Insight and analysis 2016

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2016 INSIGHT & ANALYSIS

Transcript of Insight and analysis 2016

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2016 INSIGHT & ANALYSIS

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TABLE OF CONTENTS These articles were written by pricing expert Oliver Ranson and published on ransonpricing.com during 2016. Published in February P2 – Avoiding common pricing technology pitfalls through effective RFI P4 – Defining customer archetypes P6 – There has never been a better time to abandon airline FCAs P8 – Why every airline needs revenue entrepreneurs Published in April P10 – Pricing and data science P12 – Using war games to make the right pricing decisions P13 – Incorporating the value of premium travel in pricing P15 – Karl Marx, Revenue Manager Published in June P16 – Price escalators – the part of pricing many people forget about P17 – Do you have all six pricing skill sets in your team? P19 – Are you ready for the next downturn? P20 – Pricing’s magic number Published in September P21 – Developing business cases for airline buy-on-board P23 – The differences between Pricing & Operational Research P25 – Three pricing challenges for commercial banks P27 – Excel is still the most important pricing tool Published in November P29 – Some myths about pricing P31 – Are airlines ready for NDC? P32 – Pricing strategies on RMS Titanic P35 – Why we don’t want to compete with big consulting firms

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! AVOIDING COMMON PRICING TECHNOLOGY PITFALLS THROUGH EFFECTIVE RFI It is all too easy to say that the solution to pricing challenges is simply “technology”. Progress can be so fast that it takes a dedicated specialist to even keep up with the frontier of progress, let alone see what may lie beyond. As a result, many businesses struggle to purchase the right pricing tools and specify systems that will represent the best possible value for money for their business. Common traps include buying software that addresses problems faced at other companies but not your own, using processes that are aligned with markets you do not serve and applying technology that is so complex even it’s own vendors do not understand it. Taking a few actions during the earliest stages of procurement – the Request for Information (“RFI”) stage – can help resolve these challenges. What is an RFI and how does it relate to buying pricing technology? At many businesses, formal tendering is used to buy software and technology platforms. Such a process normally involves a Request for Proposal (“RFP”) or Request for Tender (“RFT”), a technical evaluation of these proposals and a financial evaluation. Preferred suppliers will either be selected on the basis of their financial proposal or then invited to make their Best and Final Offer (“BAFO”). It is common for buyers using these processes to require approval from the board or a budget before such a tender can be issued. RFI is used before such an approval or budget is achieved to collect the information from prospective vendors that pricing specialists can use to structure their tenders and make sure that they are issuing a tender to buy the right products. What information should an RFI for pricing technology contain? Broadly speaking there are two approaches. The first, prescriptive option is for a company to specify it’s technological requirements and then ask vendors what products and services they offer that may satisfy this criteria. The problem with adopting this approach is that unless your business has access to full-time revenue technology specialists, it is unlikely that there will be a good match between what the technology vendor can offer and the requirements you have specified. If the vendor provides a bespoke solution then it is likely to be expensive and represent poor value for money. The second, collaboration-based approach is to use the RFI stage to explain clearly to the vendor what your challenges are and ask for their explanation of how they would help you solve them. Your vendor is likely then to offer you solutions that you may not otherwise have thought of.

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! What makes a good RFI? Ranson Pricing believes that writing a good RFI is all about communicating your pricing challenges and then letting the technology vendor explain how they would solve them using the collaboration-based approach. In order to do this you will need a sound understanding of what those challenges are (based on customer behaviour), your product positioning against competitors and all the other elements of pricing strategy, which Ranson Pricing has spoken of in other articles. Ultimately, a good RFI will lead to your company buying (through the rest of the procurement process) the technology it needs at fair value for money. Accordingly it is well worth investing time and effort even at this early stage to get it right.

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! DEFINING CUSTOMER ARCHETYPES A customer archetype is a typical example of somebody who buys your products and services. They can be defined on the basis of several indicators, such as demographics, the purpose for which they use your products, their buying behaviour, the means of payment they use to complete their transactions or any one of a number of other indicators. Identifying and specifying these archetypes can be extremely helpful for the pricing process because they provide a clear, communicable idea about who your customers are that other stakeholders can quickly and easily understand. In this article Ranson Pricing explains how to conduct a customer archetype definition exercise at your business. Primary research The first step is to reach out directly to your customers and potential customers using tried and tested market research techniques. Surveys and questionnaires should be drafted in such a way that the results are measurable and meaningful, and care should be taken to ensure that the mix of respondents is representative of the market. There are plenty of companies out there who will distribute your surveys and questionnaires. But developing the questions and answer options that will facilitate your analysis of how different parts of the market value different attributes of your project is a role for the pricing department. Internal data mining Once your primary research programme is under way, it makes sense to take a look at the data you already have regarding your customers and their behaviour. Statistical techniques can be used to correlate the relationships between different characteristics of your customers, the products they buy and how they make their purchase. As well as providing insights that can be used for pricing decisions, analysis of your internal data also acts as a good means of evaluating the information received from primary research. You should ask yourself whether or not the primary research matches what you would expect from analysis of your historical customers. If the match is not strong that is not necessarily a bad thing because it is possible that the research has identified segments that you are not serving at the moment.

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! Direct observation One of the most under-used pricing techniques is to actually spend time out on the shop floor, on the plane, in the airport terminal or in whichever other environment your customers can be found. Simply sitting still, observing the customers and noting who they are, what they seem to be doing and whether or not they look like they are having a good time can help your pricing team reconcile their data and analysis with reality. Using the archetypes to inform pricing decisions Once you have a good understanding of who your typical customers are the next step is to set down a clear understanding of what product bundles each will buy. From there, benchmarking and trial-improvement techniques in the real world can be used to find a price level that will optimise your revenue stream.

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! THERE HAS NEVER BEEN A BETTER TIME TO ABANDON FULL-CONTENT AGREEMENTS Travel service providers have historically been beholden to their global distribution system (“GDS”) partners through full-content agreements. These represent a rebate on fees in exchange for the airline, hotel or other operator offering every one of their products and services through a particular distribution channel. Unfortunately for the travel providers, such agreements limit their scope to innovate in pricing, distribution and market segmentation in the medium to long term, severely constraining revenue growth opportunities. Human nature being what it is, finance directors find it hard to give up certain revenue today for potentially greater revenue tomorrow, but there are three good reasons to think that there has never been a better time to abandon these old-fashioned agreements. Established distribution platforms can be used in new ways Most airline, hotel and other travel service operators use internet booking engines to allow their passengers and guests to book directly through their web site. Most of the time these tools are based on GDS distribution. But special rates can offered through the web site and there may be value in distributing them selectively. This value arises from the chance to trial and improve initiatives based on a user’s characteristics (such as geographic location or history of searches) or confirmed behaviour (through loyalty programme membership for example). Such initiatives would not normally, in Ranson Pricing’s view, be the pernicious and short-sighted attempts to increase revenue through increasing prices in line with previous searches that we sometimes read about on our favourite Internet bulletin boards. Rather we would recommend trying to inspire the customer to book a special trip using targeted promotions or direct their custom to a less busy flight or hotel through price incentives. New technology creates alternative distribution channels Ranson Pricing’s friends in the technology sector always surprise us with the new things that they are talking about. We are not technologists ourselves, but sometimes it seems to us that new technology could be a real boon to pricing professionals seeking to segment their markets in different ways. Augmented reality (see our September 2015 article) is one example.

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! Rigorous customer behaviour analysis presents new opportunities As organisations develop new tools and techniques for analysing customer behaviour it makes sense to put this analysis to use, designing new products and services that reward customers in different ways depending on their willingness and ability to pay.

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! WHY EVERY AIRLINE NEEDS REVENUE ENTREPRENEURS Pricing and revenue management is well established at many airlines. The department will closely align itself with tried and tested methods of distribution and sales, as well as industry standards and practices as defined by IATA resolutions. But such ingredients are not enough for an airline to consider itself a leader in this field. Applying systems and technology to demand forecasting and data management augment the standard activities, adding a good few percentage points to revenue and bringing an airline up to standard practice. But to go beyond this level and achieve something more, guaranteeing long-term profitability, one more element is required – the revenue entrepreneur. What are revenue entrepreneurs? Revenue entrepreneurs at an airline are individuals in the commercial team who possess three critical attributes. First, they actively seek commercial opportunities where there might be scope to increase revenue, even if their competitors or the industry in general are not looking in those directions at the moment and especially when their managers have not explicitly told them to do so. Second, they have some appetite for risk and can evaluate the chance of a new initiative being profitable. And finally they have the ability to convince the carrier’s leadership team that their recommendations, even if they involve some risk, are worth pursuing. These individuals will often be found operating in the commercial department, but there is scope for them to make a difference in other areas too, such as product and service development (enterprising people by their nature usually love developing new products!), cost optimisation (people with entrepreneurial skills are often good at finding new, more efficient ways of doing things) and potentially almost every other area of operations. Why do airlines need revenue entrepreneurs? Systems, tools and technology in revenue management have helped airlines achieve low levels of (long-term) profitability and sustainability for many years. But as these methods become standard practice there is a risk that what profit there is to be found could be eroded away. Also, the profit margins typically achieved are lower than other industries, limiting incentives for those enterprises in the private sector who are not airline enthusiasts to invest. With good revenue entrepreneurs on board, airlines can keep ahead of the game and adopt initiatives that can push their profitability that little bit higher to industry leading levels.

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! Where can airlines find their revenue entrepreneurs? In Ranson Pricing’s experience airlines tend to attract people who are passionate about what they do. It is likely that there are already people in your team who, with the freedom to pursue some of their own projects and with access to the leadership team to sell their initiatives, could quickly add value beyond what you ever thought possible. Try allowing team members who might be interested to work on their own initiatives one day of the week and be prepared for them to move on to manage their project full-time if their idea is really good. Openness, praise for innovation and organisational flexibility are the keys to success for airlines that believe that helping their most enterprising employees reach the limits of their potential is in their own best interests.

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! PRICING AND DATA SCIENCE It seems fashionable these days to talk about “data science” when discussing application of quantitative techniques to commercial challenges. What data science is may not be clear at first – it might be statistics, operations research or even consulting. At Ranson Pricing we believe that data science is simply old-fashioned common sense applied to large data sets to facilitate decision-making. In this article we outline what data science means for pricing in a little more detail, explain why the topic is so substantial that no one individual is likely to be able to master everything, evaluate how to incorporate data science specialists in your pricing team and set out the links to traditional consulting. Pricing has always been a data science Pricing is the art of selling the right product to the right customer at the right time. Each of those elements is measurable, so pricing decisions have been driven by facts for many years. But the nature of the information in use does seem to have changed in recent years, as powerful portable computers and high speed access to large data sets has opened up opportunities to conduct pieces of analysis that were not possible before. However at Ranson Pricing we caution that whilst analysis should always be robust and rigorous, it does not always need to be complex. A table of regression results with discussion of R-squared and heteroskedasticity rarely leads to a different conclusion than could be seen from a well presented chart and table. And since pricing analysis is intended to facilitate decisions, the results should be presented in a way that makes it easy for busy non-specialists to quickly understand and support those decisions. Data science is vast in scope so nobody can claim to master everything At Ranson Pricing we think that the following skills are part of a data scientist’s repertoire: (i) analysing and evaluating data (ii) translating data into compelling stories to help decision-makers

understand what the data really represents (iii) evaluating how outcomes might have changed had circumstances

been different (iv) extracting information from a data source (v) validating that information is complete and accurate, and that

conclusions are meaningful (vi) deliver appropriate recommendations on the basis of available

information (vii) persuade stakeholders to adopt the recommendations.

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! Together these seven competences can represent a vast array of skills. Everything from statistics and econometrics through to salesmanship and story telling is included. As such it is unlikely that any one individual will encompass all the necessary skills. We also note that none of the skills necessarily involve complexity, although in the right circumstances they can. We caution against seeking a team of data scientists made up entirely of people with strong coding and analytical skills as the ability to sell initiatives to reluctant stakeholders is also critical. It is easy to slot data scientists into your pricing team A career in pricing presents great opportunities for data scientists. There are a two different ways to incorporate them in pricing, either attached to specific teams or as a group of internal consultants. Consultants are data scientists too Traditional management consulting often involves the application of a small amount of data to help solve a problem. To achieve this all seven of the competences outlined above are required. Accordingly we think that consultants are data scientists too.

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! USING WAR GAMES TO MAKE THE RIGHT PRICING DECISIONS In the armed services and defence ministries around the world it is common practice to act out military scenarios as “war games” to understand how the planners’ own commanders and forces, and those of their enemies, may react in certain circumstances. The insights are used to understand what strategies and tactics may and may not work well in real life, should the need arise. At Ranson Pricing we hope and pray that the war games enacted on our behalf work to keep the peace, just as they are intended. But we also see an opportunity for businesses to use similar exercises to boost their commercial performance. In this article we explain what you need to do to run effective pricing war games. A game needs rules, at least two teams and a referee One good way of staging a pricing war game is to set two teams of pricing specialists against each other and see what they do, and how they react to each other’s moves, in certain circumstances. A set of rules should be determined in advance (e.g. prices cannot be below zero, it is not possible to sell more than 1,000 units, transport costs are USD 10 per mile etc…) and an impartial referee should be appointed to ensure that those rules are obeyed. It may be necessary to replay the game several times with different teams Just because an outcome is observed once does not necessarily mean that it should be considered the final outcome of the game. Repeating the game several times, possibly with different teams, will help you understand how likely it is that an outcome will occur, not a certainty. Changing the initial scenarios to understand the sensitivity of results is also important as real life is hard to predict and what you are faced with may be different to what you have gamed. But by playing several different types of game it will be easier to read the situation in hand and take an informed decision about how to react. Documenting results is critical As with most initiatives in pricing, it is just as important to record the results of gaming exercises as it is to trial and improvement exercises. Recording the results provides a point of reference for future managers and also acts to internalise the knowledge learnt in the person writing them down.

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! INCORPORATING THE VALUE OF PREMIUM TRAVEL IN PRICING At many airlines the revenue management team enjoy staff travel benefits. The pricing specialists, demand forecasters, inventory managers, systems developers and their families can holiday around the world in first and business class, provided that the seats are not sold to paying customers. Duty travel is conducted under similar arrangements. But there is one unfortunate consequence of this great employee perk. The team will never need to actually pay the market price for a ticket themselves and accordingly may not appreciate it’s true value. At Ranson Pricing we reckon that this is a shame since we believe that first and business class air travel is one of the most valuable commodities in the world, not because of it’s frills, bells and whistles, but because of the intangibles. Premium travel buys time A passenger taking a flight in business class is able to use their time more productively on the plane, but they also get to use their time more productively on the ground at either end. Before departure, passengers can spend more time working, or with their friends and family because less recovery time is required at the other end. After landing, passengers can either proceed straight into meetings or holiday activities with relatively ease so less rest time is required. At Ranson Pricing our pricing expert Oliver Ranson finds that business class travel secures half a day of activity per time zone crossed and first class travel secures an extra half day on top of that. Premium travel buys peace of mind Passengers looking forward to their trip in business or first class will either enjoy the last few days of their holiday that much more or will be able to focus on their business activities without the worry of knowing that they have to endure a long flight in economy. Perhaps this all adds up to several hours or days (depending on the individual) of valuable extra time available. How to price premium travel Fundamentally, premium travel pricing all comes down to valuing the intangibles of time and peace of mind. But it must also consider the willingness and ability to pay of different market segments, bearing in mind capacity constraints. For a business traveller, how much is time worth? It will partly depend on the company in question’s cash flow, but for established corporate entities Ranson Pricing would expect a professional person to add at least a thousand Pounds of value per day and most likely a good deal more. If they were not, then given the costs of recruitment, management, support, office space and the staff member’s salary the company would probably be better off not employing them!

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! At a thousand Pounds per day and half a day of productivity per time zone crossed, for a trip from London to New York (five hours time difference) it would be worth paying GBP 2,500 each way for the company to pay to upgrade the employee from economy to business class. For leisure travel though pricing must be a little different since most professional people on professional salaries (on which they pay tax) would struggle to pay an extra GBP 2,500 each way for a flight to New York. But that does not mean that the airline cannot offer leisure seats in this cabin, suitably fenced of course. The way to do this is charge a reasonable but relatively small premium over the prevailing premium economy fare for business class seats that would otherwise go unsold. Something that people will be able to afford if they choose, but which is expensive enough that the cabin will not sell out immediately. Accordingly an airline with a strong premium pricing strategy will probably be simultaneously the cheapest and most expensive carrier in the market.

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! KARL MARX, REVENUE MANAGER When our pricing expert Oliver Ranson was at LSE some his fellow students were followers of the famous philosopher Karl Marx. After graduation they either decided to become stock brokers or work as ‘trade representatives’ for countries whose governments seem to work quite a bit differently from our friends operating authorities in the UK. But maybe they should have become pricing strategy professionals instead. After all, Marx wrote “from each according to his ability, to each according to his need” and to Ranson Pricing’s ears that sounds just like working down a demand curve to offer different products to different market segments based on their willingness and ability to pay. At Ranson Pricing we believe that pricing strategy is a fundamentally good thing. When done well it allows many consumers to buy products that they would not otherwise be able to afford through sales, promotions and tactical initiatives. And it also ensures that businesses sell their stock at sustainable yields through capturing higher yield from customers with substantial willingness to pay when otherwise vigorous market forces might shake out incentives to innovate. All in all, sound pricing strategy secures the cash flow which promotes long term investment in jobs, technical progress and any investment that a firm might make in promoting what they perceive to be good works in wider society. To do that pricing strategy well you can follow the maxim “from each according to his ability to pay, to each a sustainable and profitable mix of products according to his need”.

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! PRICE ESCALATORS – THE PART OF PRICING MANY PEOPLE FORGET ABOUT We live in a world where inflation is a fact of life. Our suppliers increase their prices, shrinking our margins, and our customers enjoy increases in the nominal value of their income, increasing their willingness to pay. But there seem to be few organisations out there which use a ‘price escalator’ to slowly but surely increase their price levels. There are four good reasons why you should do this. Small increases add up over time If you increase your prices by 1% every six months, then after five years your prices will be 10.5% higher than if you had not changed the prices at all. During those years you will enjoy the benefits of slightly higher revenues, which can be reinvested in your products, services and pricing processes to secure a prosperous future for your business. Small changes are less likely to be noticed by competitors Imagine bumping your prices up by 10.5% at once. Your competitors and customers would surely notice and most likely the competitor would be able to hoover up business as a result. By increasing prices slowly but surely, your actions will help to instil market discipline in both competitors and customers. Small changes are less costly to correct if things do not go according to plan If you had to raise prices by 10.5% all at once and things did not work out, it could be very costly for your business in terms of lost revenue, brand damage and customer trust. But if you increase prices by just 1% at a time, if things do not work out then you can change things back with no harm done. Small changes can be applied across your product range and tailored accordingly You can also happily leave a price increase in some products while removing it from others. Products might include bundles of different items as well as goods and services sold individually. So the price escalation method is extremely flexible.

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! DO YOU HAVE ALL SIX PRICING SKILL SETS IN YOUR TEAM? Pricing teams need a wide range of skills to function effectively. At Ranson Pricing we believe that pricing is not all about developing complex software, solving tough maths problems and performing complex pieces of analysis. This work has it’s place, but it is important not to neglect the ‘softer’ pricing skills. In this article we explore the six pricing skill sets that you should have in your team. Operational pricing It is always necessary to have in place a process for continual monitoring of how markets change. As competitors adjust their prices and customers change their behaviour some form of response is often vital. To handle this, there should be people on your team who are able to work quickly and in real-time to address operational issues as and when they arise. Sometimes these skills are hard to combine with the other elements that we describe below so be cautious to ensure that individuals do not have too many different types of task to do. Pricing strategy The strategy side of pricing is all about ensuring that the tools, processes and technology available meets your organisation’s requirements, and people operating in this part of pricing will need to be able to secure agreement with sometimes reluctant stakeholders to make sure that your pricing reflects your company’s wider objectives. Technology & systems development in pricing Pricing analysis is complex and it is likely that you use special technology to complete your projects. Accordingly your team should be able to engage with people who develop and manage this type of technology while at the same time ensuring that data owners supply information that the technologies can use to create the insights necessary for your team to make their pricing decisions. Pricing & revenue integrity Are there any holes in your pricing strategy that enterprising customers can take advantage of? Your pricing and revenue integrity people will look for these and take what actions they can, be they based in technology, incentives or contracts, to reduce the risk.

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! Pricing data management At Ranson Pricing one of our brand values is taking decisions on the basis of facts (the others are attention to every detail and clarity in decision-making). In your organisation it is vital that pricing decisions are based on the facts and so it is important to have people on your team who are able to analyse, audit, evaluate and generally manage data. Note that the people doing the analysis and evaluation may not necessarily be the same people as the data managers and auditors. Loyalty, ancillary revenue, CRM & e-commerce Whilst loyalty, ancillary revenue, CRM and e-commerce do not always sit within a pricing team, having links with these areas is extremely valuable. Since these areas have insights and analysis in common with pricing there may be organisational efficiencies in performing analysis and research studies once across groups rather than several times individually. There may also be potential to implement special prices for distribution through these channels. Having people who know about these areas in your pricing team will ensure that you can have all the facts to hand.

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! ARE YOU READY FOR THE NEXT DOWNTURN? Economic history shows that from time to time economies enter a period of shrinking, either relatively as the rate of economic growth falls or absolutely when average incomes decline. These periods present a series of interesting challenges for pricing specialists as they try to ensure that customers still choose products they are pleased to consume at a price that reflects the value they receive. The pricing challenges during an economic downturn are more or less the same as during periods of growth, but they need to be considered in a slightly different way. Studying history is still worthwhile At Ranson Pricing our creed is to apply the lessons of history to see more clearly into situations where we are called to act. When pricing in downturns, look to the past for inspiration. Ask yourself questions about what happened during the last economic contraction. For example, did customers change their product mix, what happened to your share of volumes and revenue, how did average spend change and did customers buy products in larger or smaller transactions? Use these lessons to formulate hypotheses about what might happen this time and roll out trial-improvement initiatives to test whether or not conditions are similar this time round. If conditions are similar, this will give you good ammunition to take to other stakeholders seeking aggressive pricing initiatives that you might not be comfortable with. Be cautious of the competitors and do not enter a price war Not all companies address their pricing calmly and conservatively and some may be tempted to discount heavily in response to “market conditions”, whatever that may be. At Ranson Pricing we recommend caution. Remember the effort that you put into building your brand and developing quality products during the good times and apply primary research, data mining and trial-improvement exercises as usual when considering discounts. Customers may change the mix of products they buy During a downturn your customers may feel the need to save money and might change the mix of products they buy. This might involve trading down a level or two of quality (e.g. from supermarket premium to standard, or from standard to value) or between substitute products (e.g. from steak to chicken). The pricing opportunities here revolve around bundling, CRM and loyalty. You will need to incorporate pricing and other commercial initiatives that are flexible enough to accommodate changes at the individual consumer basis. As always in pricing, do your research, formulate a strategy, roll it out and see how it performs to make a start. Remember that you do not necessarily need to get it right first time and that your first move does not need to be your last, and then you will be well placed to price effectively during the next downturn.

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! PRICING’S MAGIC NUMBER As human beings it seems that we tend to think about numbers logarithmically. Base ten (10, 100, 1,000 etc…) is popular because we have ten fingers on our hands. But when it comes to financial matters a look at many currencies indicates that the preferred pattern of thought is 1, 2, 5, 10, 20, 50, 100 etc…, which is a sequence approximately equal to the cube root of ten raised to various powers. We can see this because if we define the cube root of 10 as a number ‘c’, then c^0 = 1, c^1 = 2.15, c^2 = 4.64, c^3 = 10, c^4 = 21.54, c^5 = 46.42, c^6 = 100 and so on. At Ranson Pricing we wonder whether or not this cube root of ten is a magic number in pricing and whether or not there are any lessons that can be drawn. Will consumers be more likely to buy a higher priced product if the price is closer to a power of the magic number than a lower priced competitor? Sometimes people can be a little irrational. Retailers know this and use techniques of ‘retail geography’, red tags and other methods to position certain products at eye level. But might it be the case that pricing could be important too. Might a customer be more likely to buy a product priced at GBP 20.00 (close to a power of the magic number) than GBP 17.99? Any volunteers – let us know?! Is precision to the magic number more profitable than penny-level discounts? We have written before about the end of 99p pricing. The magic number could help us think about two opportunities to price slightly differently. First it might be worthwhile, especially for items priced at low numbers like consumer goods, to price exactly at the 1-2-5-10-… points. For items priced at high numbers on the other hand like airline tickets there might be scope to price exactly at a power of a magic number. For example, a business class ticket on a long flight could be priced at GBP 2,154.43 (c^10) or GBP 4,641.59 (c^11). As always in pricing, trial and improvement is a necessary step to take when examining whether or not ideas really work in practice. If you do try out ‘magic number’ based pricing, please let us know how you get on.

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DEVELOPING BUSINESS CASES FOR AIRLINE BUY-ON-BOARD Once upon a time airline passengers whizzed across oceans eating gourmet cuisine and drinking the finest wines available to humanity. Apparently. Ranson Pricing is not convinced that airline catering was ever really that good. But we know for sure that many airlines continue to offer a “fully bundled” service that includes food and drink and we wonder if this is really a product that today’s travellers want. Airlines operate in a wide range of markets across the world and serve passengers with a huge range of tastes, experiences and expectations. The most important distinction between flights is probably the so-called “stage length”, or the distance travelled (and hence the time taken). On extremely short flights with less than 60 minutes in the air meals are clearly not “required” as passengers will soon be on the ground and can either eat at home or visit a restaurant. Many such flights will take place away from typical meal times so a large number of passengers will not be hungry. But nevertheless some people may be looking for something to eat and in some cases a quite substantial meal, especially when their trip on the aeroplane is the only time they have to eat during the day. The challenge for airlines is understanding when and how to satisfy the needs of their different segments. Back in the last century BA and BMI waged breakfast wars, offering substantial breakfasts involving egg, bacon, sausages, mushrooms and other morning delights to business travellers. This made sense because such travellers were getting up early and heading for a day of activity. BA continues to offer a full breakfast on flights from London to Scotland and, in their premium cabin, elsewhere in Europe. The longer the flight though the more opportunities there are for airlines to play with their service. On longhaul flights substantial food options are probably compulsory as passengers will need to eat, but this need not mean that they be either all the same or free. Airlines seeking to evaluate their catering have a number of options: (a) Do not offer food and drink at all, offering substantial cost savings and elimination of operational complexities at the risk of either leaving ancillary revenue opportunities on the table, damaging consumer perceptions of the brand and/or leaving some seats unsold as passengers who value the catering travel with other operators. (b) Offer some things for free and other things at a charge, for example a free bar but paid-for food. This option gives all passengers a standard product but gives others a wider set of options should they so desire.

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(c) Offer a standard product for free and a premium product at an extra charge. Air France for example offers all their longhaul economy cabin passengers a meal but also has a selection of premium meals available for an extra charge, provided that a passenger buys the product before a flight. It would also be possible to offer a more premium product as buy-on-board (airlines that offer alcoholic drinks at a price and soft drinks for free are a good example) but airlines will need to carefully forecast demand and balance wastage costs (and incremental fuel burn) against revenue opportunities. (d) Offer customers a fully-bundled service with all products loaded on the aircraft available without any extra charges. This approach will leave ancillary revenue on the table, but will reduce complexities in billing and payment (particularly as society moves increasingly cashless). With this approach there is a risk that some people working for airline finance departments will begin to see catering as a pure cost centre and under-account for catering’s impact on brand perception and repeat business. It is also possible that the range of products offered may be more limited than in other options, leaving some passengers disappointed even if their meal was “free” and feeling that they would rather have had the chance to pay extra for something better. Any airline which decides to offer catering at all should bear in mind that they will need to offer customers a product they want to consume at a price they are willing to pay. This will be based on consumer behaviour studies, price sensitivity and feasibility in product delivery. Remember that margin matters more than costs as such but also that airlines seeking to expand their catering options will have a number of other costs. There may be a cost base implication from larger and heavier fixed galley configurations than might otherwise be achieved, procurement, maintenance and storage of the necessary electrical and non-electrical equipment, the same for both serving equipment and rotable/disposable items such as plates, cutlery, packaging and other items, fuel burn from carriage and also the opportunity cost of using the space occupied by the most-likely larger plinths and monuments as saleable seating space. Airlines should also note that as well as the chance that incremental seats may not always be sold, at the lower end of the demand curve (especially on shorthaul) marginal costs such as boarding cards, bag tags, cost of sale etc… might be significant so the value of a seat instead of a galley monument may be a lower than usual proportion of revenue. The business case for buy-on-board is not necessarily clear-cut at realisable price points but there is still one final point to consider. If current food on shorthaul flights is not appreciated and simply thrown away it can be safely removed and the resulting anticipated cost savings can be used to do the research and development required to create a new, world-leading buy-on-board product.

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THE DIFFERENCES BETWEEN PRICING & OPERATIONAL RESEARCH Pricing is the art of selling the right product to the right customer at the right time and Operational Research (“OR”) is the application of advanced analytical methods to help make better decisions. The two disciplines have much in common, but because they also have some important differences there are seven important distinctions that companies looking to build organisations with Pricing and Operational Research practices will need to bear in mind. OR specialists apply analytical and statistical techniques to reach the solution to a business challenge that is as close to perfect, or “optimal” in OR terms, as possible. Some Pricing problems, particularly those involving an optimisation problem, can happily be solved by applying OR. But some other pricing issues are much more strategic in nature, particularly when organisations are seeking to understand their customer base and it’s behaviour, gain insight into the competitive environment and use business intelligence to carefully specify the available options, clarify plans and define and then reach objectives. There are four key similarities between the skills required to make a successful Pricing specialist and a successful OR specialist. These are: (a) Both apply measurable and meaningful quantitative and qualitative information to reach a recommendation (b) Both are at home working closely with other teams and stakeholders, delivering on projects that ideally can be carried forward by those others without further assistance (c) Both apply analytical techniques to justify recommendations, define objective criteria for determining whether or not an initiative will have been a success and help other stakeholders understand whether or not a successful outcome has been realised in the end (d) Both focus on translating information into actionable, achievable decisions (or at least a clear guide that will steer another decision maker into taking the recommended actions). On the other hand there are seven important differences between the two disciplines. These are: (a) Pricing, particularly strategic Pricing, often applies more “informal” methods – since Pricing decisions involve many stakeholders, including people with non-technical backgrounds, it is frequently necessary to use methods that are easier for boards and decision makers to digest, and such methods may be less analytically rigorous than those used in OR and not valid for “optimisation” purposes (b) Pricing often involves more qualitative information, such as how customer perception of a product or brand can impact a product’s competitive positioning

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(c) Pricing often involves “smaller” data (really large data sets with a certain amount of aggregation already performed) while OR specialists commonly apply their analysis to “raw” data (d) Pricing specialists typically do not use statistical tools like SAS while OR specialists will not typically use pricing software from the various specialist vendors (e) Pricing specialists may be more inclined to recommend testing analysis through real-world trial and improvement exercises than OR specialists (f) Pricing specialists may be more inclined to spend time evaluating options, opportunities and unmeasurable elements, as well as focussing on the human dimensions to project planning, than OR specialists may be (g) Pricing specialists tend to specialise in Pricing, while OR specialists tend to operate across a wider range of projects, leading to OR specialists not quite having the same depth of experience as the Pricing experts. Both disciplines bring distinct products to the table and organisations need to think carefully about how they structure their Pricing teams and other organisations to make the most of what both groups of specialists have to offer.

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THREE PRICING CHALLENGES FOR COMMERCIAL BANKS Commercial banks have much in common with retailers, airlines, entertainment venues and the other businesses that have successfully applied Ranson Pricing’s style of pricing strategy. They have a large number of customers, each of whom have different willingness to pay, buying a large number of relatively standard products that can be distinguished by observable characteristics, such as a mortgage that can be repaid over 10, 15 or 20 years. Financial institutions will need to overcome three types of challenges to make the most of the pricing opportunities – structural, regulatory and product. Structural challenges – different types of prices When we visit the supermarket we are invited to pay GBP 5.00 for a steak or GBP 7.00 for a premium steak, and either GBP 1.00 for own-brand biscuits or GBP 1.50 for branded biscuits. Everything is priced in whole Pounds, Dollars or Dinars. But in financial services fees can be fixed (e.g. GBP 6.00 to use an overdraft facility in one month) or proportional (e.g. 3.9% for a two-year personal loan). To add even more complexity insurance products are priced actuarially, where an actuary sets a minimum price, bearing in mind the expected risks of the policy in question. Both fixed and proportional fees have disadvantages when it comes to alignment with willingness to pay. A customer who goes GBP 5.00 into their overdraft for one day might be aggrieved to face a GBP 6.00 fee for this and banks who do not refund the fee when the customer complains will lose goodwill. On the other hand, a customer who goes GBP 10,000 into their overdraft for a week might not be too worried about the GBP 6.00 fee. But interest rates on the other hand are not perfect either. Banks no doubt have costs of supplying overdraft facilities and when a customer goes a few Pounds into the red for a day or two the bank’s set up costs of permitting the overdraft will not be recovered by the penny or two in interest that will result. When it comes to actuarially set prices for insurance, banks will need to think carefully about whether or not they can safely bundle these products with credit cards, loans, mortgages etc… below the price that the actuary has permitted. Regulatory prices – there may be a consumer backlash against ‘complexity’ While airline tickets, cinema seats and chocolate biscuits are luxuries, banking is an essential utility for most people. If banks decide to increase complexity in pricing through loyalty programmes, bundling, product differentiation and promotion, they must be careful to make sure that they do not cause regulators to strike down harshly and set pricing in the industry back many years.

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Ranson Pricing recommends one-step-at-a-time exercises based on trial and improvement – over many years, gradual improvements will all add up to significant results but hopefully consumers will not be too alarmed in the process. Product definition Banks offer solutions for people who want to store money and people who want to borrow money. On the storage side, in these days of low interest rates banks will find it increasingly hard to compete with non-financial asset classes such as real estate, art and other capital assets. Some savers might even decide to enjoy a leisure preference, travel and entertainment rather than saving. Banks will have to consider these ‘competitors’ when setting prices for savings products and a thorough understanding of customer preferences through direct research and ‘revealed preference’ experiments will be required. One solution might be found on the borrowing side, where enterprising banks might offer financing for consumers to purchase items that they would not otherwise be able to afford but which are expected to provide a strong return. Buy-to-let mortgages are probably a prime example of such a practice, but there may be other opportunities and Ranson Pricing will be happy to undertake the necessary work to identify them. Ranson Pricing is not yet sure how banks will resolve these challenges, but we are certainly willing to step up to the plate and work with financial institutions to find solutions. We are sure though that the best outcomes will be found through applying sound research, considered strategies and careful management of innovative initiatives through trial and improvement.

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EXCEL IS STILL THE MOST IMPORTANT PRICING TOOL (APART FROM PEOPLE) When companies are looking to become ever more data-driven in pricing and other areas it makes sense to invest in technology to help your people retrieve, manipulate and evaluate all your information. It is tempting to get caught up in slick advertising and sales pitches from wealthy platform vendors. But while new technology can be a good investment, the benefits may not be entirely realised unless your people have an unusually firm command of Excel. This is because there are three dimensions to becoming a data-driven pricing organisation, and they all rely on Excel basics more than the sophisticated analytics that require special tools. The first step is to make sure that people are comfortable using, interpreting and analysing data. Critically, they need to be able to use data to make things happen in the real world. Sometimes reluctant senior stakeholders and people in other teams need to be persuaded to buy-in to a pricing team’s ideas too. Excel is a great tool for achieving both parts of this step because it is easy to use, easy to transfer to other computers and most people are already familiar at least with the basics. The second step is to think a little more closely about how the data will be used. You will need to consider the distinction between data owners, data super-users and data end-users – for each person in the team, pick any one or two (you cannot have all three). Data owners will probably not find Excel a sufficient tool for many of their purposes as they probably use database tools. But data storage is not really pricing work. Data owners may find Excel helpful though for communicating their own insights and analysis, which can help teams down-stream including pricing. When it comes to data super- and end-users, there are three uses for your company’s information – optimisation, analysis and decision-making. Optimisation uses data and a selection of algorithms to maximise revenue, requiring special tools. But both analysis and decision-making are perhaps better done in Excel rather than other tools because high-level aggregation by various indicators is all that is required. Data owners and super-users will probably participate in the optimisation process, interacting directly with a source to feed the optimiser. But data super-users and end-users create the insights required for analysis and decision-making, even if they might not ultimately take the decision themselves. The third dimension to becoming a data-driven pricing organisation is technology procurement. Because Excel is so much cheaper than other tools and so much more likely to be already installed on your organisation’s computers it is a tool that you can use immediately. So often in pricing, it is important to act quickly, and if you can find value from immediately getting to work rather than going through a lengthy procurement process Excel could be worth much more than alternative platforms.

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When it comes to buying other tools, remember that it has to make things happen in the real world. Complication, over-specification and feature creep can be expensive. If you do need pricing tools other than Excel, Ranson Pricing recommends RFI-ing the vendors (stating your objectives and financial constraints) to have them tell you your solution for free

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SOME MYTHS ABOUT PRICING When our Pricing Expert Oliver Ranson tells his friends about what he does for a living they often tell him what they imagine his work is all about. But surprisingly there seems to be a bit of a gap between how Oliver sees pricing and how his friends do. Eight things in particular seem to be common myths and they are the subject of this article. Myth 1 – pricing is all about SAVING MONEY Over the past 30 years CFOs have made tremendous efforts to streamline their organisations, running efficiently and increasing profits through either careful cost optimisation (good) or vigorous cost-cutting (probably bad). As a result the idea that the only way to increase profits is to cut costs seems to be ingrained in society. If pricing increases profits it must also cut costs. But this is not true – sound pricing increases revenue with minimal impact on costs. As a result pricing is a great force for good in business. The proceeds can be re-invested in new and improved good and services that secure the business’s future or returned to shareholders as dividends. And they can also be used to make the company a better place to work, with higher compensation, rewards and incentives for staff and other luxuries like first and business class travel for everyone. Myth 2 – pricing requires expensive technology There are plenty of companies out there who make a living by selling over-priced and over-specified IT platforms. Ranson Pricing is not one of them. There is a role for technology in pricing, but it needs to be carefully tailored to a company’s specific requirements to work well and must not be biased by excessive ‘influencing’ using pre-existing but incorrect thoughts and ideas. Simple models developed on Excel, pricing team empowerment and sound organisational design can unlock 80% to 90% of the value of effective pricing without needing to spend a penny on ‘optimisation’. Myth 3 – pricing only works for giant firms You don’t have to be an airline or a supermarket to invest in your pricing. Every business sets a price, and every business can increase revenue if they can capture a higher proportion of their customers’ willingness to pay. Myth 4 – pricing is ‘impossible’ Pricing does require effort, and some of the concepts and changes required can be quite scary for some businesses. But there are plenty of companies out there increasing their revenue with minimal cost impact, so you can too!

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Myth 5 – pricing is only relevant in B2C markets Our article about B2B pricing from May 2015 outlines a five-step process to help you price effectively for your B2B market segments. Myth 6 – pricing is only required by technology and digital firms Certainly not – modern pricing based on customer behaviour and willingness to pay was invented by the airlines and the supermarkets, and later developed by other travel companies and entertainment venues. Technology and digital can certainly find a lot of value when investing in their pricing, but your business certainly can too! Myth 7 – pricing is so tough that you need a degree in maths to understand it Pricing decisions need to be taken on the basis of facts and data. Sometimes tough calls about when to increase or reduce prices need to be made and optimisation technology, when implemented well, can be a great help. But at Ranson Pricing we believe that a robust understanding of your customers and competitors, combined with common sense and a passion for the work, is the most important qualification for the pricing team – quantitative skills, if required, can be developed through training the right person. Check out our article from June 2016 examining the six skill sets you need in your pricing team. Myth 8 – pricing is a job for the sales team Quite where pricing sits within an organisation is an open question for most companies. It can sit by itself with a certain amount of scale, but for small businesses and even most large ones it probably makes sense to bundle the work within another part of the organisation. However at Ranson Pricing we caution particularly against having the same people handle both pricing and sales as experience suggests that sales’ passion for volume can easily dominate any passion for yield. Both the right yield and the right volume are required for successful pricing – if you sell everything you are too cheap and if you are too expensive you sell nothing.

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ARE AIRLINES READY FOR NDC? From a pricing perspective airlines are retailers – they sell a large amount of distinct but individually homogeneous products to many customers. But unlike retailers airlines have spent their pricing focus on optimisation and distribution. To make the most of IATA’s New Distribution Capability (“NDC”) this will need to change… What are airlines doing well? Many airlines deploy their GDS and revenue management specialists in NDC work. The teams are often highly skilled in GDS management, revenue optimisation, demand forecasting and systems development. So when an airline uses NDC you can be sure that it will work technically. Why do airlines need to change? Unfortunately at the operating level many airlines seem to think of NDC as a technical challenge, something that must work flawlessly like confirming a reservation or issuing a ticket. Unfortunately this is of limited value in itself, as the products that must eventually be sold through NDC need to be defined and priced. At Ranson Pricing we often see airlines not focussing enough on the product and pricing definition. Where do airlines need to go? Airlines need to think more like retailers. How are airlines going to get there? Study our May 2014 article “unlocking your inner retailer” to understand how to think and act like a retailer. These are the key points: Lesson 1: offer a wide range of products which you know from research and analysis that customers will really want to buy Lesson 2: don’t be afraid to be simultaneously the cheapest and most expensive in the market Lesson 3: bundle products and services effectively to appeal to different market segments Lesson 4: develop your own distinctive and branded range of products to occupy a clear position in the market place Lesson 5: reward loyalty to track your customers’ spending habits and behaviour. Airlines already have a large amount of the skills, information and initiative they need to make NDC work. The missing ingredient for now seems to be the management exercises that must pull all these together to take the commercial departments out of their comfort zones.

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PRICING STRATEGIES ON RMS TITANIC In 1997 the world went Titanic mad as James Cameron’s epic blockbuster hit the silver screens. Much historical information about Titanic is widely available, including everything from deck plans (or, in airline speak, LOPAs!) to passenger lists and menus. What can these tell us about how White Star (the operator) set their pricing strategy and how do these compare with airlines today? Multiple markets served Titanic, along with her long-lived sister ship Olympic (1911-1935) and short-lived sister Britannic (1915-1916), were designed to operate from Southampton to New York via Cherbourg and Queenstown (now Cobh). On the return there was no stop in Ireland and Titanic would have dropped off passengers at Plymouth, Cherbourg and Southampton. Southampton and Plymouth served the wealthy United Kingdom markets, which then as now had close business and social ties with the east coast of the United States. Ireland seems to have been largely a source of immigrant traffic and 91.9% passengers embarking at Queenstown travelled in Third Class. Cherbourg on the other hand was a bit of a mixed bag with tourists and business travellers as well as emigrant flows from France and elsewhere, some of whom from as far afield as Turkey and the Levant. 52.8% of passengers embarking at Cherbourg travelled in First Class, 9.6% in Second and 37.6% in Third. Just like smart airlines today, the White Star Line knew that there was money to be made away from the economy cabin. It is probably something of a myth that all the Third Class passengers were poor and destitute – tired and huddled masses yearning to be free and seeking the cheapest fare would most likely have gone on other ships, although some would have been aboard Titanic as in many cases tickets were valid for Third Class passage by the first available steamer. Just like smart airlines today, White Star served many different market segments in each service class. Working the demand curve – classes of service Titanic and her sisters offered three classes of accommodation – First, Second and Third. Although cabins were relatively homogeneous in the lower two classes, First seemed to offer a variety of options at increasing price points. Titanic’s accommodations worked along a demand curve like this: Third Class = 2, 4, 6 and 8-bed cabins at one-way fares from around £7 1s (GBP 629.50 in 2015) per person, comparable to economy class fares today Second Class = 2 and 4-bed cabins at one-way fares from around £10 10s (GBP 937.50 in 2015) per person, comparable to premium economy class fares today

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First Class basic = 1, 2 and 3-bed cabins at one-way fares from £25 11s (GBP 2,281.00 in 2015) per person, comparable to business class fares today – inside cabins on E deck (the lowest deck offering First Class accommodation) were the cheapest and outside cabins on A deck (one of the highest decks with the best views) more expensive (£56 18s (GBP 5,081.00 in 2015)). First Class suites = larger, more luxurious apartments on B and C decks, sleeping up to three people and often sold as pairs at one-way fares from approximately GBP 200 (GBP 17,860 in 2015) – note that these are fares for a whole room sleeping up to three people and there were not really many compartments of this standard available, even in First Class – it is something of a myth that everybody travelling in Titanic’s First Class accommodation sailed in luxury. First Class parlour suites = the most luxurious accommodations, offering sitting rooms, bathrooms and, in two cases, private promenade decks – these were extremely expensive even by international First Class air travel standards and off-peak fares were GBP 512 6s 7d (GBP 45,750.00 in 2015). During the summer season fares were higher. Then as now April was probably something of a shoulder season and there may have been lower fares at certain times of the year. Note that fares are one-way but effectively included a week’s accommodation, food and drink. Just like smart airlines today, White Star offered a differentiated core product to extract higher portions of passenger willingness to pay than might otherwise have been achieved. (Sources: fares data from Encyclopedia Titanica, inflation calculator operated by Measuring Worth) Ancillaries White Star did not have a shiny new NDC product to play with, but they found other ways of profiting from their customers. Of course there were bars, souvenirs from the barber’s shop and the chance to send a telegram, but there were two quite subtle revenue opportunities that Ranson Pricing is impressed with. An expensive a la carte restaurant offered high quality meals for an additional price. Regular meals in the dining saloon were included in a passenger’s fare but despite myths about Titanic being a floating palace catering was probably hotel buffet standard, good but not great and produced efficiently in high volume. The a la carte restaurant on the other hand was apparently remarkable, with one passenger speaking about eating fresh strawberries (in 1912, in the middle of the north Atlantic, in April). From the pricing strategy perspective it can be no co-incidence that the a la carte restaurant was located on B deck, close to the most expensive accommodation and hence the passengers with highest willingness and ability to pay.

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Promotional literature focused heavily on a gym, squash court, Turkish bath and swimming pool. These were probably something of a novelty in 1912 and it is interesting to note that while most of these facilities were located low down on F and G deck, the gym was on the boat deck, the highest of all. Why were they separated? Most likely because by making the gym a beautiful, light and airy space passengers would be attracted to take a look, at which point they could be sold tickets to use the baths and racquet court – clever stuff!

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WHY WE DON’T WANT TO COMPETE WITH BIG CONSULTING FIRMS Understanding who your competitors are is one of the key skills in pricing strategy. At Ranson Pricing we certainly have competitors, although some of our friends seem to think that these must be the big consulting firms. Because we know our product we can say for sure that in fact nothing could be further from the truth. Our product is different Big consulting firms offer access to a large amount of experience across different topics. Work on the details of pricing strategy is often something that is left to junior generalists. At Ranson Pricing we focus exclusively on pricing and revenue management and our Pricing Expert has more than a decade of experience helping businesses like yours find as many revenue opportunities as possible. Would you prefer to have an expert helping you with pricing rather than a junior generalist? If so, choose Ranson Pricing. Sometimes there is more value in doing things slowly Big consulting firms will happily deploy large teams to your business in return for enormous fees. But sometimes they complete work so quickly (because of the enormous fees) that your team may not be able to absorb all the benefits or really learn everything that will benefit their work once the consultants have left. In the end, when you do a quick project with a large firm you will inevitably have to engage them again and pay even more. At Ranson Pricing our approach is different. It might take our Pricing Expert Oliver Ranson three months to complete a project that a team of six people could complete in one month, but at the end of the process your team will be better equipped to handle pricing in the long term. At Ranson Pricing we pride ourselves on our ability to get things right first time and touch things only once. Would you prefer to do a consulting project only once rather than three times? If so, choose Ranson Pricing. We only handle one project at a time When you engage a large firm the Partner who sells you the work will most likely be busy with many projects at once. Now these people are generally extremely smart and knowledgeable but they are also human. If they are not giving you all their focus, can you really be sure that all the key issues relevant to your business are being addressed? If you want a guarantee that your consultant is paying 100% of his attention to your project, choose Ranson Pricing.