Capture and Communicate

Value in the Pricing of

Services
By: Manjit S. Yadav, Associate Professor of Marketing
Texas A & M University

Dr. Manjit Yadav is an Associate Professor of Marketing and Center for Retailing Studies
Faculty Fellow, Department of Marketing, Mays College & Graduate School of Business,
Texas A&M University. Permission to excerpt this article was granted by Sloan
Management Review. Dr. Yadav will be one of our speakers at the upcoming fall
conference in Chicago.

Introduction are intangible. Goods, on the other hand, are

Widespread pricing mismanagement plagues
service industries because too many services
marketers ignore the special challenges of pricing
intangible products. The authors discuss the
implications of this kind of pricing in today's highly
competitive conditions and offer a framework that
reconciles the implications with customers' quest
for value. Three distinct but related strategies for
services pricing -- satisfaction-based pricing,
relationship pricing, and efficiency pricing -- can
help services marketers capture and communicate
value through their pricing.
In this article, we discuss the implications of
pricing intangible products in today's intensely
competitive markets and offer a framework that
reconciles these implications with customers' quest
for value. Following our advice will not be a simple
matter for some companies. It may mean carving
out a new strategy for the business and earning
customers' confidence gradually. Pricing services
effectively calls for a longer-term perspective than
some executives may feel is practical.
Implications of Pricing Intangibles
Unfortunately, little research exists on the pricing
of services, and few people understand the special
challenges involved. But services are a special
breed of product, and marketers need to treat them
as such. Services are performances; therefore, they
objects; they can be seen and touched. Customers
can see tangibles associated with the service, such
as the people who provide the service and the
equipment, but they usually cannot see the service
itself. This inherent invisibility creates conditions
that are far from ideal for services marketers, but
they need to consider it if they want to improve
their pricing practices. Purchasers of goods acquire
tangibles -- a couch, a VCR, a necktie, tennis
shoes, toothpaste. Purchasers of services incur an
expense rather than add to their accumulation of
goods. They might, for example, take a trip, visit
the doctor, or get a haircut, but at the end of the
day, their "market basket" is empty. Purchasers of
goods buy ownership and use; purchasers of
services buy only use. A dry cleaner or an auto
mechanic returns customers' property to an earlier
state: clean clothes or a well-running automobile.
Credit card issuers rent money and hotels rent
space, but no transfer of possession occurs.
Automobile insurance "pays off" for customers only
when something bad happens.
Recognizing this subtle but important distinction
between tangibility and intangibility can provide
useful clues to understanding customers' reactions
to services prices. Take, for example, a plumbing
company that charges $60 to fix a leaky toilet.

The Journal of Professional Pricing 29

 Satisfaction-Based, Relationship, and Efficiency Pricing Strategies

Pricing strategy Provides value by… Implemented as…

Satisfaction-based pricing Recognizing and reducing customers’ Service guarantees

Relationship pricing
Efficiency pricing
perceptions of uncertainty, which the Benefit-driven pricing
intangible nature of services magnifies. Flat-rate pricing
Encouraging long-term relationships Long-term contracts
with the company that customers view Pricing bundling
as beneficial.
Sharing with customers the cost Cost-leader pricing
savings that the company has
achieved by understanding, managing,
and reducing the costs of providing
the service.

By charging that amount, the plumber aims to
recoup the fixed and variable costs of operating the
business (facilities, trucks, labor, telephones,
insurance, gasoline), as well as to generate a profit.
Customers, on the other hand, might be shocked
at a price of $60 for twenty-three minutes. They
could have bought a new sweater or some compact
disks for that. They might say the psychology of
the transaction is not favorable to the plumber.
Comparing Prices, Making Choices, Assessing
Value. The intangibility of services makes it more
difficult for customers to compare prices. In a
supermarket, prices are affixed to tangible
products grouped by category, but the nonphysical
nature of services impedes price and product
comparisons. Since the products are invisible,
customers cannot easily see their costs. For
example, they have no fast method for comparing
AT&T, MCI, and Sprint long distance services or
prices before deciding which to select. Thus
intangibility accentuates the complexity of services
prices for customers.
Services differ from goods in the degree to which
they possess search, experience, and credence
attributes, three categories that help marketers
distinguish among products. Those that can be
evaluated before purchase and use have search
attributes, those that can be evaluated only after
they have been used have experience attributes,
and those that cannot be fully evaluated even after
use have credence attributes? In general, tangible
products are more likely to possess search
attributes, whereas services tend to be higher in
experience and credence attributes?
Clients who hire a lawyer, for example, will want to
hire a competent and conscientious person, but
how are they to do that? Few search attributes
exist to guide their decision process. There are no
tires to kick, nothing to test-drive. Word-of-mouth
can help if available, or a lawyer's years of
experience may be a useful indicator. A prospective
client may choose to phone or visit various law
firms to get cost estimates, but estimates
frequently are inaccurate in the long run. Even if a
client believes that an estimate will be reliable, how
can it guide the choice of a lawyer? Who would be
better, the least expensive Or the most expensive?
Lacking firsthand experience with a product,
customers often use price as a surrogate indicator
of quality. They assume that the least expensive
lawyer may also be the least skilled, and vice versa.
Legal services typically are high in experience and
credence attributes. The legal client evaluates
quality and value when experiencing the service
and, to some degree, may never know if the lawyer
performed optimally. Services having credence
properties usually are technical in nature or are
not performed in the customer's presence.
Automobile repair, medical, marketing research,
and many other services have one or both of these
characteristics. Customers wonder, were all the
repairs necessary? Were they done properly? Were
the laboratory tests performed correctly? Did the
patient actually have all the tests that the hospital
bill lists? Did the marketing research firm train its
interviewers?
Services in general, and credence services in
particular, invite pricing and performance abuses.

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Customers know that they are vulnerable to such
abuses, so they are suspicious about being taken
advantage of and become resentful and angry
when it happens. For that reason, Sears has never
completely recovered from the widely publicized
charges that it defrauded its auto center customers
by selling unneeded parts and services. Service
customers tend to remember that kind of
experience for a long time.
Undifferentiated Offerings
The lack of physical differentiation among
competing services is another factor that
contributes to poorly executed pricing. The styling
of an automobile, the fit and feel of a pair of slacks,
the color and pattern of a necktie, even the picture
on a cereal package differentiate a product from its
competitors and give customers a reason not
related to price for favoring it. Tangibles -- for
example, the appearance of service facilities and
providers -- play a role in differentiating services
too, but often the tangibles associated with a
service are relatively unimportant to the purchase
decision or differ little from the competition. For
this reason, marketers try to differentiate their
service through nonphysical means -- quality or
price, for example -- and, frequently, they
concentrate on the price tool. Price may seem
easier to implement, faster in its effects, or more
persuasive with targeted customers.
The pricing of airline services, which by and large
are marketed as a commodity, is a case in point.
When one carrier announces a price cut, its
competitors usually match the cut within hours.
The industry makes thousands, even hundreds of
thousands of domestic fare changes daily, creating
a nightmare of confusion for customers and
employees. American Airline’s best fare from Dallas
to Memphis today may cost $200 more or less
tomorrow.
Airlines services are only one of many in which
pricing practices are not working well. To alleviate
the situation, we propose three distinct but related
strategies tailored to the unique pricing challenges
that services present. When executed well, they
can enable services marketers to capture and
communicate value.
Value Strategies for Services Pricing
The key to improved services pricing is to dearly
relate the price that customers pay to the value
that they receive. A customer may or may not look
for the absolute lowest price available for a service,
but everyone wants something worth the price he
or she pays.
Services pricing strategies often derail because
they lack any obvious association between price
and value.
For customers, value means benefits received for
burdens endured. No product is free of cost, which
comes in two forms: monetary (the economic price)
and non-monetary (for example, time or physical or
mental effort). When making purchasing decisions,
customers want to feel they are getting at least as
much as what they are paying; that is, the benefits
should be commensurate with the burdens.
Not understanding this trade-off, services
marketers frequently undermine the effectiveness
of their pricing strategies. Consider an advertising
campaign for a service that claims the lowest
available prices but presents them in a complex
series of combinations. That kind of pricing
message carries a heavier burden for customers
than the advertiser realizes. Customers have to
figure out how the different pricing plans work,
which one is the best, and whether any of them
actually give them more value, or whether they are
all just hype. The non-monetary burden of such a
pricing strategy increases the customers' overall
burden and therefore weakens the marketers
benefits-to-burdens offer.
The importance of considering non-monetary cost
as part of the value message in services pricing is
illustrated by the avalanche of calling plans that
the big long distance telephone companies have
unleashed during the past few years. Collectively,
they spent hundreds of millions of advertising
dollars for an unrelenting stream of lowest-price
claims and pricing counterattacks.
A 1995 study of customers' perceptions of long
distance telephone providers conducted by CDB
Research & Consulting found that 60 percent of
the respondents were confused by the many
different calling plans. Among customers with
incomes of $50,000 or more and those aged 18 to
34 -- two coveted markets -- 78 percent indicated
they were tired of all the advertising and hype
about long distance rates. Moreover, 60 percent of
the respondents felt that all the major long
distance companies charge essentially the same?
The industry seems to be grasping the significance
of straightforward pricing for value. The complexity
and risk associated with buying many services
underscores the need for services prices to be
straightforward, easy for customers to understand,
and dearly linked to the customers' perception of
value.
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Such an approach lessens the complexity of
customers' buying decisions and conveys pricing
integrity. Prices are more credible when they are
understandable and simple, and customers don't
suspect pricing tricks or hidden charges. The risk
that customers take on when they buy services
with experience or credence properties lends
persuasive power to pricing strategies that instill
trust and confidence.
Not only should marketers avoid needless
complexity in their services pricing, they should
also avoid simplistic approaches that fail to
recognize the heterogeneity of customers' wants.
Prices can be straightforward, easy for customers
to understand, and communicate value without
being simplistic. Sometimes, customers realize the
most value from a service by being able to buy
different benefit levels at different price levels.
Movie theaters, for example, increase the value of
their service by allowing customers to choose
whether to pay a higher price for prime time or a
lower price for non-prime time. Such segmented
pricing also lets the movie theaters synchronize
demand patterns with supply capacity. Without
segmented pricing, more customers would go to
the movies in the evening, and the facilities would
be underutilized during the day.
In order to price for value, services marketers must
first understand what constitutes value for their
target markets. Their goal then becomes capturing
and communicating this value proposition -- as
clearly and compellingly as possible -- through the
pricing. We suggest three distinct but related
pricing strategies for capturing and communicating
the value of a service: satisfaction-based
relationship, and efficiency pricing. They can be
used independently or in combination.
Satisfaction-Based Pricing
The intangible nature of services challenges both
company and customer to dearly establish the
value of the service. Some uncertainty is associated
with any purchase, whether it is a service or a
tangible product, but intangibility accentuates the
uncertain. The goal of satisfaction-based pricing
strategies is to alleviate customers' uncertainty.
Companies can do this in several ways, including
service guarantees, benefit-driven pricing, and flat-
rate pricing.
Service Guarantees. Explicitly guaranteeing a
service can be a powerful reassurance for
customers. Even if they end up dissatisfied with
the service, the guarantee gives them a recourse --
usually a reduced price or refund for a burden that
they have endured. When executed well, service
guarantees symbolize both a company's
commitment to customer satisfaction and the
confidence it has in the quality of its service. After
all, no one would expect a business to guarantee a
poor service. Companies should not adopt this
strategy lightly, however. A service guarantee is a
bold step, calling for a thorough analysis of the
reasons for doing so, as well as the risks involved.
Service guarantees make the most sense for
companies that market services perceived as high-
risk, that wish to capitalize on their superior
service quality or that need a differentiating
message to enter a market against established
competitors. Companies with poor or mediocre
service should improve their service significantly
before considering a service guarantee.
Benefit-Driven Pricing. Satisfaction-based pricing
also can be based on how a service is used and
how it creates value. Benefit-driven pricing involves
explicitly pricing the aspect of the service that
directly benefits customers. The result is that
customers usually feel more satisfied and less
uncertain than if a service's price is unrelated to
the benefits it delivers. While identifying what
customers value in a service is crucially important
for developing an effective benefit-driven pricing
strategy, determining what customers do not value
is equally important.
One big complication arises from the possibility
that valuations can vary significantly across
customer segments. Once such information has
been gathered systematically, however, it can serve
as a secure foundation for implementing benefit-
driven pricing. Generally, the pricing must
establish and communicate a dear association
between the price and the service attributes that
customers value.
Flat-Rate Pricing. An important source of
uncertainty for some customers is the actual costs
that they will incur. For many labor-intensive
services, the exact price cannot be established
before delivery. The cost of legal representation, for
example, often is influenced by events that cannot
be known fully in advance. Flat-rate pricing
alleviates customers' uncertainty by agreeing on a
price beforehand. In effect, the service provider
assumes the risk of any cost overruns. Flat-rate
pricing can be an effective strategy for companies
in industries in which service prices are
unpredictable and costs are badly managed, or in
which competitors make low estimates to win
business but have no intention of honoring them.
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Flat-rate pricing needs at least three conditions to
make sense. First, the flat-rate price must be
competitive. If customers perceive it as too high, it
will dilute the risk-reduction benefits that make
the strategy appealing. Second, the company must
develop and maintain a highly efficient,
streamlined cost structure to provide some cushion
for unanticipated costs. Costs in the service system
that do not add value to customers must be
eliminated. Third, the potential for relationship
marketing must be high; that is, even if
unexpected costs drain the profit from one service
episode with a customer, additional opportunities
to serve the customer -- and make money -- still
loom on the horizon.
In summary, satisfaction-based pricing strategies
can effectively reduce customers' uncertainty in
purchasing services. Service guarantees
compensate customers if they are not satisfied.
Benefit-driven pricing aligns the pricing specifically
with the benefits that the customer perceives. Flat-
rate pricing negates any dissatisfaction that might
result from higher than anticipated prices. These
strategies apply only under certain conditions,
however, and they are definitely not for timid
competitors. Each strategy is risky in its own way,
and each requires strong commitments: to service
excellence for the service guarantor, to
understanding how the service creates value for
the benefit pricer, and to a highly efficient cost
structure for the flat-rate pricer.
Relationship Pricing
Relationship marketing, which involves “attracting,
maintaining, and – in multi-service organizations—
enhancing customer relationships is increasingly
viewed as a desirable marketing strategy because
of its profit potential and its appeal to customers.
Service companies dearly gain if they can do more
business with existing customers for a longer
period of time. Equally important, customers gain
if they can establish a relationship with a
competent, dependable provider of a high-risk
service that presents a complex decision with
regard to purchase and is difficult to evaluate. A
customer fortunate enough to have an excellent
auto repair person, physician, or real estate agent
has a lower effort and risk burden than someone
who needs the service but hasn't yet developed a
satisfactory relationship.
The question is, what role should pricing play in
relationship marketing? An obvious approach is to
use price reductions to initiate relationships. That
approach is easy to implement and has
considerable intuitive appeal, but it is also the
most easily imitated -- which is why relationships
based solely on price incentives disappear so
swiftly.
Services marketers can develop creative pricing
strategies that contribute to sustainable
relationships. Such strategies offer an incentive for
customers to consolidate more of their purchasing
with the company and to resist the entreaties of
competitors. Marketers first need to understand
their customers' needs and their motivations for
developing a long-term relationship with the
company. They should also analyze potential
competitors' moves and implications for
profitability.
Long-Term Contracts. Marketers can use long-
term contracts that offer customers price and non-
price incentives to enter into multiyear
relationships, either to strengthen existing
relationships or to develop new ones. Such
contracts can alter fundamentally a service
provider's relationships with its customers. They
can transform business transactions from
relatively isolated events to a series of steady
sustained interactions. Each transaction provides
one more snapshot of customers' needs and
therefore facilitates learning and efficiency gains
for the company -- which also may result in greater
savings for customers as the relationship evolves.
The steady revenue stream from long-term
relationships enables the service provider to
concentrate more resources on widening the value
gap between what it offers and what competitors
offer.
Price Bundling. This strategy, which also aims to
enhance and sustain customer relationships,
involves selling two or more services bundled
together. Price incentives assure buyers that
purchasing the services together is less expensive
than buying them separately. Service providers can
benefit in two ways from price bundling. First,
bundling can reduce costs. The cost structure of
most service companies is such that providing an
additional service costs less than providing the
second service alone. In a bank, for instance,
shared account-opening and computer-processing
costs result in economies when the bank can sell a
certificate of deposit and a savings account along
with a checking account. If the bank passes some
or all of the economies to customers in the form of
reduced fees or higher interest, it is giving them an
incentive to buy the bundled services.
A second benefit of bundling that appeals to
customers is purchasing related services from one
The Journal of Professional Pricing 33
service provider. They can save time and money by
interacting with and paying one provider rather
than multiple providers.
Relationship pricing aims to encourage the
development of profitable, long-term customer
relationships. It can be applied under many varied
conditions. A careful analysis of mutual benefits is
essential to determine the factors that make the
relationship work. Such an analysis will suggest
how much emphasis the service company should
place on price incentives. Consolidating purchases
of services with a single supplier must have the
potential of offering customers increased benefits,
reduced monetary and non-monetary costs, or,
ideally, all of the above. The service should be one
that customers use on a recurring or continuous
basis, with movement by customers among
multiple suppliers a common phenomenon, and
there should be potential for expanding
relationships with customers through increased
use of one service or the purchase of multiple
services.
Efficiency Pricing
Understanding, managing, and reducing costs are
the cornerstones of efficiency pricing. Some or all
of the resulting cost savings are passed on to
customers in the form of lower prices. To be
effective, the leaner cost structure must be difficult
for competitors to imitate in the short run.
Furthermore, cost savings passed on to customers
must genuinely enhance their value perceptions.
Cost trimming that results in a less expensive but
unsatisfactory service will not be successful.
Understanding costs is particularly difficult for
service companies. Traditional cost-accounting
procedures were designed to monitor costs
associated with the consumption of raw materials,
depreciation, and labor. In the case of services, for
which the final product is a composite of
performances, traditional accounting practices are
inadequate.
Activity-based costing (ABC), which focuses on
resources consumed by specific activities that lead
to the final product, may be a more useful tool.
Take, for example, a pizza delivery operation. ABC
would estimate the cost of each activity in the
service chain, from taking the order to delivering
the pizza. Once the cost elements were identified,
cost-reduction efforts could be focused on
streamlining or eliminating activities that don't add
enough value for customers.
Southwest Airline’s relentless cost-reduction efforts
are based on a keen understanding of the cost-
value relationships of specific activities that make
up air travel services. While other airlines focused
on establishing expensive hub-and-spoke networks
in the 1980s, Southwest became the industry's
most productive airline, in part by flying shorter,
more direct routes and by using less congested,
less expensive airports whenever possible.
To summarize, efficiency pricers reduce
customers' monetary burden through efficient
operating practices. They focus on delivering in the
best and most cost-effective way the customers'
most valued aspects of the service. They either
streamline or eliminate low-priority elements of the
service chain. Gradually, the focus on efficiency
through innovation becomes embedded in the
company's culture, a factor that makes catching
up even more difficult for competitors.
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