The future of pricing and revenue models - Springer Link

Futures

The future of pricing and revenue models Received (in revised form): 25th February 2010

Irene C.L. Ng is a Professor of Marketing Science at the University of Exeter Business School (UK), ESRC/AIM Service Fellow and Visiting Research Fellow at the Institute of Manufacturing, University of Cambridge. She is also the Academic Advisor and ESRC/NHS Public Sector Fellow with the Cambridge University Health Partners with various research projects in value-based service systems (value-basedservicesystems.blogspot.com). Correspondence: Irene C.L. Ng, Institute for Manufacturing, University of Cambridge, Alan Reece Building, 17 Charles Babbage Road, Cambridge CB3 0FS, UK

ABSTRACT This article considers four major movements which the author believes would have an impact on the future of pricing and revenue models. First, the inclusion of the customer and other stakeholders for value co-creation would have an impact on pricing. Second, value in future services would reside within a complex service system with multiple stakeholders gaining and contributing to the system and pricing models would need to evolve to incorporate systems thinking. Third, future payments will be payment for rights, rather than in exchange for ownership and finally, an understanding of the context of use and the way services and goods are used in combination within the context would lead to new mechanisms for pricing, bundling and new revenue opportunities. Journal of Revenue and Pricing Management (2010) 9, 276–281. doi:10.1057/rpm.2010.11 Keywords: resources; systems; value co-creation; complexity; context; access rights

INTRODUCTION Modern films, literature and speech are built on a language which is, in turn, built on a set of alphabet which, configured differently, communicates messages of knowledge, love, passion, danger and wonder. On its own, alphabet is meaningless. With human creativity and skill however, a set of only 26 alphabets (in the case of the English language) can bring peace, communicate joy and incite violence. Modern Science is built on basic principles (for example, the periodic table in Chemistry, sub-atomic particles in Physics) that classify, systematize and describe all of physical science phenomena from the Northern lights to photosynthesis. On its own, science brings about understanding. With human creativity and skill however, science brings ‘progress’ both in the way we heal and in the way we kill.

Modern life is built on resources: natural, human and process resources. On their own, they are a reservoir of potential value. With human creativity and skill however, they are transformed into goods and services of effectual value, bringing a better and more meaningful quality of life to many while indulging the excesses of others; making less resources achieve more even while we deplete other resources at an unsustainable rate. The deployment of resources to manufacture physical goods has been a hallmark of economic activity since the beginning of the industrial era. As early as 1776, Adam Smith proposed that the wealth of nations was built upon a country’s ability to produce an excess quantity of goods and then export this excess to generate wealth. This provided the foundation for the dominant view of goods as the staple for

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value and wealth creation for betterment of society. As technology advanced and as competition heightened, firms have felt the pressure to add value to achieve effectual outcomes, rather than merely providing merchandise or equipment (Baines et al, 2007; Neely, 2009). This has led to a service-dominant logic where service is ‘the application of competences (skills and knowledge) for the benefit of another party’ (Vargo and Lusch, 2004, 2008) and such competencies are resources that could be embedded in physical goods, or reconfigured to serve different needs, and combinations of physical assets, technology, people and processes can be put together to achieve more sophisticated outcomes. The modern service economy can now provide a fully and continuously functional operating system, rather than software in a box. Entertainment, rather than a TV. Communication, rather than telephones. Power, rather than engines. Many services could be rendered remotely, allowing people to work and learn from home, connecting people around the world and even providing health care. Modern life has harnessed the reservoir of resources and, through commerce, found ways to assist and enrich our day-to-day lives. Yet, such provisions have changed the landscape of payments. Payments were traditionally exchange oriented – something given in exchange for something of value. Today, pricing models are less straightforward and the modern service economy have moved from exchangebased pricing to more sophisticated models that incorporate relational, temporal and behavioral issues. Fifty years ago, we paid for telephone bills according to whom we called. Today, some of us pay according to when we call and others pay a flat fee whether we make calls or not. Our behavior, in line with these pricing mechanisms, changes accordingly to exploit what is free and to be tightfisted with what is charged. Consider the pricing of mobile telecommunication across the world – where talk is cheap with all-youcan-talk packages and no roaming charges, for

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example, in the United States the average monthly talk time is 788 min. This is in contrast to 133 min in Japan where talk is expensive and texting and emailing is cheap.1 What are the drivers of the way new pricing and revenue management models are formulated and how do we make sense of the future? In this article, I attempt to describe four major movements I believe will have an impact on the future of pricing and revenue models.

FROM VALUE TO VALUE CO-CREATION The role of the customer and our abilities to assess our own resources to complement the firm’s offerings to achieve outcomes is now playing a heightened role, a concept commonly called value co-creation (Prahalad and Ramaswamy, 2000; Vargo and Lusch, 2004, 2008; Ng et al, 2009b). Value co-creation is the idea that firms do not really provide value, but merely value propositions, and it is the customer that determines value and co-creates it with the firm at a given time and context best for the customer to achieve the outcomes they want. As Ballantyne and Varey (2006) puts it, a ‘customer’s value-in-use begins with the enactment of value propositions’ (p. 337). Hence, a firm’s product offerings, be they goods or activities, are merely value unrealized, that is, a ‘store of potential value’ (p. 344), until the customer realizes it through co-creation and gains the benefit. Woodruff and Flint (2006) proposed a new bidirectionality for mutual satisfaction. Gummesson (1999) also suggested the term balanced centricity to illustrate this concept. In the understanding of value co-creation, there is a need to understand the role of the customer in the firm’s processes and systems, and the role of the firm in the customer’s processes and systems. Value co-creation therefore implies customer resources to realize the value to become central towards achieving end benefits (outcomes, see below). This further implies that the price charged by the firm to the customer has to trade-off against the

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customer’s abilities to realize the value. A savvy phone user would have the necessary resources to realize the value of an iPhone and would pay for it, whereas a less technologically inclined consumer may not have such resources and would therefore not care for the phone at all. We are seeing value co-creation gaining prominence, as customer resource involvement to achieve outcomes become more dominant in industries such as health care (with greater customer empowerment), mobile telecommunication and the Internet (with user-generated content), and education (with self-study courses). All this implies that there is currency in customers’ time; ‘eyeballs’, effort and all type of resources accessible only to customers themselves which can be traded off with money and the firm’s propositions, resulting in a myriad of pricing models (Ng, 2007). The organization of the future is one that is able to seize the opportunities presented through the inclusion of the customer and other stakeholders in managing, designing and pricing for value co-creation.

FROM COMPONENTS TO SYSTEMS THINKING, NETWORK AND COMPLEXITY SCIENCES Systems thinking is not intuitive. Our scientific education have taught us to be reductionist in that the division of a complex problem into separate components is acceptable, and that the elements of the whole are the same when examined independently of the whole as when they are examined as a whole. As Checkland (1981) writes: the central concept of a system embodies the idea of a set of elements connected together which form a whole showing properties which are properties of the whole rather than properties of its component parts. Systems thinking is important because it radically changes the way we think. If components

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are loosely connected then we can take them apart, analyze them, improve or change them and then put them back together and the whole will be improved. However, the world in which we are currently operating is becoming more complex, where components cannot be analyzed on their own but within their ‘whole’, as the interactions between components are key to achieving system level outcomes. This is the case with complex systems such as the body where we cannot modify a component (for example, heart) and replace it within the body without expecting effects elsewhere. The science behind systems thinking is also different (Ng et al, 2010) and necessitate different approaches and technologies. Systems thinking and related studies in complexity, network and system sciences will have an impact on the future of pricing models because of the evolution towards complex systems where offerings are interconnected. The nature of the interdependencies is accelerated by technologies moving towards convergence, resulting in the involvement of multiple stakeholders and multiple customers all contributing resources into the system and paying for different facets of the system and deriving different benefits. This is already happening, for example in what is termed as ‘mash-ups’, where providers of server farms (for example, Amazon), social media (for example, Facebook), advertisers and search engines (for example, Google) facilitate our information pursuits on just one web page on the Internet. In such systems, it is hard to tell who is the provider and who is the customer. Also, who pays whom for what is also unclear. As technologies become smarter, platforms such as mobile phones, GPS, laptop, TV are converging to achieve different outcomes for the consumer. If we follow the development of the ‘internet of things’, our washing machines of the future could be asking the electricity grid when is the cheapest time of the day to turn itself on (a line borrowed from IBM’s smarter planet movement2). Convergence brings about new stakeholders with new


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resources delivering new types of value to customers but breaking down traditional boundaries. The future therefore resides in a service system of resources proposed, consumed and value co-created by a web of stakeholders, including customers themselves, all of whom have something to gain and something to give to the system. Pricing models based on direct exchanges would struggle, as cause (who is delivering value) and effect (who is consuming value) become increasingly blurred. In addition, the interplay between processes and outcomes within a service system which are non-linear and multi-directional in nature suggests that current pricing mechanisms may not be as effective. Indeed, techniques traditionally used could be to, as Miller and Page (2007) put it, ‘understand running water by catching it in a bucket’. The future will also see the development of more dynamic system level pricing and a better understanding of system capacity, with the system as a unit of analysis in prescribing innovatively different pricing models.

FROM OWNERSHIP AND PRODUCTION TO OUTCOMES, ACCESS RIGHTS AND SYSTEM CAPACITY As the world moves towards moderating resource depletion, it becomes obvious that as consumers, we do not all need to own the drill that is used three times a year, a car in the city or even the baby items from 10 years ago sitting in the basement or garage. Where borrowing, leasing or buying from charity shops made consumers feel either like a freeloader or a miser, increasing pressure to be green will usher more ‘feel good’ sentiment, increasing potential for companies such as rentalic.com, which bring together a community of consumers to share items that they do not really need to own. By renting or leasing, consumers buy outcomes of goods, rather than the goods themselves. Such a phenomenon is not just happening


at a local consumer level but even with large organizations. Engines produced by Rolls Royce are maintained through a ‘power-bythe-hour’ pricing mechanism, with Rolls Royce selling propulsion (outcomes of engines) rather than the activities to service the engines (see Ng et al, 2009c). The maintenance, repair and overhaul service for the entire UK RAF Tornado is priced based on BAE Systems’s ability to deliver a bank of flying hours for the fleet, rather than on repairs and parts (see Ng et al, 2009a, b). This has resulted in the alignment of the interests of the provider with that of the customer, with both parties interested in keeping the jets flying, with better technology and minimum cost of parts. From the connected world perspective, delivering and pricing on outcomes is also starting to take shape in cloud computing. The ‘cloud’, as the Internet is metaphorically called, provides firms with services without the need for them to own the technology infrastructure behind the services. Firms buy the ability to conduct complex computations, control payroll or manage databases without knowing or owning server capacity. If we consistently buy goods, commerce will consistently produce it. The move towards outcomes starts with a trickle, but with the right pricing incentives, could potentially snowball to have a big impact on sustainability where quality of life improvements (for consumers) and effectiveness and efficiency (for businesses) come not through ownership or consumption of goods, but through contracting and buying outcomes. Clearly, such outcomes are delivered not by goods alone but by activities as well, and even without passing ownership of goods over to the customer, outcomes are still delivered through resources, just different configurations of it. Thus, the convergence of goods and activity-based resources for achieving outcomes would result in different resource combinations in a system. Consequently, future pricing models would surround the payment for the right to access such resources which include firm and


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customer resources. Spohrer et al (2008) describe access rights as ‘the social norms and legal regulations associated with resource access and usage’. The capacity of such resource access and usage in a system configuration to deliver outcomes will feature prominently in the future of revenue management. Capacity-driven revenue management models used successfully when capacity were seats, space and rooms will be challenged to define what capacity is in a system of access rights configuration to deliver outcomes and how it could be optimized to match customers’ willingness to pay. Future business models will trigger more sophisticated revenue management models at a system level. Finally, in line with value cocreation, access rights to customer resources may encroach on privacy. Future pricing models would be designed with creative incentive mechanisms so that the loss suffered from giving up some privacy is outweighed by the benefits attained. By its logical extension, future payments will be payment for rights, rather than in exchange for some good or activity.

FROM PROFILING TO CONTEXTING The convergence of technological platforms described previously has resulted in a greater focus on context rather than merely profiling customers. Segmentation of customers for price discrimination is still widely practiced but such segmentation tends to discriminate on customer types, rather than use-types. Technology convergence allows customers to play multiple roles and take on diverse tasks leading to inaccurate profiling. Frequent flyers may have certain needs and are prepared to pay for certain services, but would behave radically different when they are travelling on the same airline but with children and family. Future pricing models will be more concerned with not just who the customers are but how they derive their value in-use, that is, when, where and how customers are consuming the goods and

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activities. The future will see more sophisticated data being available – location-based, RFID tagging –which could provide data on use and contexts and provide insights into the value customers hold in all these contexts, and how they could be priced within each context, or in bundles. The move towards context would also be hastened by a liberated workforce that is able to work at different times and places according to where it is most suited. Employees can clear their email inboxes and work on projects, papers and reports on the move, at home or even in bed because technology has allowed them to choose the most effective and appropriate moments to do various kinds of work to match different types of environment. Convergence in technology therefore drives the breaking down of traditional boundaries and creates different combination of use contexts, resulting in the need for different services and different pricing bundles. Working from home and on the move has already spawned new services such as the virtual receptionist, and virtual equipment such as e-fax. Technology has also allowed the aged to live independently at home, on a yacht, or wherever they choose, with sophisticated methods of communicating, diagnosing, sharing and gaming. Pricing any individual service or good with a good understanding of the context of use and the way these services and goods are used in combination with others within the context would lead to new mechanisms for pricing, new bundling and revenue opportunities.

CONCLUSION Pricing and revenue models are powerful mechanisms as they can stimulate change just as much as they can also impede innovation. Behaviors, attitudes and lives change according to the way the world pays for goods and activities. With imagination and creativity, the possibilities to develop innovative pricing mechanisms would be limitless. Yet we must


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shed the baggage of the industrial era of pricing as a commodity (goods or activity) exchange mechanism. The future of pricing and revenue management lies in the management of revenue derived from paying for resource rights, in the contexts appropriate to customers, as they become a stakeholder among other stakeholders co-creating value in a complex service system.

NOTES 1 ‘The Apparatgeist calls’, The Economist, 29 December 2009. 2 http://www.ibm.com/smarterplanet/us/en/ index.html?ca=v_think.

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