bias against those not
mentioned. This information becomes public property upon
publication and may be printed verbatim with credit to MSU
Extension. Reprinting cannot be used to endorse or advertise
a commercial product or company.
This file was generated from data base TD on 09/30/03.
Data base TD was last revised on 06/06/02.
For more information about this data base or its contents please contact
alexande@msue.msu.edu . Please read our
disclaimer for important
information about using our site.