Approaches to Pricing Services

Answer 1

Cost - Based Pricing

• Price = Direct costs + Overhead costs + Profit margin.

• ( Direct costs involve materials and labour that are associated with delivering the service, overhead costs are a share of fixed costs, and the profit margin is a %age of full costs( direct + overhead)

Problems with cost - based pricing

• Costs are difficult to trace.

• Labour is more difficult to price than materials.

• Costs may not equal the value the customers perceive the services are worth

• Cost - based pricing is used in construction, engineering, advertising.

• Hourly fee usually charged for consultancy or by lawyers.

Competition- based pricing

Focuses on the prices charged by other firms in the same industry and market. This approach usually works where services are standard (eg dry- cleaning) or where there are oligopolies (a few large service providers, as in airlines)

Problems

• Small firms may charge too little and not make adequate margins. Many small establishments cannot deliver services charged by chain operators.

• Heterogeneity of services across and within providers also makes it difficult for a firm to follow this approach. (eg different banks have different charges for making D.D.s.

• Price signaling occurs in a market with a high concentration of sellers. Any price offered by one company will be matched by competitors to avoid giving a low- cost seller an advantage eg airlines.

• Going - rate pricing involves charging the most prevalent rate in the market. ( eg Taxi operators in NCR). For years the rates set by Hertz for car rentals were matched by all others.

Demand - based pricing

This involves setting prices in accordance with customer perceptions of value. Price is based on what the customer will pay for the services provided. In this approach non - monetary costs and benefits must be factored into the calculation of perceived value.

Problem

• When services require time, inconvenience, psychological and search costs, the monetary price must be adjusted to compensate.

• And when services save time, inconvenience psychological and search costs, the customer is willing to pay a higher monetary price.

• The challenge is to correctly assess the value to customers of each of the non- monetary aspects involved.