Pricing policy

Both “profitability” and “appropriation of rents” are, as the discussion above shows, distinguished by the fact that they are relatively wide and inclusive product market level concepts that, when applied to a specific functional field, such as pricing, do not very easily lend themselves to operationalization or practical use. However, the problems of defining the desired end of a pricing capability on a product market level in terms of realized profits or appropriated rents can be resolved, as sug-gested by other authors, by identifying the effects of pricing capability on the particular activities/business processes (Ray et al, 2004) and strategy/policy (Barney, 1991) being implemented.

The concept of pricing policy is defined as a policy that governs how price varies over products, customers or time. In line with definitions

provided by other authors¹⁷ (Tellis, 1986; Noble & Gruca, 1999), pric-ing policy is viewed as the means by which the firm tries to achieve spe-cific price related market outcomes in response to a given scenario by the use of a certain price level or price schedule.

The pricing literature and the neoclassical model are quite specific about desirable properties of pricing policy. More specifically, these properties can be described according to three dimensions: (1) Price discrimination, (2) Price elasticity leverage, and (3) Operating leverage.

Price discrimination implies setting a price equal to the individual cus-tomer’s (or segment’s) perceived benefit of the product being sold.

Price elasticity leverage implies setting a relatively higher price if the price elasticity of demand is low, or setting a relatively lower price if the price elasticity of demand is high.

Operating leverage implies setting a higher price if the firm has a lower operating leverage (i.e. higher variable costs), or setting a lower price if the firm has a higher operating leverage (i.e. high fixed costs).

The three suggested pricing policy dimensions can, in a generic sense, be used to characterize the economic principle underlying particular pricing policies. Naturally, all individual pricing policies are to a greater or lesser degree characterized by all three dimensions.

The classification, or dimensionalization, of the concept of pricing pol-icy provided above differs somewhat from prior studies suggesting spe-cific taxonomies of individual pricing policies. The taxonomy of pricing strategies (policies) provided by Tellis (1986) outlines nine different pricing strategies¹⁸. Pricing strategies are classified according to shared

17Tellis (1986) and Noble and Gruca (1999) use the term “pricing strategy”. How-ever, in order to prevent confusing the concept with “competitive strategy” (Por-ter, 1980) and avoid discussion about “functional strategies”, the term “pricing policy” will be used.

18The pricing strategies suggested by Tellis (1986) are; random discounting, peri-odic discounting, second market discounting, price signaling, penetration pric-ing/experience curve pricing, geographic pricing, image pricing, price bun-dling/premium pricing, and complementary pricing.

economies¹⁹ among buyer segments, firms and products. The classifica-tion scheme is constructed based on two dimensions: (1) pricing objec-tive (differential pricing, competiobjec-tive pricing, product line pricing), and (2) characteristics of consumers (search costs, reservation price/price sensitivity, transaction costs).

In a later study, partly built on the taxonomy provided by Tellis (1986), Noble & Gruca (1999) identified ten different pricing strate-gies commonly used by firms in industrial pricing. Each of the ten pric-ing strategies is linked to one or more determinants that were found to govern firms’ choice of pricing strategy. Further, pricing strategies were also classified as belonging to one of four different pricing situations.

The identified determinants and pricing situations partly correspond to Tellis (1986) notion of consumer/firm/product characteristics and pric-ing objective. Table 3.3 presents the pricpric-ing strategies identified by Noble & Gruca (1999:438; 452) along with pricing situations and de-terminants.

The use of different pricing policy dimensions in this thesis, and in the two cited studies, can primarily be attributed to the chosen level of ab-straction. For example, Tellis’ (1986) notion of shared economies can be explained in terms of operating leverage, and achieving an optimal allocation of costs across different customers or products, while product line strategies can be explained as either price elasticity leverage, in terms of utilizing strong cross-product elasticity, or price discrimina-tion, in terms of utilizing differential customer price sensitivity. Hence, rather than influencing the classification of pricing policy dimensions, the two cited studies contribute to the pricing capability framework outlined in this thesis by suggesting particular examples of widely used pricing policies. However, a number of reservations should be made.

The study by Tellis (1986) was primarily focused on consumer mar-kets, while the framework outlined in this thesis is primarily focused on business-to-business settings. The study by Noble & Gruca (1999) was, although conducted in an industrial setting, primarily focused on uni-form pricing policies, while the concepts developed in this thesis fit both per-sale and uniform pricing policies. Further, there are important

19Shared economy is defined as a situation in which “[…] one consumer segment or product bears more of the average costs than another, but the average price still reflects cost plus acceptable profit.” (Tellis, 1986:147).

differences in perspective between the present and Noble & Gruca’s (1999) framework. Whereas the capability framework outlined in this thesis focuses on the internal elements enabling the implementation of particular pricing policies, the study by Noble & Gruca (1999) ad-dresses the applicability of pricing policies given (external) determi-nants.

In conclusion, the desired end of pricing capability can be represented by the implementation of a particular pricing policy described along the dimensions of price discrimination, price elasticity leverage and operat-ing leverage, or in terms of the correspondoperat-ing pecuniary amount (prof-its) representing the level of economic value appropriated by the seller through the implementation of the selected pricing policy.

The desired properties of pricing policy and market outcomes, outlined above, are as suggested by the integrative capability framework pre-sented in Chapter 2 (Figure 2.2), most immediately governed by the firm’s activities. These are addressed in the next section.

Table 3.3 Pricing strategies (-policies) and determinants (adapted from Noble &

Gruca, 1999:438; 452).

Strategy Description Determinants New product pricing

situa-tion

Price skimming We set the initial price high and then systematically reduce it over time. Cus-tomers expect prices to eventually fall.

High product differentiation Cost disadvantage due to scale

Penetration pricing We initially set the price low to acceler-ate product adoption.

Cost advantage due to scale Elastic demand

Inelastic brand demand Experience curve pricing We set the price low to build volume

and reduce costs through accumulated experience.

High product differentiation Not major product change Low capacity utilization Competitive pricing

situa-tion

Leader pricing We initiate price changes and expect other firms to follow.

No significant determinants

Parity pricing We match the price set by the overall market or the price leader.

High costs Low market share

Low product differentiation Elastic market and brand demand High capacity utilization

Low-price supplier We always strive to have the low price in the market.

Low factor utilization Low costs

Cost advantages due to scale No cost advantages due to learning Elastic brand demand

Product line pricing situa-tions

Complementary product pric-ing

We price the core product low when complementary items such as accesso-ries, supplies, spare parts, services, etc.

can be priced with higher premium.

High profits on supplementary sales

Price bundling We offer this product as parts of a bun-dle of several products, usually at a total price that gives our customers an attrac-tive savings over the sum of individual prices.

Per sale/contract pricing Elastic brand demand

Customer value pricing We price one version of our product at a very competitive level, offering fewer features than are available on other versions.

Hard to detect price changes Narrow market appeal High market growth

Cost-based pricing situation

Cost-plus pricing We establish the price of the product at a point that gives us a specified percent-age profit margin over our costs.

No significant determinants