Archive Template

Why Service Pricing Strategies Don't Work^©
by Al Hahn

In a few days, I will be conducting a pricing workshop for a large, well-known, high-technology company. Except for the manager who hired me and knows me well, the rest of the attendees have some fairly substantial surprises ahead of them. They think that I will help them develop a pricing strategy, and I will. Before we get to that point, however, I will probably challenge everything they think they know about pricing and dispel some illusions they are entertaining regarding pricing strategies.

I have found, over many years of experience pricing services, consulting, and teaching in this area, that most service pricing strategies don't work. For starters, many people confuse pricing methodologies with pricing strategies. Methodologies or techniques include cost-plus, percent-of-list, value pricing, and several other approaches. These are definitely useful techniques, but are not to be confused with pricing strategies. A strategy might be to price at a premium (high) level to maximize profits and support a position as a market leader. Another strategy might be to under price the market leader. I'll mention a few later in this column. But first, let me bore in on why they often don't work.

The First Mistake
An all-too-common mistake is to treat pricing as a separate activity from the other Ps of marketing. The Marketing Mix consists of Product (services in our case), Price, Place (actually distribution channels, but a word starting with the letter P was needed to make four Ps), and Promotion. Many organizations make the mistake of separating pricing from the other marketing functions. This is a terrible mistake. Price needs to be skillfully blended with the other Ps so that they support each other. A premium service needs a premium price, and economy service needs a lower price. Each service/price combination must be promoted properly, addressing the specific target market with an appropriate message. Prices and service usually change, based upon distribution channels as well. Separating pricing activities too much is like having separate kitchens with different cuisines preparing dishes for the same meal. It might work on occasion, but it will often result in disharmonious meals.

One of the worst practices that I identified in a column earlier this year was the existence of pricing committees. These often are composed of service operations managers or executives or financial people. In my very strong opinion, pricing is, above all, a marketing activity. Committees typically focus on costs and their sense of competition. This is the ultimate mistake of separating pricing from the other Ps. Pricing, in the hands of those without marketing training, is going to be a disaster that frustrates marketers and confuses customers and sellers alike. In this situation, an effective strategy is but a dream.

The Other Common Error
Another common mistake centers on misunderstanding price elasticity. Price elasticity is the relationship between price and volume. Simply put, there is often a price point at which buying behavior is affected and the volume of purchases increases dramatically. The PC is a good example. The price point of early PCs helped establish a huge market for computers that had not previously existed. Of course, the product had to support this market as well in terms of size, features, and cost. The problem is that price elasticity does exist and we experience it daily. This can subtly cause us to expect that if we lower a price, sales will automatically increase. In fact, this is not an automatic result. Each product/market combination has its own curve that describes the relationship between price and volume.

I have been testing this for high-technology services over the past eight years and have found that price elasticity in our markets occurs at a point that is simply not useful. Most service prices would have to be reduced by 65 percent to dramatically increase buying behavior. One year, I tried reducing a specific service price by 25 percent to increase volume. At the end of the year, I had exactly 25 percent less revenue for this service. Price elasticity may be more useful in some product markets, however, which can lead to an expectation that it is the same for services. Price elasticity is a fundamental assumption that often underlies many pricing strategies, rendering them flawed for those of us in the service side of things.

What Works?
So what does work for a pricing strategy? Things like pricing time and materials services high to make service contracts look better economically. This completely ignores the costs of T&M, and is appropriate if you want to sell contracts. Other successful strategies usually combine price and other Ps. For example, to maximize revenues, you want lots of different services at different prices, as well as many different options and uplifts. The basic approach is to have a service and a price to fit any situation. You can't do this with price alone. To maximize margins you might decide to emphasize premium offerings at premium prices, again pairing the service with the price. To support maximum growth, keep your offerings and your prices simple and competitive, making them easier to sell. These are some strategies that can work. If you have used other strategies that have worked for you, drop me an e-mail. I would love to share your successes with our readers.