Basic Ideas of how to price your services

Prepared by Rung-jin Ju, MBA The Geroge Washington U

 Instructed by Professor Charles N. Toftoy

Figure 1  Degrees of tanibility and intangibility

 
Characteristics of services

     There are differences between goods and services, which results in special problems for making special marketing efforts.   For example, it is easier for a customer to picture or price a car than to evaluate a training program since the latter provides more intangible assets to customers, such as directors' experiences, and the curriculum.  Since the most fundamental difference is the degree of intangibility, it is important for us to know that "the inherent benefits from a service are intangible assets."  In other words, when we plan to price a service and sell it, we need to understand its intangible values and enhance these values.

(If a product has more intangibility and less physical features, it is more intangible-dominant.)
 
 

Pricing Decisions

Cost Considerations.  Traditionally, people tend to price a service based on cost instead of market orientation.  One way, "the job-jacket", of evaluating human resources is to allocate cost on each account based on how much time is spent on that account.  Also, the cost of overhead is allocated in same way plus expenses for unused time.  The following is the example:

  A consultant in an accounting firm spends 6 hours on an account at a hourly rate.  This rate is equal to his/her Yearly Salary divided by   Total Chargeable Hours in a year.  Suppose he gets paid $100,000 annually and has 2,000 chargeable hours.  His hourly rate would be $50.  Then, assume the Overhead plus unused time cost is $195,000 and there are 13,000 hours of actual time allocated to accounts by all the consultants in the firm.  Thus, the hourly rate for using Overhead would be $15.  Finally, we find out that the cost for this account is $390 (6*$50 + 6*$15).  However, this approach incurs two problems.  First, a time charge based on salary may not well evaluate the individual efforts put in serving customers.  After all, the variation in performing a service is related to education and experience.  Therefore, if only taking time standards as the payment standards, people may tend to be less competent by taking more time to finish the service.   Second, sometimes, it is difficult to allocate fixed costs associated with services and make adjustment for different volumes of business.  In order to prevent the problems described above, some people-oriented service companies have used a "multiple of direct time costs to arrive at total costs.  Generally, the first approach is more suitable for a equipment-intensive service.

Market Considerations.  Many successful service companies found that to innovate constantly is one of answers to deal with the difficulty in equating costs with units of services.  When adding new features to services, the value is added.  But, this kind of value pricing depends on the estimates of how the market will evaluate the service.  That is, the innovations have to fit the major concerns of the target market.
 
 

Service Pricing Strategies.

Cost-Based Pricing.
 

		Cost-plus pricing:  This approach involves charging the customer the cost of service plus a set percentage fee, which is suitable for professional services, such as law, consulting and health care.  Under this approach, the service companies believe that they are delivering more distinctive services to their customers than their competitors.
		Labor-Plus-Materials:  For equipment-intensive services, such as repair, installation and maintenance services, this is a common way to price their services.  They rely on the cost considerations more than the market considerations.   Moreover, some equipment-intensive sevices are affected more by the scale of economies and capacity considerations.  The multiple-unit motion picture theaters, jumbo jets and 24-hour operation of data processing installations are some examples.

　

Demand Fluctuation Pricing
 

Developmental Pricing Schemes:  When pricing services for non-peak time, this approach may be used.  For example, for a resort hotel, in order to boost sales in off-seaon periods, it may provide special vacation packages for customers.  However, this approach may result in incremental loss when the increase in costs to cover the development in demand for non-peak times exceeds the enhanced revenues.  In addition, another risk from this approach is a "flip-flopping" of peak and non-peak periods.  In other words, some of the customers may shift from a peak period to a non-peak period, which results in less revenues for business.

Capacity Pricing
 

		For equipment-based services, the ups and downs of demand make it difficult to determine the price of a service.  For instance, data processing equipment may handle from 4,000 to 20,000 transactions in a 24-hour time period.  It is obvious that the level of demand affects the transaction costs.  Suppose the expected return on this equipment is $1,000 each day--4,000 transactions per day will cost users 0.25 per transaction, while 20,000 transactions per day will cost users only $ 0.05 per transaction.  Thus, a capacity pricing needs to be developed.  The first step is to decide the competitive price for equivalent services.  The second step is to find out the components of the service--the return on equipment and human resource cost.   This step is to decide which costs are important, which ones shoud be eliminated and which ones could be reduced when the productivity increases.  Then, the third step is to devide Return plus Personnel costs by the competitive price so we will know the number of units of service necessary to break-even.  The following is the example:
		Suppose the rate of return on a data processing equipment is $1,000 per day and the minimum rate is $900 per day.  Personnel-related costs are $200 per day with possible production improvement for saving $20 per day.  Assume the competitive prices for similar services range from 0.075 per transaction to 0.09 per transaction with 0.082 per transaction charged by major competitors.

Table 1.
 

Alternative

0.075

0.082

0.09

 

$1100 ($900+ $200	14,667	13,415	12,223
$1080 ($900+ $180)	14,400	13,171	12,000
$1200 ($1000 + $200)	16,000	14,634	13,334
$1180 ( $1000 +$180)	15,734	14,391	13,112

 

From the table above, we know that the lowest number of transactions needed is 12,000,    while the largest number of transactions possible is 16,000.  The former shows a minimum rate of return, productivity improvement and a market price of 0.09 per transaction.  Te latter shows a desired rate of return, no productivity improvement and 0.075 per transaction.

　

Price Bundling
 

This approach combines two or more services in a single package at a special price that is less than the total price of the services when customers purchase them separately.  For example, a banking package covers a check account, free services such as cashier's check and traveller's checks, loan programs and credit cards.   A bundling price that provides a discount for customers on the total cost of two or more services will maximize cross-selling opportunities.

　

Internet Resources
 

http://chem-eng.toronto.edu/~cmte/research/publications/yan-par-abstract.html

 

This web site is provided by U. of Toronto's Center for Management Technology and Entrepreneurship.  They provide a pricing system with a proper cost allocation to assist in the cost-benefit analysis of investments in information technology and minimizes client cross-subsidization

This page is about a newsletter for government contractors and grantees.  It   focuses on PROPOSAL PRICING for competitive contracts.  Some of the ideas could be applied to grants as well, particularly in terms of improving the cost efficiency of services.

This web site is hosted by the Kellogg Graduate School of Management which provides programs for upper management and for all managers responsible for making pricing decisions, including pricing and product managers, as well as engineering and accounting executives.

Fleming Retail Pricing Services which is the host of this web site provides customer retail pricing strategy through the use of pricing tools and the consultative process.

This web site is created by e*Vantage that  focuses on COMPARATIVE PRICING STRATEGIES.  They assist customers with analysis of global competitive position on bids or in specific markets arising from currency trends, including alternative currency choices.  They also provide evaluation of pricing protection techniques to account for the cost of currency risk associated with sales priced in other currencies.    In addition, the assistance in selection of conversion rates for U.S. dollar price lists is provided by them.

Hosted by Market Wise, this web site shows the workshops available from this organization, which includes the workshop for building pricing strategies.

References:  Hanna, Nessim and H. Robert Dodge, 1995.   Pricing: Policies and Procedures.  Pg. 171-84.