Pricing Strategies for Information Technology Services: A Value-Based Approach.

Abstract

While commoditization is creating opportunities for customers of information technology services, it is creating new challenges for the service providers. Pricing strategies are one of the most important challenges and decisions for today's IT service providers. Pricing strategies for IT services have traditionally focused on covering costs, achieving desired margins and meeting the competition. These pricing schemes range from simple approaches, easily copied by competitors, to complex models with high management costs. In order to be successful in today's competitive business world, the service providers need to define their pricing strategies by considering the customer's perceived value from the service they receive rather than using traditional cost-based pricing strategies. This paper surveys literature on IT services pricing and presents a value-based approach to effectively price IT services.

Full text

Pricing Strategies for Information Technology Services:
A Value-Based Approach
Robert Harmon
Portland State University
harmonr@pdx.edu
Haluk Demirkan
Arizona State University
haluk.demirkan@asu.edu
Bill Hefley
Carnegie Mellon University
hefley@cmu.edu
Nora Auseklis
Intel Corporation
nora.auseklis@intel.com
Abstract
While commoditization is creating opportunities for
customers of information technology services, it is
creating new challenges for the service providers.
Pricing strategies are one of the most important
challenges and decisions for today’s IT service
providers. Pricing strategies for IT services have
traditionally focused on covering costs, achieving
desired margins and meeting the competition. These
pricing schemes range from simple approaches, easily
copied by competitors, to complex models with high
management costs. In order to be successful in today’s
competitive business world, the service providers need
to define their pricing strategies by considering the
customer’s perceived value from the service they
receive rather than using traditional cost-based
pricing strategies. This paper surveys literature on IT
services pricing and presents a value-based approach
to effectively price IT services.
1. Introduction
The pricing decision is one of the most critical
decisions that a firm can make whether planning the
introduction of a new information technology (IT)
service or repositioning an existing IT service. No tool
in the marketing toolbox can either increase sales or
reduce demand more quickly than pricing strategy.
Pricing strategies for IT services have traditionally
overemphasized cost-related criteria at the expense of
the value of the service to the customer [34] [54]. Cost-
based pricing strategies are focused on creating short-
term value for the service provider. Conversely, value-
based pricing focuses on the customer’s perception of
the value of the service, not on service costs only (see
Figure 1). The goals are focused on setting prices that
facilitate the development of customer relationships
that can create long-term value for the customer,
which, in turn, enables the achievement of the service
provider’s financial and strategic objectives.
From a marketing perspective, the goal of pricing
strategy is to assign a price that is the monetary
equivalent of the value the customer perceives in the
product while meeting profit and return on investment
goals [41]. This paper posits the view that the
traditional cost-based approach to IT service pricing is
typically short-term, tactical in nature, and places the
interests of the provider over the interests of the
customer. Conversely, pricing approaches based on the
customers’ perceptions of value are strategic and long-
term in nature since they are focused on monetizing the
service value perceptions from each customer through
the pricing mechanism [21]. Firms that understand the
strategic role of pricing and utilize a systematic
approach to setting prices, by understanding how
customers value service alternatives and arrive at
prices that they are willing to pay, can make better
decisions throughout the service development and
implementation process.
Figure 1. Cost-centric pricing compared with
customer value-based pricing
Services, whether they are knowledge and labor
intensive (e.g. personal services, consulting, medical,
education, software engineering, etc.) or dependent on
IT infrastructure have the following shared
characteristics:
- Relatively intangible primary components that
cannot be easily transported as goods
- Perishable components unable to be stored for later
use
- Higher levels of customer contact that lead to higher
instantaneous demand for a service
- Non-standardized components
- Simultaneous production and consumption [5][65]
The emerging definition of IT services leverages
these characteristics while seeking to systematize
services and overcome some of the service challenges
(in terms of transportability, storage, and
standardization) in service delivery environments.
Therefore, IT service providers seek to integrate
tangible products such as hardware and software with
relatively intangible services such as maintenance,
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support, and professional IT services into an overall
value solution. In doing so, they are applying new
governance mechanisms, standards and metrics (e.g.
service level agreements, ITIL [53], eSCM [36]) and
designing environments and interfaces that leverage
the scalability and strengths of products and systems
facilitating the delivery of high-value services.
In this article, after reviewing the traditional cost-
based pricing strategies, we present a value-based
approach to effectively price IT services. This study is
one of the early attempts to survey the literature on IT
service pricing.
2. Cost-Based Pricing
Cost-based IT services pricing is a popular method
since it relies on readily available information from
cost accounting systems. IT and financial managers
often price IT services to yield a desired return on fully
allocated costs. Service development plans typically
are not approved without sufficient and timely return
on investment (ROI) [38][44].
IT services costs are a blend of service and
infrastructure costs. Infrastructure costs are often
assumed to be fixed but assigned allocations that can
vary with assumptions about projected volume [37].
Service delivery is assumed to be a variable cost. The
inability to successfully model the circular nature of
the impact of price on volume and of volume on price
can lead to overpricing in weak markets and under
pricing in strong markets [52]. It may be particularly
inappropriate for services where it is difficult to assign
costs to intangibles.
The most common cost-based pricing strategies are.
1. Flat pricing. Sometimes called “all you can eat” or
“all in one” pricing, users pay a fixed price for
unlimited use of the IT service, typically without up-
front fees. Cost recovery is a primary pricing goal.
2. Tiered-pricing. Tiered-pricing attempts to package
IT services to ensure cost recovery and higher
margins by matching price levels with the user’s
willingness to pay. This approach to pricing is an
attempt to link the cost of IT services to customer
service level requirements.
3. Performance-based pricing. IBM pioneered a
pricing model where license prices were based on
the theoretical throughput of the system in terms of
the MIPS (Million Instructions per Second)
capability of the machine running the software [24].
The goal for the provider is to recover costs and
ensure margins and not set prices based on perceived
customer value. Customer dislike this pricing model
since the same software performing similar tasks but
running on different machines is priced differently.
4. User-based pricing. The charge is based on the
number of users that utilize a collection of IT service
capabilities over a given period of time. The
assumption is usage is related to costs. The principal
variations on this theme are:
Per-user pricing is set to an individual user who
typically can use the product on an unlimited basis
for the term of the license [3]. This approach
typically offers one price for a specified number of
users [58].
High water mark pricing charges are based on the
maximum number of concurrent users over a given
time period.
Per-seat pricing is similar to per user pricing, except
that the license is assigned to the workstation and
can be used by a designated number of users [62].
5. Usage-based pricing. Known as “pay-as-you go
pricing” or “network pricing”, customers pay only
for what they actually use on a transaction basis. It is
often associated with an application service provider
(ASP) model [9].
3. Value-Based Pricing
The key to value-based pricing success is the
recognition that the price depends on the customer’s
value requirements rather than those of the IT service
provider. Buyers make judgments about benefits and
prices, and choose those products and services that
maximize their perceived value. The goal of value-
based pricing is to enable long-term profits by
capturing more value. That price should, in turn,
determine the level of development costs that the
company is willing to incur and what services can be
sold given the cost and residual margin structure [25].
3.1. Customer Value Drivers
Customer value is the overall benefit derived, as the
customer perceives it, at the price the customer is
willing to pay [32][56]. IT service providers must first
understand how their customers perceive value.
Perceived value is defined in terms of the tradeoff
between perceived benefits to be received and the
perceived price for acquiring the product or service
that delivers those benefits [33]. Service providers
should understand what these tradeoffs are and how to
influence product and service configurations that can
maximize customer value and business outcomes [18].
The power of choice mandates that those
configurations that deliver superior value will win in
the market place.
In order to create the foundation for setting prices, it
is necessary to identify the relevant set of value drivers
for the market segment being targeted and understand
the importance of each in the purchase decision
[39][32]. Customer value drivers are emotional links
that summarize customer perceptions about the product
and firm, create positive attitudes and feelings, provide
the basis for differentiation, and provide the reason to
buy [32][56]. The primary categories are:
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1. Economic value. Economic-value drivers are based
on the buyer’s perceptions about the cost (price) of
acquiring, owning, installing, using, and disposing of
a product or service. It is associated with functional
value [25][51][52][38][56].
2. Performance Value. Performance value is based on
the buyer’s perceptions of the utility to be derived
from the functional features, advantages, and
benefits associated with a product or a service. This
value driver is associated with functional value [56].
3. Supplier Value. The buyer’s perceptions about the
credibility of the provider and trust in the business
relationship links directly to brand acceptance. A
strong brand provides a greater barrier to
competition since it takes much longer to change
perceptions about a company [31]. Supplier value is
associated with emotional value and epistemic
(knowledge) value [56].
4. Buyer Motivation. The buyer’s psychological
motivations for a particular purchase are central to
the decision process [68][45][46]. This value driver
is analogous to emotional value and epistemic value
[56].
5. The Buying Situation. Customer value perceptions
occur within a situational context that may inhibit,
facilitate, or have no effect on purchasing behavior
[4]. Key situational variables are:
Task definition What tasks or uses does the service
address? [10][31]
Resource capability The physical and intellectual
resources of the buyer including budgets,
infrastructure, and technical skills [25].
Time horizon Buyers with short decision time
horizons tend to be less price-sensitive. How far in
the future is the decision and how long will the
service be used? [66][67].
Social influences How do the customer and service
users (those managing, influencing and executing the
purchase decision) influence the adoption of IT
services? [68][40][42].
Experience level Highly experienced buyers tend to
have stronger product-related attitudes, which
influence price expectations [49].
Availability refers to the degree of accessibility of
objective information about the service or company
for assessing performance and risks [64].
3.2. Theoretical Foundations of Value-Based
Pricing
Customer value is created by interactions between
the customer and the service provider [65]. Therefore,
in addition to understanding the cost structure of the
service offering, the services provider must understand
price-relevant customer characteristics in order to set
the service organization’s pricing objectives. Tellis
[63] classifies pricing strategies into three groups based
on the objectives of the firm: differential, competitive
and product-line pricing. We will extend “product-line
pricing” to “product-service line pricing” since the
object here is to delineate the value-based concepts that
can apply equally well to products or services
individually or in combination. Differential pricing
objectives are considered when the product is sold
across multiple segments at different prices with shared
costs and potential shared benefits [69]. For instance a
high-price segment may subsidize a low-price one. But
the increased volume in the low-price segment may
lower overall product costs to the long-run benefit of
all consumers. Competitive pricing objectives are set to
exploit a competitor’s vulnerability. Product-service
line pricing objectives enable the exploitation of shared
economies across the product-service line and across
segments.
The second major factor to be considered is the pre-
purchase characteristics of customers that may
predominate in any pricing situation and enable
different pricing strategies to be utilized [63][18].
Customers can be classified by search costs,
reservation prices, and transaction costs. Some
customers have high search costs since they place a
high importance on their time and opportunity costs.
They are not willing to spend time searching for
purchase-relevant information. Since they are not well
informed they tend to associate high prices with high
quality [27] or to buy randomly at higher prices. Others
may search somewhat more actively to take advantage
of discounts. Customers with low reservation prices
have no pressing need for the product or service and
will wait for a lower price. Others with high
reservation prices may associate low prices with low
quality.
Finally, customers can be segmented into unique
groups based on special transaction costs. These costs
include service testing and evaluation, priority status,
shipping and handling, installation, switching costs,
cost of capital and investment risk [29]. Lowering
transaction costs is a key motivation for IT service
adoption [8].
Common value-based approaches to pricing are:
1. Penetration Pricing Strategies target market
segments where buyers have a high degree of price
sensitivity [47]. Price-sensitive buyers typically have
low reservation prices. Delivering benefits that are
perceived as industry standard at a price that is
sufficiently low to generate increases in sales volume
creates customer value.
Low-price leader (low reservation price/competitive
pricing) targets buyers with low reservation prices.
This strategy targets the mass-market buyers with
reasonable features at a low price. The competitive
pricing objective recognizes that the market has
reached maturity. Buyers emphasizing economic
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value drivers would be attracted to the lower prices
provided the service features were industry standard.
Experience-curve pricing (low reservation price/
competitive pricing) targets buyers with low
reservation prices. The initial price is set below cost
in order to build volume and move more rapidly
down the cost curve toward profitability and
discourage competition. Service providers in this
situation are typically targeting high-volume price-
sensitive segments in mature markets [47].
Bundling (low reservation price/product-service line
pricing) features several services or combinations of
products and services that are packaged together and
priced as a single unit. It is a product-line strategy
that maximizes sales and profitability of
complementary products within the product line
[47][52].
2. Skim-Pricing Strategies target buyers that are
relatively insensitive to price [47][55][57]. All have
high search costs.
Price signaling (high search costs/segment
differential pricing) is often used for segment
differential pricing of new service offerings where
time is a primary factor in the decision process.
Information about price is more easily acquired than
that about quality or performance [26][27][45][46].
Reference pricing (high search costs/competitive
pricing) is a variant of price signaling. Comparison
with the higher-priced product highlights the value
of the moderate priced product and vice versa
[25][47].
Image/prestige pricing (high search costs/product-
service line pricing) targets customers with high
search costs who are attracted to brands that have
achieved a reputation for high quality and exclusivity
[45][46][57]. Buyers have expectations for
exclusiveness and high levels of support and service.
3. Hybrid Pricing Strategies combine elements of
skimming and penetration strategies. Combinations
of high search costs, low reservation prices, and/or
special transaction costs may characterize potential
buyers. Special transaction costs might include the
complex and expensive evaluation process for
enterprise IT services or the switching cost for
changing service providers.
Cost-plus pricing (special transaction costs/
competitive pricing) is often used by IT service
providers that develop systems for the government,
or other large customers, where risks are not easily
quantified, and special transaction costs are high.
Cost-plus pricing guarantees the provider a rate of
return on project costs [43].
Complementary pricing is a product-service line
strategy based on a solution’s shared economics that
exploits differences in customer value for the base
component (low reservation price/product-service
line pricing), which may be either a product or a
service, and a complementary (higher-margined)
component (special transaction costs/product-service
line pricing), which is typically a consumable or a
service. The base component is sold at a low price
that minimizes resistance to purchase but becomes
the key link to repeated purchases of consumables
and services [52]. The goal is to generate higher
profits from the complementary components due to
the additional special transaction costs, higher
margins, and repeat transactions. For example,
application service provider (ASP) software services
minimize the front-end investment (and front-end
transaction costs) by eliminating the need for
purchasing software or servers [61][30]. Profits are
generated by the higher margins from
complementary transaction-based services such as
maintenance and support.
Premium pricing (high search costs/product-service
line pricing) Marketers address different groups of
customers by using a product-service line strategy
that addresses the higher search costs of some groups
and the lower reservation prices of others [47]. This
practice is also known as “price lining.” The strategy
is implemented by pricing versions of the product to
address entry level, mid-level, and high-end
premium-buying customers. Prices are set based on
the levels of the value the buyer perceives in each
market segment.
Random discounting (high search costs/ differential
pricing) A random discounting strategy maintains a
high skimming price but offers discounts on a
random basis as an incentive to new buyers to try the
product [18]. This strategy can be applied as a
variant of the ASP pricing scenario where users can
try the product at a discount before they sign up for a
longer-term license.
Periodic discounting (low reservation price/segment
differential pricing) creates customer value for
sequential classes of buyers with increasingly low
reservation prices. The initial strategy focuses on
skimming the inelastic demand of the innovator then
reducing prices on a predictable basis as the market
matures in order to attract more price-sensitive
customer groups [63].
Second-market discounting (differential pricing/
special transaction costs) is the situation in which
marketers introduce an existing product to a new
market where buyers are more price-sensitive than
the primary market and have identifiable special
transaction costs. For instance, Microsoft has offered
second-market discounts to buyers that are
contemplating implementations of Linux-based
operating systems in the server market [29].
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Table 1. The Customer-Value Dimensions of Cost-Based and Value-Based Pricing
Customer
Value Driver Cost Based-Pricing Value-Based Pricing
Economic
Value
Flat pricing Delivered initial cost is the key driver
Tiered-pricing Cost to customer will vary with need
for higher performance
Performance-based pricing (1) User pays up front
based on power of host processor
User-based pricing Pay by number of users
Usage-based pricing (1) Match price to usage
Low-price Leader
Bundling (1) Lowers initial costs & increases switching costs
Experience-curve pricing Lowers initial cost to obtain volume
Complementary pricing (1) Lower initial cost for the base
unit initial cost
Premium pricing (1) Low-end product, second market
discounting
Performance
Value
Tiered-pricing Pay more for higher performance
potential.
Performance-based pricing (2) Pay more for higher
performance outcomes. Workload license charges
attempts to match license fees to actual workload.
Usage-based pricing (2) Pay more as usage increases
Bundling (2) Increased performance at a given price.
Complementary pricing (2) Consumables or services-higher
margins on matched consumable item or services.
Premium pricing (2) High-end product—The high-
performance product contrasts with lower-price members of
product line. (See (1) above.)
Supplier
Value
Price signaling Brand name is synonymous with high quality
and commands higher price
Reference pricing Buyers with high-perceived risk will look to
high-credibility brand
Image/prestige pricing Reputation of the supplier is key to the
purchase decision
Buyer
Motivation
Reference pricing Buyer has high-perceived risk and needs a
reference point
Random discounting Entice buyers with high-perceived risk to
try the product
Image/prestige pricing Buyer is emotionally involved with
brand image
Buying
Situation
The net effect is to serve as a constraint or facilitator on the purchase decision. For instance, a buyer with very specific
task requirements may be less price-sensitive and accept a higher price for the right solution. A company with its own in-
house IT department and a high degree of product experience may be more price-sensitive.
Table 1 depicts the differences between cost-based
pricing and value-based pricing from a customer-
value driver perspective. Some strategies extend over
two characteristics where (1) is the lower end of
economic value and (2) indicates the higher-priced
component of the shared relationship. It can be
readily concluded that cost-based pricing is totally
focused on the economic value and performance
value dimensions. Unless the service provider has
sufficient market power to enforce its cost
recovery/ROI-based pricing strategy, competition
will quickly force lower prices as performance
standards become common industry-wide.
Conversely, value-based pricing targets the economic
and performance value dimensions in order to
provide additional value to the customer as the basis
for forming long-term and more profitable
relationships. Market penetration and hybrid
strategies dominate. One can also discern that the
more profitable skimming strategies, driven by
supplier value and buyer motivations, leverage brand-
image, self-image and other intangibles to increase
perceived value and enable higher prices.
4. Traditional Pricing Strategies for IT
Services
We define IT services from a total customer value
perspective—the aggregate value available to the
customer from the systematic integration of the
individual IT service components. Therefore, IT
services consist of software, hardware,
telecommunications networks, data, maintenance,
technical support, and consulting necessary to design,
deploy, operate, and maintain computer applications
for the purpose of delivering superior customer value.
The software industry’s shift from product-centric to
service-centric business models provide the
opportunity for exploring value-based pricing
strategies. This shift has been enabled by
improvements in Web-based IT infrastructure that
have enabled new approaches such as Software as a
Service (SaaS) (where the “product” might become
the “service”) and Infrastructure as a Service (IaaS)
leveraging delivery models such as “cloud
computing” or “on-demand” computing in addition to
more traditional IT services such as maintenance,
support, file and print services, business recovery,
and professional consulting [1][17].
4.1. The Shift to Services
Pricing for IT services is often a neglected topic for
many IT managers [35]. Transitioning from a pricing
strategy based on software products to an IT services
orientation is extremely complex but highly
important for both providers and customers to
understand [12].
Cusumano [13] observes that the transition to
services is a long-term trend. As traditional software
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product sales and license fees have declined over the
past decade, the emphasis on services such as
maintenance, upgrades, technical support and
consulting has increased, especially for enterprise-
software providers. The growth of open source and
free software has accelerated the trend toward
standardization and commoditization of software
products [14][50]. Cusumano [13] further argues that
the SaaS model has disrupted the traditional
separation of product and service revenues by
including maintenance and technical support within
its value proposition.
The growth of IT services might be the result of a
natural lifecycle of software companies or a
deliberate business choice to emphasize services [13].
The life-cycle notion posits that young companies
generate most of their revenues from product sales
and license fees, maturing companies shift to a mix
of products and services for competitive reasons, and
mature software companies’ revenues are mostly
from services since license fees have declined. Due to
industry consolidation only about half of the 300
public software product companies in 1997 remain
[12][13]. Increasingly, those companies are looking
to services for their continued growth.
4.2. Information Technology Enhanced
Pricing Strategies
Dixit et al. [18] extended the scope of the Tellis
[63] pricing-strategy taxonomy to encompass recent
developments in information technology. They
explored three classes of IT influences that drive six
pricing approaches that the authors call information
technology enhanced pricing strategies (ITEPS).
1. IT influences on pricing strategy. The drivers are
increased information availability, enhanced reach,
and expanding interactivity that inform auctions,
revenue management, price signaling, automated
pricing, price customization, and bundling [18].
Increased information availability about IT
solutions enables customers to make better choices.
IT enables the collection, analysis, and
dissemination of decision-relevant information,
enhances price customization, bundling options,
revenue management, and automated pricing
strategies [15][16].
Enhanced reach. IT services enable large numbers
of customers to access solutions through the
Internet. This creates pricing opportunities for
bundling/unbundling, price customization, and
online auctions. Auction participants may be deal
prone and searching for low prices. Alternatively,
the broader number of participants may bring in
buyers that are willing to pay more, as well.
Expanded interactivity may increase efficiency by
enabling electronic transactions and customer
interactions. User support groups, search,
interactions between buyers and sellers, and group
buying programs are some examples. Interactivity
supports auctions, revenue management, and
bundling price strategies.
2. ITEPS Pricing Classifications. Dixit et al. [18]
uses the Tellis [63] differential pricing, competitive
pricing, and product-line classifications for
introducing six ITEPS approaches to pricing as
summarized below:
Differential pricing strategies arise because of the
heterogeneity of consumers which suggests that
firms can sell similar products to consumers in
different segments at different prices [63].
i. Internet auctions may be either forward (buyers
compete for items from a single seller) or reverse
(sellers compete to sell to a single buyer). In both
cases the typical situation is buyers with low
reservation prices.
ii. Revenue management. A pricing approach that
is based on market segmentation and the ability to
forecast factors that would cause demand and
prices to fluctuate over time [11]. Revenue
management (yield management) is used to
maximize revenues for airline reservations and IT
resources [19]. This approach pits the power of the
seller against the time constraints and special
transaction requirements of the buyer.
Competitive pricing strategies are based on a
firm’s competitive position [63]. The primary goal
is to exploit scale economies to penetrate the
market by pricing below competitors. Consumers
tend to equate higher prices with higher quality if
the price cues are more readily available than
quality cues [27][45][46].
i. Price signaling. Consumers will look for cues
such as brand reputation to infer quality. Lacking
that, price can become a surrogate for quality for
those with high search costs [63].
ii. Automated pricing. Internet shopping agents
(ISAs) enable consumers with low reservation
prices to search and compare prices among many
online retailers.
Product-line pricing strategies are relevant when a
firm offers a set of related products at different
price-points. These products may be bundled to
provide more value [6][7]. Having products at
different price-points enables price customization
to balance price across the product-line.
i. Customization. Marketers build relationships
with customers where they can offer special deals
to their best customers to reward loyalty and
enhance the lifetime value of the customer.
ii. Bundling/unbundling enables firms to mitigate
the effect of direct price comparisons. Bundling
may be profitable since more revenue is generated
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for each transaction without incurring additional
incremental costs.
Traditionally, software companies used three
revenue models: the up-front license fee, separate
maintenance agreements, and professional services
to install, integrate, deploy, train users, and customize
the software. A common mix now is one-third of
revenues from license fees, one-third from
maintenance payments, and one-third from other IT
services [12]. Cusumano [13] evaluated the pricing
models for 108 Web-based enterprise software
companies. Monthly subscription fees are the most
commonly used pricing model, used 49% of the time
followed by some type of “free” pricing, annual
license fees, open source, advertising supported and
pay-per-use. Combining these categories, we can
arrive at a reasonable picture of current IT services
pricing strategies:
1. Monthly subscription fee. This approach has
become the default pricing model for Web-based
solutions such as SaaS. The application,
maintenance, and some level of technical support
are often bundled into the monthly fee.
2. Free and free, but not free. Open source software
is available for free. However, unless the
“customers” are willing to do their own service
work such as customization, installation,
integration, deployment, maintenance, and
technical-support work themselves, there is ample
opportunity for the IT services firm to generate
service revenue by making the open-source
software more user friendly. Some observers
believe that most software companies will be
forced into this type of model as the marginal cost
(subsequently prices) of applications on the Web
approaches zero [2].
3. Up-front license fees. This is a dying pricing
model used mostly by legacy software firms. They
typically sell services separately. This model favors
providers and is usually not attractive to customers.
4. Pay per use. This is an old cost-based pricing
model that provides more value to the provider
than the customer.
Table 2 in the Appendix presents a comparative
taxonomy of IT pricing models. Several conclusions
can be made. ITEPS pricing strategies focus on basic
penetration and skimming strategies not conducive to
customer relationship-building and does not appear
appropriate for IT services. ITEPS may be used for
online pricing of products and services that is more
deal-oriented, automated or self-serve. Software
firms transitioning to IT services are using relatively
unsophisticated models—monthly subscription fees
and some version of free services. License fees and
pay-per-use will continue to fade.
5. Implementing Value-Based Pricing
for IT Services
Customer-value based pricing strategy is market
segment-specific, since value perceptions vary
between customer groups. After choosing the target
market, marketers must determine the value that
customers perceive in the service. This assessment
includes identification of the customers’ value
drivers, price sensitivity, choice perceptions, and
other price-related characteristics. Once the price the
customer is willing to pay is determined, this
information is integrated with cost-volume estimates
to determine if the IT service, as configured, can be
sold at a profit [48]. This type of information, which
is interactive with the customer and the market, can
be used to adapt the service’s design to meet the
customer’s value expectations or to reconfigure the
pricing strategy.
Figure 2 shows the framework for the development
of customer-value based pricing strategies for IT
services. Pricing strategy is dependent on the
organization’s knowledge of the service situation,
customer relationship expectations, price-relevant
customer characteristics (value drivers, transaction &
search costs, reservation prices buying situation), the
competitive situation, service costs, and pricing
objectives. The dynamics depicted in the diagram can
be assessed at any time in the strategy development
process in order to associate customer price
perceptions with IT service development and
commercialization options. This early-stage analysis,
by linking cost estimates to anticipated prices, can
help to determine if a particular product-service
configuration should be pursued [23][33][40]. This
price information can be used for commercialization
and to check post-launch pricing efficacy.
This type of value-related information is superior
to the cost-oriented approach that is most often based
on projections of product-costs, project management-
oriented economic analyses, and managerial rules-of-
thumb. Adding a margin to standard costs is not a
defensible way to price services [22][28][29][54]. IT
service providers need to use value-based pricing
methods that model actual customer value, price
sensitivity, and value-in-use scenarios [59][60].
6. Conclusion
This paper presents a review of contemporary cost-
based IT services pricing models contrasted with
value-based approaches. The cost-based pricing
models have evolved from a financial perspective
based on the economics and internal cost-drivers of
the software development process. As markets have
become more competitive and providers are moving
to more services-based revenue models, cost-based
pricing models that ignore customer-value
Proceedings of the 42nd Hawaii International Conference on System Sciences - 2009
7

requirements can no longer ensure a favorable rate of
return to the IT service providers. A taxonomic
analysis of customer value drivers indicates that cost-
based models appeal to price-performance value
drivers with promises of improved ROI for the
customer while ignoring other potentially more
important value drivers that are more intangible in
nature.
The primary contribution of this paper is the
detailed discussion of value-based pricing strategies
as they relate to the emerging IT services industry.
The article develops a prescriptive pricing taxonomy
that depicts the relationships between customer
characteristics, company objectives, and pricing
strategy. It suggests that comprehensive knowledge
of the customer can result in more appropriate
approaches to pricing strategy.
Finally, we propose that IT organizations develop
the organizational commitment to create human,
systems, and social pricing capital that places the
marketing organization at the center of value-based
price decisions. In such a scheme the IT services and
processes that companies develop will more
accurately reflect the value that customers expect and
are willing to pay for.
Figure 2. Framework for a Customer-Value Based Pricing Model (Adapted from [34])
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Appendix
Table 2. Taxonomy of IT Services Pricing Models
Objective of the Firm
Segment Differential Pricing Competitive Pricing Product Line Pricing
Pricing
Objective
Customer
Characteristic
Value-based
Pricing
ITEPS
Pricing
[1]
Emerging
Revenue
Models[13]
Value-based
Pricing
ITEPS
Pricing
[1]
Emerging
Revenue
Models [13]
Value-based
Pricing
ITEPS
Pricing
[1]
Emerging
Revenue
Models [13]
Penetration
Pricing
High Search Costs
Low Reservation
Price
Auctions/
reverse
auctions
Low-price
leader
Experience
curve
Automated
(dynamic)
pricing
Free
Open source
Bundling Bundling
Special Transaction
Costs
Skim
Pricing
High Search Costs
Up front
license
Price
signaling
Reference
pricing
Price
signaling Up front
license
Image-prestige
pricing
Custom
pricing
Up front
license
Low Reservation
Price
Special Transaction
Costs Revenue
management
Pay-per-use
Hybrid Pricing High Search Costs Random
discounting
Subscription Subscription Premium pricing
(higher priced
item)
Subscription
Low Reservation
Price
Periodic
discounting
Free, but not
free
Adverting-
based
Service
based
Complementary
pricing (base
item) Premium
pricing (lower
priced
comparator)
Special Transaction
Costs
Second market
discounting
Complementary
pricing
(consumable)
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