DO NOT COPY Chapter 9

SERVICE operations management and business pricing

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Learning Objective

•Explain the difference between cost and value.•Explain fixed and variable cost•Explain Cost –plus versus value based pricing•To build a pricing strategy•Explain different pricing tactics •Raising or lowering Prices.•How to price a service product •Use methods of pricing

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Introduction

Price is determined by what:A buyer is willing to pay, A seller is willing to accept, Competition is allowing to be charged.

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The difference between cost and value

The cost of product or service is the amount you spend to produce itThe price is financial reward for providing the product or serviceThe value is what customer believes the product or service is worth to them

Pricing should be in line with the value of benefits that business provides for its customers while also bearing in mind the price competitors charge.

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To maximize profitability find out

What benefits customers gain from using product or serviceThe criteria customers use for buying decisions - for example, speed of delivery, convenience or reliabilityWhat value customers place on receiving the benefits you provideWherever possible, set prices that reflect the value you provide - not just the cost.

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Covering fixed and variable costs.

Every business needs to cover its costs in order to make a profit. Working out costs accurately is an essential part of working out pricing.

Divide costs under two headings:fixed costs are those that are always there, regardless of how much or how little you sell, for example rent, salaries and business ratesvariable costs are those that rise as sales increase, such as additional raw materials, extra labour and transportWhen you set a price, it must be higher than the variable cost of producing product or service. Each sale will then make a contribution towards covering fixed costs - and making profits.

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Cost-plus versus value-based pricing

Cost-plus pricingThis takes the cost of producing product or service and adds an amount that you need to make a profit. This is usually expressed as a percentage of the cost.It is generally more suited to businesses that deal with large volumes or which operate in markets dominated by competition on price.But cost-plus pricing ignores image and market positioning. And hidden costs are easily forgotten, so true profit per sale is often lower than you realize.

Value-based pricingThis focuses on the price you believe customers are willing to pay, based on the benefits business offers them.Value-based pricing depends on the strength of the benefits you can prove you offer to customers.If you have clearly-defined benefits that give you an advantage over competitors, you can charge according to the value you offer customers. While this approach can prove very profitable, it can alienate potential customers who are driven only by price and can also draw in new competitors.

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How to build a pricing strategy?

Need to decide whether to use cost-plus or value-based pricing.It's important to find out what competitors offer and what they charge.The perception of product or service is also important.

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Different pricing tactics

DiscountingOdd Value pricingLoss leaderSkimmingPenetration

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Raising or lowering pricesThere are two key questions you will need to answer:What effect will the price change have on the volume of sales?What will the effect be on the profit per sale?

Increasing prices:Increasing prices can improve profitability even though sales volume may drop.If you are increasing prices, always explain to customers why you are doing it. You can use the price change as an opportunity to re-emphasize the benefits you offer. A good explanation can also strengthen relationship with a customer.

There are also ways that you can hide price increases. For example, you might:introduce new, higher-priced products or services and make older, cheaper ones obsolete lower the specification - and costs - while maintaining the same price

But be aware that hiding price increases can risk adverse reactions from customers if they realize what you are doing.

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Reducing prices

You should never take the decision to lower prices lightly. Low prices often go hand-in-hand with poor-quality service - is this the image you want to create for business?

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Ways of calculating prices

Cost -plus pricingTarget return pricingValue based pricingPsychological pricingFair point pricing

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Strategic role of operations management as cost leadership

Produce at lowest costBy reducing the cost of operations

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Pricing methods: basic pricing methods and pricing strategy

Determining prices – and overall pricing strategies – is one of the toughest challenges most businesses face.

Should you be the low-price provider?

Should you charge premium prices for premium products or services?

What happens if competition enters – or leaves – your marketplace?Cost basedDemand basedCompetition based

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Price Strategy Objectives

1. Maximize Current Profits2. Maximize cash flow3. Maximize profit margins4. Maximize sales quantity5. Serve different market segments6. Serve different market verticals7. Generate new customers8. Create additional sales opportunities9. Minimize Credit sales10. Minimize barriers to purchase

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Six steps to setting a price strategy for your business

1. Select the pricing objective to decide where you want to position your market offering.

2. Determine the demand.3. Estimate the costs. 4. Analyze competitor costs, prices, offers and

possible reactions. 5. Select a pricing method.6. Finally, select the price.