Demand-based pricing of Services | Problems | Methods

Demand-based pricing is one of the major approach to pricing. Under this method, the service provider does not consider cost of service rendered by him. He allows the demand that prevails for the service to determine price. Strictly speaking, demand-based pricing involves estimation of customer’s perception and setting the prices consistently. Prices are based on the perceived value of service to customers.

Customers-perceive value of service in four ways:

  1. Low price,
  2. Finding what one wants in a product or service,
  3. Quality the customer gets for the price he pays,
  4. Value is what he gets for what he pays.

In the words of Zeithaml and Mary Jo Bitner,

“Perceived value is the consumer’s overall assessment of the utility of a service, based on perceptions of what is received and what is given”.

The service provider should, therefore, translate the customer’s value perceptions into an appropriate price for a specific service offering.

Problems of Demand-based pricing for services :

Demand-based pricing of service is comparatively difficult since it is based on perceived value to the customers. There are non-monetary costs incurred by the consumers such as time, inconvenience, psychic cost etc. The monetary price must be adjusted to compensate these non-monetary costs.

When services save time, arrest inconvenience and other psychological costs, customers are prepared to pay a higher monetary price. Moreover, customers do not have adequate information about service costs. So; they are tempted to value the price of the service only in terms of quality. Since quality is an abstract term to the consumers, their perceived value may not be fair and accurate.

Methods of demand-based pricing

The following methods belong to the demand-based pricing as shown by the following figure..

1. ‘What the traffic can bear’ pricing: Under this method, the seller charges the maximum price that the customers are willing to pay for the product or services under given circumstances. This method earns high profit in the short run. However, it cannot be used in the long run. This method holds good where demand is inelastic to the price and where competition is not high. Consumer movement is opposed to this kind of pricing. Possibility of earning larger profits in the short-run attracts new competitors.

2. Skimming pricing: Skimming pricing is the strategy for new products or services. It aims at high price and high profits in the early stage of marketing the product. When the segments of the market do not bother much about the price, the service provider can skim the market through high price. Though skimming is possible in the first instance, subsequently the service provider settles for a low price. This method is very useful in pricing new service which commands the patronage of an affluent and non-price sensitive market segment.

Generally, new products or services are aimed at innovators. This group consists of consumers who buys innovative services. The job of marketer is to locate this group and target new products at them. As this group is not big, the marketer has to cover the next group called early adopters. They are the opinion leaders in their respective communities and they constitute a sizable segment.

The subsequent ‘early majority‘ is not all that venturesome like the ‘innovators‘. They are positive in their approach in trying out new things. The ‘late majority‘ group may buy the new services only when lot of people around them have adopted them. Finally, ‘laggards‘ are the last group to adopt new service when the price has fallen sufficiently. Skimming strategies aim to realize the highest possible price from the early adopters. When sales become saturated, price is lowered to appeal to early adopters.

3. Penetration pricing: Penetration pricing seeks to attain deep market infiltration through comparatively low prices. This method is useful in the following situations.

  • When the new product is not a luxury item,
  • When there is price sensitive segment; and
  • When the new product is capable of bringing in large volume of sales.

Penetration pricing helps the marketer sell a large volume at a reasonable price before competitors enter the same business. Sometimes, Penetration pricing helps marketer have a wider market and keep away competition. Since the price is comparatively lower, large sales may be required to break-even in the initial stage. Large volume of sales facilitates substantial economies in unit cost of production and marketing. The strategy helps to establish the product or service in the market.