Services Marketing:

People, Technology, Strategy

CHAPTER 6
Service Pricing and Revenue
Management

1
Integrated Model of Services
Marketing

2
Learning Objectives
By the end of this chapter, the reader should be able to:
• Recognize that effective pricing is central to the financial
success of service firms.
• Outline the foundations of a pricing strategy as
represented by the pricing tripod.
• Define different types of financial cost and explain the
limitations of cost-based pricing.
• Understand the concept of net value and how gross
value can be enhanced through value-based pricing and
reduction of related monetary and nonmonetary costs.

3
Learning Objectives
• Describe competition-based pricing and
situations where service markets are less price
competitive.
• Define revenue management and describe how
it works.
• Discuss the six questions marketers need to
answer to design an effective service pricing
strategy.

4
Chapter Overview

5
Chapter Overview

• Objectives of Service

• Components of the Pricing Tripod

– Value to Customer (Price Ceiling)

– Competitor Pricing (Competitive Benchmark)

– Unit Cost to Firm (Price Floor)

6
Chapter Overview

• Revenue Management (RM)

– When Should RM be Used?

– How to Apply RM?

– Rate Fences

• Fairness and Ethical Concerns in Service Pricing

– Ethical Concerns

– Design Fairness into RM

7
Chapter Overview

• Putting Service Pricing into Practice

– How much should be charged?

– What should be the basis of pricing?

– Who should collect payment and where?

– When should payment be made?

– How should payment be made?

– How should prices be communicated?

8
Objectives for Establishing Prices

• Revenue and Profit Objectives

– Gain Profit /Cover Costs
• Patronage and User Base-Related Objectives
– Build Demand
– Develop a User Base: Encourage trial and adoption of a
service
• Strategy-Related Objectives
– Support Positioning/Support Competitive Strategy

9
Objectives for Pricing of Services
Revenue and Profit Objectives
Gain Profit
• Make the largest possible long-term contribution or profit.
• Achieve a specific target level but do not seek to maximize profits.
• Maximize revenue from a fixed capacity by varying prices and target segments over
time. This is done typically using revenue management systems.

Cover Costs
• Cover fully allocated costs, including corporate overhead.
• Cover costs of providing one particular service, excluding overhead.
• Cover incremental costs of selling one extra unit or to serve one extra customer.

10
Objectives for Pricing of Services
Patronage and User Base-Related Objectives
Build Demand
• Maximize demand (when capacity is not a restriction), provided a certain
minimum level of revenue is achieved (e.g., many nonprofit organizations are
focused on encouraging usage rather than revenue, but they still have to cover
costs).
• Achieve full capacity utilization, especially when high-capacity utilization adds to
the value created for all customers (e.g., a “full house” adds excitement to a
theater play or basketball game).

11
Objectives for Pricing of Services
Patronage and User Base-Related Objectives
Develop a User Base
• Encourage trial and adoption of a service. This is especially important for new
services with high infrastructure costs, and for membership-type services that
generate a large amount of revenues from their continued usage after adoption
(e.g., cell phone service subscriptions or life insurance plans).
• Build market share and/or a large user base, especially if there are large
economies of scale that can lead to a competitive cost advantage (e.g., if
development or fixed costs are high), or network effects where additional users
enhance the value of the service to the existing user base (e.g., Facebook and
LinkedIn).

12
Objectives for Pricing of Services
Strategy-Related Objectives
Support Positioning Strategy
• Help and support the firm’s overall positioning and differentiation strategy (e.g., as
a price leader or as a premium quality provider).
• Promote a “We-will-not-be-undersold” positioning, whereby a firm promises the
best possible service at the best possible price. That is, the firm wants to
communicate that the offered quality of service products cannot be bought at a
lower cost elsewhere.
Support Competitive Strategy
• Discourage existing competitors to expand capacity.
• Discourage potential new competitors to enter the market.

13
I. Pricing Strategy Stands on Three Foundations

Outline the
foundations of a
pricing strategy as
represented by
the pricing tripod.

14
 1. Cost-Based Pricing

• Establishing the Costs of Providing Service.

– Fixed, semi-variable, and variable costs, contribution and
break-even analysis
• Activity-Based Costing.
– Indirect costs are linked to the variety and complexity of
services produced and not just on physical volume
• Pricing Implications of Cost Analysis
– A firm must set its price high enough to recover the full costs
of producing and marketing the service and add a sufficient
margin to yield the desired profit.
– Some firms promote loss leaders, which are services sold at
less than full cost to attract customers

15
Cost-Based Pricing

Figure 6.4 Train services have very high infrastructure costs, and variable costs of
transporting an additional passenger are insignificant

16
Marketing Review 6.1

Understanding Costs, Contribution, and Break-Even

Analysis
• Fixed costs are economic costs a supplier would continue to incur (at
least in the short run) even if no services were sold.
• Variable costs refer to the economic costs associated with serving an
additional customer, such as making an additional bank transaction or
selling an additional seat on a flight.
• Semi-variable costs fall in between fixed and variable costs. They
represent expenses that rise or fall in a stepwise fashion as the volume
of business increases or decreases.

17
Marketing Review 6.1

Understanding Costs, Contribution, and Break-Even

Analysis
• Contribution is the difference between the variable cost of selling an
extra unit of service and the money received from the buyer of that
service.
• Determining and allocating economic costs can be a challenging task
in some service operations because of the difficulty of deciding how to
assign fixed costs in a multiservice facility such as a hospital.
• Break-even analysis allows managers to know at what sales volume a
service will become profitable.

18
 2. Value-Based Pricing

• Understanding Net Value.

– Net value equals perceived benefits minus perceived costs.
• Managing the Perception of Value
– Effective communications and personal explanations are
needed to help customers understand the value they receive.

19
 2. Value-Based Pricing

Figure 6.6 Net value equals perceived benefits minus perceived costs
20
Related Monetary and
Nonmonetary Costs
• Related Monetary Costs.
– Customers incur significant financial costs in searching for,
purchasing, and using the service, over and above the
purchase price paid to the supplier.
• Nonmonetary Costs.
– Reflect the time, effort, and discomfort associated with the
search, purchase, and use of a service
– Time costs
– Physical costs
– Psychological costs
– Sensory costs

21
Reducing the Related Monetary
and Nonmonetary Costs
• Working with operations experts to reduce the
time required to complete service purchase.
• Minimizing unwanted psychological costs of
service.
• Eliminating or minimizing unwanted physical
effort.
• Decreasing unpleasant sensory costs of service.
• Suggesting ways in which customers can reduce
associated monetary costs.

22
Defining Total User Costs

23
 2. Value-Based Pricing

Figure 6.7 Blondie seeks her money’s worth from the plumber

24
 3. Competition-Based Pricing

• Price Competition Intensifiers.

– Increasing number of competitors
– Increasing number of substituting offers
– Wider distribution of competitor and/or substitution offers
– An increasing surplus capacity in the industry
• Price Competition Inhibitors.
– Non-price-related costs of using competing alternatives are
high
– Personal relationships
– Switching costs are high
– Services are often time and location specific

25
Defining Total User Costs
Which clinic would you patronize if you needed a chest X-ray
(assuming that all three clinics offer good technical quality)?
Clinic A Clinic B Clinic C
• Price $95 • Price $165 • Price $255
• Located 1 hour away by • Located 15 minutes • Located next to your
car or transit away by car or transit office or college building
• Next available • Next available • Next available
appointment is in 3 appointment is in 1 appointment is in 1 day
weeks week • Hours: Monday to
• Hours: Monday to • Hours: Monday to Saturday, 8:00 a.m. to
Friday, 9:00 a.m. to 5:00 Friday, 8:00 a.m. to 10:00 p.m.
p.m. 10:00 p.m. • By appointment;
• Estimated waiting time • Estimated waiting is estimated waiting time
is about 2 hours about 30–45 minutes is 0–15 minutes

26
 II. Revenue Management:
What It Is And How It Works
• Revenue management is important in value
creation.
• Ensures better capacity utilization and reserves
capacity for higher-paying segments.
• A sophisticated approach to managing supply and
demand under varying degrees of constraint.
• Also known as yield management.

27
Revenue Management:
What It Is And How It Works

Figure 6.13 Golf courses have a high fixed cost structure, so it benefits them to
implement revenue management

28
Revenue Management:
What It Is And How It Works
• In practice, revenue management involves setting
prices according to predicted demand levels
among different market segments.
• The least price-sensitive segment is the first to be
provided capacity, paying the highest price; other
segments follow at increasingly lower prices.

29
Revenue Management:
What It Is And How It Works
• Because higher-paying segments often book closer
to the time of actual consumption, firms need a
disciplined approach to save capacity for them
instead of simply selling on a first-come, first-
served basis.

30
Setting Capacity Allocation Targets by
Segment for a Hotel

The figure above is an illustration of the capacity allocation in a hotel setting, where
demand from different types of customers varies not only by day of the week but also
by season.
31
Measuring the Effectiveness of a Firm’s
Revenue Management Strategy
• Maximizing the revenue per available capacity for
a given space and time unit (RevPAST)
• Success in revenue management means increasing
RevPAST
• Competitors’ pricing affect revenue management
• Price elasticity

32
How Does Competitors’ Pricing Affect
Revenue Management?
• Because revenue management systems monitor
booking pace, they indirectly pick up the effects of
competitors’ pricing.
• For example, if an airline prices a flight too low, it
will experience a higher booking pace and its
cheaper seats fill up quickly.
• If the initial pricing is too high, the firm will get too
low a share of early booking segments and may
later have to offer deeply discounted “last-
minute” tickets to sell excess capacity.
33
Price Elasticity

The concept of elasticity describes how sensitive

demand is to change in price and is computed as
follows:

34
Illustration of Price Elasticity

Figure 6.15 Illustration of price elasticity

• This figure shows the price elasticity for two segments, one with
highly elastic demand and the other with highly inelastic demand.
• To allocate the price capacity effectively, the revenue manager
needs to find out how sensitive demand is to price and what net
revenues will be generated at different price points for each target
segment.
35
Designing Rate Fences
• Price customization — charging different customers
different prices for the same product

• Rate Fences can be either physical or nonphysical.

– physical fences refer to tangible product differences related to the
different prices
– nonphysical fences refer to differences in consumption, transaction, or
buyer characteristics, but the service is basically the same

36
 Key Categories of Rate Fences:
Physical (Product-Related) Fences

Product-Related Fences
Rate Fences Examples
Basic Product  Class of travel (Business/Economy class)
 Size and furnishing of a hotel room
 Seat location in a theater
Amenities  Free breakfast at a hotel, airport pick up,
etc.
 Free golf cart at a golf course
Service Level  Priority wait listing
 Increase in baggage allowances
 Dedicated service hotlines
 Dedicated account management team
Key Categories of Rate Fences:
Non Physical Fences

Transaction
Characteristics
Rate Fences Examples
Time of booking or  Requirements for advance purchase
reservation  Must pay full fare two weeks before
departure
Location of booking  Passengers booking air tickets for an
or reservation identical route in different countries are
charged different prices
Flexibility of ticket  Fees/penalties for canceling or changing a
usage reservation (up to loss of entire ticket
price)
 Non-refundable reservation fees
 Key Categories of Rate Fences:
Non Physical Fences

Consumption
Characteristics
Rate Fences Example
Time or duration of  Early bird special in restaurant before 6pm
use  Must stay over on Sat for airline, hotel
 Must stay at least five days
Location of  Price depends on departure location,
consumption especially in international travel
 Prices vary by location (between cities, city
centre vs. edges of city)
Key Categories of Rate Fences:
Non Physical Fences

Buyer Characteristics

Rate Fences Examples

Frequency or volume  Member of certain loyalty tier with the

of consumption firm get priority pricing, discounts or
loyalty benefits
Group membership  Child, student, senior citizen discounts
 Affiliation with certain groups (e.g.,
Alumni)
Size of customer  Group discounts based on size of group
group
Relating Price Buckets to The Demand
Curve
• A good understanding of the demand curve is
needed so that “buckets” of inventory can be
assigned to the various products and price
categories.

41
Relating Price Buckets to The Demand
Curve

An example from the airline industry is shown

below.

Shaded areas denote amount of consumer surplus (the

goal of segmented pricing is to reduce this). 42
Fairness and Ethical Concerns in Service
Pricing
Factors contributing to unethical pricing behavior
• Service Pricing is Complex
– Quoted prices used by consumers for price comparisons may
be only the first of several charges that can be billed
– Pricing is mostly based on usage-related factors
– Consumers find it difficult to forecast their own usage
• Piling on the Fees
– “Hidden extras”
– Adding (or increasing) fines and penalties

43
Designing Fairness into Revenue
Management
• Designing price schedules and fences that are
clear, logical, and fair
• Using high-published prices and frame fences as
discounts
• Communicating consumer benefits of revenue
management
• “Hiding” discounts through bundling, product
design and targeting
• Taking care of loyal customers
• Using service recovery to compensate for
overbooking
44
Certain Service Recovery Procedures
• Giving customers a choice between retaining their
reservation or receiving compensation
• Providing sufficient advance notice for customers
to make alternative arrangements
• Offering a substitute service that delights

45
Designing Fairness into Revenue
Management

Figure 6.21 Limousine service providers usually charge for no shows

46
 Putting Service
Pricing into Practice
 III. Pricing Issues:
Putting Strategy into Practice

3. Who
1. How 2. What
should
much to basis for
collect
charge? pricing?
payment?
4. Where 5. When 6. How
should should should
payment be payment be payment be
made? made? made?

7. How to
communica
te prices?
III. Putting Service Pricing into Practice

 How much to charge?

1. How
 Pricing tripod provides a useful starting point
much to
charge?
 A specific figure must be set for the price
 Need to consider the pros and cons, and ethical
issues

2. What
 What basis for pricing? basis for
pricing
 Completing a task
 Admission to a service performance
 Time based
 Monetary value of service delivered (e.g.,
commission)
49
III. Putting Service Pricing into Practice

• Who should collect payment? 3. Who

should
– Service provider or specialist collect
intermediaries payment?

– Direct or non-direct channels

4. Where
• Where should payment be made? should
payment be
– Conveniently located intermediaries made?
– Mail/bank transfer
• When should payment be made? 5. When
should
– In advance payment be
made?
– Once service delivery has been completed

50
III. Putting Service Pricing into Practice

• How should payment be made?

6. How
– Cash should
payment be
– Token made?
– Stored value card
– Electronic fund transfer
– Charge Card (Debit/Credit)
– Vouchers 7. How to
communica
• How to communicate prices? te prices?
– Relate the price to that of competing
products
– Ensure price is accurate and intelligible
51
Conclusion

• To determine an effective pricing strategy, a firm

has to have a good understanding of its costs, the
value created for customers, and competitors’
pricing.
• Revenue management is a powerful tool that
helps to manage demand and price different
segments closer to their value perceptions.
• Pricing strategy must address the central issue of
what price to charge for a given unit of service at a
particular point in time.
52
Conclusion

• If pricing schedules become so complex and hard

to compare, it:
– can confuse customers
– can lead to accusations of unethical
behavior
– causes loss of trust
– causes customer dissatisfaction.

53