What Makes Pricing Services Different?

While there are many similarities in pricing strategy between selling products and selling services, there are also plenty of differences that make pricing services more difficult. Applying the same pricing methods used in products to sell services is a formula for disaster.
Why are services so hard to price? It is because, in the case of products, it is relatively easier to identify either your product acquisition cost or the cost of direct materials. Usually they serve to help as a starting point for many pricing strategies. In the case of services, cost components are harder to attribute.
In the case of a pure service business like consultancy or manpower services, there are two basic problems. First is determining your costs. The main difficulty, however, is when you have to put a price on your own value if you are the one providing the service, as in the case of consultancies.
It is even more complicated if what you are selling is a combination of products and services. Since there is a tangible product to cost, there is a strong tendency to continue treating this as only a product business. Unfortunately, this is often the situation. Due to intense competition, there is a strong tendency to add services to products sold and the same is true to a lesser degree in the case of services.
In the case of mixed products and services, a multiplier or a fixed percentage is often applied to the materials used. A prime example of this is the costing technique used often in printing presses. I will use a printing press as an example frequently because it is, in fact, both a service and a product business. In many printing presses, the paper cost and other readily seen material costs are just multiplied by a factor of three to take care of various untraced expenses and profit margins.
This may work in some situations, but in competitive bidding where you must know your cost accurately, you either will be pricing too high or too low. For example, if your materials cost P10 per piece and the order is for one million units, if you multiply the cost by three, the price becomes P30 per unit. You are then in a dilemma if a competitor prices at P27 since you do not know how much you can lower your price and still make a profit. If you knew that your cost would be P20, then you could bid P25 and have a better chance of winning the bid.
Due to fixed costs per unit decreasing as volume increases, usually the pricing style mentioned above results in too low a price for very low volumes, but too high if the order is huge. Either way, you will lose if you do not know your exact cost.
Entire books have been written on pricing and I can just offer a few guidelines in this short article. Nevertheless, these basic pricing tips should help you get started on finding your best pricing strategy:
Learn how to get an accurate total cost of your service. Although I advocate pricing based on value, the cost of the service is vital in determining how low you can price. In calculating costs, few people have an accurate figure because the focus is mostly on the materials used. One very useful approach is to use activity-based costing. This technique is used to trace overhead expenses to a particular product or service. Going back to our printing press example, we stopped offering calling cards despite very high markups on the materials used. This is because overhead expenses like salesman time and order processing traceable to the item were too high for the usually very low peso value of the calling card orders.
Base your price on value, not cost. The customer does not care that you are so inefficient that you have higher costs, nor would clients mind if your high productivity enables you to have lower costs. What is important is the value of your service as compared to your competitors.
Give options. While there are major advantages in having a single type of offer, you can close more sales and earn more profits if you offer options. There are two major reasons for this. The first is that you can sell based on different types of services. Customer can buy only the services they need. Clients who see the different types of services are more likely to find the things that they want. You may also offer options based on price affordability. You can have one for the price conscious buyer, another for those willing to pay for top quality, and one for the majority who wants a mid-range option.
Pricing services is often more difficult than pricing products especially for small firms or individual professional ventures. The difference in complexity lies in costs being harder to compute in services, unlike when you are selling tangible products. However, learning more accurate ways of pricing can mean a great deal to your company’s bottom line.

*Originally published by the Manila Bulletin. C-4, Sunday, September 9, 2012. Written by Ruben Anlacan, Jr. (President, BusinessCoach, Inc.) All rights reserved. May not be reproduced or copied without express written permission of the copyright holders.