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Pricing of services

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Sarath Allapra
Sarath Allapra

Pricing services is more complex than pricing goods due to several factors: customer knowledge of service prices can vary; services often have high variability between providers; and providers may be unwilling to estimate prices in advance as the nature of the service is not fully known until delivery. Non-monetary costs like time, search, convenience, and psychological costs also influence demand. While reputation and advertising are preferred quality cues, price may be viewed as a quality signal, especially for high-risk services. Common approaches to pricing services include cost-based pricing using direct and overhead costs, competition-based pricing by monitoring competitors, and demand-based pricing by relating price to customer perceived value.

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PRICING OF SERVICES
Why Pricing of Services is different?  Customer knowledge of service price – a reference price is a price point in memory for a good or a service  High degree of variability often exists across providers of services – not every physician defines a checkup the same way  Providers are unwilling to estimate prices in advance – legal service providers; fundamental reason being they do not know themselves what the service will involve until the process of service delivery unfolds
 Individual customer needs vary – your haircut fro the same stylist may cost you differently  Price invisibility – particularly in financial services, most customers know about only the rate of return and not the costs they pay in form of fund and insurance fees
Role of Non-monetary Costs  Demand is not just a function of monetary price but is influenced by other costs as well. Like:  Time cost since most services require direct participation of the consumer and thus their real time  Search costs - the effort invested to identify and select among services you desire since prices for services are rarely displayed in shelves an each service establishment offers only one brand of service (except brokers & agents)  Convenience costs – like customers have to travel to the service, if service hours do not coincide with customer’s available time  Psychological costs – fear of not understanding (education), fear of rejection (bank loan), fear of results (surgery)
Price as an Indicator of Service Quality     Customers prefer cues like company reputation, level of advertising to access the quality In other situations when quality is hard to detect or price varies a great deal within a class of services, consumers may believe that price is the best indicator of quality In case of high risk services like medical treatment, customer looks price as a surrogate for quality Thus in addition to cover the cost and match competitors price, prices must be set with care to convey the appropriate service quality
Pricing of services
Price as an Indicator of Service Quality Infers High Quality Service Infers Low Quality Service
APPROACHES TO PRICING SERVICES
COST BASED PRICING COMPETITION BASED PRICING DEMAND BASED PRICING
Pricing of services
Cost -Based Pricing  Price = Direct costs + Overhead costs + Profit Margin  Challenges:  Costs are difficult to trace as cost based pricing involves defining the units in which a service is purchased  Thus services are sold in terms of input units (like hours) rather units of measured output  Labor is more difficult to price than material  Used in industries in which cost can be estimated in advance like, advertising, construction
Competition-Based Pricing  Monitor competitors’ pricing strategy (especially if service lacks differentiation like dry cleaning and its an oligopoly like airline)  Challenges:  Small firms may charge too and not make margins high enough to remain in business  Heterogeneity of services across and within providers makes it difficult to compare
Demand-Based Pricing  Relate price to value perceived by customer i.e. prices are based on what customers will pay for the services provided  Challenges:   Monetary price must be adjusted to reflected the value of non-monetary costs Information on service costs may be less available to customers, making monetary price not as salient indicator to quality
 1. Value has 4 meanings: Value is low price – equate value with low price like, a carpet on sale 2. Value is everything I want in a service – emphasize the benefits rather price like, best education for a MBA 3. Value is the quality I get for the price I pay – trade off between the money they give up and the quality they receive like, for a business travel, lowest price for a quality brand 4. Value is all that I get for all that I give – consider all benefits and sacrifice components (money, time, effort)

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Pricing of services

  • 2. Why Pricing of Services is different?  Customer knowledge of service price – a reference price is a price point in memory for a good or a service  High degree of variability often exists across providers of services – not every physician defines a checkup the same way  Providers are unwilling to estimate prices in advance – legal service providers; fundamental reason being they do not know themselves what the service will involve until the process of service delivery unfolds
  • 3.  Individual customer needs vary – your haircut fro the same stylist may cost you differently  Price invisibility – particularly in financial services, most customers know about only the rate of return and not the costs they pay in form of fund and insurance fees
  • 4. Role of Non-monetary Costs  Demand is not just a function of monetary price but is influenced by other costs as well. Like:  Time cost since most services require direct participation of the consumer and thus their real time  Search costs - the effort invested to identify and select among services you desire since prices for services are rarely displayed in shelves an each service establishment offers only one brand of service (except brokers & agents)  Convenience costs – like customers have to travel to the service, if service hours do not coincide with customer’s available time  Psychological costs – fear of not understanding (education), fear of rejection (bank loan), fear of results (surgery)
  • 5. Price as an Indicator of Service Quality     Customers prefer cues like company reputation, level of advertising to access the quality In other situations when quality is hard to detect or price varies a great deal within a class of services, consumers may believe that price is the best indicator of quality In case of high risk services like medical treatment, customer looks price as a surrogate for quality Thus in addition to cover the cost and match competitors price, prices must be set with care to convey the appropriate service quality
  • 7. Price as an Indicator of Service Quality Infers High Quality Service Infers Low Quality Service
  • 9. COST BASED PRICING COMPETITION BASED PRICING DEMAND BASED PRICING
  • 11. Cost -Based Pricing  Price = Direct costs + Overhead costs + Profit Margin  Challenges:  Costs are difficult to trace as cost based pricing involves defining the units in which a service is purchased  Thus services are sold in terms of input units (like hours) rather units of measured output  Labor is more difficult to price than material  Used in industries in which cost can be estimated in advance like, advertising, construction
  • 12. Competition-Based Pricing  Monitor competitors’ pricing strategy (especially if service lacks differentiation like dry cleaning and its an oligopoly like airline)  Challenges:  Small firms may charge too and not make margins high enough to remain in business  Heterogeneity of services across and within providers makes it difficult to compare
  • 13. Demand-Based Pricing  Relate price to value perceived by customer i.e. prices are based on what customers will pay for the services provided  Challenges:   Monetary price must be adjusted to reflected the value of non-monetary costs Information on service costs may be less available to customers, making monetary price not as salient indicator to quality
  • 14.  1. Value has 4 meanings: Value is low price – equate value with low price like, a carpet on sale 2. Value is everything I want in a service – emphasize the benefits rather price like, best education for a MBA 3. Value is the quality I get for the price I pay – trade off between the money they give up and the quality they receive like, for a business travel, lowest price for a quality brand 4. Value is all that I get for all that I give – consider all benefits and sacrifice components (money, time, effort)