The foundations underlying pricing strategy can be described as a tripod, with the three legs being named costs, competition, and value to the customer.
The costs to be recovered set a floor to the price that may be charged for a specific product; the value of the product to the customer sets a ceiling.
Whereas the price charged by competitors for similar or substitute products may determine where, within the ceiling-to-floor range, the price level should actually be set.
The foundations of service price are as follows:
Companies seeking to make a profit must recover the full costs associated with producing and marketing services, and then add a sufficient margin to yield satisfactory profit.
An exception occurs in the case of “loss leaders,” designed to attract customers who will also buy profitable products from the same organization.
But even with such loss leaders, managers need to know the full costs associated with these products, so that the amount of promotional subsidy is fully understood.
Price may also play a role in communicating the quality of service. In the absence of tangible clues, customers may associate higher prices with higher levels of performance on service attributes.
The term “value” is one that is rather loosely used. Research by Zeithaml found that “what constitutes a value – even in a single product category – appears to be highly personal and idiosyncratic.
In exploratory research on beverages, she found four broad expressions of value:
- Value is the low price
- Value is whatever want in a product,
- Value is the quality get for the price I pay, and
- Value is what I get for what I give.
If the sum of all the perceived benefits (gross value) minus the sum of all the perceived costs, it follows that the greater the positive difference between perceived benefits and perceived costs, the greater the net value.
If the perceived costs of using a service are less than the perceived benefits, then it will possess negative net value; customers will probably describe the service as “poor value” and decline to purchase it.
Marketers can think of calculations that customers make in their minds as similar to a pair of scales, with product benefits located in one tray and being offset to some degree by the weights in the other tray representing the costs associated with obtaining those benefits in the other tray.
Firms with relatively undifferentiated services need to monitor what competitors are charging and should try to price accordingly.
When they see little or no difference between competing offerings, customers may choose what they perceive as the cheapest. Price competition increases with:
- An increasing number of competitors
- An increasing number of substituting offers
- Wider distribution of competitors and/or substitution