The Pricing of Services

Dr. Brian Monger

Introduction

Pricing decisions are of major importance in service marketing strategy. As with other marketing mix elements, the price of a service should be related to the achievement of marketing and organisational goals and should be appropriate for the service organisation’s marketing program.

Service pricing principles and practices tend to be based on principles and practices used in pricing goods. As with goods, easy generalisations about pricing are difficult to make. There is as much diversity in the service sector as in the goods sector.

The great variety of environments in which service pricing decisions are made and the diversity of pricing practices which may apply, is partly reflected in the many different terms used to describe the prices of services.

Characteristics of Services and their Influence upon Service Prices

The characteristics of services as with all Products will influence prices set in markets. The influence of these characteristics will vary according to the type of service and market situation under consideration. They are however an added consideration when examining the traditional main forces influencing price; costs, competition and demand. Some impacts of these services characteristics include these five categories:

(a)        Service perishability, the fact that service may be difficult (though not impossible) to be stored and that fluctuations in demand cannot be met as easily through using inventory, has price implications. Special price offers and price reductions to use up spare capacity may be used and marginal pricing may be more commonplace. This may happen in markets like airline travel and package holidays. Constant use of these forms of pricing may lead to increasing customer sophistication; buyers may deliberately hold off from purchasing certain services with the expectations that price reductions will occur. Sellers for their part may try to compensate for this effect by offering advantageous reductions on orders for services placed early. Again the holiday tour market exhibits some of these forces at work.

(b)        Customers may be able to delay or postpone the performance or use of many services. Alternatively they may be able to perform certain services for themselves. These features can lead to keener competition amongst the sellers of services. They can also encourage a greater degree of price stability in certain markets, in the short term.

(c)        Apparent Intangibility has many price implications. First-time users may have great difficulty understanding what they get for their money but this may be influenced by the material content of the service product. The higher the material content, the more will prices set tend to be based on costs and the greater the tendency towards more standard prices. The  smaller the material content the more customer orientated and the less standard will prices be.

Service product intangibility also means that services provided may be more easily varied than physical products. Thus service level, service quality and service quantity can be adjusted to meet particular customer requirements. Prices may ultimately be determined by negotiation between buyer and seller.

(d)       Where service products are fairly homogeneous (e.g. car washes, dry cleaners) then pricing may be highly competitive. On the other hand regulatory agencies may discourage price cutting through prescribed fees and charges (e.g. trade associations or government agencies). The more unique a service then the greater the discretion of the seller to vary price according to what buyers in the market are prepared to pay. In such situations price may be used as a quality indicator and the reputation of the individual or organisation offering the service may give considerable price leverage.

(e)        The inseparability of service from the person providing it may place geographic limits or time limits on markets that can be served. Equally buyers of services may search for service provision within certain geographic or time zones. The degree of competition operating within these limits will influence prices charged.

Pricing and Marketing Strategy

Integrated marketing strategies imply that the various elements of the marketing mix are formulated and implemented with the objectives of those strategies clearly in mind. Pricing decisions are no exception to this principle. In setting price objectives for services a number of factors must be considered. The more significant of these are:

(a)        the planned market position for the service product;

(b)        the stage of the life cycle of the service product;

(c)        elasticity of demand;

(d)       the competitive situation;

(e)        the strategic role of price.

The Planned Market Position for the Service Product

Market position means the place the service product is intended to take up and does take up in the customer’s eyes and in comparison with competitors. It refers to the customer’s perceptual positioning of the service product; in other words how the service product is “seen” in relation to others available. Clearly price is an important element in the marketing mix influencing this position. Tangible products may occupy a particular position by virtue of their physical characteristics (e.g. a grade of industrial steel tubing). Services, on the other hand, are more often “positioned” on the basis of their intangible attributes.

The Stage of the Life Cycle of the Service Product

The price of the service product will also relate to its life cycle. For example in introducing a new service an organisation could opt to set low prices to penetrate markets and gain rapid market share. Alternatively an organisation could opt to charge high prices to make as much profit as possible in a short time (skimming policy). This strategy is only possible if there is no immediate competition and a high level of buyer need urgency (e.g. windscreen replacement services). However, the value of the life cycle as an analytical tool in services marketing was questioned earlier and the weaknesses identified there should be borne in mind.

Elasticity of Demand

The discretion a service organisation has to determine its pricing objectives will be influenced by elasticity of demand in the market. Elasticity of demand refers to the responsiveness of demand to changes in price. In some markets demand is much influenced by price changes (e.g. urban bus services) in others this is less so. Clearly it is vital for a service organisation to understand how elastic or inelastic demand for its services is in response to price change. For example, if a service company reduces its prices and demand is elastic then the effect would be to reduce margins with no compensating increase in demand. Elasticity may impose limitations on certain price options.

The Competitive Situation

The strength of competition in the market influences a service organisation’s direction over its prices. In situations where there is little differentiation between service products and where competition is intense (e.g. a seaside resort during a poor tourist season) then price discretion is limited.

Competition of course has a number of dimensions apart from interbrand or intertype competition. In transport services, for example, there is competition between different modes of transport (e.g. rail v road), different brands  as well as alternative uses of the potential customers’ time and money (e.g. not to travel at all). Nevertheless a degree of price uniformity will be established in those markets with little differentiation between service products and strong levels of competition. In other settings tradition and custom may influence prices charges (e.g. Advertising agencies commission system).

The Strategic Role of Price

Pricing policies have a strategic role aimed at achieving organisational objectives. Thus the pricing decision on any particular service product should fit in with strategic objectives. For example, a new holiday company intent upon establishing itself in the package holiday market might use a deliberate policy of low prices to obtain substantial market share although this could mean unprofitable trading for some time. Maximum sales would be won through penetration pricing as a deliberate policy. Any pricing strategy must of course fit in with the way in which other elements of the marketing mix are manipulated to attain strategic ends.

Methods of Pricing Services

There are few schemes available which deal with pricing practices in services markets. Below is one of the more popular. Services organisations may use:

(i) Cost-Based Pricing

(a)        Profit orientated – aiming at a minimum profit target. Prices fixed by professional and trade associations belong to this category. If entry is severely restricted, prices will be related more to the customer’s ability and willingness to pay and less to costs.

(b)        Government-controlled prices – aiming at consumer protection by fixing prices on a cost-plus-a-modest-margin basis.

(ii)   Market-orientated pricing

(a)        Competitive – either accepting the going rate or maintaining or increasing market share by an aggressive pricing policy.

(b)        Customer oriented – prices set with regard to consumers’ attitudes and behaviour. Quality and costs of services may be varied to remain in harmony with prices.

In service businesses it is often difficult to establish, for cost purposes, what a “unit” of service is, let alone to calculate its cost. Particular difficulties occur with highly intangible services where people are the chief element of cost. For example it may be difficult to measure the time spent in performing a service; also overhead allocation may be problematic. Yet it is difficult to develop a pricing strategy for a service business without some clear idea of costs; if only to establish how costs act as a constraint on the lower limit of price discretion available to the price maker. People-intensive services like professional services have to develop more accurate methods of identifying and allocating costs to overcome the problems of costing in such service businesses, i.e.

the product is difficult to describe and measure;

costs are primarily people costs;

other costs (e.g. rent, travel) are people-related costs;

people are more difficult to cost than machines.

Price Tactics

Many of the tactical price techniques used to sell tangibles can be used to sell intangibles. In both cases the particular tactics used are dependent upon the kind of service involved, the target market and general conditions prevailing in that marketplace at the time (e.g. supply shortages therefore possible over-demand for service products). Some of the frequently used pricing tactics in services markets are now considered. They are:

(a)        differential or flexible pricing;

(b)        discrete pricing;

(c)        discount pricing;

(d)       diversionary pricing;

(e)        guarantee pricing;

(f)        high price maintenance pricing;

(g)        loss leader pricing;

(h)        offset pricing;

(i)         price lining.

Dr. Brian Monger.

Brian Monger is the Executive Director of MAANZ International and a Principal Consultant with The Centre for Market Development.  His profile can be found on LinkedIn.

He is available for consulting tasks and speaking engagements

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