Pricing in the service industry

According to Mckinsey Company's consultants, the fastest and most effective way for a firm to achieve maximum profit is to get its price right (Marn and Rosiello, 1992). These consultants reported that a 1 percent price improvement generates an average of 11.1 percent increase in profits among the 2,462 companies they studied. Given the importance of price in generating revenues and profits for a company, the approach used by service firms in price setting has been relatively unsophisticated. In an attempt to identify problems and strategies in service marketing, Zeithaml et al. (1985) found that cost-oriented pricing was the most popular approach used by service firms. Although this method offers some advantages, the simplistic nature of cost-oriented pricing is not effective in a complex and competitive business world. As consumers have become more sophisticated and demanding, it is very important that service firms be adapted to this changing environment when setting prices.

Typical progress of marginal cost

English: Figure 17: Pricing according to the FLO s...

Costcurve - Marginal Cost

Cost-oriented approach and competitive-oriented approach are the two traditionally dominant pricing approaches in the service industry (Zeithaml et al., 1985). A cost-oriented pricing approach sets a service price based on all the costs plus a desirable profit margin (Beard and Hoyle). It is usually based on full cost, but it can also be a contribution and incremental basis. For competitive-oriented pricing approach, the price is set to meet the market competitive situation (Kotler and Bloom, 1984). The simplistic nature of these two pricing approaches provides the advantage of a useful and quick pricing method. On the other hand, the simplicity of these two pricing approaches also causes them to lose their effectiveness as the business world becomes more dynamic and complex. In general, competitive-oriented services pricing approach provides no guidance on how much higher or lower than a competitor's price a service provider should set its price. Also...