Pricing of Services

©2006 Thomson Learning, Inc. South-Western

Chapter 7

The Pricing of Services


Chapter Objectives • Describe how consumers relate value

and price.• Understand the special considerations

of service pricing as they relate to demand, cost, customer, competitor, profit, product and legal considerations.

• Discuss the circumstances under which price segmentation is most effective.

• Explain satisfaction-based, relationship, and efficiency approaches to pricing.


Opening Vignette: Pricing Woes Continue for US Airlines

The airline industry is expected to lose at least $2 billion in 2005. Who will be left in the end?


The Art of Pricing

• Pricing policy is the last stronghold of medievalism in modern management… [Pricing] is still largely intuitive and even mystical in the sense that the intuition is often the province of the big boss (Dean, 1947).


• Pricing is approached in Britain like Russian roulette--to be indulged in mainly by those contemplating suicide (Chief Executive, 1981).

The Art of Pricing


Source: Philip Kotler, Marketing Management, 9th ed. (Englewood Cliffs, NJ: Prentice-Hall), 1997, p. 37.

Product value

Service value

Personnel value

Image Value

Monetary cost

Time cost

Energy cost

Psychic cost

Buyer’s perceptionof value

Totalcustomer

value

Totalcustomer

cost

Figure 7.1 Buyer’s Perception of Value


• Demand tends to be more inelastic

• Cross price elasticity considerations need to be examined

• Price discrimination is a viable practice to manage demand and supply challenges

Demand Considerations


Factors Influencing Consumer Price Sensitivity

Price sensitivitydecreases as

Inventory Effect Unique Value

Fairness Effect Switching Costs

Price-Quality Effect

Shared-costs Effect Comparison Effect

End-benefit EffectExpenditure Effect

PerceivedSubstitutes


• Perceived Substitute Effect– few search attributes– providers often lack resources and

marketing expertise– limited product mix

• Unique Value Effect– conveying “uniqueness” is difficult– provider may need to educate the

market– uniqueness is often short-lived

Price Sensitivity Factors



• Switching Costs– higher levels of perceived risk– uncertainty involved in changing

providers– consequences associated with a bad

outcome

• Difficult Comparison Effect– high number of experience attributes– inherent heterogeneity


• Price-Quality Effect– price acts as a quality indicator when

consumers:• believe that quality differs among providers• believe that low quality imposes greater

consequences• lack other sources of objective information

• Expenditure Effect– amount of expenditure relative to

consumer household income



• End-benefit Effect– the more price sensitive consumers

are to the cost of the end-benefit, the more sensitive they will be to purchases that contribute to the end-benefit.• Price bundling adds value to the

consumer’s end-benefit

• Shared-cost Effect– consumer price sensitivity decreases

as the shared-costs with third parties increase



• Fairness Effect– fairness is typically assessed by comparing

the price to:• previous prices paid for similar services• prices paid for similar services under similar

circumstances• the benefit gained

– assessing “service” fairness is difficult

• Inventory Effect– consumers are able to protect themselves

from future price increases by building inventories



Criteria for EffectivePrice Discrimination

1. Different groups of consumers must have different responses to price.

2. Different segments must be identifiable, and a mechanism must exist to price them differently.


3. No opportunity should exist for individuals in one segment who have paid a low price to sell their tickets to those in other segments.

4. The segment should be large enough to make it worthwhile.

5. Costs should not exceed the incremental revenues obtained.

6. Customers should not be confused.

Criteria for EffectivePrice Discrimination


• Price is sometimes not know until after the service has been produced

• Cost-oriented pricing is more difficult– activity-based costing breaks down the

organization into a set of activities, and activities into tasks, which convert materials, labor, and technology into outputs

• High fixed cost to variable cost ratio

• Economies of scale tend to be limited

Cost Considerations


• Price tends to be one of the few search clues available

• More likely to use price as a quality cue

• Consumers are less certain about reservation prices

Customer Considerations


• Comparing prices is more difficult

• Self-service is a viable alternative

Competitive Considerations


• Price bundling makes the determination of individual prices in the bundle of services more complicated

• Price bundling is more effective in a service context

Profit Considerations


• Many different names for price

• Consumers are less able to stockpile by taking advantage of discount prices

• Product-line pricing is more difficult– Home sellers have

three levels of service (6, 7, or 8%)

Product Considerations


• Opportunity for illegal pricing practices to go undetected is greater for services than goods

• To consumers, the issue is one of fairness and dual entitlement

Legal Considerations


• Satisfaction-based pricing– primary goal is to reduce the amount of

perceived risk– service guarantees– benefit-driven pricing: charges customers

for services actually used as opposed to overall membership fees

– flat-rate pricing: customer pays a fixed price and the provider assumes the risk of price increases and overruns

Emerging Service Pricing Strategies


• Relationship Pricing– primary objective is to enhance the firm’s

relationship with its targeted consumers.•long-term contracts: offers price and

nonprice incentives for dealing with the same provider over a number of years

•pricing bundling: marketing two or more services as a single package for a single price



• Efficiency Pricing– primary objective is to appeal to

economically-minded consumers by delivering the best and most cost-effective service for the price.• Example: Southwest Airlines



• The price should: – Be easy for customers to understand– Represent value to the customer– Encourage customer retention and

facilitate the customer’s relationship with the providing firm

– Reinforce customer trust– Reduce customer uncertainty

Services Pricing: Final Thoughts

Documents

Pricing of Services