The Pricing Decision: A Service Industry's Experience

THE PRICING DECISION: A SERVICE INDUSTRY'S EXPERIENCE Of the many difficult problems faced in business, few are as troublesome as the pricing decision. Traditional price theory holds that firms will continue to supply goods or services until the marginal (i.e., incremental) revenue of the last unit sold equals the marginal (i.e., incremental) cost of production and sales. However, this model assumes (1) perfect information about the market and the firm's cost per product, (2) no barriers to entry into the market (financial, legal, technical, cultural or otherwise), and (3) a "rational economic man'--a profit maximizer. In pactice, these assumptions often prove unrealistic: First, it is generally not easy to estimate the demand curve for a firm's products. Second, the marginal cost curve can rarely be obtained from the firm's accounting records and can be computed only after considerable analysis, judgment, and, finally, even arbitrary allocations.1 1 Robert S. Kaplan, Advanced Management Accounting (Englewood Cliffs, New Jersey: Prentice-Hall, Inc., 1982), p. 224. Moreover, barriers to entry do exist. Some are sanctioned--e.g., patents, licenses, certifications. Others force their presence--e.g., cartels, monopolies. Finally the profit maximizer assumption has been challenged repeatedly by behavioralists. Thus the marginal revenue-marginal cost equality concept probably cannot be expected to provide firm-specific pricing decision rules. EMPIRICAL STUDIES The absence of a comprehensive predictive pricing model has led a number of researchers to investigate how prices are determined in practice. Curiously, almost all of the empirical studies have been drawn from the manufacturing or retailing sectors.2 For the most part, service firms have been ignored. 2 See, for example, Lawrence A. Gordon et al., The Pricing Decision (New York: National Association of Accountants, 1981); W. W. Haynes, Pricing Decisions in Small Business (Lexington, Kentucky: University of Kentucky Press, 1962); Lee E. Preston, Profits, Competition, and Rules of Thumb in Retail Food Pricing (Berkeley: University of California Institute of Business and Economic Research, 1963); F. C. Ripley and L. Segal, "Price Determination in 395 Manufacturing Industries,' Review of Economics and Statistics (August 1973), pp. 263-71; A. Sahling, "Price Behavior in U.S. Manufacturing: An Empirical Analysis of the Speed of Adjustment,' American Economic Review, 67 (December 1977), pp. 911-25; and Y. Shinkia, "Business Pricing Policies in Japanese Manufacturing Industry,' Journal of Industrial Economics, (June 1974), pp. 255-64. That the service sector has not received much attention is unfortunate. Intuitively, we might expect some differences between services and manufacturing or retailing. For example, cost-based pricing is fairly common among manufacturers, especially those in less competitive markets. Cost-based pricing could prove more difficult for service firms, however, due to the lack of a tangible product on which to hang the costs. Further, service firms would seem to incur more common or joint costs, making pricing even more difficult. RATIONALE AND METHODS The principal focus of this study was to determine how the managers of fabricare firms (the drycleaning and laundry industry) make pricing decisions. The following questions were addressed: What are the pricing objectives of fabricare firms? What strategies are used to accomplish those objectives? What factors are important in establishing those strageties? Among the issues explored are: the relative importance of various pricing objectives (profits, market share, etc.); whether prices are based more on costs or on market conditions; and the relationship, if any, between pricing and price leadership. "Price leadership' refers to whether or not a firm sets its own prices (a price leader) or tends to react to prevailing prices set by others (a price follower). …