A pricing metric is the unit of consumption by which customers are charged (e.g. charging per litre for paint). A value metric is the unit of consumption by which the customer derives value (e.g. surface area covered by the litre of paint). For pricing to be successful, the pricing metric should track how the customer derives value from a product or service offering. If the customer cannot connect how they are charged to how they derive value, it creates discontent. Connecting pricing metrics to value metrics requires an in-depth understanding of customer value creation.
In this blog post, we will explore how the same customer can be effectively charged using different pricing metrics using the example of how Heathrow Airport charges airlines for the use of airport facilities.
Heathrow Airport charges inbound aircrafts a fixed amount per landing (based on aircraft size/type) while for the same aircraft, departing flights are charged a fee per passenger.
Why has charging two different pricing metrics been successful for Heathrow Airport, and what can we learn that can be applied across other industries?
Clarity on goals
What are the seller’s pricing goals? Does having multiple pricing metrics for the same customer improve the seller’s chances of achieving these goals? Multiple pricing metrics if implemented incorrectly can end up confusing the customer. The seller must have a solid business case that supports a multiple pricing metric strategy. Otherwise, the strategy will result in customer resistance.
In the case of Heathrow Airport, the overarching goal is to increase revenues through maximizing capacity utilization at minimal cost to serve. Heathrow currently operates at 99% capacity. Therefore, to ensure more efficient use of their scarce runway resources, Heathrow incentivizes larger aircrafts by charging them more economic fixed landing charges than smaller, shorter haul aircrafts. Additionally, in alignment with Heathrow’s environmental goals, aircrafts with lower emission rates also receive more economic fixed landing charges.
Twenty-one percent of Heathrow’s revenue is from fixed landing charges. But, the lion’s share (75%) of their revenue is from charging a per passenger rate for departing fights - which is approximately $29 per passenger ticket. For a high volume airport, charging per passenger results in higher returns than charging a fixed rate per departing flight.
Additionally, within Heathrow’s capacity constraint, the key strategy for passenger growth is to increase the number of passengers on each plane. Currently, there are about 21.6 million empty seats per year going through Heathrow. So the airport also plans on offering rebates per incremental passenger to incentivize maximizing flight loads, which is also in alignment with their overarching goal of maximizing capacity utilization.
Value creation for the customer
For a multiple pricing metric strategy to be successful, there should be:
- incremental value creation for the customer
each pricing metric must create value for the customer differently
the cumulative value creation for the customer from being charged different pricing metrics must be greater than if they were charged just one price
In the case of Heathrow Airport, being charged a fixed amount for landing creates value for the airlines by allowing a “predictable” cost of operations.
Additionally, being charged a fee per departing passenger is not detrimental to the airlines, as they pass this fee down to their customers through ticket prices. Heathrow is currently proposing to add in additional incentives to help airlines maximize load and fill the 21.6 million empty seats, by offering rebates per incremental departing passenger in 2019 over 2018 passenger volumes. However for the airlines to receive the rebate, Heathrow’s total number of passengers in 2019 must increase over 2018. This would not only grow passenger throughput for Heathrow, but would allow the airlines to improve their margins per passenger as well.
For a multiple pricing metric strategy to be successful, there has to be customer buy-in. For customer buy-in ,the pricing metrics must be perceived as fair, transparent and consistent.
Is value being created for both buyer and seller?
Who does the pricing metric benefit?
Does it make the pie bigger for all parties?
How were the prices set?
Who are the stakeholders? Were their motivations considered?
Is the seller effectively communicating how value is created for the stakeholders?
- What are the seller’s goals?
Are the goals for the different pricing metrics in alignment or do they contradict each other and end up confusing the customer?
In the case of Heathrow Airport, the pricing metrics were set in consultation with all stakeholders within the airline community, which was critical to buy-in and effective implementation.
When done right, a multiple pricing metric strategy can have lasting impact on the stickiness of a product or service offer. But the downside risk of confusing the customer is also very high. So within this high risk-high return scenario, it is critical to have an in-depth understanding of the customer’s economic (monetary) and emotional value drivers. A seller looking to explore this pricing strategy should start with market segmentation and see the different ways they can create value for the same customer.