Cost management in
Service Sector
Prepared By:
Dr. Ashima Pahwa
Assistant Professor
Mittal School of Business
Lovely Professional University
Learning Outcomes
• apply appropriate costing methods based on
the nature of the service provided
NEWS
SERVICE SECTOR
• also known as the tertiary sector
• the fastest growing sector having
significant contribution to GDP
• crucial part of modern economies
• This includes a wide range of
industries such as healthcare, hotels,
IT, education, finance, entertainment,
and information technology.
Cost Management
Unique challenges arise,
such as high variability and
the intangibility of services.
Example: Consider a hotel
chain; managing costs while
maintaining service quality is
critical for profitability.
Characteristics of the Service
Sector
Intangibility: Services like consulting or education cannot be physically
touched or stored.
Inseparability: The service is produced and consumed simultaneously
(e.g., a haircut).
Heterogeneity: Variability in service delivery can affect quality (e.g.,
restaurant service).
Perishability: Services, such as flights, cannot be inventoried.
High Labor Involvement: Employee skills and efficiency are crucial cost
factors.
Product Costing Vs Service Costing
Analytical Question
How does the intangibility of services impact
cost management and pricing strategies?
Provide examples from industries like
hospitality or healthcare
SERVICE COST UNIT
SERVICE COST UNIT
• ABSOLUTE BASIS (WEIGHTED
COMPOSITE AVERAGE)
• COMMERCIAL BASIS (SIMPLE
COST UNIT AVERAGE)
EQUIVALENT
COST UNIT
Costing Methods in the Service Sector
• Activity-Based Costing (ABC): Allocates overhead costs based on activities,
enhancing accuracy (e.g., a call center analyzing costs per call type).
• Job Costing: Tracks costs for specific projects, common in consulting services.
• Process Costing: Useful for standardized services (e.g., customer service centers).
• Standard Costing: Helps in setting benchmarks for service performance and
efficiency.
Real-Life Example
Netflix employs Activity-Based Costing to
analyze costs associated with different types of
content and customer preferences, ensuring
pricing aligns with the value perceived by
subscribers.
PRICING STRATEGIES
IN
SERVICE SECTOR
Cost-Plus Pricing
• Description: This strategy involves adding a markup to the total cost of
providing the service. The markup is typically a percentage of the costs
incurred.
• Application: It’s straightforward and ensures all costs are covered.
• Example: A construction company estimates the total cost of a project
and then adds a percentage to cover profit, ensuring they earn a return
on their investment.
Value-Based Pricing
• Description: Pricing is based on the perceived value of the service to the
customer rather than the actual cost of providing it. This strategy focuses
on how much customers are willing to pay for the benefits they receive.
• Application: It requires understanding customer needs and perceptions.
• Example: A luxury hotel charges premium prices based on the exceptional
service, ambiance, and experiences offered, rather than just the cost of
accommodations.
Dynamic Pricing
• Description: Prices fluctuate based on demand, seasonality, customer
segment, or time of booking. This strategy allows businesses to
maximize revenue by adjusting prices according to market conditions.
• Application: Common in industries with fluctuating demand.
• Example: Airlines and hotels often use dynamic pricing, where prices
rise during peak seasons or as the booking date approaches.
Penetration Pricing
• Description: Setting a low initial price for a new service to attract
customers and gain market share. Once the service has gained
acceptance, the price may gradually increase.
• Application: Useful for entering competitive markets.
• Example: A new streaming service may offer a low subscription rate
for the first few months to attract subscribers before increasing prices.
Freemium Pricing
• Description: Offering a basic version of a service for free while charging
for premium features or services. This strategy helps attract a large user
base and convert free users to paying customers over time.
• Application: Common in digital services and software.
• Example: Many apps offer free basic functionality, with charges for
advanced features or ad-free experiences.
Rest are:
Skimming Pricing
Bundle Pricing
Psychological Pricing
Geographic Pricing
Subscription Pricing
Analytical Question
Evaluate the effectiveness of dynamic pricing in
the airline industry.
What factors should airlines consider when
adjusting prices, and how can they balance
maximizing revenue with maintaining customer
satisfaction?
