Pricing Based On Customer End Use

Update 2/15/2011: See how pricing based on customer end use works in my case.

A recent NYTimes article on renting hybrid cars is titled, “The Excessive Rates for Hybrid Rental Cars“. Most pricing articles written by customer advocates take a dim view of pricing based on two aspects:

1. Reference price: What the customers are used to paying regardless of value they get. In this case, the reference price is set by regular rentals. The Times article looks at the rental prices of comparable non-hybrid cars and states hybrids are priced way higher.
2. What it costs the marketer to deliver the product: The author does a cost math and says, “Hybrids generally cost more to buy in the first place, in general, but such premiums are often much higher than the difference in price between the models.”

The cost argument is meaningless. Once the rental car company buys the car, the costs are sunk. But the point is, they are very good at determining customer needs  and in revenue management. They would not have bought high priced hybrid rental if it were not possible for them to rent these at higher prices. Rental companies may use the cost argument in their favor to justify the higher price but they are not going to use it for pricing.

Be it pricing the rental car or any other product, price should be based on what the customer segments are hiring the product for and what they are willing to pay for it. In the case of  rental cars (in general), there are three major segments:

1. Business customers at Airports
2. Leisure customers at Airports
3. Other customers at non-Airport locations

Business customers may not get to choose hybrid rentals and if they are allowed by their employers then the price does not matter to them.

The other two segments are different in their end purpose and have different alternatives to renting a car. Why will a leisure customer rent a hybrid at airport? There are two sub-segments:

1. Green Customer: Who owns a hybrid and always wants to drive green. It is a small segment. This segment clearly has higher WTP.
2. Experience Segment: Those who cannot commit to buying a hybrid car for rational and emotional reasons but are very eager to experience the product without commitment. These are very similar to those segments that rent luxury products. This segment has higher WTP for hybrid rentals (splurge for the occasion). These customers usually have no knowledge of how much should the hybrid rental cost and hence the reference price argument does not apply.

Together, both the segments are still small but have higher WTP than the rest of the leisure segment. Hence it makes perfect business sense to price the hybrid rentals at much higher rate.

What if there is no demand at such high rates on a given day? It does not matter, they will “delight a customer” with a hybrid upgrade. On the average they will find higher uptake for the hybrid rentals at higher rates.

What about the rental at city locations? If you read the story carefully you will find this quote from Enterprise Rent-A-Car spokesperson that sheds some light on how they price for this segment:

“limited availability of hybrids at the airport can result in a higher pricing” and at city locations “you will see much less price volatility.”

Limited availability argument is a red-herring. Customers who rent at city locations have multiple alternatives and hence have lower WTP. Their purchase occasion is much different from a leisure traveler who is willing to splurge. So what the Enterprise spokesperson is really saying is, at city locations they are pricing the hybrids at prices closer to non-hybrids.

Pricing hybrid rental provides us a great example of segmentation based on end use and pricing at each segment’s willingness to pay.

What  are your customer segments and why are they hiring your products?