Applications of flexible pricing in business-to-business electronic commerce

IBM Systems Journal,  July, 2002  by M. Bichler,  J. Kalagnanam,  K. Katircioglu,  A.J. King,  R.D. Lawrence,  H.S. Lee,  G.Y. Lin,  Y. Lu

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Revenue management. Revenue management originated in the airline industry as the practice of controlling the availability and/or pricing of travel seats in different booking classes, with the objective of maximizing revenue and/or profits. (19) Other recent applications of revenue management are discussed in References 20-23. As shown in Figure 1, we generalize these concepts to include pricing policy (e.g., price discrimination) on the sell side as well as the question of how to allocate fixed product resources optimally across the multiple sales channels mentioned above. Price discrimination is illustrated in Figure 2, where we consider a simple seller-based price-demand curve. Customer segmentation can be used to assign customers to price classes. Using a single price class [p.sup.*], demand for quantity [q.sup.*] will generate total revenue of [q.sup.*] times [p.sup.*] ([p.sup.*] is selected to maximize this revenue). By adding an additional price class, p1, with associated demand q1, additional revenue of q1 times (p1 - [p.sup.*]) can be generated. As noted in Figure 2, it is possible for this additional revenue class to promote "cannibalization," or customers switching between fare classes. The downward shifting of the price-demand curve in Figure 2 is due to cannibalization. In general, it is possible to increase revenue by optimal allocation of the total quantity across multiple price classes. (4) Significant additional complications arise when bills of materials are present, because we need to do a similar analysis across multiple resources.

[FIGURE 2 OMITTED]

Pricing policy, including product-portfolio decisions, can include product differentiation (mentioned earlier in the section "Differential pricing") and product/service bundling as a means of capturing consumer surplus (i.e., the portion of the market that is willing to pay more than the average price). At any point in time, different sell-side channels will have potentially different market conditions (e.g., demands and price elasticities), and thus channel allocation, driven by current market conditions, is becoming an increasingly important technology for businesses with multiple sales channels. To some extent, this is driven by the observation that the Internet not only provides buyers the ability to make price comparisons but can also make sellers' costs transparent to buyers. (24)

Product differentiation imposes specific requirements across the supply chain. Bundling price and delivery commitments in a business-to-consumer environment and providing enhanced inventory management offerings such as JIT (just in time) and VMI (vendor-managed inventory) in a business-to-business environment can be a means to create differentiation. It is a widespread practice among the suppliers in assembly manufacturing and high-tech industries to offer price and service bundles. A manufacturer, for instance, can bundle price with a number of delivery options and thus generate differentiation. (25) In order for this practice to be effective, a manufacturer needs to be able to generate an accurate ATP (available to promise) profile. Companies also need to be able to make real-time projections of the cost of providing these bundles. This may require advanced ABC (activity-based costing), particularly in cases where bundles are massively customized.