Answer: A business can use a variety of pricing strategies when selling a product or service. The Price can be set to maximize profitability for each unit sold or from the market overall. It can be used to defend an existing market from new entrants, to increase market share within a market or to enter a new market. Businesses may benefit from lowering or raising prices, depending on the needs and behaviors of customers and clients in the particular market. Finding the right pricing strategy is an important element in running a successful business.
Foundation of pricing strategy
The foundation underlying pricing strategy can be described as a tripod, with the three legs being named costs, competition, and value to the customer.
Cost: The costs to be recovered set a floor to the price that may be charged for a specific product. Companies seeking to make a profit must recover the full costs associated with producing and marketing a service, and then add a sufficient margin to yield a satisfactory profit.
Competition: The price charged by competitors for similar or substitute products may determine where, within the ceiling-to-floor range, the price level should actually be set. An exception occurs in the case of “loss leaders” designed to attract customers who will also buy profitable products from the same organization.
Value to the customer: The term “value” is one that is rather loosely used. Research by Zenithal found that “What constitutes value—even in a single product category—appears to be highly personal and idiosyncratic.” The net value is the sum of all the perceived benefits (gross value) minus the sum of all the perceived costs.
In exploratory research on beverages, she found four broad expressions of value;
- Value is low price.
- Value is whatever I want in a product.
- Value is the quality I get for the price I pay and
- Value is what I get for what I give.
How to increase Net Value
A marketer can increase the net value of a product either by adding benefits or by cutting costs (or by a combination of the two). Of particular interest to service marketers are the opportunities to cut for customers by such means as;
- Reducing the amount of time involved in service purchases, delivery and consumption.
- Minimizing unwanted mental effort or psychological stress involved in obtaining service.
- Putting out any unwanted physical effort that customers are required to undertake in order to obtain service.
- Minimizing unpleasant sensory experiences through such means as creating more attractive visual environments, noise education, installing furnishing and equipment that are more comfortable to use, curtailing offensive smells, and ensuring that any foods, beverages or medicines to be consumed taste nice.
Establishing monetary pricing objectives
Pricing strategy must be a clear understanding of the organization’s objectives. There are three basic categories of pricing objectives open to a service organization. These are;
- Revenue oriented objectives: Private sector firms are profit-seeking organizations. Within certain limits, they attempt to maximize the surplus of income over expenditures. Managers responsible for public and nonprofit service organizations, by contrast, are more likely to be concerned with breaking even or keeping the operating deficit within acceptable bounds. Determining the cost of the pricing equation can be difficult. We’ll look at three different types of costs;
- Fixed costs: Fixed costs are those that would continue (at least in the short run) to be incurred even if no services were provided. This “institutional overhead” is likely to include such elements as building rent, depreciation, utilities, taxes, insurance, administrative salaries, and wages of contract employees who cannot be laid off at short notice, security, and cost of capital.
- Semi-variable cost: Semi-variable cost is those that are related to the number of customers served or volume or services produced by the organization. Included are operating costs such as incremental utilities, cleaning at service delivery sites, and wages and salaries incurred in paying overtime or hiring additional personnel.
- Variable costs: Variable costs are those associated with making an additional sale—such as a new loan at a bank, a single seat in a train or theater, a room in a hotel, or one more repair job.
- Operations Oriented Objectives: Some organizations seek to match demand and supply so as to ensure optimal use of their productive capacity at any given time. Hotels, for instance, seek to fill their rooms, since an empty room is an unproductive asset. Similarly, professional firms want to keep their staff members occupied, airlines want to fill empty seats, and repair shops try to keep their facilities, machines, and workers busy. When demand exceeds capacity, however, these organizations may try to increase profits and ration demand by raising price.
- Patronage oriented: Not all service organizations suffer from a short-term capacity constraint. New services, in particular, often have trouble attracting customers. Introductory price discounts may be used to stimulate trial, sometimes in conjunction with promotional activities such as contests and giveaways. Firms wishing to maximize their appeal among specific types of customers need to adopt pricing strategies that recognize differential ability to pay among various market segments.
Formulating pricing strategy
By now it should be clear that determining pricing strategies in a service organization requires making decisions on a range of different issues. These, in turn, must be based on both a clear understanding of the organization’s objectives and sound information on a range of relevant inputs.
- How much should be charged for this service?
- What costs is the organization attempting to recover? Is the organization trying to achieve a specific profit margin or return on investment by selling this service?
- How sensitive are customers to different prices?
- What prices are charged by competitors?
- What (discounts) should be offered from basic prices?
- Are psychological pricing points (e.g. $4.95 versus $5.00) customarily used?
- What should be the basis of pricing?
- Execution of a specific task.
- Admission to a service facility.
- Units of time (hour, week, month, year).
- Percentage commission on the value of the transaction/
- Physical resources consumed.
- Geographic distance covered.
- Weight or size of object serviced.
- Should each service element be billed independently?
- Should a single price be charged for a bundled “package”?
- Who should collect payment?
- The organization that provides the service
- A specialist intermediary (travel or ticket agent, bank, retailer etc.).
- How the intermediary should be compensated for this work—flat fee or percentage commission?
- Where payment should be made?
- The location at which the service is delivered.
- A convenient retail outlet or financial intermediary (e.g. bank).
- The purchaser’s home (by mail or phone).
- When should payment be made?
- Before or after delivery of the service.
- At which times of day.
- On which days of the week.
- How should payment be made?
- Cash (exact change or not).
- Token (where can these be purchased?)
- Stored value card.
- Check (how to verify).
- Electronic funds transfer.
- Charge card (credit or debit).
- Credit account with service provider.
- Third-party payment (e.g. insurance company, government agency)?
- How should price be communicated to the target market?
- Through what communication medium? (Advertising, signage, electronic display, sales people, customer service personnel).
- What message content (how much emphasis should be placed on price).