CHAPTER 4 – THE PRICING OF SERVICES

4.1 Introduction

4.2 What does it mean to Provide Value?

4.3 Special Considerations of Service Pricing.

4.3.1 Cost Considerations

4.3.2 Demand Considerations

4.3.3 Customer Considerations

4.3.4 Competitive Considerations

4.3.5 Profit Considerations

4.3.6 Product Considerations

4.3.7 Legal Considerations

4.4 Emerging Service Pricing Strategies

4.4.1 Satisfaction Based Pricing

4.4.2 Relationship Pricing

4.4.3 Efficiency Pricing

4.5 Some Final Thoughts on Pricing Services

4.1 Introduction

Of the traditional marketing mix variables, price has the most direct effect on profitability
and is the most easily controlled element of the marketing mix.1 However, despite its
importance and ease of use, the development of effective pricing strategies remains
perhaps the most elusive concept in business today. Pricing is often a perplexing issue
for practitioners and researchers alike.
4.2 What does it mean to Provide Value?

Often, both service providers and service customers incorrectly assume that value is
calculated simply by comparing the value of the core service provided (e.g., medical
care, transportation, sporting event) to the money spent to obtain the service.

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Ultimately, the buyers’ perceptions of value represent a tradeoff between the perceived
benefits of the service to be purchased and the perceived sacrifice in terms of the total
costs to be paid (see Figure 6.1). Total customer costs include more than just the
monetary cost paid for the service. Other costs include time costs, energy costs, and
psychic costs, which reflect the time and trouble the customer has to endure to acquire
the service. Similarly, total customer value extends beyond product value and includes
service value, personnel value, and image value.

4.3 Special Considerations of Service Pricing.

The ultimate pricing decision faced by most firms is determining a price that sells the
service while at the same time offering a profitable return.

The literature suggests that strategic pricing decisions should be based on cost,
demand, customer, competitive, profit, product, and legal considerations.

While these market conditions are the same for goods and services, the content of the
considerations differ. The discussion that follows highlights these key differences.
Figure 6.2 provides a summary of the key considerations.

4.3.1 Cost Considerations

Compared to their goods-producing counterparts, service firms encounter a number of

unique cost considerations that need to be addressed when formulating service pricing
strategy. First, service pricing is often not finalized until after provision. Consequently,
the consumer experiences greater price uncertainty. Second, since services have no
cost of goods sold (nothing tangible was produced), cost-based pricing is more difficult
for services. Third, many service industries are often characterized by a high fixed cost
to variable cost ratio which leads to further pricing challenges. Finally, the mass
production of services leads to limited economies of scale.

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Figure 6.2 – Unique Difference Associated with Service Prices

4.3.2 Demand Considerations

Service firms that are better able to extract the full value from the market take into
account external market factors such as demand considerations. There are a number of
demand considerations that differentiate the pricing of services from the pricing of
goods. First, demand for services tends to be more inelastic. Cost increases are often
simply passed along to consumers. Second, consumers of services often implicitly
bundle prices. For example, the demand for food services at a theme park may be
impacted by the price of the theme park’s hotel and ticket prices. Consequently, the

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cross-price elasticity of services should be taken into careful consideration. Finally, due
to the supply and demand fluctuations inherent in services, price discrimination
strategies should also be investigated.

4.3.3 Customer Considerations

Customer considerations take into account the price the customer is willing to pay for
the service. In comparison to goods, the price of the service tends to be one of the few
search attributes available to consumers for alternative evaluation purposes. As a
result, the price of the service is often used as a quality cue—the higher the price, the
higher the perceived quality of the service. Services that are priced too low may very
well be perceived as inferior in quality and bypassed for more expensive alternatives.
Finally, service customers tend to be less certain about reservation prices.

4.3.4 Competitive Considerations

Service pricing strategy is affected by two unique competitive considerations. First,

comparing prices of service alternatives is often difficult, which may make competitive-
based pricing a less-important consideration for services compared to goods. In
addition, a unique competitor must be considered when pricing services—the self-
service consumer.

Consumers are often willing to provide self-service to save money and customize the
end result among other perceived advantages.

4.3.5 Profit Considerations

Price bundling often increases the profit opportunities for service firms. Compared to
goods, services are more amenable to price bundling; however price bundling makes
the determination of individual prices in the bundle of services more complicated. Price
bundling involves pricing a group of services at a price that is below their cost if bought
separately. For example, a ski lodge located in the Rocky Mountains may bundle a
guest room, dinner, ski tickets and ski lessons. In general, price bundles are perceived
as a better value for the customer and typically generate additional revenues for the
selling firm.

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 4.3.6 Product Considerations

Service pricing strategy recognizes three unique service product considerations. First,
price is called by many different names in the service sector. As a result, price may be
perceived differently in some sectors compared to others. Second, since service
products are unable to be inventoried, service consumers should be less price sensitive
and less prone to delay their purchases until a better price is offered some time in the
future. Finally, the common practice of price lining used for tangible products makes
less sense to service consumers.

4.3.7 Legal Considerations

Finally, when developing pricing strategy, marketers must not only consider what is
profitable, but also what is legal. In general, the opportunity to engage in and benefit
from illegal pricing practices in the service sector is predominantly attributed to
intangibility, inseparability, and heterogeneity. As discussed in Chapter 3, intangibility
decreases the consumer’s ability to objectively evaluate purchases, while inseparability
reflects the human element of the service encounter that can potentially expose the
customer to coercive influence techniques.

4.4 Emerging Service Pricing Strategies

Due to the many special considerations surrounding the pricing of services, traditional
pricing strategies such as penetration pricing, competitive pricing, and premium pricing
may offer little benefit to service customers or service providers. For example,
competitive pricing has led to disappearing profit margins in such industries as car
rental, airlines, and health insurance, and to customer confusion and mistrust in
industries such as long distance telephone service.

To price services effectively, the service firm must first understand what its target
market truly values. Three alternative pricing strategies that convey value to the
customer include satisfaction-based, relationship, and efficiency pricing.

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 4.4.1 Satisfaction Based Pricing

The primary goal of satisfaction-based pricing is to reduce the amount of perceived risk
associated with the service purchase and appeal to target markets that value certainty.
Satisfaction-based pricing can be achieved through offering guarantees, benefit-driven
pricing, and flat-rate pricing.

4.4.2 Relationship Pricing

The primary objective of relationship pricing is to enhance the firm’s relationship with its
targeted consumers. For example, in the banking industry, relationship pricing
strategies can be utilized to further nurture the relationship between the bank and its
existing checking account customers by offering special savings accounts, deals on
safe deposit boxes, and special rates on certificates of deposit. Two types of
relationship pricing techniques include long-term contracts and price bundling.

4.4.3 Efficiency Pricing

The primary goal of efficiency pricing is to appeal to economically minded consumers

who are looking for the best price. “Efficiency prices almost always are industry
heretics,” shunning traditional operating practices in search of sustainable cost
advantages.

Southwest Airlines and its relentless efforts to reduce costs is one such example.
Southwest Airlines reduces costs by flying shorter, more direct routes to less-
congested, less-expensive airports. No meals are served, passengers are seated on a
first-come, first-served basis, and the airline was the first to offer “ticketless” travel on all
flights.

Efficiency pricing focuses on delivering the best and most cost-effective service
available for the price. Operations are streamlined, and innovations that enable further
cost reduction become part of the operation’s culture. The leaner the cost structure, the
more difficult it is for new competitors to imitate Southwest’s success. Understanding
and managing costs are the fundamental building blocks of efficiency pricing.

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4.5 Some Final Thoughts on Pricing Services

The pricing service is a complex task. Consumers are purchasing an experience and
often feel uneasy about or do not understand what they are paying for. Similarly, service
providers do not have a cost of goods sold figure upon which to base their prices.
Confused and bewildered, many providers simply look to what the competition is
charging, regardless of their own cost structures and competitive advantage. In
contrast, successful service providers tend to abide by the following pricing guidelines:

• The price should be easy for customers to understand.

• The price should represent value to the customer.

• The price should encourage customer retention and facilitate the customer’s
relationship with the providing firm.

• The price should reinforce customer trust.

• The price should reduce customer uncertainty.

Note: The given chapter contents are compiled from the given source. [ CITATION Hof11 \l 1033 ]

Works Cited
Hoffman, K. D., & Bateson, J. E. (2011). Services Marketing Concepts, Strategies & Cases. Mason, OH:
South-Western Cengage Learning.

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