Capture and-communicate-value-in-the-pricing-of-serviceserdem

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Capture and-communicate-value-in-the-pricing-of-serviceserdem

  1. 1. Capture and CommunicateValue in the Pricing ofServicesBy: Manjit S. Yadav, Associate Professor of MarketingTexas A & M University Dr. Manjit Yadav is an Associate Professor of Marketing and Center for Retailing Studies Faculty Fellow, Department of Marketing, Mays College & Graduate School of Business, Texas A&M University. Permission to excerpt this article was granted by Sloan Management Review. Dr. Yadav will be one of our speakers at the upcoming fall conference in Chicago.Introduction are intangible. Goods, on the other hand, areWidespread pricing mismanagement plagues objects; they can be seen and touched. Customersservice industries because too many services can see tangibles associated with the service, suchmarketers ignore the special challenges of pricing as the people who provide the service and theintangible products. The authors discuss the equipment, but they usually cannot see the serviceimplications of this kind of pricing in todays highly itself. This inherent invisibility creates conditionscompetitive conditions and offer a framework that that are far from ideal for services marketers, butreconciles the implications with customers quest they need to consider it if they want to improvefor value. Three distinct but related strategies for their pricing practices. Purchasers of goods acquireservices pricing -- satisfaction-based pricing, tangibles -- a couch, a VCR, a necktie, tennisrelationship pricing, and efficiency pricing -- can shoes, toothpaste. Purchasers of services incur anhelp services marketers capture and communicate expense rather than add to their accumulation ofvalue through their pricing. goods. They might, for example, take a trip, visit the doctor, or get a haircut, but at the end of theIn this article, we discuss the implications of day, their "market basket" is empty. Purchasers ofpricing intangible products in todays intensely goods buy ownership and use; purchasers ofcompetitive markets and offer a framework that services buy only use. A dry cleaner or an autoreconciles these implications with customers quest mechanic returns customers property to an earlierfor value. Following our advice will not be a simple state: clean clothes or a well-running automobile.matter for some companies. It may mean carving Credit card issuers rent money and hotels rentout a new strategy for the business and earning space, but no transfer of possession occurs.customers confidence gradually. Pricing services Automobile insurance "pays off" for customers onlyeffectively calls for a longer-term perspective than when something bad happens.some executives may feel is practical. Recognizing this subtle but important distinction between tangibility and intangibility can provideImplications of Pricing Intangibles useful clues to understanding customers reactionsUnfortunately, little research exists on the pricing to services prices. Take, for example, a plumbingof services, and few people understand the special company that charges $60 to fix a leaky toilet.challenges involved. But services are a specialbreed of product, and marketers need to treat themas such. Services are performances; therefore, they The Journal of Professional Pricing 29
  2. 2. Satisfaction-Based, Relationship, and Efficiency Pricing Strategies Pricing strategy Provides value by… Implemented as… Satisfaction-based pricing Recognizing and reducing customers’ Service guarantees perceptions of uncertainty, which the Benefit-driven pricing intangible nature of services magnifies. Flat-rate pricing Relationship pricing Encouraging long-term relationships Long-term contracts with the company that customers view Pricing bundling as beneficial. Efficiency pricing Sharing with customers the cost Cost-leader pricing savings that the company has achieved by understanding, managing, and reducing the costs of providing the service.By charging that amount, the plumber aims to Clients who hire a lawyer, for example, will want torecoup the fixed and variable costs of operating the hire a competent and conscientious person, butbusiness (facilities, trucks, labor, telephones, how are they to do that? Few search attributesinsurance, gasoline), as well as to generate a profit. exist to guide their decision process. There are noCustomers, on the other hand, might be shocked tires to kick, nothing to test-drive. Word-of-mouthat a price of $60 for twenty-three minutes. They can help if available, or a lawyers years ofcould have bought a new sweater or some compact experience may be a useful indicator. A prospectivedisks for that. They might say the psychology of client may choose to phone or visit various lawthe transaction is not favorable to the plumber. firms to get cost estimates, but estimates frequently are inaccurate in the long run. Even if aComparing Prices, Making Choices, Assessing client believes that an estimate will be reliable, howValue. The intangibility of services makes it more can it guide the choice of a lawyer? Who would bedifficult for customers to compare prices. In a better, the least expensive Or the most expensive?supermarket, prices are affixed to tangible Lacking firsthand experience with a product,products grouped by category, but the nonphysical customers often use price as a surrogate indicatornature of services impedes price and product of quality. They assume that the least expensivecomparisons. Since the products are invisible, lawyer may also be the least skilled, and vice versa.customers cannot easily see their costs. Forexample, they have no fast method for comparing Legal services typically are high in experience andAT&T, MCI, and Sprint long distance services or credence attributes. The legal client evaluatesprices before deciding which to select. Thus quality and value when experiencing the serviceintangibility accentuates the complexity of services and, to some degree, may never know if the lawyerprices for customers. performed optimally. Services having credence properties usually are technical in nature or areServices differ from goods in the degree to which not performed in the customers presence.they possess search, experience, and credence Automobile repair, medical, marketing research,attributes, three categories that help marketers and many other services have one or both of thesedistinguish among products. Those that can be characteristics. Customers wonder, were all theevaluated before purchase and use have search repairs necessary? Were they done properly? Wereattributes, those that can be evaluated only after the laboratory tests performed correctly? Did thethey have been used have experience attributes, patient actually have all the tests that the hospitaland those that cannot be fully evaluated even after bill lists? Did the marketing research firm train itsuse have credence attributes? In general, tangible interviewers?products are more likely to possess searchattributes, whereas services tend to be higher in Services in general, and credence services inexperience and credence attributes? particular, invite pricing and performance abuses. The Journal of Professional Pricing 30
  3. 3. Customers know that they are vulnerable to such Services pricing strategies often derail becauseabuses, so they are suspicious about being taken they lack any obvious association between priceadvantage of and become resentful and angry and value.when it happens. For that reason, Sears has nevercompletely recovered from the widely publicized For customers, value means benefits received forcharges that it defrauded its auto center customers burdens endured. No product is free of cost, whichby selling unneeded parts and services. Service comes in two forms: monetary (the economic price)customers tend to remember that kind of and non-monetary (for example, time or physical orexperience for a long time. mental effort). When making purchasing decisions, customers want to feel they are getting at least asUndifferentiated Offerings much as what they are paying; that is, the benefitsThe lack of physical differentiation among should be commensurate with the burdens.competing services is another factor thatcontributes to poorly executed pricing. The styling Not understanding this trade-off, servicesof an automobile, the fit and feel of a pair of slacks, marketers frequently undermine the effectivenessthe color and pattern of a necktie, even the picture of their pricing strategies. Consider an advertisingon a cereal package differentiate a product from its campaign for a service that claims the lowestcompetitors and give customers a reason not available prices but presents them in a complexrelated to price for favoring it. Tangibles -- for series of combinations. That kind of pricingexample, the appearance of service facilities and message carries a heavier burden for customersproviders -- play a role in differentiating services than the advertiser realizes. Customers have totoo, but often the tangibles associated with a figure out how the different pricing plans work,service are relatively unimportant to the purchase which one is the best, and whether any of themdecision or differ little from the competition. For actually give them more value, or whether they arethis reason, marketers try to differentiate their all just hype. The non-monetary burden of such aservice through nonphysical means -- quality or pricing strategy increases the customers overallprice, for example -- and, frequently, they burden and therefore weakens the marketersconcentrate on the price tool. Price may seem benefits-to-burdens offer.easier to implement, faster in its effects, or morepersuasive with targeted customers. The importance of considering non-monetary costThe pricing of airline services, which by and large as part of the value message in services pricing isare marketed as a commodity, is a case in point. illustrated by the avalanche of calling plans thatWhen one carrier announces a price cut, its the big long distance telephone companies havecompetitors usually match the cut within hours. unleashed during the past few years. Collectively,The industry makes thousands, even hundreds of they spent hundreds of millions of advertisingthousands of domestic fare changes daily, creating dollars for an unrelenting stream of lowest-pricea nightmare of confusion for customers and claims and pricing counterattacks.employees. American Airline’s best fare from Dallasto Memphis today may cost $200 more or less A 1995 study of customers perceptions of longtomorrow. distance telephone providers conducted by CDB Research & Consulting found that 60 percent ofAirlines services are only one of many in which the respondents were confused by the manypricing practices are not working well. To alleviate different calling plans. Among customers withthe situation, we propose three distinct but related incomes of $50,000 or more and those aged 18 tostrategies tailored to the unique pricing challenges 34 -- two coveted markets -- 78 percent indicatedthat services present. When executed well, they they were tired of all the advertising and hypecan enable services marketers to capture and about long distance rates. Moreover, 60 percent ofcommunicate value. the respondents felt that all the major long distance companies charge essentially the same?Value Strategies for Services PricingThe key to improved services pricing is to dearly The industry seems to be grasping the significancerelate the price that customers pay to the value of straightforward pricing for value. The complexitythat they receive. A customer may or may not look and risk associated with buying many servicesfor the absolute lowest price available for a service, underscores the need for services prices to bebut everyone wants something worth the price he straightforward, easy for customers to understand,or she pays. and dearly linked to the customers perception of value. The Journal of Professional Pricing 31
  4. 4. Such an approach lessens the complexity of they have endured. When executed well, servicecustomers buying decisions and conveys pricing guarantees symbolize both a companysintegrity. Prices are more credible when they are commitment to customer satisfaction and theunderstandable and simple, and customers dont confidence it has in the quality of its service. Aftersuspect pricing tricks or hidden charges. The risk all, no one would expect a business to guarantee athat customers take on when they buy services poor service. Companies should not adopt thiswith experience or credence properties lends strategy lightly, however. A service guarantee is apersuasive power to pricing strategies that instill bold step, calling for a thorough analysis of thetrust and confidence. reasons for doing so, as well as the risks involved. Service guarantees make the most sense forNot only should marketers avoid needless companies that market services perceived as high-complexity in their services pricing, they should risk, that wish to capitalize on their superioralso avoid simplistic approaches that fail to service quality or that need a differentiatingrecognize the heterogeneity of customers wants. message to enter a market against establishedPrices can be straightforward, easy for customers competitors. Companies with poor or mediocreto understand, and communicate value without service should improve their service significantlybeing simplistic. Sometimes, customers realize the before considering a service guarantee.most value from a service by being able to buydifferent benefit levels at different price levels. Benefit-Driven Pricing. Satisfaction-based pricingMovie theaters, for example, increase the value of also can be based on how a service is used andtheir service by allowing customers to choose how it creates value. Benefit-driven pricing involveswhether to pay a higher price for prime time or a explicitly pricing the aspect of the service thatlower price for non-prime time. Such segmented directly benefits customers. The result is thatpricing also lets the movie theaters synchronize customers usually feel more satisfied and lessdemand patterns with supply capacity. Without uncertain than if a services price is unrelated tosegmented pricing, more customers would go to the benefits it delivers. While identifying whatthe movies in the evening, and the facilities would customers value in a service is crucially importantbe underutilized during the day. for developing an effective benefit-driven pricing strategy, determining what customers do not valueIn order to price for value, services marketers must is equally important.first understand what constitutes value for theirtarget markets. Their goal then becomes capturing One big complication arises from the possibilityand communicating this value proposition -- as that valuations can vary significantly acrossclearly and compellingly as possible -- through the customer segments. Once such information haspricing. We suggest three distinct but related been gathered systematically, however, it can servepricing strategies for capturing and communicating as a secure foundation for implementing benefit-the value of a service: satisfaction-based driven pricing. Generally, the pricing mustrelationship, and efficiency pricing. They can be establish and communicate a dear associationused independently or in combination. between the price and the service attributes that customers value.Satisfaction-Based PricingThe intangible nature of services challenges both Flat-Rate Pricing. An important source ofcompany and customer to dearly establish the uncertainty for some customers is the actual costsvalue of the service. Some uncertainty is associated that they will incur. For many labor-intensivewith any purchase, whether it is a service or a services, the exact price cannot be establishedtangible product, but intangibility accentuates the before delivery. The cost of legal representation, foruncertain. The goal of satisfaction-based pricing example, often is influenced by events that cannotstrategies is to alleviate customers uncertainty. be known fully in advance. Flat-rate pricingCompanies can do this in several ways, including alleviates customers uncertainty by agreeing on aservice guarantees, benefit-driven pricing, and flat- price beforehand. In effect, the service providerrate pricing. assumes the risk of any cost overruns. Flat-rate pricing can be an effective strategy for companiesService Guarantees. Explicitly guaranteeing a in industries in which service prices areservice can be a powerful reassurance for unpredictable and costs are badly managed, or incustomers. Even if they end up dissatisfied with which competitors make low estimates to winthe service, the guarantee gives them a recourse -- business but have no intention of honoring them.usually a reduced price or refund for a burden that The Journal of Professional Pricing 32
  5. 5. Flat-rate pricing needs at least three conditions to most easily imitated -- which is why relationshipsmake sense. First, the flat-rate price must be based solely on price incentives disappear socompetitive. If customers perceive it as too high, it swiftly.will dilute the risk-reduction benefits that makethe strategy appealing. Second, the company must Services marketers can develop creative pricingdevelop and maintain a highly efficient, strategies that contribute to sustainablestreamlined cost structure to provide some cushion relationships. Such strategies offer an incentive forfor unanticipated costs. Costs in the service system customers to consolidate more of their purchasingthat do not add value to customers must be with the company and to resist the entreaties ofeliminated. Third, the potential for relationship competitors. Marketers first need to understandmarketing must be high; that is, even if their customers needs and their motivations forunexpected costs drain the profit from one service developing a long-term relationship with theepisode with a customer, additional opportunities company. They should also analyze potentialto serve the customer -- and make money -- still competitors moves and implications forloom on the horizon. profitability.In summary, satisfaction-based pricing strategies Long-Term Contracts. Marketers can use long-can effectively reduce customers uncertainty in term contracts that offer customers price and non-purchasing services. Service guarantees price incentives to enter into multiyearcompensate customers if they are not satisfied. relationships, either to strengthen existingBenefit-driven pricing aligns the pricing specifically relationships or to develop new ones. Suchwith the benefits that the customer perceives. Flat- contracts can alter fundamentally a servicerate pricing negates any dissatisfaction that might providers relationships with its customers. Theyresult from higher than anticipated prices. These can transform business transactions fromstrategies apply only under certain conditions, relatively isolated events to a series of steadyhowever, and they are definitely not for timid sustained interactions. Each transaction providescompetitors. Each strategy is risky in its own way, one more snapshot of customers needs andand each requires strong commitments: to service therefore facilitates learning and efficiency gainsexcellence for the service guarantor, to for the company -- which also may result in greaterunderstanding how the service creates value for savings for customers as the relationship evolves.the benefit pricer, and to a highly efficient cost The steady revenue stream from long-termstructure for the flat-rate pricer. relationships enables the service provider to concentrate more resources on widening the valueRelationship Pricing gap between what it offers and what competitorsRelationship marketing, which involves “attracting, offer.maintaining, and – in multi-service organizations—enhancing customer relationships is increasingly Price Bundling. This strategy, which also aims toviewed as a desirable marketing strategy because enhance and sustain customer relationships,of its profit potential and its appeal to customers. involves selling two or more services bundledService companies dearly gain if they can do more together. Price incentives assure buyers thatbusiness with existing customers for a longer purchasing the services together is less expensiveperiod of time. Equally important, customers gain than buying them separately. Service providers canif they can establish a relationship with a benefit in two ways from price bundling. First,competent, dependable provider of a high-risk bundling can reduce costs. The cost structure ofservice that presents a complex decision with most service companies is such that providing anregard to purchase and is difficult to evaluate. A additional service costs less than providing thecustomer fortunate enough to have an excellent second service alone. In a bank, for instance,auto repair person, physician, or real estate agent shared account-opening and computer-processinghas a lower effort and risk burden than someone costs result in economies when the bank can sell awho needs the service but hasnt yet developed a certificate of deposit and a savings account alongsatisfactory relationship. with a checking account. If the bank passes some or all of the economies to customers in the form ofThe question is, what role should pricing play in reduced fees or higher interest, it is giving them anrelationship marketing? An obvious approach is to incentive to buy the bundled services.use price reductions to initiate relationships. Thatapproach is easy to implement and has A second benefit of bundling that appeals toconsiderable intuitive appeal, but it is also the customers is purchasing related services from one The Journal of Professional Pricing 33
  6. 6. service provider. They can save time and money by Understanding costs is particularly difficult forinteracting with and paying one provider rather service companies. Traditional cost-accountingthan multiple providers. procedures were designed to monitor costs associated with the consumption of raw materials,Relationship pricing aims to encourage the depreciation, and labor. In the case of services, fordevelopment of profitable, long-term customer which the final product is a composite ofrelationships. It can be applied under many varied performances, traditional accounting practices areconditions. A careful analysis of mutual benefits is inadequate.essential to determine the factors that make therelationship work. Such an analysis will suggest Activity-based costing (ABC), which focuses onhow much emphasis the service company should resources consumed by specific activities that leadplace on price incentives. Consolidating purchases to the final product, may be a more useful tool.of services with a single supplier must have the Take, for example, a pizza delivery operation. ABCpotential of offering customers increased benefits, would estimate the cost of each activity in thereduced monetary and non-monetary costs, or, service chain, from taking the order to deliveringideally, all of the above. The service should be one the pizza. Once the cost elements were identified,that customers use on a recurring or continuous cost-reduction efforts could be focused onbasis, with movement by customers among streamlining or eliminating activities that dont addmultiple suppliers a common phenomenon, and enough value for customers.there should be potential for expanding Southwest Airline’s relentless cost-reduction effortsrelationships with customers through increased are based on a keen understanding of the cost-use of one service or the purchase of multiple value relationships of specific activities that makeservices. up air travel services. While other airlines focused on establishing expensive hub-and-spoke networksEfficiency Pricing in the 1980s, Southwest became the industrysUnderstanding, managing, and reducing costs are most productive airline, in part by flying shorter,the cornerstones of efficiency pricing. Some or all more direct routes and by using less congested,of the resulting cost savings are passed on to less expensive airports whenever possible.customers in the form of lower prices. To beeffective, the leaner cost structure must be difficult To summarize, efficiency pricers reducefor competitors to imitate in the short run. customers monetary burden through efficientFurthermore, cost savings passed on to customers operating practices. They focus on delivering in themust genuinely enhance their value perceptions. best and most cost-effective way the customersCost trimming that results in a less expensive but most valued aspects of the service. They eitherunsatisfactory service will not be successful. streamline or eliminate low-priority elements of the service chain. Gradually, the focus on efficiency through innovation becomes embedded in the companys culture, a factor that makes catching up even more difficult for competitors. The Journal of Professional Pricing 34

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