Businesses price products in many different ways, but and correct pricing provides better profits and returns for their shareholders. There are many different tools and strategies companies uses to figure out how to price a service. Two of the strategies to price services include value-of-service pricing and cost-of-service pricing. The differences between the two are subtle but may make a huge differences in the price of the product and the profits received.
Value-of-service pricing is basing the price on the utility factor of the service provided. The hard part about this is figuring out the utility a customer receives from the service provided. Pricing using this strategy is more art than science. One way to figure out the utility of a service is looking at pricing from a customer perspective and seeing how much time they save by using your services. The danger of this is that if there is strong competition, pricing a product at value-of-service won't work if competitors are selling their services at half of the cost.
Cost-of-service pricing is pricing the service based on how much it costs the company. Companies usually figure out the profits they want on a service and mark the service up so they receive the profits they want. However, this may be not the best strategy because a customer does not care how much it costs the company to provide the service. A customer only cares about how much value it receives from the service.
The two different pricing strategies are completely unrelated because they are based on two different variables. Sometimes they can lead to similar prices but more often than not, they will be different. The cost-of-service pricing is a lot easier to figure out because all a company needs to know is the cost of the service and the markup they want on the service.
It is best to use a combination of tools and strategies to price your product. You have to see the environment you are in. Just basing your strategy on one concept may drive you out of business. If you are in a very competitive environment, it might not make any sense to do value-of-service pricing. Doing cost-of-service pricing does not make much sense in any environment because it doesn't matter to anyone what the cost of your service is.
Alex Shadunsky has a bachelor's degree in finance and is pursuing a Master of Business Administration from Indiana University. He has worked at Briefing.com as a junior equity analyst specializing in health-care stocks.