3. Practical aspects of the development process
3.5 Pilot survey
The pilot survey is the vital part of the development process. Different pricing methods can be tested in practice and then the most suitable selected. The test survey can also provide additional information about the price variability between the enterprises and so provide valuable information on the sample size required (i.e. the greater the variation the larger the sample size required). During the test survey the product identification and questionnaire should be improved in co-operation with the enterprises.
After the pilot survey has been carried out successfully and it is confirmed that the questionnaires and the pricing methods are plausible then the survey can be extended.
Ideally the sampling unit is the establishment/KAU, but in practice an enterprise is often used. The selection of enterprises in the pilot survey should be performed using the same method planned for the production survey. It is common that service price indices are developed industry by industry. This allows a different sampling strategy to be used in different industries, which may also depend to some extent on the quality of the frame available for the industry.
Due to a lack of survey design information, it can be difficult to determine an appropriate sample size using statistical procedures47. Sample size may be determined by using some fixed, expected coverage rate or by taking the decision on the basis of the resources available for the survey.
The sample size in the pilot study is normally smaller than in the production phase. A more detailed description of different sampling methods and stratification criteria can be found in the PPI Manual, Chapter 5.
To ensure a successful pilot study it is important to be first acquainted with accounting practices of the industry. After that, the questionnaire and instructions can be drafted. In many cases the international service classifications are not detailed enough to specify a unique service product that can be re-priced from period to period. These international classifications (for example CPA) are mainly referring to certain families of services that belong to this wider group because they have common end-use or are
47 This refers to standard sampling techniques, which generally require detailed information on the variation of the variable of interest. This is generally not available in the case of price variation for service product groups.
considered to be close substitutes. Information from industrial descriptions and trade organisations can be used to complete the classification information to form more detailed service headings that all belong to the same family of services.
Depending on resources the enterprises may first be contacted by personal visits, or by phone or mail (post or e-mail). When the right contact person has been found inside the enterprise it is very important to have detailed discussion with her/him on the purpose of the index. The services that are going to be priced and their detailed specifications are decided in co-operation with the enterprises48.
3.6 Treatment of quality change 3.6.1 Preparatory work for handling quality changes in service
products
Services are more difficult to specify than goods and, consequently, changes in the quality of services are often difficult to identify. A general rule is that there is a case for quality adjustments if a client is willing to pay more/less for a changed service. This rule is not easy to follow particularly because services are often partly or fully unique. Moreover, changes in service characteristics might take very different forms and they are not necessarily systematically either improvements or deteriorations. As a result, some subjectivity cannot be avoided when deciding when a quality adjustment should be made.
The need for quality adjustments and replacement of pricing specifications is encountered continuously in the index compilation. Therefore, preparedness for changes in the market and service products should be enhanced and maintained as far as possible. It is important to discuss with price collectors on procedures of how to handle quality changes in service products.
Preferably, guidelines on this can be provided at the same time as sample price specifications are discussed. Particularly the following subjects need
48 Ideally, the selection of services would be undertaken from a complete census of the relevant transactions. Obviously, in most cases this information is not available.
to be addressed in discussions with the price collectors and enterprises:
1. expected changes in the representativeness of services over time;
2. expected changes in the quality of services;
3. quality adjustment methods to be considered, and
4. data availability for implementing quality adjustments.
Possibilities to predict all changes are, of course, quite limited in practice but efforts should still be made. Advance preparations can better ensure that required replacement of pricing specifications and associated quality adjustments can be carried out quickly when necessary.
3.6.2 Examples of quality adjustment methods
In principle, the same quality adjustment methods can be used for services as for goods. In practice, fewer possibilities are available for services and also the usability of various methods differs between goods and services. This is illustrated in Box 10 that compares the use of quality adjustment methods for goods vis-à-vis services in Japan. The table shows that for only one third of services a quality adjustment method could be found whereas for more than half of goods an adjustment could be made.
The following text describes some examples on the use of quality adjustment methods for services. The examples are based on experiences in Japan49 where methods used for SPPIs are:
- Overlap method,
- Comparable replacement,
- Quantity adjustment,
49See the following papers; Moriya K., Utsunomiya K., Quality adjustment in practice: Case studies in the Corporate Service Price Index (CSPI), the 18th Voorburg Group Meeting, Tokyo, 2003 paper;
Hirakata N., Kouju A., Utsunomiya K., Quality adjustment method in prepackaged software in Japan’s 2000 base Corporate Service Price Index, the 19th Voorburg Group Meeting, Ottawa, 2004 paper; Ugai H., Quality adjustment of service prices, November 2001, Bank of Japan.
- Differences in production and option costs,
- Hedonic approach.
Each method has both advantages and disadvantages. The choice between various methods depends on service characteristics and data availability.50
Box 10: Use of various quality adjustment methods in corporate price indices in Japan, 2003
Services Goods
Number
of cases (%) Number of cases (%) Production
cost 65 9.1 269 17.3
Overlap 30 4.2 49 3.2
Hedonic
regression 2 0.3 52 3.4
Direct
comparison 125 17.5 428 27.6
Unit price 0 0.0 20 1.3
Impossible
to compare 489 68.5 727 46.8
Others 3 0.4 7 0.5
Total 714 100 1 552 100
Overlap method51
The overlap method can be used when old and new products are transacted simultaneously during a certain period of time and thus it is possible to use observations in the overlapping period as a link. An implicit assumption in the method is that the price difference between the old and new products reflects entirely differences in quality.
A major problem in this method can be that the old product is at the end of its lifespan and the new one is entering the market and, consequently, the market is not necessarily in equilibrium. This
50 Discussion on various adjustment methods and their suitability in different situations can also be found also in Chapter II of the OECD Handbook on hedonic indexes and quality adjustments in price indexes:
special application to information technology products.
(Handbook).
51 Detailed discussion of the overlap method can be found in the PPI Manual, Chapter 7, par. 7.80-89.
situation is encountered particularly if the service products concerned are under strong technological development and, as a result, old services rapidly lose their attraction while new ones gain ground.
Also in the case of slower progressing service products, a similar instability of the market might be a result if aggressive price competition is used as course of action to penetrate the market. The assumption that differences in prices reflect entirely differences in quality does not hold in these cases.
Box 11: Outdoor advertising
For “outdoor advertising”, an advertisement is specified based on size and location. If one of advertisements expires, the sample price is replaced for another. In this case the overlap method is often used providing that the new sample price has coexisted with the old one and the price difference between them has been relatively stable in the past.
Comparable replacement
When no quality difference exists between old and new service products, the direct comparison method – which incorporates the prices of new service products into the index by comparing them directly with those of old services – can be used. A typical example of these cases is when the name of a service product has changed but not the service itself, or cases in which the reporting enterprise has changed due to affiliations but transacted services and transaction conditions have remained the same.
Box 12: Domestic air passenger transportation Air tickets might be sold during a limited time (e.g. in the holiday season) at discount or by different names. If the quality of services, cancellation rights and terms of payments etc. are largely unchanged, comparable replacement is a sound method to be applied in these cases.
Quantity adjustment
Quantity adjustments are used in cases where the specification of service products is based on a given standard that slightly changes from the previous period. To be applicable, it is also important that fixed costs of service provision are
relatively small. In these cases prices can sometimes be expressed as unit prices which make it possible to establish price comparison between periods. Examples of these kinds of services are taxi transportation and newspaper advertising where prices are established based on given standards. The method should, however, be applied with caution and only if changes in standards are relatively modest.
Box 13: Newspaper advertising
In newspaper advertising, the size of standard advertisement is increased from 36.85 to 44.28 square centimeters (from 5.5 x 6.7 to 5.4 x 8.2 centimeters), and the price increases from 903.2 yen for the old sample to 1 085.5 yen for the new sample. No price change is shown, because the unit price remains unchanged (24.51 yen per square centimeter).
Differences in production and option costs
The production/option cost method is typically used in a situation where an old service product is replaced by a new one and there is no overlapping period where a representative set of prices are available for both services at the same time. In the method, the quality difference between the old and new products is measured based on the assumption that changes in production costs reflect directly the quality difference between the old and replacement service products. An advantage of the method is that as long as data can be obtained from surveyed enterprises, the information can be incorporated easily. The index compiler has to constantly exchange information with enterprises to judge to what extent changes in production costs really correspond to changes in quality.
Box 14: Building cleaning service
The frequency of cleaning services is increased.
Correspondingly, actual prices change from 1 000 euros in the old sample to 1 100 euro in the new one. The enterprise reports that the price of the additional cleaning is 130 euros.
An appropriate price index is:
97 1000
The formula is the same when the amount of services decreases but the sign of at is negative in this case.
The method is applicable for services that undergo simple changes rather than change in terms of contents. It is particularly convenient in a situation where only the specified amount of service changes. Thus, the method is often used in situations where also the quantity method might be applicable. For example, it could be considered for cleaning services in cases when the area to be cleaned and/or the frequency of cleaning change.
Hedonic approach
The hedonic approach is used for products that are under rapid development and where sufficiently representative and robust prices cannot be found to cover overlapping periods. Instead of relying directly on prices of new and old products, a price comparison is established on the basis of the characteristics of products.
In market equilibrium and perfect competition, prices are supposed to reflect the importance of various characteristics of products. This makes it possible to use actual data for identifying price determining factors and for establishing a
regression model. The model can then be used for estimating an overall quality change of products whose characteristics change over time.
For services, price determining factors are difficult to identify or to measure, and therefore the hedonic method is rarely directly applicable.
However, it might be used indirectly, namely, in cases when services are related to goods of which price changes are estimated using the hedonic approach. An example is the rental of machinery like computers, whose price index might be based on a hedonic regression model.
Box 15: Computer rental
The rental of a notebook computer for six months costs 26 700 yen and increases to 38 900 yen. In the old sample, the memory size of the computer was 374MB and the clock frequency 1.0GHZ while in the new sample these characteristics changed to 768MB and 1.6GHz. A hedonic regression model showed that the quality of the computer improved by 48.7 per cent.
The old sample price is adjusted to make it comparable with the new sample price: 1.487*26 700 yen =39 703 yen. Thus, the price decreased by 2 per cent (change of prices from 39 703 yen to 38 900 yen).