Value based pricing for services
Services are different than “goods” or physical products! When considering how to price a service, it is important to understand those differences and understand how to position yourself to maximize profitability. For products that consist of both “goods and services” such as a car with an extended service plan, it is important that both pieces work well together and complement each other. As an example, I won’t buy a car from a certain manufacturer because I’ve had such poor service from that manufacturer.
Services are Intangible
Unlike physical products, services can’t be experienced until they are purchased. For example, I don’t know how my haircut will look until the cutting is done. As a result of this, people feel there is more risk in the purchase of a service. In addition to recommendations from satisfied customers, people often rely heavily on price to judge the quality of the service – more so than with a physical product. Services that are seemingly priced too low are often avoided. I shy away from places that offer haircuts for $5.99.
Services are Inseparable
If a person renders the service, then a human is part of the service. For companies to grow, it is critical to have employees who can deliver the same level of service that the owner can. If I bring my car into a repair shop, I want to know that my car will run great whether it gets worked on by the head mechanic or the junior mechanic. Otherwise, I may not be willing to pay the prices they ask. Services that are delivered consistently well can pull in a premium price.
Services are Perishable
Services cannot typically be stored so the provider must be able to react to a spike in demand. Loyal customers or customers willing to pay more have the right to expect better service levels. This needs to be considered when setting up price lists and service delivery expectations.
Value Based Pricing Principles Still Apply
The value based pricing model that Pricing Gurus sets for product pricing applies equally well for services. Services pricing should be based on the value that is delivered to the customer, not on costs or on your competitors. It is critical to understand the benefits you deliver verses customer needs, and verses what your competitors can provide.
This also applies to professional services. Imagine that you can save a client $100,000 with a 1 hour consulting engagement. (Nice job if you can get it.) If your normal hourly rate is $100/hr., do you only charge them $100? Or do you charge based on the value delivered. It is important to understand this when deciding whether to price by the hour or by the project.
Costs should only be used to calculate the profitability of the services you deliver – not to calculate prices. If you find that you are not profitable based on value based pricing, consider restructuring the service you are delivering, or get out of the business. Services that are bundled with physical products may have to be evaluated for profitability along with the physical product. Services may be priced low to enhance physical product sales, or the service may be the long term recurring profit engine for the company.
Maximizing Service Profitability
Get customer inputs on pricing. It’s OK to ask them what they want and are willing to pay.
Include features that drive profits.
Remove features that customers don’t value and add to your costs.
Price for maximum profitability vs. maximum market share.
Communicate the value of your offering. This is often more critical in services vs. goods.