Managing Profit

8/2/2019 Managing Profit

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Managing Price and Profits



Terms for price in service organisation

Universities – Tuition

Professional firms-- fees

Banks –

Interest and service charge

Brokers –Commission

Insurance companies---premium Roadways---toll



What Makes Service Pricing Strategy Different?

No ownership of services--hard for firms to calculate financial

costs of creating an intangible performance

Variability of inputs and outputs--how can firms define a “unit of

service” and establish basis for pricing?

Many services hard for customers to evaluate--what are they

getting in return for their money?

Importance of time factor--same service may have more value to

customers when delivered faster

Delivery through physical or electronic channels--may create

differences in perceived value





B. Cover costs

1.Cover fully allocated cost , including institutional

overhead

2.Cover cost of providing one particular service excluding

overhead

3.Cover incremental cost of selling one extra unit of one

extra customer

Objectives of Pricing Strategies



Patronage and user base-related objectives

A. Build demand

1. Maximize demand (when capacity is not a constraint ), subject

to achieving a certain minimum level of revenues

2. Achieve full capacity utilization , especially when high capacity

utilization adds to the value created for all customers . Ex. Fullhouse adds excitement to theater play or basket ball games




B. Build a user base

1. Stimulate trial and adoption of service . This is specially important

for new services with high infrastructure cost and for membership

type services that generate significant revenues from their

continued use after adoption ( e.g. mobile phone service

subscription and life insurance plans)

2. Build market share and / or a large user base , especially if there are

significant economies of scale that can lead to a competitive cost

advantage ( ex. If development of fixed cost are high)




The Pricing Tripod

Pricing Strategy

CostsCompetition

Value to customer



Three Main Approaches to Pricing

Cost-Based Pricing

Set prices relative to financial costs (problem: defining costs)

Competition-Based Pricing

Monitor competitors’ pricing strategy (especially if service

lacks differentiation)

Who is the price leader? (one firm sets the pace)

Value-Based

Relate price to value perceived by customer



Cost Based Pricing

Its usually more difficult to establish the costs involved in producing

an intangible performance than it is associated with producing

physical good

Labour and infrastructure needed to create performance , many

service organizations have much higher ratio of fixed cost to

variable cost than it is found in manufacturing firm.

The traditional cost based approach is use in service organisation in

which cost must be estimated in advance

ex. Construction , engineering advertising , many professional

services etc.



Cost Based Pricing

Major difficulty in cost based approach involves defining

the units in which a service is purchased

For this reason many services are sold in terms of input

rather than units of measured output

Ex professional services such as consulting , engineering

, architecture, tutorials are sold by an hour For complex product line with shared infrastructure ( ex. Retail

banking products) it may be worthwhile to use ABC approach



Cost= Fixed Cost + semi variable cost+ variable cost

Fixed Cost: are those economic costs that supplier would continue to incur, evenif no service sold.

Ex. Rent ,depreciation, utilities , taxes insurance salaries and wages , securities

and interest payment

Variable cost : the economic costs associated with serving an additional

customer.

Selling an additional seat on a flight, making an additional bank transaction

In may sercices such cost are very low . For instance , very little labour or fuel

cost is involved in transporting an extra passenger

and higher cost in case of parts to repairs.Semi variable costs: fall in fixed and variable and represent expenses that rise

or fall in a stepwise fashion as the volume of business increase or decrease.

Ex. Adding an extra flight to meet increase demand

Cost Based Pricing



Contribution = difference between the variable cost of selling an

extra unit of service and money received from the buyer of thatservice

Determining and allocating economic cost

Difficult to assign fixed costs in a multiservice facility

Ex. In hospital fixed cost is allocated to emergency share of overhead on one of the way i.e. , Percentage of floor area

occupied, employee hours, or to the percentage of total patient

contact one of this approach may show profit making other loss

making operationBreak-Even Point : sales volume will be profitable

Cost Based Pricing



Activity-Based Costing: Relating Activities to

the Resources They Consume

Managers need to see costs as an integral part of a firm’s effort to create value for

customers

When looking at prices, customers care about value to themselves, not what

production costs the firm

Traditional cost accounting emphasizes expense categories, with arbitrary allocation

of overheads

ABC management systems examine activities needed to create and deliver service

(do they add value?)

Must link resource expenses to:

variety of products produced

complexity of products

demands made by individual customers



ABC analysis begins with the identification of various

activities being performed and then determine the cost of

each activity as it relates to each expense category.

Unit level activities

Batch level activities

Activity-Based Costing: Relating Activities

to the Resources They Consume



Competition based pricing This approach focus on pricing charge by the

other firms in the same industry or market as ananchor for the firms price

This approach use in two situations:

1. When services are standard across providers

Ex. Dry cleaning industry

2. In oligopoly with a few large service providers

Ex. Airline industry



Increase in Price Competition

1. Increase in number of competitors

2. Increasing number of substituting offers

3. Increasing surplus capacity in Industry

4. Wider distribution of competitor

Reduce in Price Competition

1. Non price related costs of using alternatives are high (Save time or effort

are more important to customer )

2. Personalization , customization and switching cost matters ( hair Styling ,

family medical care discouraging them from competitive offer )

3. Time and location specificity reduce choice( Ex Bank near to your home )



Value Based Pricing

No customer will pay more for a service than he or shethinks it is worth.

To set an appropriate price , marketer needs to understand

how customer perceive service value

Understanding Net Value

When customers purchase a service , they are weighing the

perceived benefits obtained from the service against the

perceived cost they will incur.

People are willing to pay higher price to reduce the

nonmonetary cost of service



Four meaning of perceived value

Customer define value in four ways1. Value is low price

Dry cleaning “ value means the lowest price”

Discounting, Odd pricing, Penetration pricing

2. Value is whatever I want in product or serviceMBA : Value is best education I can get

Prestige pricing, Skimming pricing

3. Value is the quality I get for the quality I pay

Hotel for vacation: Value is the price first and quality second

Value pricing, Market Segmentation pricing

4. Value is what I get for what I give

For a hairstyle : value is what I pay in cost and time for thelook I get

Price framing , Price bundling



Perceived

Benefits

Time

e

Effort

Net Value = (Benefits – Outlays)

PerceivedOutlays



Enhancing Gross Value

Pricing Strategies to Reduce Uncertainty service guarantees benefit-driven (pricing that aspect of service that creates value) flat rate (quoting a fixed price in advance)

Relationship Pricing

non-price incentives discounts for volume purchases discounts for purchasing multiple services

Low-cost Leadership

Convince customers not to equate price with quality Must keep economic costs low to ensure profitability at low

price



Paying for Service: The Customer’s Perspective

Customer “expenditures” on service comprise bothfinancial and non-financial outlays Financial costs:

price of purchasing service

expenses associated with search, purchase activity,usage

Time expenditures

Physical effort (e.g., fatigue, discomfort)

Psychological burdens (mental effort, negative feelings)

Negative sensory burdens (unpleasant sensations affecting anyof the five senses)



Trading off Monetary and Non-Monetary Costs (Fig. 6.5)

Which clinic would you patronize if you needed a chest x-ray (assuming all three clinics offer good quality) ?

Price Rs 85

Located 15 min awayby car or transit

Next availableappointment is in 1week

Hours: Monday –

Friday, 8am –

10pm Estimated wait at

clinic is about 30 - 45minutes

Clinic B

Price Rs 125

Located next to youroffice or college

Next appointment isin 1 day

Hours: Mo –Sat, 8am – 10pm

By appointment -estimated wait atclinic is about 0 to 15minutes

Clinic CClinic A

Price Rs 45

Located 1 hour awayby car or transit

Next availableappointment is in 3weeks

Hours: Monday –

Friday, 9am –

5pm Estimated wait at

clinic is about 2 hours



Increasing Net Value by ReducingNon-financial Costs of Service

Reduce time costs of service at each stage

Minimize unwanted psychological costs of service

Eliminate unwanted physical costs of service

Decrease unpleasant sensory costs of service



Revenue Management: Maximizing Revenue

from Available Capacity at a Given Time

Based on price customization - charging differentcustomers (value segments) different prices for sameproduct

Useful in dynamic markets where demand can bedivided into different price buckets according to pricesensitivity

Requires rate fences to prevent customers in one value

segment from purchasing more cheaply than willing topay



Price Elasticity

De

De

Di

Di

Price per unit of service

Quantity of Units Demanded

De : Demand is price elastic . Small changes in price lead to big changes in demand.

Di : Demand for service is price inelastic . Big changes have little impact on demand.



Pricing Issues: Putting Strategy into Practice

How much to charge?

What basis for pricing?

Who should collect payment?

Where should payment be made?

When should payment be made?

How should payment be made?

How to communicate prices?



Comparative study of any four mobile service providerpricing schedule on the following dimensions

Air time ,

Subscription fees Free minutes

Per second/ minute bills

Usage profile of customer



From a customer perception , what serves todefine value in the following services:

A hairdressing salon

A legal firm specializing in business and taxationlaw

A nightclub

Documents

Managing Profit