Consumers' choices depend on the net value they get after taking into account both monetary and non-monetary costs incurred from the purchase. Associate Professor Irene Ng, who graduated with a PhD from NUS Business School in 2003, explains how the identification and the converting of Pareto losses, coupled with the use of technology, will enable firms to innovate and increase price, demand and customer satisfaction.
Traditional business thought has it that price is the only and critical avenue through which businesses are able to generate revenue. With good pricing and segmentation strategies, firms are more likely to succeed since this would ensure that consumers would be more likely to pay for a good or service. However, today's consumers do not make purchase decisions based on price alone, but on the net value that they can get from their purchase. This includes both price and non-price considerations.
To enjoy the benefits of a service, buyers are aware that they are required to pay a price, a monetary cost. They are often unaware of other monetary costs involved, especially when consuming a service, or non-monetary costs that may be incurred as a result on purchasing a good or service. For example, when a buyer purchases a gym membership, he or she may incur further monetary costs in purchasing gym gear or car park charges. He or she may also incur non-monetary cost of having to wait to be served by a gym consultant.
Though unaware, consumers may unconsciously process such considerations and the expected net value (ENV) outcome may result in the decision of whether or not to purchase the service. Consumers too may decide not to purchase if they find themselves incurring other non-monetary costs such as time, feeling uncomfortable, being vulnerable to risk or opportunity costs.
Clearly, consumers do not just consider price as the deciding factor for purchase. There is thus a need for a revised understanding of the key economic concepts relating to price.
Service Innovation and Pareto Loss
Pareto Loss is defined as the non-monetary costs incurred by buyers. Simply put, Pareto loss benefits no party. Neither the consumer nor the firm benefits from it. By waiting, neither the consumer nor the firm benefits. In fact, it could even lead to a loss for the firm since the consumer may give up buying the service, or demand 'compensation' for having to wait, such as demanding a lower price for the service.
By understanding the concept of Pareto loss, and being able to identify it, firms can take the opportunity to innovate by converting this non-monetary costs incurred by buyers to higher revenue through increased price, increased demand or improved customer satisfaction.
To increase revenue, firms can attempt to reduce customer's non-monetary outlay and increase the price accordingly, maintaining the ENV and therefore retaining the number of customers in the market for the service. An example would be dry cleaning services, where customers willingly pay a higher price for an express (quicker) service or speedy boarding for low cost airlines, where customers pay to reduce waiting or to be able to choose their seats.
Alternatively, the firm can benefit from an increase in demand by reducing the non-monetary outlay and not increasing the price of the service at all. By doing so, the ENV increases and this may entice more customers to purchase the service. For example, mothers shopping at IKEA are able drop off their children at a well-designed and well-managed daycare with lots of activities for kids and this attracts them to shop at IKEA as it would reduce the difficulty of managing children (a non-monetary outlay) while shopping for furniture.
Today, technology allows firms to also convert Pareto loss into higher level of satisfaction for firms. Customers who have little time to go to the bank or the post office can now do their banking or bill payments online. When there is uncertainty as to whether there is enough snow at ski resorts, a webcam and a half-hour report on slope conditions available on the Internet provides tremendous value to the skiing customer.
Even without technology, innovative firms have identified some non-monetary costs that many of us would gladly 'buy' our way out of. For example, we are able to hire a personal concierge to help with errands that we might not have time to complete. As WCBS TV reports, "Time is so precious, and this is a way to buy time."
One of the reasons why technology has been a key driver in the servitisation of the economy is because it allows more Pareto losses to be converted to revenue-generating service businesses. This in turn, raises productivity levels across the board and as economists like to observe, increases consumption that would further stimulate the economy. Buyers' needs today are more complex, with a greater demand on time. Yet, the key driver isn't merely technology, but our need for more time, greater convenience and less risk.
Thus, when firms convert Pareto loss into a service, whether chargeable or not, it results in greater customer choice and satisfaction.
Conclusion
The explosion of pricing strategies of recent times has also been very much technology-led. Channels of purchase have increased tremendously over the past 20 years with more ways than ever to sell and deliver services. With the proliferation of sales and delivery channels, service entrepreneurs and innovators are able to discover ways and means to uncover latent need for convenience and time, and meet them in innovative ways.
Consequently, buyers can now purchase through a channel that is most conducive for them, i.e. the channel that gives them the greatest value. Since buyers now determine their purchase decisions by considering both monetary and non-monetary costs, different Pareto losses exist for different channels. Converting such Pareto losses would give rise to many permutations in terms of pricing.
With markets now being divided into finer segments, leading to the term micro-segmentation, it is now possible to price for each of these micro-segments and therefore allow firms to refine their revenue management strategies. With third generation mobile telephony, TV on the web, music on the move, convergence of mobile and Internet as well as other technologies, pricing and revenue management strategies have to be clever, creative and innovative. Otherwise, firms that are any less dynamic run the risk of being left behind.
Dr Irene C L Ng is an Associate Professor of Marketing and the Director for the Centre for Service Research at the School of Business and Economics, University of Exeter (UK). She was previously the CEO of SA Tours, the largest tour operator in Southeast Asia based in Malaysia, Singapore and China and the founder and CEO of Empress Cruise Lines, a cruise company with a turnover of $250m per annum.
The adapted article was an excerpt from one of the eleven strategies in her book, "The Pricing and Revenue Management of Services: A Strategic Approach".
More on her other strategies can be found in her book located at http://astore.amazon.co.uk/irenngsperswe-21.
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"In today's context, technology allows firms to turn Pareto loss into higher revenues for firms through service innovation."
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