PRICING STRATEGIES OF SERVICES

8.1 Introduction of Pricing Strategy

Once the pricing objectives are understood, we can focus on pricing strategy. The
foundations of pricing strategy can be described as a tripod, with costs to the provider,
competitors’ pricing, and value to the customer as the three legs. In the pricing tripod, the costs a
firm needs to recover usually set a minimum
price or price floor for a specific service
offering. The customer’s perceived value of
the offering sets a maximum price or price
ceiling.
The prices charged by competing
services typically determine where within the
floor-to-ceiling range the price can be set.
Let’s look at each leg of the pricing tripod in
greater detail, starting with costs to the
provider.
8.2 Cost-Based Pricing
It’s usually harder to determine the
financial costs of creating a process or intangible real time performance than of producing a
physical good. In addition, service organizations typically have a higher ratio of fixed costs to
variable costs than manufacturing firms. Service businesses with high fixed costs include those
with expensive physical facilities (such as hospitals or colleges), a fleet of vehicles (such as
airlines or trucking companies), or a network (such as railroads, telecommunications, and gas
pipeline companies).
Establishing the Costs of Providing Service: Even if you have already taken a marketing
course, you may find it helpful to review how service costs can be estimated using fixed, semi-
variable, and variable costs. It is also important to understand how the notions of contribution and
break-even analysis can help in making pricing decision.
Activity-Based Costing: For service firms with high fixed costs and complex product
lines with shared infrastructure (e.g., retail banking), it may be worthwhile to consider the more
complex activity-based costing (also called “ABC”) approach. It is a more accurate way to
allocate indirect costs or overheads.
When determining the indirect cost of a service, a firm looks at the resources needed to
perform each activity. It then allocates an indirect cost to the service based on the quantities and
types of activities required to create and deliver the service. Thus, resource expenses (or indirect
costs) are linked not only to physical volume but also to the variety and complexity of services
produced. If the activity-based costing approach is implemented well, firms will be in a better
position to estimate the costs of their various services, activities, and processes. The net result is a
management tool that can help companies to pinpoint the profitability of different services,
channels, market segments, and even individual customers.
Pricing Implications of Cost Analysis: To make a profit, 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 at the predicted sales volume.
Managers in businesses with high fixed and marginal variable costs may feel that they
have tremendous pricing flexibility. This may prompt them to set low prices to boost sales. Some
firms promote loss leaders, which are services sold at less than full cost to attract customers. It is
hoped that these customers will then be tempted to buy more profitable service offerings from the
same organization in the future. However, if all relevant costs are not recovered, service
businesses will have no profit at the end of the year and may even go bankrupt. Hence, firms that
compete on low prices need to have a very good understanding of their cost structure and of the
sales volumes needed to break even.
8.3 Value-Based Pricing
Another leg of the pricing tripod is value to the customer. No customer will pay more for a
service than he or she thinks it is worth. Marketers need to understand how customers perceive
service value in order to set an appropriate price.
Understanding Net Value: When customers purchase a service, they weigh the perceived
benefits of the service against the perceived costs they will incur. However, customer definitions
of value may be highly personal and idiosyncratic. Valarie Zeithaml proposes four broad
expressions of value:
 Value is a low price.
 Value is whatever I want in a product.
 Value is the quality I get for the price I pay.
 Value is what I get for what I give.
In this book, we focus on the fourth category and use the term net value, which is the sum
of all the perceived benefits (gross value) minus the sum of all the perceived costs of the service.
The greater the positive difference between the two, the greater the net value. You can think of
calculations that customers make in their minds as being similar to weighing with a pair of old-
fashioned scales, with product benefits in one tray and the costs associated with obtaining those
benefits in the other tray. When customers evaluate competing services, they are basically
comparing the relative net values.
Managing the Perception of Value: Since value is subjective, not all customers have the
skills or knowledge to judge the quality and value they receive. This is true especially for
credence services, the quality of which customers cannot assess even after consumption.
Marketers of services such as strategy consulting and specialized hospitals must find ways to
communicate the time; research, professional expertise, and attention to detail that go into, for
example, completing a best-practice consulting project. This is because the invisibility of back-
stage facilities and labor makes it hard for customers to see what they’re getting for their money.
Therefore, the service provider has to manage their perception of value.
Consider a home owner who calls an electrician to repair a defective circuit. The
electrician arrives, carrying a small bag of tools. He disappears into the closet where the circuit
board is located, finds the problem, replaces a defective circuit breaker, and presto! Everything
works. A mere 20 minutes have elapsed. A few days later, the home owner is horrified to receive
a bill for $150, most of which covers labor
charges.
Effective communications and even
personal explanations are needed to help
customers understand the value they receive.
Customers often fail to recognize the fixed costs
that business owners need to recoup. The
electrician in our earlier example has to cover
the costs for his office, telephone, insurance,
vehicles, tools, fuel, and office support staff.
The variable costs of a home visit are
also higher than they appear. To the 20 minutes
spent at the house, 15 minutes of driving each
way might be added, plus 5 minutes each to unload and reload the necessary tools and supplies
from the van. Thus, the labor time devoted to this call is effectively tripled to a total of 60
minutes. The firm still has to add a margin in order to make a profit.
A firm can create competitive advantage and increase consumer value by minimizing non-
monetary and related monetary costs. Possible approaches include:
 Working with operations experts to reduce the time required to complete service purchase,
delivery, and consumption; becoming “easy-to-do-business-with.”
 Minimizing unwanted psychological costs of service at each stage by eliminating or
redesigning unpleasant or inconvenient procedures, educating customers on what to expect,
and retraining staff to be friendlier and more helpful.
 Eliminating or minimizing unwanted physical effort, notably during search and delivery
processes. Improving signage and “road mapping” in facilities and on webpages can help
customers find their way and prevent them from getting lost and frustrated.
 Decreasing unpleasant sensory costs of service, such as by creating more attractive visual
environments, reducing noise, installing more comfortable furniture and equipment, and
curtailing offensive smells.
 Suggesting ways in which customers can reduce associated monetary costs, including
discounts with partner suppliers (e.g., parking) or the online delivery of services that
previously required personal visits.
Perceptions of net value may vary widely among customers. Most services have at least two
segments—one that spends time to save money and another that spends money to save time.
Therefore, many service markets can be segmented by sensitivity to time savings and
convenience versus price sensitivity. Consider which identifies a choice of three clinics
available to an individual who needs to obtain a routine chest X-ray. Each offering involves not
only varying dollar prices but also different time and effort costs. Depending on the customer’s
priorities, non-monetary costs may be as important, or even more important, than the price
charged by the service provider.
8.4 Competition-Based Pricing
The last leg of the pricing tripod is competition. Firms with relatively undifferentiated
services need to monitor what competitors are charging and price their services accordingly.
When customers see little or no difference between competing offerings, they may simply choose
what they perceive to be the cheapest. In such a situation, the firm with the lowest cost per unit of
service enjoys an enviable market advantage and often assumes price leadership (i.e., one firm
acts as the price leader, with others taking their cue from this company). You can sometimes see
this phenomenon at the local level when several gas stations compete within a short distance of
one another. As soon as one station raises or lowers its prices, the others follow suit.
Price-Competition Intensifiers: Price-competition intensifies with:
 Increasing number of competitors,
 Increasing number of substituting offers,
 Wider distribution of competitor and/or substitution offers, and
 Increasing surplus capacity in the industry.
Price-Competition Inhibitors: Although some service industries can be fiercely
competitive (e.g., airlines and online banking), not all are, especially when one or more of the
following circumstances reduce price competition:
 Non-price-related costs of using competing alternatives are high: When saving time
and effort are of equal or greater importance to customers than price in selecting a
supplier, the intensity of price competition is reduced. Competing services have their own
 sets of related monetary and non-monetary costs. Therefore, the actual prices charged
sometimes become secondary for competitive comparisons.
 Personal relationships matter: For services that are highly personalized and customized,
such as hairstyling or family medical care, relationships with individual providers are often
very important to customers and discourage them from responding to competing offers.
Many global banks, for example, prefer to focus on wealthy customers in order to form
long-term personal relationships with them.
 Switching costs are high. When it takes effort, time, and money to switch providers,
customers are less likely to take advantage of competing offers. Cell phone service
providers often require one- or two-year contracts from their subscribers and charge
significant financial penalties for early cancellation of service. Likewise, life insurance
firms charge administrative fees or cancellation charges when policy holders want to
cancel their policy within a certain time period.
 Time and location specificity reduces choice. When people want to use a service at a
specific location or at a particular time (or perhaps both), they usually find that they have
fewer options. This reduces price competition.
This pricing is based on what the competitor is offering. A service firm uses this method to
make an entry in the market, finding an appropriate price bracket for its service offer - without
having to go through a trial and error process - by pegging itself to the competition. The service
marketer needs to be astute enough to recognize who his competition is. The competition could be
from firms offering the same services fulfilling similar needs (direct competition - State Bank of
India versus Canara Bank), different services fulfilling similar needs (substitute competition - a
restaurant versus movie theatre versus discotheque) or similar services fulfilling different needs
(indirect competition - a theme park like Essel world catering to tourists, lovers, recreationists,
shoppers etc.)
8.4.1 Going Rate Pricing: This is used in those services where cost levels are difficult to
establish, and a going rate is preferred.
Example: In one street a cluster of restaurants (.Khau gali. and .Chowpatty. in Mumbai,
Chhappan Dookaan. and .Sarafa. in Indore, .Paranthe wala Gali. in Delhi, etc.) serve basically the
same fare at the same prices. The same is true for apparel stores, electronics or books in one street
(Fashion Street and Heera Panna. in Mumbai). Charging a going rate is an easy way to avoid
calculation of costs.
8.4.2 Sealed-bid pricing: This is the system of tenders and quotations where bids are received
from service providers. Thus housekeeping, restaurant and canteen contracts, security services,
fleet operations, etc., are usually awarded on the basis of predetermined specification fulfilment
and their offer price. The appropriate price and therefore the provider are chosen.
8.4.3 Pricing below the Competition: Here the new entrant of service provider will offer his
price below the competition, with the full intention of increasing his market share at the time of
consideration. Thus, an airline that intends to slash its prices will definitely acquire more
customers trading off against profitability. The danger to this approach is that the service marketer
might price himself out of business or might invite price retaliation. This will increase
commoditisation of the service, make customers very price sensitive and may forever remove
concepts of value and brands. The size of the market actually comes down. Often, cash discounts
are offered. Certain service providers, like discount retailers, base their lower-than-the-
competition price on low mark-up, high volume and minimal service.
8.4.4 Pricing above the Competition: This kind of pricing works only for premium or very
distinctive services. If the target market is class (foreign banks, high-end boutiques like Sheetal,
Concorde aircraft flights, up-market restaurants, etc.) as opposed to mass, then this pricing method
works. But if there is a general recession, then above-the-market pricing is un-sustainable.

EFFECTIVENESS OF SERVICES REVENUE MANAGEMENT

9.1 Introduction of Revenue Management
It is essential for every company, whether small or big, to have a revenue management
process for sustainable growth. In today’s market, many companies are coming and going. Still,
only a few of them can become stable. Implementing high-quality Revenue Management is
crucial to get established in the market.
Revenue Management is a business practice used to maximize revenue under certain
conditions. In today's blog post, we're going to look at some examples of revenue management
that have been around for a long time.
Many service organizations have built their success on being customer oriented –
managing the entire organization and employees toward building long term customer relationships
and delivering outstanding service, meeting customer needs. Total quality management
philosophy needs to be rethought and recreated in the context of recent global transformations that
make the shift to global quality management (Sitnikov, 2008). In recent years, an increasing
number of service organizations have also recognized the rapidly growing importance of yield
management, also referred to as revenue management. As a result, they have taken steps to propel
their yield management initiatives out of the realm of information technology and decision science
into the center of marketing strategies and decision making.
9.2 What is Revenue Management - Meaning
Revenue management, also known as yield management, refers to a pricing strategy in
which the prices of goods/services are set depending on the consumer demand at any point in
time. Revenue management is also known as yield management. It is the combination of pricing
and strategies to increase production. Many companies have services and products whose costs
may vary depending upon the situation. Airline seats, for instance, are sold at different pricing on
different days based on what travelers are willing to pay.
Revenue Management: What It Is and How It Works
Many service businesses now focus on strategies to maximize the revenue (or
contribution) that can be obtained from the available capacity at any given point in time. Revenue
management is important in value creation as it ensures better capacity utilization and reserves
capacity for higher-paying segments. It’s a sophisticated approach to the management of supply
and demand under varying degrees of constraint.
Airlines, hotels, and car rental firms in particular, have become adept at varying their
prices in response to the price sensitivity and needs of different market segments at different times
of the day, week, or season. Hospitals, restaurants, golf courses, on-demand IT services, data-
processing centers, concert organizers, and even non-profit organizations are also increasingly
using revenue management. It is most effective when applied to service businesses characterized
by:
 High fixed-cost structure and relatively fixed capacity, which result in perishable inventory
 Variable and uncertain demand
 Varying customer price sensitivity
9.3 The Advantages of Revenue Management
Revenue management (RM) or Yield management has been practiced at the airline (1992),
Hotels (1992), and auto rental businesses (1995) for almost two decades, and has recently
attracted Interest in other sectors, including the subscription management industry.
 Revenue management's primary goal is to sell the right product at the right price to the
right customer. After they decided to implement a flexible pricing approach, the airline industry
started the practice depending upon the demand to maximize each ticket's value to ensure they
recover the losses (empty seats).
Revenue Management can help a company predict products or services demand and
customer's wants and needs. It can also help in setting up an effective pricing strategy to maximize
profits and minimize losses.
There are some of the other benefits of Revenue Management, such as:
1. Revenue Management helps companies understand what their customer expects in their
products or services.
2. Revenue Management helps in increasing the products and services demand with adequate
& flexible pricing policies.
3. Revenue Management helps a company stay ahead of their competition by creating a
competitive pricing strategy to draw new customers.
4. Revenue Management helps in avoiding overbooking that could lead to high-losses.
5. Revenue Management helps improve workflows and adjust the human resources involved
in the company's administration or enterprise.
Revenue Management helps companies with the chance of creating a new effective program
by coordinating the working divisions of a company.
9.4 How to Increase Revenue with the help of Yield Management?
A business needs to follow the right process for attaining sustainable growth and
appropriate profit increment to increase revenue with the help of Yield Management. The goal is
to increase the revenue and profit; revenue is the total amount generated after the sale of a product
or service, and profit is the income remains after accounting all the expenses (production cost,
resources, and marketing cost).
For example, if you are selling a subscription-based food product and the production cost
of that product is $20, you sell this product for $25 each, so you are making $5 profit on each sale.
But, you forgot to add $5 marketing expense to market the product. After adding the $5, your total
product’s cost is $25, i.e., the same price you are selling the product for.
Always remember that revenue and profit are two different things. So, how do you
increase your revenues the right way using the Yield Management process? A key to becoming a
high-performing organization is the ability to find new ways to generate revenues. You can do this
in many ways, but we’re going to discuss the seven essential Yield Management processes that
can guarantee substantial revenue gains.
9.4.1 Offer new products/services: Selling new products and services is one of the
effective ways to increase revenue. Put yourself in your customer’s shoes. If you were them and
you were buying one of your products, what else would complement it? An example of this would
be cross-selling products or services.
9.4.2 Increase your customer base: Keep utilizing different strategies that could help in
increasing your customer base. For example, create blog posts that educate customers, offer a
discount for new customers, promote your business on social media platforms, and offer excellent
customer service.
9.4.3 Increase your prices: Increasing your prices sounds simple enough, but be very
careful and base your price adjustments on research. A company must justify the price increase to
its customers to be successful in implementing the new prices. You can do this by increasing the
perceived value to differentiate your product from your competitors.
 9.4.4 Increase repeat purchases: In Addition to increasing your prices, you can also
increase repeat purchases or sales by selling more to your existing customers. Establish a good
reputation with your customers, and they will be willing to explore new businesses with you.
9.4.5 Increase your net margin on sales: If your net margin on sales is low, your
business will struggle to examine your customers' profitability. You may find that some segments
and customers provide you the highest returns on purchases.
Another excellent approach for increasing revenue is to meet with other business
owners who sell a non-competing (or even better complementary) product that can pay off
huge - and often long term. And, if what you have is genuinely integral, it also helps your
customer. Customers would much rather go to a business that was referred by someone
they know and trust rather than finding it through advertisement.
9.5 Revenue Management Strategies
Revenue Management is vital for every business because it can help you sell your product
or service drastically for higher or lower prices depending upon the demands. It is essential to
utilize the amount coming in from revenues to cover the fixed-cost of a product or service.
Alternatively, one can apply a Revenue Management strategy for ensuring predictable income and
growth.
9.5.1 Applying Dynamic Pricing: Understanding and implementing the right dynamic
pricing for your product or service is vital. Nowadays, especially if you are in the Hotel or Airline
industry, the pricing of a room or a flight ticket changes frequently depending on the demands.
You can use your sales history to balance between under pricing and overpricing your product or
service prices in response to demand and supply, the same as they do for a Hotel room or a flight
ticket.
9.5.2 Integrating PMS: A Property Management System (PMS) or Central Reservation
System (CRS) allows hoteliers to expand its industry reach and to maximize its product or service
bookings and distribution channels.
9.5.3 Analyzing Data: Analyze your past data, including sales, customers, churn rates,
revenues, profits, cost of production, marketing costs, and any other useful information related to
your business that could increase your income. The goal here is to study the data and implement
the successful strategies that lead to increased revenue in the past.
9.5.4. Tracking Competition: It is crucial to monitor and track your industry’s
competition continually. Find exclusive opportunities and avoid failures by following your
competitor’s strategy. Don’t mimic your competitors, find out their USP & weakness, and
implement your path across it to be ahead of them all of the time.
9.6 Measure the Effectiveness of a Firm’s Revenue Management
Many capacity-constrained service organizations use percentage of capacity sold as a basic
indicator of success. For instance, airlines talk of “load factor,” hotels of “occupancy rate,” and
hospitals of “census.” Similarly, professional firms monitor the proportion of their partners’ and
associates’ time that counts as “billable hours.” However, by themselves, these percentages tell us
little about the relative profitability of the business attracted, since high usage rates may simply be
a reflection of heavy discounting.
Success in revenue management is generally defined as maximizing the revenue
per available capacity for a given space and time unit (RevPAST). For example, airlines
seek to maximize revenue per available seat kilometer (RevPASK); hotels try to maximize
their revenue per available room night (RevPAR); and performing arts centers try to
maximize their revenue per available seat performance. These indices show the interplay
between capacity utilization and average rate or price achieved. They can be tracked over
 time and benchmarked across firms as well as operating units within a service firm (e.g.,
across hotel properties in a larger chain).
9.7 Price Elasticity
For revenue management to work effectively, there must be two or more segments
that attach different values to the service and have different price elasticities. The concept of
elasticity describes how sensitive demand is to changes in price. It is computed as follows:
% Change∈Demand
Price Elasticity=
% Change∈Price
When price elasticity is at “unity,” sales of a service rise (or fall) by the same percentage
that price falls (or rises). If a small change in price has a big impact on sales, demand for that
product is said to be price elastic. If a change in price has little effect on sales, demand is
described as price inelastic. The concept is illustrated in the simple chart presented in Figure 6.18,
which shows the price elasticity for two segments—one with a highly elastic demand and the
other with a highly inelastic demand. To allocate and 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.
9.8 Fairness and Ethical Concerns in Service Pricing
Do you sometimes have difficulty understanding the cost of using a service? Do you
believe that many prices are unfair? If so, you’re not alone.
9.8.1 Service Pricing Is Complex: Pricing for services tends to be complex and hard to
understand. Comparisons across providers may even require complex spreadsheets or
mathematical formulas. Consumer advocates sometimes allege that service suppliers deliberately
choose this complexity to reduce price competition. They don’t want customers to be able to
determine which firm offers the best value for money and therefore reduce price competition. In
fact, complexity makes it easy (and perhaps more tempting) for firms to engage in unethical
behavior.
For example, cell phone companies have a confusing variety of plans to meet the distinct
needs and usage patterns of different market segments. Plans can be national, regional, or purely
local in scope. Monthly fees vary according to the number of minutes and mobile data capacity
selected in advance. There can be separate allowances for peak and off-peak minutes. Overtime
minutes and “roaming minutes” on other carriers are charged at higher rates. Some plans allow
unlimited off-peak calling, while others have free incoming calls. Data plans (including features
such as being allowed to roll over unused mobile data to the next month), hand-set subsidies for
new phones, roaming fees, family and bundled plans that can include several cell phones and
other mobile devices, landlines, and internet services add further to this complexity. In addition,
many people find it difficult to forecast their own usage, and this makes it even harder for them to
compute comparative prices when evaluating competing suppliers whose fees are based on a
variety of usage-related factors.
9.8.2 Piling on the Fees: Not all business models are based on generating income from
sales. Today, there is a growing trend of imposing fees that have little to do with usage. In the
United States, the car rental industry has attracted some notoriety for advertising bargain rental
prices and then telling customers on arrival those other fees such as collision insurance and
personal insurance are compulsory. In some Florida resort towns, there were so many “hidden
extras” for car rentals at one point that people started joking: “The car is free, the keys are extra!”
There has also been a trend of adding (or increasing) fines and penalties. Banks have been heavily
criticized for using penalties as an important revenue-generating tool rather than as a means to
educate customers and achieve compliance with payment deadlines.
 9.8.3 Designing Fairness into Revenue Management: Like pricing plans and fees,
revenue management practices can be perceived as highly unfair. Therefore, a well-implemented
revenue management strategy cannot mean blind pursuit of short-term yield maximization. The
following approaches can help firms to reconcile revenue management practices with customers’
fairness perceptions, satisfaction, trust, and goodwill:
9.8.4 Design Price Schedules and Fences That Are Clear, Logical, and Fair: Firms
should proactively spell out all fees and expenses (e.g., no-show or cancellation charges) clearly
in advance so that there are no surprises. A related approach is to develop a simple fee structure so
that customers can easily understand the financial implications of a specific usage situation.
9.8.5 Use High Published Prices and Frame Fences as Discounts: Rate fences framed
as customer gains (i.e., discounts) are generally perceived as fairer than those framed as customer
losses (i.e., surcharges) even if the situations are economically equivalent. For example, a
customer who patronizes her hair salon on Saturdays may perceive the salon as profiteering if she
finds herself facing a weekend surcharge. However, she is likely to find the higher weekend price
more acceptable if the salon advertises its peak weekend price as the published price and offers a
$5 discount for weekday haircuts. Furthermore, a high published price helps to increase the
reference price and related quality perceptions.
9.8.6 Communicate Consumer Benefits of Revenue Management: Marketing
communications should position revenue management as a win-win practice. By providing
different prices and value propositions, firms can enable a broader spectrum of customers to self-
segment and enjoy the service. For example, higher prices can be charged for the best seats in a
theater because some people are willing and able to pay more for a better location. This also
makes it possible to sell other seats at lower prices. When customers become more familiar with
certain revenue management practices, unfairness perceptions are likely to decrease over time.
“Hide” Discounts through Bundling, Product Design, and Targeting: Bundling a
service into a package effectively obscures the discounted price. When a cruise line includes the
price of air travel or ground transportation in the cruise package, the customer knows only the
total price and not the cost of the individual components. Bundling usually makes price
comparisons between the bundles and its components impossible and thereby side-steps potential
unfairness perceptions and reductions in reference prices.