Part II Tourism Economics Chapter 8 Tourism Supply and Demand Abstract The demand for tourism products may be affected by the marketing mix elements, including the nature of the product or service, its distribution, its pro- motional strategies and its price. Price is the only element in the marketing mix which actually produces revenue. However, the setting of a price is not an easy task, as there are a number of pricing strategies which any travel business may apply, including; prestige pricing, penetration pricing; cost-based pricing; differential pricing and uniform pricing. Moreover, there are a number of factors which will influence what type of pricing strategy could be employed.
Such factors include; corporate objectives; the marketing objectives, and the organisations’ cost levels, among other matters. This chapter explains the various approaches which may be utilised when setting prices. Ultimately, the customers themselves will decide whether the product that is being supplied to them will meet or exceed their expectations.1 Introduction The price one important element of the marketing mix, as it is the only one which adds value to the business. Price is very dependent on the customer demand for the service.
Generally, as price goes down, the quantity demanded rises, and as price rises, the quantity demanded goes down. This may suggest that prices are inversely related to demand. However, at times, customers perceive that higher prices could be an indicator of high quality. The relative responsiveness in demand to changes in price is known as elasticity.
An elastic demand is one where a change in price greatly changes demand. An inelastic demand is one where a change in price has a little effect on demand. Therefore, customers’ demand for products is not always related to their price. There are other elements which could affect their purchase decision.
© Springer International Publishing AG 2018 139 M. Camilleri, Travel Marketing, Tourism Economics and the Airline Product, Tourism, Hospitality & Event Management, https://doi.1007/978-3-319-49849-2_8 140 8 Tourism Supply and Demand 8.2 Determining Demand It is the customers themselves, who will determine whether a price has been cor- rectly set. The customers will decide whether the perceived value of the service reflects its asking price. If the product’s price exceeds its value, customers will not purchase it.
The price set is also dependent on the consumers’ demand for the product or service. The general rule is that price is inversely related to demand. In other words, as prices go down, the quantity demanded rises. Alternatively, as the prices rise, the quantity demanded would usually go down.
This may also be applicable to the tourism industry. As the air fare to a particular destination increases, the demand for that destination decreases. To illustrate the effect price has on quantity, the economists use what is known as the classic demand curve. The classic demand curve is normally a line sloping downward to the right.
It indicates to the marketing manager the number of units that the market will buy in a given period, at different prices, which might be charged. There is an inverse relationship between demand and price. That is, the higher the price, the lower the demand, and the lower price the higher the demand. For prestige products, the demand curve slopes upwards.
The higher price is perceived as being an indication of a high quality good. The prestige goods may be perceived as delivering more value. Demand in such circumstances can actually increase as the price goes up; although after a certain level, the curve resumes its traditional slope. An example of such a product in the airline industry might be the first and business class seats.1 illustrates the demand curve which indi- cates the relationship between price and quantity for normal and prestige products.
When setting prices, many companies try to measure their demand curve. When modelling the demand curve, one has to estimate demand at different prices.1 The quantity demanded per period for normal and prestige products 8.2 Determining Demand 141 Fig.2 Quantity demanded per period However, when carrying out this process, it is important to remember that other elements of the marketing mix must remain constant. Demand does not depend on price alone. A shift in the demand curve from D1 to D2 (i.
an increase in demand) may occur for different reasons: Customer tastes may be influenced by other marketing mix variables. Marketing mix variables such as promotion and distribution play an influential role. An improvement in these areas may cause a shift in the demand curve from D1 to D2, as featured in Fig. An increased quantity of products could be sold at an increased price.
Alternatively, a shift from D2 to D1 (a fall in demand) could happen when there are substitute products. For example, leisure passengers may travel by different modes of transports which could be cheaper for them. The marketing managers ought to ensure that other marketing factors do not vary when measuring demand. For example, an advertising campaign should not be launched if they are attempting to test various price levels.
They will not really know whether it is the actual price change or the increased product promotion which is influencing the change in customer demand.3 Elastic Demand The relative responsiveness of changes in demand to the changes in price is known as elasticity (Brons et al., 2002; Arnott et al. A marketing manager who understands the concept of elasticity will find it easier to set prices to different products. An elastic demand is one where a change in price will alter the demand for a product. In other words, if a demand is elastic, a change in price causes an 142 8 Tourism Supply and Demand opposite change in total revenue.
That is, a rise in price will decrease revenue, and a fall in price will increase total revenue. The demand curve for leisure travellers, the price sensitive segment of the market is an example of elastic demand. When an increase in price occurs, there is a decrease in the quantity demanded, and when there is a decrease in price, there is an increase in the quantity demanded.4 Inelastic Demand An inelastic demand has an opposite effect, as shown in Fig. An increase in price will increase total revenue, and a decrease in demand results in a decrease in revenue.
In other words, price has a little effect on demand. For instance, the demand for the airline’s seats in business or first class is a good example of a relatively inelastic demand (Brons et al. In such cases, the airfare is not really important to corporate passengers. A small change in price may bring little changes in demand.
Generally, it could be said that the less elastic the demand, the more the business can consider raising its prices. If there is elastic demand, firms should consider lowering their prices as a means of producing more sales revenue.5 Airline Demand There are a number of ways in which an airline may consider estimating demand elasticity: Fig.3 Quantity demanded per period for elastic and inelastic products 8.1 Direct Attitude Survey The marketing managers will explore their customers’ attitudes toward particular price changes. This information may be gathered through an inflight survey. However, great care must be taken when wording the questionnaire; so that the customers understand why an increase in price may be required.
For example, if the respondents are asked, “Would you be prepared to pay a higher price?”, most of them will say “No”.2 A Historical Analysis of Passenger Yields This analysis could take the form of a cross-sectional analysis of the relationship between price charged and demand. A historical analysis explores how prices may have affected the level of demand on particular services. A cross-sectional analysis involves a thorough investigation of the passenger mix. It determines how prices changes have affected the routes’ profitability.3 Market Test A market test is where an airline implements a price change for a fixed period of time, and studies its effect.
However, this research method may have its disad- vantages. Once a price change is introduced (especially if it is a price reduction); it may prove difficult to alter that decision without experiencing negative reactions from customers. Market testing also alerts competition of the airline’s intention, giving them the opportunity to follow such initiatives. If it is a price increase and the market is highly elastic, or if the market is very competitive, then such a test could turn out to be quite expensive.4 Conjecture Most marketing managers may rely on their past experience to charge prices for their products.
However, it should be noted that accurate assessments of elasticity are extremely difficult to ascertain. This is because elasticity varies from each end of the route, by time of day, by day of week and month of year. 144 8 Tourism Supply and Demand 8.6 Pricing Methods and Strategies In the past, international fares were agreed upon by the International Air Transport Association’s (IATA) member airlines. At the time, many governments put pressure on airlines to use cost-based pricing.
Today, the majority of airlines operate in deregulated and liberalised markets. Therefore, they are in a position to offer what fares they wish. There are a number of pricing strategies which may be applied. The following are the most common pricing methodologies that are employed by the marketing managers: 8.1 Prestige Pricing (or Price Skimming) A marketing manager uses prestige pricing strategies when they set artificially high prices for their products or services, in order to to attract hedonic, high-value customers.
Prestige products or services may be perceived as more valuable items by affluent customers, as their higher price may be associated with better quality and glamour. Such a skimming strategy may result in a rise in demand for the product. For example, First Class or Business Class fares possess a number of characteristics of prestige products. In the market place, such fares are considered to be the airlines’ premium products.
These products reflect status and high-quality lifestyles of passengers, mainly business travellers (Swarbrooke, & Horner, 2001). Many companies may apply this pricing method when they penetrate a new market, as a means of attracting high-end customers. In this case, the marketing managers will set a high price for their new products to skim maximum revenue from specific market segments, which may be willing to pay the high price. This way, the company will make fewer, but more profitable sales.2 Penetration Pricing Penetration pricing involves the setting of low prices for innovative products or services.
The marketers’ intention is to generate quick sales, and to win a large market share. If the target markets are elastic, penetration pricing will provide significant opportunities for market growth. Frequently, low-cost airlines have used penetration pricing when they first entered the market, in many countries. However, certain airlines who may have limited resources and lower capacities may find themselves having to compete with industry giants.
The industry competitors, including the legacy carriers will rely on economies of scale (Caves, Christensen & Tretheway, 1984). They may decide to cross subsidise unprofitable routes where they are competing against low-cost airlines, and raise their prices on other 8.6 Pricing Methods and Strategies 145 destinations where they own a monopoly. They often attempt to force new entrants out of their market. Such tactics are known as predatory pricing.3 Cost-Based Pricing This approach uses three similar methods of cost-based pricing, including, cost-plus, break-even or target-profit pricing.
Cost-plus pricing is the easiest method. It entails adding of a standard mark-up to the cost of the product. When applying this to the travel industry, the cost per passenger/guest is calculated, and a mark-up is usually added to set the selling price of the lowest fare or hotel rate. Break-even pricing is another cost-oriented, pricing approach.
Here the company determines the price at which it could break-even. The marketing managers using this approach must calculate how many passenger seats should be filled, or how many rooms should be occupied, to break-even.