In addition to the costs incurred by a service organization, customers may also incur up to five types of costs in purchasing and using a service:
- Financial costs
- Time costs
- Physical costs
- Psychic costs (mental effort, negative feelings)
- Sensory costs (unpleasant sights, noises, smells and tastes; physical discomfort)
Significance of types of costs in service setting
Fixed costs, or institutional overheads as they are sometimes referred to, are significant because they must be borne regardless of how much capacity is utilized. In a service setting fixed personnel costs, which may typically account for as much as 65% of all operational costs, are of particular importance.
Therefore, it is vital that fixed costs and overheads be kept to a minimum. Correspondingly, however, variable costs play a significant role in determining the contribution margin and in maximizing resource utilization and yield.
Consequently, value to a customer may be defined as the sum of all the perceived benefits (gross value) less the sum of all the perceived costs. From this it follows that the greater the positive difference between perceived benefits and perceived costs, the greater the net value to the customer.
A market can increase the net value of a service either by adding benefits or supplementary services, or by cutting costs, or by a combination of all three.
Possibilities for non-monetary cost reductions include:
- Cutting the amount of time involved in service purchase, delivery and consumption
- Minimizing unpleasant sensory experiences
Often there may be opportunities to increase monetary price if benefits have been raised and non-monetary costs reduced. When customers evaluate competing services, they are basically comparing net values to them.
Managers of service organizations should also be aware of the potential for performance and pricing abuses, especially with the provision of services high in credence attributes whose quality and benefits are hard for customers to evaluate. This means that managers need to ensure that customer ignorance is not exploited.
Companies aiming to make a profit must recover the costs associated with producing and marketing their service(s) and provide for a sufficient margin to yield a satisfactory profit. This price point, however, must be acceptable to targeted customers and capable of competitive justification or defense.
Cost based pricing types
This cost-based approach to pricing means that managers (and students) must understand the significance and implications of three different types of costs and their behavior:
- Fixed Costs
- Variable Costs
- Semi-variable Costs
Because the provision of most services is highly labor intensive, fixed wage and salary costs in a service organization typically need to be kept to a minimum. By contrast, the incurring of (incremental) variable and semi-variable costs needs to be linked directly to demand management strategies and performance.
Marketers should also understand the role and usefulness of a break-even analysis in estimating different levels of achievable sales revenue at different price points.
Why is cost-based pricing particularly problematic in-service industries?
Fundamentally because of difficulties in deciding how to assign overhead costs. Also, because the provision of services is highly labor-intensive and involves highly variable amounts of time in dealing with the different needs and requirements of different customers, estimating the amount and value of employee time required to deliver a “standard” service element is almost impossible.
It provides the means to yield accurate cost information about service business activities and processes, but managers need to move beyond seeing costs from just an accounting perspective. Rather, costs need to be viewed as an integral part of a company’s effort to create and provide value for its customers.