How to Price: A Guide to Pricing Techniques and Yield Management

By. Oz Shy 14th Jan 2008

Book Discription

Over the past four decades, business and academic economists, operations researchers, marketing scientists, and consulting firms have increased their interest and research on pricing and revenue management. This book attempts to introduce the reader to a wide variety of their research results on pricing techniques in a unified, systematic way and at varying levels of difficulty. The book contains a large number of exercises and solutions and therefore can serve as a main or supplementary course textbook, as well as a reference guidebook for pricing consultants, managers, industrial engineers, and writers of pricing software applications. Despite a moderate technical orientation, the book is accessible to readers with a limited knowledge in these fields as well as to readers who have had more training in economics. Most pricing models are first demonstrated by numerical and calculus-free examples and then extended for more technically-oriented readers.

“This book provides an extremely valuable introduction to ‘the art of pricing’. The strength of the book lies in its judicious choice of the topics to be covered and accessibility to a wide range of audiences from advanced undergraduates to practitioners who may have limited technical knowledge. In particular, the coverage of the book on ‘yield management’ truly stands out, where Oz Shy offers a very elegant, intuitive, and simple presentation of dynamic pricing techniques with capacity constraints that have been widely used in the airline and hotel industries. In summary, the book is bound to be the best single source for anyone interested in this broad topic of practical importance.” – Jay Pil Choi, Michigan State University

“Oz Shy has yet again succeeded in providing an innovative and lucid exposition of a longstanding issue: how to price. The outcome is a cleverly presented toolkit for understanding yield management and pricing strategies. The comprehensible yet rigorous style, its original focus and varying levels of mathematical formalization, as well as the novel use of computer algorithms make this book an exceptionally useful instrument not only for teachers and students in economics, management, and marketing, but also for practitioners and business people.” – Tomaso Duso, Social Science Research Center Berlin

“A valuable book for both students and practitioners — it will be a key reference for anyone working in the field. The author is an expert who himself has made important contributions to industrial organization.” – Paul Klemperer, Oxford University

“How to Price is a coherent and straight to the point introduction to the state of the art of strategic pricing. This book is especially suitable for master’s level students in economics as well as managers responsible for pricing decisions. At the targeted level the book is the first in its kind.” – Staffan Ringbom, Swedish School of Economics and Business Administration, Helsinki, and HECER

Book Information

Print Length

448 Pages




Cambridge University Press

Publication Date

January 14, 2008


7.0 x 1.0 x 10.0 inches





About The Author

About Oz Shy

Oz Shy is a senior policy adviser and economist in the Research Department at the Federal Reserve Bank of Atlanta. He has published three books: How to Price (Cambridge University Press, 2008), The Economics of Network Industries (Cambridge University Press, 2001), and Industrial Organization: Theory and Applications (MIT Press, 1996). Dr. Shy has published more than 80 journal and book articles in the areas

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Table Of Contents

This book focuses on pricing techniques that enable firms to enhance their profits.
This book, however, cannot provide a complete recipe for success in marketing a certain product as this type of recipe, if it existed, would depend on a very large number of factors that cannot be analyzed in a single book. However, what this book does offer is a wide variety of pricing methods by which firms can enhance their revenue and profit. Such pricing strategies constitute part of the field called yield management

The key to a successful implementation of any yield management strategy is getting to know the consumers. Large firms invest tremendous amounts of money on research seeking to characterize their own customers as well as potential consumers.
In economic theory, the most useful instrument for characterizing consumer behavior is the demand function. A demand function shows the quantity demanded by an
individual, a group, or all the consumers in a given market, as a function of market prices, and some other variables.

This chapter introduces basic pricing techniques. By basic we refer to techniques that are limited to simple one-time purchases of a single good only. That is, the simple techniques studied in this chapter do not address more sophisticated markets in which products and services are differentiated by the time of delivery, the length of the booking period, quantity discounts (bundling), and services that are tied with other products and services. In fact, some of basic pricing techniques described in this chapter can also be found in most intermediate college microeconomics textbooks. Clearly, readers must first understand these basic techniques
before proceeding to more sophisticated ones analyzed in later chapters.

Bundling and tying are widely used instruments for implementing price discrimination. Market segmentation is therefore accomplished by offering consumers a
variety of packages to choose from. When bundling is used, by choosing different packages, consumers implicitly reveal their willingness to pay for different quantity levels of the same good. That is, consumers with a high preference for large quantities will choose large bundles, whereas consumers with a low preference for large quantities will choose small bundles, or simply buy one unit, if available. Similarly, when tying is used, consumers implicitly reveal their preferences for some other types of goods, which are tied to the sale of the original good. Both the bundling and tying pricing techniques constitute special cases of nonlinear pricing under which the price of each unit may vary with the total number of units

Multipart tariffs constitute another widely practiced technique of nonlinear pricing, under which the price of each unit may vary with the total number of units purchased. To some degree, multipart tariffs can be viewed as an enhancement of the bundling marketing strategy analyzed earlier in Section 4.1. By an enhancement we mean that instead of limiting the pricing strategy to a fixed price for a certain number of goods bundled together in a single package, multipart tariffs consist of a fixed fee and per-unit prices that may vary with the amount consumed.
Multipart tariffs in general, and two-part tariffs in particular, are widely used.

Services constitute what economists call nonscorable goods. Electricity, telephone, transportation, banking, and most other services are consumed at the time of purchase. This monitorability characteristic of services may lead to congestion of service systems when the demand for the service is unevenly distributed among different periods or seasons. The demand for telephone services is at the highest level during daytime, during weekdays, and tends to be lower during nights, weekends, and some holidays. The demand for air travel for most places tends to be relatively high during the summer, whereas the demand for transportation to ski resorts is greatly enhanced during the winter. Electricity use follows a daily cycle related partly to the use of appliances and lighting devices. In addition, it also follows a yearly cycle because of climatic changes. Thus, the demand follows several, sometimes overlapping, periodic cycles

Service providers, particularly providers of services related to travel, engage in advance booking that use a wide variety of advance reservation systems. Fromconsumers’ perspective, this practice seems to be beneficial for the following two reasons:
• Value of time and capacity constraint: Advance reservations save considerable amount of time for consumers as otherwise they would have to travel several
times to the theater, airport, train station, or hotel, just to find out that these services may have already been fully booked.
• Purchase of complementary services: Travel arrangements almost always consist of a wide variety of complementary services that must be booked from multiple providers (flights, trains, hotels). In addition, travelers must alter their work
schedule, which may include asking for vacation time or a leave of absence. Advance reservations ensure the fulfilment of these multiple obligations at the same time.

Refunds are widely observed in almost all privately provided services and also to some degree in retail industries. Refunds are heavily used by travel-related service providers. Most noticeably, refunds are heavily used by airlines where cheaper tickets allow for a very small refund (if any) on cancellations and no-shows, whereas full-fare tickets are either fully refundable or are subject to low cancellation penalty rates.

We define overbooking as a strategy whereby service providers accept and confirm more reservations than the capacity they allocate for providing the service. Thus,
the overbooking strategy may result in service denial to some consumers if the number of actual show-ups at the time of service exceeds the allocated capacity.
Overbooking should be considered an integral part of the advance booking strategy of service providers. In this chapter, we demonstrate how service providers can increase their profits by using overbooking. Thus, in this chapter, we relax
Assumption 7.3, which so far has ruled out the use of the overbooking strategy

This chapter analyzes some additional pricing techniques and marketing tactics intended to further enhance sellers’ profits. Section 10.1 links pricing decisions to innovation and product design decisions by computing the profit-maximizing
quality levels and service classes to be introduced into the market. The underlining assumption in this analysis is that sellers cannot directly price discriminate among the different consumer groups. Therefore, the seller must devise a price scheme under which consumers belonging to different consumer groups choose to purchase different quality levels.