Who Should Control Pricing? Sales, Marketing, or Finance?

19th Mar 2013

timjsmithNB: This is an article written By Tim J. Smith, PhD Founder and CEO, Wiglaf Pricing

Who should oversee pricing decisions?  Some say marketing should since pricing decisions are fundamentally tied to product, placement, and promotional decisions.  Others say sales should since pricing directly affects customer relationships and sales is the customer-engaging organ of an organization.  And still others say finance should take the helm given pricing strongly affects profits.  Yet the answer Homburg, Jensen, and Hahn arrived at through surveying executives and correlating profitability with pricing decision-making approaches was three-fold: none of these divisions, all of them, and it depends.

The Kind of the Pricing Decision Should Drive the Who Decision

Not all pricing decisions are equal.  Some affect the way in which company engages the entire market and competes within its industry.  Others affect the way the company engages a single customer in a single transaction.  We typically call these the strategic and tactical pricing decisions, respectively.

The Who Need Not Be Singular

Strategic pricing decisions include price positioning of new products, price management over the products’ life cycle, price discounting and promotions policy, sales incentive policy, and the necessary monitoring and analysis of price capture to inform these decisions.  These strategic pricing decisions are fundamentally complex, relying upon multiple informational inputs and benefiting from multiple analytical techniques.  They are relatively high-impact, low-frequency decisions that deserve serious managerial attention.  And that is what Homburg et al. found.  More specifically, Homburg et al. demonstrated that firms which disperse strategic pricing authority horizontally among sales, marketing, and finance tend to outperform—that is, they tend to be more profitable.

Nor Need the Who be Localized

Tactical pricing decisions are those related to pricing and discounting decisions on specific sales opportunities.  Individually, these are generally relatively low-impact decisions but collectively they can have a very high impact.  These tactical decisions can appear at a relatively high frequency, and usually need to be made relatively fast.

Making these tactical pricing decisions well requires a deep understanding of the specific sales situation, an understanding which may be difficult for the salesperson managing that specific sales situation to communicate to their boss, much less to the rest of the organization.  That is, tactical pricing decisions benefit from the tacit knowledge held by the salespeople working that sale.  (Tacit knowledge is knowledge held by the holder which cannot be easily codified or communicated to others, in contrast to explicit knowledge which can.)  As such, some might expect that companies which push tactical pricing decisions down to the sales level will outperform those which restrict discounting authority.  Yet the importance of applying salespeople’s tacit knowledge to discounting decisions is only part of the story.

There is another side to that sword though: provide a salesperson too much pricing authority and the company may find salespeople discounting away all the profits.  Selling is difficult.  When direct salespeople have complete discounting authority, many researchers have demonstrated that they tend to substitute price discounts for selling effort.  It creates an agency problem.  As such, some might expect that companies which centralize all tactical pricing authority would outperform those which delegate discounting authority to the direct salespeople.  Yet that would contradict the above logic.

And that is what Homburg et al. found.  More specifically, they demonstrated that the optimal level of vertical delegation over tactical pricing decisions lies neither at the extreme of complete centralization nor at the extreme of complete salesperson autonomy, but rather somewhere in between these two poles.  That is, firms tend to outperform when discounting authority is vertically distributed, all else being equal.

The Market Dynamics Will Increase the Importance of Using Many Whos

Homburg et al. didn’t stop there.  They also looked at the role market dynamics has on the importance of engaging sales, marketing and finance in strategic pricing decisions.  Not surprisingly, they demonstrated that for companies facing turbulent market dynamics (high price volatility), it is more important to take the time to engage all relevant parties in strategic pricing decisions to improve profitability, than to take shortcuts to accelerate strategic pricing decision cycles.

The Incentive Alignment and the Many Whos Will Increase the Value of Using the One Who

Furthermore, Homburg et al. examined the role of the profit-based incentives in mitigating the agency problem and enabling companies to further delegate pricing authority to sales.  Again, unsurprisingly, they demonstrated that companies which use profit-based sales incentives are able to profitably drive tactical pricing decisions further into the organization.  Yet profit-based incentives are not necessary for everyone.

Homburg et al. also demonstrated that companies are more profitable when they couple strong dispersion of horizontal decision-making authority at the strategic pricing level with deeper vertical delegation of tactical pricing level.  This is an alternative means to manage the agency challenge.

The Whos

The work of Homburg et al. beautifully demonstrates the importance of managing strategic pricing decisions as a cross-functional issue, and limiting and/or managing tactical pricing authority through organization design and/or incentives alignment.  Hence, when it comes to designing organizational pricing-decision-making processes and structures, no one functional silo should dominate all the decisions but rather all relevant parties should contribute to the decision, depending on the type of the decision to be made, the forces within the industry, and the controls and incentives within the firm.  The question of “Who?” has been answered by Homburg et al. with “ ‘Who?’  You mean ‘Whos?’ ”

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