Chapter Objectives

• Describe how consumers relate value and

price.
• Understand the special considerations of
service pricing as they relate to demand,
cost, customer, competitor, profit, product
and legal considerations.
• Discuss the circumstances under which
price segmentation is most effective.
• Explain satisfaction-based, relationship, and
efficiency approaches to pricing.
Opening Vignette: Pricing Woes
Continue for US Airlines

The airline
industry is
expected to
lose at least $2
billion in 2005.
Who will be left
in the end?
 The Art of Pricing

• Pricing policy is the last stronghold of

medievalism in modern management…
[Pricing] is still largely intuitive and even
mystical in the sense that the intuition is
often the province of the big boss (Dean,
1947).
 The Art of Pricing

• Pricing is approached in Britain like

Russian roulette--to be indulged in mainly
by those contemplating suicide (Chief
Executive, 1981).
 Figure 7.1 Buyer’s
Perception of Value
Product value

Service value Total

customer
Personnel value value

Image Value

Buyer’s perception
of value
Monetary cost

Time cost Total

customer
Energy cost cost

Psychic cost
 Demand Considerations

• Demand tends to be more inelastic

• Cross price elasticity considerations
need to be examined
• Price discrimination is a viable practice
to manage demand and supply
challenges
 Factors Influencing Consumer
Price Sensitivity
Perceived
Perceived
Substitutes
Substitutes
Inventory
InventoryEffect
Effect Unique
UniqueValue
Value

Fairness
FairnessEffect Switching
Effect SwitchingCosts
Costs
Price
Price sensitivity
sensitivity
decreases
decreases as
as
Shared-costs
Shared-costsEffect
Effect Comparison
ComparisonEffect
Effect

End-benefit
End-benefitEffect
Effect Price-Quality
Price-QualityEffect
Effect
Expenditure
ExpenditureEffect
Effect
 Price Sensitivity Factors
• Perceived Substitute Effect
– few search attributes
– providers often lack resources and
marketing expertise
– limited product mix

• Unique Value Effect

– conveying “uniqueness” is difficult
– provider may need to educate the market
– uniqueness is often short-lived
 Price Sensitivity Factors

• Switching Costs
– higher levels of perceived risk
– uncertainty involved in changing providers
– consequences associated with a bad
outcome

• Difficult Comparison Effect

– high number of experience attributes
– inherent heterogeneity
 Price Sensitivity Factors

• Price-Quality Effect
– price acts as a quality indicator when
consumers:
• believe that quality differs among providers
• believe that low quality imposes greater
consequences
• lack other sources of objective information

• Expenditure Effect
– amount of expenditure relative to consumer
household income
 Price Sensitivity Factors

• End-benefit Effect
– the more price sensitive consumers are to
the cost of the end-benefit, the more
sensitive they will be to purchases that
contribute to the end-benefit.
• Price bundling adds value to the consumer’s
end-benefit

• Shared-cost Effect
– consumer price sensitivity decreases as
the shared-costs with third parties
increase
 Price Sensitivity Factors
• Fairness Effect
– fairness is typically assessed by comparing the
price to:
• previous prices paid for similar services
• prices paid for similar services under similar
circumstances
• the benefit gained
– assessing “service” fairness is difficult

• Inventory Effect
– consumers are able to protect themselves from
future price increases by building inventories
 Criteria for Effective
Price Discrimination

1. Different groups of consumers must

have different responses to price.

2. Different segments must be

identifiable, and a mechanism must
exist to price them differently.
 Criteria for Effective
Price Discrimination
3. No opportunity should exist for individuals
in one segment who have paid a low price
to sell their tickets to those in other
segments.

4. The segment should be large enough to

make it worthwhile.

5. Costs should not exceed the incremental

revenues obtained.

6. Customers should not be confused.

 Cost Considerations
• Price is sometimes not know until after the
service has been produced

• Cost-oriented pricing is more difficult

– activity-based costing breaks down the
organization into a set of activities, and activities
into tasks, which convert materials, labor, and
technology into outputs

• High fixed cost to variable cost ratio

• Economies of scale tend to be limited

 Customer Considerations

• Price tends to be one of the few search

clues available

• More likely to use price as a quality cue

• Consumers are less certain about

reservation prices
Competitive Considerations

• Comparing prices is more difficult

• Self-service is a viable alternative

 Profit Considerations
• Price bundling makes
the determination of
individual prices in the
bundle of services
more complicated

• Price bundling is more

effective in a service
context
 Product Considerations
• Many different names
for price
• Consumers are less
able to stockpile by
taking advantage of
discount prices
• Product-line pricing is
more difficult
– Home sellers have three
levels of service (6, 7, or
8%)
 Legal Considerations

• Opportunity for illegal pricing practices to

go undetected is greater for services than
goods

• To consumers, the issue is one of fairness

and dual entitlement
 Emerging Service Pricing
Strategies
• Satisfaction-based pricing
– primary goal is to reduce the amount of
perceived risk
– service guarantees
– benefit-driven pricing: charges customers for
services actually used as opposed to overall
membership fees
– flat-rate pricing: customer pays a fixed price and
the provider assumes the risk of price increases
and overruns
 Emerging Service Pricing
Strategies
• Relationship Pricing
– primary objective is to enhance the firm’s
relationship with its targeted consumers.
• long-term contracts: offers price and
nonprice incentives for dealing with the
same provider over a number of years
• pricing bundling: marketing two or more
services as a single package for a single
price
 Emerging Service Pricing
Strategies

• Efficiency Pricing
– primary objective is to appeal to economically-
minded consumers by delivering the best and
most cost-effective service for the price.
• Example: Southwest Airlines
Services Pricing: Final Thoughts

• The price should:

– Be easy for customers to understand
– Represent value to the customer
– Encourage customer retention and facilitate
the customer’s relationship with the
providing firm
– Reinforce customer trust
– Reduce customer uncertainty