Pricing in Services

Most existing frameworks of pricing were developed in the context of consumer goods and, as such, they fail to explain how to price complex service offerings. In this chapter, the authors explain the characteristics of services that make services pricing different from goods. Relying on theory from both the general pricing literature and from services research, they develop a conceptual model of pricing of services. This framework incorporates critical pricing elements from both the consumer’s and the service provider’s perspective. The authors also explain how consumers form value perceptions in the context of service offerings and how such knowledge can be used for developing pricing strategies for various types of services. The chapter concludes with a discussion on measuring price sensitivity in service, competitive pricing and areas for future research. Introduction Today, the service sector comprises 80 percent of US employment and 64 percent of US gross domestic product (WTO, 2007). It is well known that the professional disciplines required to manage the marketing function of service fi rms are different from those used in the marketing of goods. Consider for example an automobile manufacturing plant and the marketing of the cars produced by that plant. Now consider a law fi rm, the marketing of the services provided by the law fi rm and the individual lawyers in the fi rm. Finally consider both how the customer determines which car to buy and which lawyer to hire, and how this customer evaluates the purchase afterward. The many differences that exist between the marketing functions of these two types of industries, and the impact of these differences on pricing, are the subject of this chapter. Customers will only give money for an item – whether it is a product or a service – if they believe that the value they are receiving is greater or equal to the price they pay for the desired product or service. This presents a challenge for those selling services (e.g. hospitality business, doctors, lawyers, consultants etc.) because the purchaser cannot evaluate services prior to purchasing them. Many services (e.g. vacations, hospital visits and restaurant meals) are high in experience qualities while other services (e.g. those high in credence qualities) are difficult to evaluate even after purchase and consumption (Darby and Karni, 1973; Nelson, 1970, 1974) and consumers often lack sufficient knowledge to assess the services received. This inability to evaluate services creates uncertainty about the utility of consumption, a factor that has direct bearing on the pricing of services. Intangibility (inability to touch and feel) is another characteristic of a service that makes pricing extremely difficult to determine if the item a customer is receiving is greater than or equal to what they are paying. These two characteristics of services, as well as other characteristics of services that will be discussed, introduce much risk into the purchase decision. The main objective of this chapter is to show how fi rms both manage the heightened risk associated with service purchase and how they incorporate customers’ beliefs (both 536 Handbook of pricing research in marketing real and imagined) and knowledge into the pricing decision. The chapter is organized as follows: fi rst, we discuss the many different types of pricing in services. We then discuss a framework for setting prices in services. Third, we review how services are different from goods. In this third section we also include a discussion of the implications of these differences between the perspectives of marketers and customers. We then explore different pricing strategies employed by service fi rms. This is followed by a discussion on how to assess customers’ value perceptions. We end with a discussion on measuring price sensitivity in services, competitive pricing and areas for future research. The many different types of service pricing Defi nition of price and role of non-monetary costs From the customers’ viewpoint, price can be defi ned as ‘what he or she must give up to purchase the product or service’. The ‘what’ may include actual money, time (e.g. the time it takes to search for a doctor or lawyer), a product or service (e.g. an exchange of rooms for free advertising), mental or cognitive effort, and transaction cost (steps necessary to take actual possession of the product or service). Customers will often pay more for a reduction in both cognitive effort and search time by adopting such strategies as always buying the same brand (e.g. higher prices for in-room mini bars in hotels relative to a grocery store, and using an insurance agent that is around the corner rather than one further away). Pricing in services Pricing in services goes by many names (Ng, 2007). Table 25.1 provides examples of the terms used for the pricing of services. For instance, consumers pay ‘entrance fees’, ‘cover charges’ and ‘green fees’ when they purchase visits to museums, entrance to dance clubs and rounds of golf. To receive the knowledge of an attorney, one pays ‘a retainer’ and to attend college one pays ‘tuition’. These activities are intangible and have experiential quality to them; therefore they require a different approach to pricing than is typically found with the pricing of goods. Framework for setting prices for services Figure 25.1 provides a framework for price formation organized into two sections. The left section relates to the consumers’ role in determining price, while the right section refers to the fi rms’ role in price formation. The critical element in Figure 25.1 is the direct relationship between the ‘reservation price’ (the maximum price the customer will pay for a product) on the consumer side and the ‘fi nal price’ on the service provider side. The difference between these two prices is the consumer surplus. Firms attempt to price exactly at the reservation price in order to extract the entire ‘consumer surplus’. If they do not, they will be ‘leaving money on the table’. The challenge for fi rms is to determine this reservation price and then get customers to happily pay this price. An additional challenge is to move this reservation price higher. While these challenges are also true for goods, the characteristics of services make it more complicated. The model proposes that consumers’ ‘reservation price’ is infl uenced by both the perceived fairness of the offer and the value consumers place on the offer. These features are infl uenced by the perceived risk of the purchase, which is a result of the consumers’ Pricing in services 537 characteristics, their reasons for purchase, the type of purchase, the non-monetary costs associated with the purchase, and fi nally the characteristics of the service. The ‘fi nal price’ charged is infl uenced not only by consumers’ reservation price, but also by how and if the product is bundled, the demand and supply characteristics, how the purchase is framed, competitors’ prices, and costs to produce. We discuss each of these components next. Consumer side: characteristics of services The characteristics of services differ from the characteristics of manufactured goods in four important ways: intangibility, perishability, heterogeneity, and simultaneous production and consumption. In addition, unlike most consumer products, services provide only temporary possessions (Lovelock and Gummesson, 2004). These differences impact how service fi rms approach the pricing function, as shown in Table 25.2. Intangibility Intangibility is believed to comprise three dimensions: physical intangibility, generality, and mental intangibility. The more intangible the service, the more risk there is for buyers. This makes pricing decisions difficult. The price has to be high enough to ensure confi dence, but not too expensive that consumers will refuse to purchase (Zeithaml et al., 1996; Rust and Zahorik, 1993). The inability to touch and feel the service before the purchase suggests that con sumers make choice decisions based on their expectations of service delivery and by cues put forth by the seller. One cue is price. The higher the price, the higher the expectations that service quality will be delivered (Zeithaml et al., 1996). For instance, whom would you want to defend you against a crime you did not commit – a $150 per hour lawyer or a $1000 per hour lawyer? A second cue is the uniform worn by the service provider. Doctors wear white gowns not because they make them better doctors, but because of the impression the coats give to the patients; namely, authority, cleanliness and professionalism. Perishability Services such as airline seats or hotel rooms, information sold by news services, and the time availability of a consultant are perishable. If the service is not sold, the revenue for that service is lost forever. Perishability is compounded by the fact that most services have fi xed capacity and most are unable to increase their capacity in the short run. The challenge is to ‘manage’ both demand and capacity by getting customers Table 25.1 The many different terms for price in services Organization What consumer is buying Term used for price Museum, theater, sports team, dance club, golf course Performance, entertainment Entrance fee, cover charge,