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Managing Price and Profits

Terms for price in service organisation


Universities Tuition Professional firms-- fees Banks Interest and service charge

Brokers Commission
Insurance companies---premium

Roadways---toll

What Makes Service Pricing Strategy Different?


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
A. Seek profit 1. 2.

Make the largest possible contribution or profit Achieve a specific target level, but did not seek the

maximum profit
3.

Maximum revenue from a fixed capacity by varying prices and target segment overtime, typically using yield or revenue management system

Objectives of Pricing Strategies


B. Cover costs
1. Cover fully allocated cost , including institutional

overhead
2. Cover cost of providing one particular service excluding

overhead
3. Cover incremental cost of selling one extra unit of one

extra customer

Objectives of Pricing Strategies


Patronage and user base-related objectives

A. Build demand
1.

Maximize demand (when capacity is not a constraint ), subject

to achieving a certain minimum level of revenues


2.

Achieve full capacity utilization , especially when high capacity utilization adds to the value created for all customers . Ex. Full

house adds excitement to theater play or basket ball games

Objectives of Pricing Strategies


B. Build a user base
1.

Stimulate trial and adoption of service . This is specially important


for new services with high infrastructure cost and for membership type services that generate significant revenues from their continued use after adoption ( e.g. mobile phone service subscription and life insurance plans)

2.

Build market share and / or a large user base , especially if there are significant economies of scale that can lead to a competitive cost advantage ( ex. If development of fixed cost are high)

The Pricing Tripod


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

Cost Based Pricing


Its usually more difficult to establish the costs involved in producing

an intangible performance than it is associated with producing

physical good
Labour and infrastructure needed to create performance , many

service organizations have much higher ratio of fixed cost to

variable cost than it is found in manufacturing firm.


The traditional cost based approach is use in service organisation in

which cost must be estimated in advance


ex. Construction , engineering advertising , many professional

services etc.

Cost Based Pricing


Major difficulty in cost based approach involves defining

the units in which a service is purchased


For this reason many services are sold in terms of input

rather than units of measured output


Ex professional services such as consulting , engineering

, architecture, tutorials are sold by an hour


For complex product line with shared infrastructure ( ex. Retail

banking products) it may be worthwhile to use ABC approach

Cost Based Pricing


Cost= Fixed Cost + semi variable cost+ variable cost Fixed Cost: are those economic costs that supplier would continue to incur, even if no service sold. Ex. Rent ,depreciation, utilities , taxes insurance salaries and wages , securities and interest payment Variable cost : the economic costs associated with serving an additional customer. Selling an additional seat on a flight, making an additional bank transaction In may sercices such cost are very low . For instance , very little labour or fuel cost is involved in transporting an extra passenger and higher cost in case of parts to repairs. Semi variable costs: fall in fixed and variable and represent expenses that rise or fall in a stepwise fashion as the volume of business increase or decrease. Ex. Adding an extra flight to meet increase demand

Cost Based Pricing


Contribution = difference between the variable cost of selling an extra unit of service and money received from the buyer of that service Determining and allocating economic cost Difficult to assign fixed costs in a multiservice facility Ex. In hospital fixed cost is allocated to emergency share of overhead on one of the way i.e. , Percentage of floor area occupied, employee hours, or to the percentage of total patient contact one of this approach may show profit making other loss making operation Break-Even Point : sales volume will be profitable

Activity-Based Costing: Relating Activities to the Resources They Consume


Managers need to see costs as an integral part of a firms 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

Activity-Based Costing: Relating Activities to the Resources They Consume


ABC analysis begins with the identification of various

activities being performed and then determine the cost of each activity as it relates to each expense category.
Unit level activities Batch level activities

Competition based pricing


This approach focus on pricing charge by the

other firms in the same industry or market as an anchor for the firms price This approach use in two situations: 1. When services are standard across providers Ex. Dry cleaning industry 2. In oligopoly with a few large service providers Ex. Airline industry

Increase in Price Competition


1. 2. 3. 4.

Increase in number of competitors Increasing number of substituting offers Increasing surplus capacity in Industry Wider distribution of competitor

Reduce in Price Competition


1.

Non price related costs of using alternatives are high (Save time or effort are more important to customer )

2.

Personalization , customization and switching cost matters ( hair Styling , family medical care discouraging them from competitive offer )

3.

Time and location specificity reduce choice( Ex Bank near to your home )

Value Based Pricing


No customer will pay more for a service than he or she

thinks it is worth. To set an appropriate price , marketer needs to understand how customer perceive service value
Understanding Net Value
When customers purchase a service , they are weighing the

perceived benefits obtained from the service against the perceived cost they will incur. People are willing to pay higher price to reduce the nonmonetary cost of service

Four meaning of perceived value


Customer define value in four ways 1. Value is low price

Dry cleaning value means the lowest price Discounting, Odd pricing, Penetration pricing 2. Value is whatever I want in product or service MBA : Value is best education I can get Prestige pricing, Skimming pricing 3. Value is the quality I get for the quality I pay Hotel for vacation: Value is the price first and quality second Value pricing, Market Segmentation pricing 4. Value is what I get for what I give For a hairstyle : value is what I pay in cost and time for the look I get Price framing , Price bundling

Net Value = (Benefits Outlays)

Effort Time

Perceive d Benefits

Perceived 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 Customers Perspective


Customer expenditures on service comprise both financial 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)

Trading off Monetary and NonMonetary Costs (Fig. 6.5)


Which clinic would you patronize if you needed a chest xray (assuming all three clinics offer good quality) ? Clinic A
Price Rs 45 Located 1 hour away by car or transit Next available appointment is in 3 weeks Hours: Monday Friday, 9am 5pm Estimated wait at clinic is about 2 hours

Clinic B
Price Rs 85 Located 15 min away by car or transit Next available appointment is in 1 week Hours: Monday Friday, 8am 10pm Estimated wait at clinic is about 30 - 45 minutes

Clinic C
Price Rs 125 Located next to your office or college Next appointment is in 1 day Hours: Mo Sat, 8am 10pm By appointment estimated wait at clinic is about 0 to 15 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

Price Elasticity
Price per unit of service
Di De

De Di

Quantity of Units Demanded


De : 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.

Pricing Issues: Putting Strategy into Practice


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?

Comparative study of any four mobile service provider pricing schedule on the following dimensions Air time , Subscription fees Free minutes Per second/ minute bills Usage profile of customer

From a customer perception , what serves to

define value in the following services: A hairdressing salon A legal firm specializing in business and taxation law A nightclub

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