What Makes Service Pricing Strategy Different (and Difficult)?• No ownership of services--hard for firms to calculate financial costs of creating an intangible performance• Variability of inputs and outputs--how can firms define a “unit of service” and establish basis for pricing?• Many services hard for customers to evaluate-- what are they getting in return for their money?• Importance of time factor--same service may have more value to customers when delivered faster• Delivery through physical or electronic channels-- may create differences in perceived value
Objectives of Pricing Strategies• Revenue and profit objectives – Seek profit – Cover costs• Patronage and user base-related objectives – Build demand – Build a user base
The Pricing Tripod (Fig. 6.1) Pricing Strategy Competition Costs Value to customer
Three Main Approaches to Pricing• Cost-Based Pricing – Set prices relative to financial costs (problem: defining costs)• Competition-Based Pricing – Monitor competitors’ pricing strategy (especially if service lacks differentiation) – Who is the price leader? (one firm sets the pace)• Value-Based – Relate price to value perceived by customer
Activity-Based Costing: Relating Activities to the Resources They• Managers need toConsume an integral part of a see costs as firm’s effort to create value for customers• When looking at prices, customers care about value to themselves, not what production costs the firm• Traditional cost accounting emphasizes expense categories, with arbitrary allocation of overheads• ABC management systems examine activities needed to create and deliver service (do they add value?)• Must link resource expenses to: – variety of products produced – complexity of products – demands made by individual customers
Net Value = (Benefits – Outlays) (Fig. 6.3) Effort Time e Perceived Perceived Benefits Outlays
Enhancing Gross Value• Pricing Strategies to Reduce Uncertainty – service guarantees – benefit-driven (pricing that aspect of service that creates value) – flat rate (quoting a fixed price in advance)• Relationship Pricing – non-price incentives – discounts for volume purchases – discounts for purchasing multiple services• Low-cost Leadership – Convince customers not to equate price with quality – Must keep economic costs low to ensure profitability at low price
Paying for Service: The Customer’s PerspectiveCustomer “expenditures” on service comprise bothfinancial and non-financial outlays• Financial costs: – price of purchasing service – expenses associated with search, purchase activity, usage• Time expenditures• Physical effort (e.g., fatigue, discomfort)• Psychological burdens (mental effort, negative feelings)• Negative sensory burdens (unpleasant sensations affecting any of the five senses)
Determining the Total Costs of a Service to the Consumer (Fig. 6.4)Search Costs Price Operating Costs Related Monetary Costs Incidental Expenses Time CostsPurchase and Physical CostsUse Costs Psychological Costs Sensory Costs Necessary follow-upAfter Costs Problem solving
Trading off Monetary and Non- Monetary Costs (Fig. 6.5) Which clinic would you patronize if you needed a chest x- ray (assuming all three clinics offer good quality) ? Clinic A Clinic B Clinic C Price $45 Price $85 Price $125 Located 1 hour away Located 15 min away Located next to your by car or transit by car or transit office or college Next available Next available Next appointment is appointment is in 3 appointment is in 1 in 1 day weeks week Hours: Mo –Sat, 8am Hours: Monday – Hours: Monday – – 10pm Friday, 9am – 5pm Friday, 8am – 10pm By appointment - Estimated wait at Estimated wait at estimated wait at clinic is about 2 hours clinic is about 30 - 45 clinic is about 0 to 15 minutes minutes
Increasing Net Value by Reducing Non-financial Costs of Service• Reduce time costs of service at each stage• Minimize unwanted psychological costs of service• Eliminate unwanted physical costs of service• Decrease unpleasant sensory costs of service
Revenue Management: Maximizing Revenue from Available Capacity at a Given Time• Based on price customization - charging different customers (value segments) different prices for same product• Useful in dynamic markets where demand can be divided into different price buckets according to price sensitivity• Requires rate fences to prevent customers in one value segment from purchasing more cheaply than willing to pay• RM uses mathematical models to examine
The Strategic Levers of Revenue (Yield) Management Price Fixed Variable Quadrant 1: Quadrant 2:Duration Predictable Movies Hotel Rooms Stadiums/Arenas Airline Seats Function Space Rental Cars Cruise Lines Quadrant 3: Quadrant 4: Unpredictable Restaurants Continuing Care Golf Courses Hospitals
Dealing with Common Customer Conflicts Arising from Revenue ManagementCustomer conflict can arise from: Marketing tools to reduce customer conflicts: Perceived Unfairness & Perceived Fenced Pricing Financial Risk Associated with Bundling Multi-Tier Pricing and Selective Categorising Inventory Availability High Published Price Unfulfilled Inventory Commitment Well designed Customer Recovery Programme for Oversale Unfulfilled Demand of Regular Preferred Availability Policies Customers Unfulfilled Price Expectation of Offer Lower Displacement Cost Group Customers Alternatives Change in the Nature of the Physical Segregation & Perceptible Service Extra Service Set Optimal Capacity Utilisation Level
Price Elasticity (Fig. 6.6) Price per Di unit of De service De Di Quantity of Units DemandedDe : Demand is price elastic. Small changes in price lead to big changes in demand.Di : Demand for service is price inelastic. Big changes have little impact on demand.
Key Categories of Rate Fences (Table 6.2)Rate Fences ExamplesPhysical (Product-related) FencesBasic Product Class of travel (Business/Economy class) Size and furnishing of a hotel room Seat location in a theatreAmenities Free breakfast at a hotel, airport pick up etc. Free golf cart at a golf courseService Level Priority wait listing Increase in baggage allowances Dedicated service hotlines Dedicated account management team
Key Categories of Rate Fences (Table 6.2 cont’d)Non Physical FencesTransaction CharacteristicsTime of booking or Requirements for advance purchasereservation Must pay full fare two weeks before departureLocation of booking or Passengers booking air tickets for anreservation identical route in different countries are charged different pricesFlexibility of ticket Fees/penalties for canceling or changing ausage reservation (up to loss of entire ticket price) Non refundable reservation fees
Key Categories of Rate Fences (Table 6.2 cont’d)Non Physical Fences (cont’d)Consumption CharacteristicsTime or duration of Early bird special in restaurant before 6pmuse Must stay over on Sat for airline, hotel Must stay at least five daysLocation of Price depends on departure location, esp inconsumption international travel Prices vary by location (between cities, city centre versus edges of city)
Key Categories of Rate Fences (Table 6.2 cont’d)Non Physical Fences (cont’d)Buyer CharacteristicsFrequency or volume Member of certain loyalty-tier with the firm getof consumption priority pricing, discounts or loyalty benefitsGroup membership Child, student, senior citizen discounts Affiliation with certain groups (e.g. Alumni)Size of customer Group discounts based on size of groupgroup
Relating Price Buckets and Fences to the Demand Curve (Fig. 6.7)Price perSeat First Class Full Fare Economy (No Restrictions) One-Week Advance Purchase One-Week Advance Purchase, Saturday Night Stayover 3-Week Advance Purchase, Saturday Night Stayover 3-Week Adv. Prchs, Sat. Night Stay., $100 for Changes 3-Wk Adv. Prchs, Sat. Night Stay, No changes/refunds Late Sales through Consolidators/ Internet, no refunds Capacity Capacity of 1st-class of Aircraft Cabin No. of Seats Demanded
Ethical Concerns in Pricing• Customers are vulnerable when service is hard to evaluate or they don’t observe work• Many services have complex pricing schedules – hard to understand – difficult to calculate full costs in advance of service• Unfairness and misrepresentation in price promotions – misleading advertising – hidden charges
Pricing Issues:Putting Strategy into Practice (Table 6.3) How much to charge? What basis for pricing? Who should collect payment? Where should payment be made? When should payment be made? How should payment be made? How to communicate prices?
Consumption follows the Timing of Payments (Research Insight 6.1) Health Club Visits Annual Payment Plan Quarterly Payment Plan Frequency of Semiannual Payment Plan Monthly Payment Plan Health Club Visits Frequency of Time Line Time LineSource: John Gourville and Dilip Soman, “Pricing and the Psychology of Consumption,”Harvard Business Review, September 2002, 90-96.