Beruflich Dokumente
Kultur Dokumente
Managerial Practice
Peter M. Noble Thomas S. Gruca
College of Business, Humboldt State University, 1 Harpst St., Arcata, California 95521,
pmnl .humbolt.edu
College of Business, University of Iowa, Iowa City, Iowa 52242-1000,
thomas-gruca@uiowa.edu
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cost-based. The basis of this organization is a set of ity pricing, and low-price supplier strategies. We ex-
determinants which are common to every strategy in pect that the stage of the product life cycle and ease of
a given situation and unique to that situation.
The first situation, new product, includes the three
strategies most closely associated with new products:
skim pricing, penetration pricing, and experience
curve pricing. Every one of these strategies shares the
distinction of being appropriate in the early life of a
product. Therefore, we expect that the age of the model
being priced will determine whether a manager
chooses one of the new product pricing strategies.
In the competitive pricing situation, the main focus
is the price of the product relative to the price of one
or more competitors. A mature market and easy to es-
tmate demandare common to the leader pricing, par-
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is the interna! costs of the firm including fixed and entire product line (accessories, spare parts, etc.) is an-
variable costs, contribution margins, and so on. The other important consideration. Therefore, as in this
strategy included in this category is cost-plus pricing. well-known case study, there can be one, two, or more
Severa! related strategies, such as target-return pricing, pricing situations (i.e., new product, competitive,
are included as part of cost-based pricing strategies. product line, and/ or cost-based) involved in a single
Diamantopoulos (1991) claims that cost-plus pricing pricing decision.
is by far and away the most widely used pricing strat- We organized the current literature with regard to
egy. The Hall and Hitch (1939) survey of 39 business the pricing situations, the pricing strategies, and their
managers found the general pa ttern of price setting to determinants in Table 2.
be cost-based. The later Brookings Institution Studies In the next section, we will discuss the determinants
(Kaplan et al. 1958) corroborated this finding. Thirty for each pricing strategy within its pricing situation.
years later, Bonoma et al. (1988) found that managers
continue to use cost as a primary pricing concern. Determinants of Pricing Strategies
Most authors caution managers against relying on In three of the pricing situations, new product, com-
cost-based methods for establishing prices (e.g., Nagle petitive, and product line, there is more than one pos-
and Holden 1995). The only competitive situation in sible pricing strategy. For each of these strategies, we
which cost-plus pricing is profit-maximizing is one in have identified the determinants which are unique to
which average unit costs are likely to be constant over that strategy and those which are common to other
time and at any point on the demand curve (Lillien strategies within that strategy situation. The unique
and common determinants for these strategies are dis-
and Kotler 1983, p. 405-407). However, dueto econo-
cussed next.
mies of scale and/ or experience curve effects, neither
of these conditions are likely to hold in a manufactur-
New Product. There are three options for pricing
ing industry (Lillien and Kotler 1983, p. 407).
new products: skimming, penetration, and experience
The weakness of cost-plus pricing is that it ignores
curve pricing. Skimming is the practice of setting a
consumer and competitive information. However, if a high initial price which is often systematically dis-
manager has little or no information about demand, counted over time. The purpose of skim pricing is to
we expect that he or she is more likely to choose cost- discriminate between those buyers who are insensitive
plus pricing (Harrison and Wilkes 1975). to the initial high price because of special needs. As
There may be additional organizational factors this segment becomes saturated, the price is lowered
which may lead to a firm using cost-based pricing. For to broaden the appeal of the product (Dean 1950).
example, risk aversion or the need to justify a given The timing of subsequent entry is a key factor in the
price internally might lead to a reliance on cost-based success of skim pricing. Since new competitors will
methods. drive down prices, skim pricing takes advantage of a
It is important to note that a manager may be in temporary monopoly position. The additional margins
more than one pricing situation simultaneously. For obtained through skim pricing have to be balanced
example, in the classic Harvard Business School case, against lower current unit sales and leave a larger de-
"Deere & Company: Industrial Equipment Opera- mand potential available to subsequent entrants.
tions" (Shapiro 1977), the price for a new model of bull- Skim pricing is recommended over penetration or
dozer has to be determined, clearly a new product sit- experience curve pricing when there is a high degree
uation. At the same time, since the demand for of product differentiation in the market (Jain 1993).
bulldozers is mature and market leader Caterpillar of- Without this condition, there cannot be a "better"
fers comparable models, the pricing has to reflect com- product which would command a higher price. In ad-
petitive prices as well. Deere also sells spare parts that dition, there must be sorne buyers who are price in-
represent a significant income stream over the life of sensitive, i.e., willing to pay more for a product that
the product. Maximizing the revenue stream from the meets their special needs (Guiltinan et al. 1997; Schoell
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New Product Pricing Situation Skim Pricing Penetration Pricing Experience Curve Pricing
Determinant of pricing situation: Product age New (1, 10) New (1,0) New (10, 11)
Determinants of pricing strategies: Product differentiation High (4,8,10) Low (4,8,10) Low (4,8,10)
Significance of product change Majar (6,10) Minar (6,10) Minar (6,8,10)
Costs High (4,10) Low (4) Low (4)
Scale or experience curve effects Disadvantage (10) Advantage: sea le (3,4,8, 10, 11) Advantage: experience ( 4,8, 10, 11)
Demand lnelastic (4,8, 10) Elastic (1,3,4,6,8) Elastic (1,3,4,6,8,9)
Factory capacity utilization High (3, 10) Low (10, 11) Low (10, 11)
Determinant of pricing situation: Product Lite Cycle Mature (5) Mature (3,5) Mature (5)
Ease of determining demand Easy (4) Easy (4) Easy (4)
Determinants of pricing strategies: Market share High (4,5) Low (8) Low (2,5)
Costs Low (4) High (2,3,4) Low (8)
Scale or experience curve effects Advantage (2,4) Disadvantage (3) Advantage (4)
Ease of detecting price changes Easy (2) Easy (3,8) Difficult (2)
Total demand lnelastic (2,3) lnelastic (3) Elastic (3)
Factor capacity utilization High (10) High (10) Low (5)
Product differentiation Low (8) Low (8)
Brand Demand Elastic (3) Elastic (3)
Determinants of pricing situations Firm sells supplementary and/or Yes (3) Yes (3) Yes (3)
complementary products (other models,
ancillary products, spare parts)
Determinants of pricing strategies: Profitability of accompanying or supplementary sales High (3,5)
Switching costs High (11)
Per sale/contract pricing Yes (4)
Market appeal Narrow
Market growth rate Low
Ease of detecting price changes Difficult
Brand demand Elastic (3) Elastic (3,7,8,10)
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and Guiltinan 1995). The new product usually repre- Parity pncmg involves imitating the prevailing
sents a major improvement over previous versions in prices in the market or maintaining a constant relative
order to command a premium price (Mercer 1992). Fi- price between competitors. In sorne respects, this strat-
nally, firms with high factory utilization (Schoell and egy is born of weakness. If a firm hada superior prod-
Guiltinan 1995) or those who lack cost advantages due uct, it should be able to command a premium price
to scale or learning should consider skimming over the (Guiltinan et al. 1997). Or, if the firm had cost advan-
low-price new product pricing strategies (Schoell and tages, it could become a low-price supplier (Jain 1993).
Guiltinan 1995). If a firm has high costs, its only option in a mature
Both penetration and experience curve pricing in- market is to employ parity pricing (Jain 1993, Guiltinan
volve setting a low initial price for a new product. Pen- et al. 1997).
etration pricing is used to speed adoption of a new Three conditions are common to both leader pricing
productor establish itas a de facto standard. lt is sug- and parity pricing: markets in which price changes are
gested that firms with cost advantages dueto scale use easy to detect (Nagle and Holden 1995), inelastic total
penetration pricing (e.g., Tellis 1986). demand (Guiltinan et al. 1997), and high factory utili-
Experience curve pricing has a different focus and zation (Schoell and Guiltinan 1995).
source of advantage than penetration pricing. The ex- Low-price suppliers could be exploiting a cost ad-
perience (or learning) curve effect shows that unit costs vantage (Nagle and Holden 1995) or reflecting a weak-
fall with cumulative volume due to increased famil- ness (i.e., low factory utilization; see Kotler 1997). In
iarity with the assembly process and other factors (Bos- addition, a low-price supplier might be exploiting a
ton Consulting Group 1972). However, there is a great lack of pricing knowledge in the market by undercut-
<leal of controversy about the extent of these effects ting its rivals (Greer 1984). If this undercutting behav-
(e.g., Amit 1986). ior were known, it might ignite a damaging price war.
Experience curve pricing seeks to exploit the expe- Finally, the low-price supplier strategy should be more
rience / learning curve by setting prices low to build successful in markets with high levels of overall elas-
cumulative volume quickly and, thereby, drive down ticity (Guiltinan et al. 1997).
unit costs. The presence of these experience/learning
Common to both the low-price supplier strategy and
curve effects are necessary for this pricing strategy to price leadership is low costs (Greer 1984, Nagle and
be a success (Tellis 1986, Jain 1993; Nagle and Holden Holden 1995) due to scale or experience curve effects
1995). Whether this is a sound long-term strategy has (Jain 1993). Low market share is a common determi-
been questioned on many fronts (e.g., Abernathy and nant for parity pricing and low-price supplier pricing
Wayne 1974, Alberts 1989, Ghemawat 1985, Kiechel (Nagle and Holden 1995, Kotler 1997). As mentioned
1981).
above, both parity pricing and low-price supplier pric-
The common conditions that favor the low-price
ing are suggested for markets where brand elasticity
new product strategies contrast those for skim pricing:
is high (Guiltinan et al. 1997). In addition, these two
low product differentiation (Schoell and Guiltinan
strategies are expected to be more successful in mar-
1995), used for minor product revisions (Mercer 1992),
kets with low levels of product differentiation (Nagle
elastic demand (Guiltinan et al. 1997), and low capacity
and Holden 1995).
utilization (Schoell and Guiltinan 1995).
Competitive Pricing. Price leaders initiate price Product Line Pricing. The economic and psycho-
changes and expect that others in the industry will fol- logical aspects of price bundling have been explored
low suit. Price leaders tend to have higher prices than in depth elsewhere (Thaler 1985, Guiltinan 1987). Most
their competitors who use the leader's price to set their of the suggested determinants for bundling pricing are
own price levels (Greer 1984, Jain 1993). Hence, this common to other pricing strategies. Therefore, such
strategy is also known as Umbrella pricing. Price lead- determinants cannot be used to predict which firms
ers such as Caterpillar in heavy equipment tend to will use bundling versus other strategies that share
have the highest market share as well (Kotler 1997). these determinants.
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The sole exception is the type of price-setting pro- Manufacturers of consumer durables such as Pella
cess. When each sale or contract is priced separately, Windows have introduced new lines of products with
as in the case of system selling of mainframe comput- fewer features and lower pricing points than their tra-
ers, then bundling is a preferred option (Jain 1993). For ditional customized lines (Nagle and Holden 1995, p.
example, a major avionics firm uses bundling in most 165). Usually, these products are intended for a specific
of its pricing. Its customers need systems for control, market segment. In the case of Hon furniture, it pro-
communications, and navigation. To avoid a compet- duced a new line of less expensive office furniture for
itive pricing battle for each system, this firm quotes a home offices to be distributed through category killers
bundled price for the entire package. Since this firm is (narrowly focused retailers) such as Staples rather than
one of the few that makes all of these products, it usu- their full-service dealer network.
ally wins the contract. Other firms could submit a bid In industrial markets, Forbis and Mehta (1981) argue
for the entire bundle by using subcontracting. How- that the appeal of value-priced products vares by the
ever, the firm that makes all of these components in- intensity of product usage and geographical scope of
house has important supply synergies that it can ex- usage. For example, low intensity users of cranes (such
ploit through a lower price. In addition, bundling as junk yards) are more sensitive to the initial price
reduces the number of suppliers and potential incom- than heavy users (such as contractors). When operat-
patibility problems for the airframe manufacturer. This ing in a developing country, the reliability of an earth
is a clear demand-side advantage for the full-line avi- moving machine and the availability of spare parts be-
onics firm. comes more important than the initial acquisition
Complementary product pricing is well illustrated price. Other important factors might include the
by Gillette's strategy of selling razors cheaply and growth rate of the customer's business and the partic-
blades dearly. In many industrial markets, a firm will ular application of the product within the customer's
offer a wide range of supplies, spare parts, and acces- business.
sories which make up a large portian of the profit In contrast to the case with consumer markets, cus-
stream from the customer. In the Deere case above, it tomer value pricing in industrial markets is more likely
was suggested that a bulldozer consumes 90% of its to be successful if price changes are difftcult to detect.
initial purchase price in spare parts over its lifetime. Since the firm is providing most of the functionality of
Under this strategy, the main productor platform is its main product for a lower price, it runs a large risk
sold for a relatively low price while the ancillary or of cannibalizing its main, higher priced product (Dolan
supplementary products carry a high margin and Simon 1996, pp. 212-214).
(Guiltinan et al. 1997). For example, the markup on Both bundling and customer value pricing should
spare parts for bulldozers can be as high as 200%, be more successful in markets with high levels of
much higher than the margin on the main product brand elasticity (Guiltinan et al. 1997, Nagle and
(Kotler 1997, p. 515). Tellis (1986) suggests that high Holden 1995).
customer switching costs may keep customers buying
the captive, high-margin additional products. Summary
Customer value pricing is becoming increasingly In Table 2, we organize and summarize the previous
common in industrial markets. This strategy involves normative research on pricing in a new and, we feel,
pricing one version of the product at very competitive enlightening way. This framework can be used by
levels, offering fewer features than are available for managers to understand how academic research pre-
other versions. The most visible applications of this scribes different pricing strategies under various mar-
strategy have been in consumer markets. For example, ket, product, and information conditions. Further-
when McDonald' s lowered the price of its basic ham- more, this framework can be used to guide future
burger to 59 cents in 1990, its was employing customer empirical and theoretical work on pricing strategies
value pricing to spur sales in a low growth market since it shows where current research is under-
(Gibson 1990, Rigdon 1990). developed. For example, little is understood about
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how organizational factors affect or should affect pric- pricing, competitive pricing, product line pricing, and
ing strategy. In the next section, we use the determi- cost-based pricing-did not appear on the survey. We
nants for the pricing situations and pricing strategies wanted to avoid priming the subject to choose the ap-
presented above to model the pricing decisions of propriate strategy for the stated situation. Therefore,
practicing managers. our tests of the first level of the framework in Table 2
should be less biased.
In the pretesting for this study, we found that none
A Study of Managerial Pricing of the managers used more than three alternatives. In
Practice our final results, we found that 48.5% used one strat-
We conducted an extensive survey of industrial pric- egy, 28.5% two, and 22.5% used three strategies. We
ing managers to determine how well current practice note that the average importance of the third strategy
matches the norma tive pricing theory discussed above. was 15% (versus 28% for the second strategy). There-
This survey provides important benchmarking infor- fore, if there is any bias in not allowing for more than
mation for managers seeking to understand how other three strategies, it is not expected to be very large.
firms choose their pricing strategies. In addition, we allowed the manager to specify a
pricing strategy that was not part of the list of ten strat-
Survey
egies provided. Of the 21 who did, a total of 17, upon
The survey document was a four page questionnaire
review by two independent judges and the authors,
mailed to practicing managers in May and June of
were found to be special cases or related strategies of
1994. The survey underwent extensive pretesting to as-
sure readability and accurate understanding of the the original ten strategies. The remaining observations
questions. This included pilot testing with written and were dropped from the analysis.
verbal feedback from a convenience sample of execu-
Measures of Determinants. We modeled the
tive MBA students as well as a review of the survey
scales to measure the determinants after the questions
by two noted academic pricing scholars from other in-
used in the PIMS database (Buzzell and Cale 1986). We
stitutions. Copies of the survey are available from the
pretested the wording and meaning of the scales in a
authors.
pretest with experienced managers. The determinants
To avoid the criticisms leveled at many studies of
and their measurement scales are presented in
pricing objectives by Diamantopoulos (1991, p. 136),
Table 3.
we asked the managers to provide information on their
most recent pricing decision of a single industrial cap-
Sample
ital good rather than indicating an overall pricing strat-
We focused our survey on the pricing decisions of dif-
egy for all products or circumstances.
ferentiated, durable capital goods in business-to-
Measures of Pricing Strategies. Previous research business markets. We restricted our sample to these
on pricing objectives shows that many managers use industries since industrial components, supplies, or
more than one objective in their pricing decisions (e.g., raw materials are less likely to be highly differentiated,
Diamantopoulos 1991). To reflect the similar complex- which would restrict the pricing strategy options of the
ity of the pricing strategy decision, we allowed re- firms. Furthermore, since channels of distribution in
spondents to indicate their usage of up to three pricing industrial markets tend to be shorter than those in con-
strategies. The response to this question was ratio- sumer markets, the manufacturer exerts more control
scaled (importance weights summing to 100%) in or- over pricing to end-users.
der to assess the magnitude of the importance of a Fifteen such industries were identified using 4-digit
given strategy in the decision. SIC codes. The target industries and distribution of
Note that we did not label any of the pricing strat- firm sizes are presented in Table 4.
egies with respect to their corresponding pricing situ- Contact names and addresses for the 1,534 firms
ation. The proposed pricing situations-new product were purchased from Dun and Bradstreet. Initially,
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Market Conditions
Sensitivity of customers to price differences between brands = insensitive, 7 = sensitive
Sensitivity of total demand to changes in average price = insensitive, 7 = sensitive
Ease of determining market demand = easy, 7 = difficult
Market growth = low, 7 = high
Switching costs = low, 7 = high
Competitive Conditions
Ease of detecting competitive price changes = difficult, 7 = easy
Concentration: Three firm concentration ratio = <5%, 7 = >80%
Product differentiation 1 = low, 7 = high
Product/Company Conditions
Age of product in years = not yet available, 2 = <1 year, 6 = 10 + years
Cost (dis)advantage due to experience curve = (dis)advantage, O = otherwise
Cost (dis)advantage dueto economies of scale = (dis)advantage, O = otherwise
Capacity utilization (relative) 1 = low, 7 = high
Costs (relative to competitors) 1 = advantage, 7 = disadvantage
Major Product Change: Significance of most current design change 1 = totally new product, O = otherwise
Market Coverage 1 = all segments, 7 = one segment
Market Share 1 = low, 7 = leader
Per sale/Contract Pricing = yes, O = no
surveys were to be addressed only to job titles includ- firms. The number of firms remaining after the pretest
ing Director of Marketing, Sales Manager, Pricing in the largest four categories was relatively small. A
Manager, and variations of these titles. However, this survey was sent to every one of these firms. The re-
targeting approach resulted in the exclusion of too maining names were randomly selected from those
many smaller companies. Therefore, the category of available in the smallest category.
President, CEO, and variations of these titles was in- This approach is consistent with syndicated surveys
cluded as well since this was the only title available such as the Neilsen Retail Index. Our intent is to un-
for the majority of the smaller companies. derstand marketing behavior in as large a proportion
A total of 1,021 firms was selected from this list (after of the market as possible. Therefore, this sampling ap-
deleting replicated records from the total of 1,034). In proach should capture the widest variation in pricing
a pretest using a similar survey,1 a sample of 200 mail- behavior in these industries since there are more stra-
ings was sent out. The sample was stratified based on tegic options for larger firms than smaller ones.
firrn size. This pretest showed that response rate in- Each firrn was sent a survey package including a
creased monotonically with firm size. personalized, hand-signed cover letter with a pledge
To best represent the pricing behavior in these in- of confidentiality of individual responses, a four-page
dustries, we drew a disproportionate stratified sample survey, and a $1 incentive. The pretest also showed
for the final study. There were five size categories of that the response rate for a $2 incentive (32%) was
identical to that for a $1 incentive (31 %).
1The Noble (1997) study of pricing objectives is identical except for A total of 347 surveys were returned to the authors.
the measures of pricing strategies. Of these, 77 were returned blank (62), incomplete, or
Company Size (Annual Revenue in Millions) Number of Firms Number of Firms in Final Mailing Number of Firms Responding
were otherwise2 unusable (15). This yielded a gross re- these 270 respondents made 470 choices among the ten
sponse rate of 34% (347 /1,007 delivered). The total us- alternative pricing strategies.
able sample was 270 for a usable response rate of 27%
Respondent Profile. The responding managers are
which is a similar sample size3 and usable response
highly experienced with pricing as the majority are in-
rate4 to recent surveys of marketing managers. Overall,
volved in such decisions for more than 20 products.
2 The majority of respondents also report 10 + years of
For example, the respondent indicated multiple price levels which
may indicate the response was for a product line rather than a single experience in the industry and with their current com-
product. pany. In addition, these managers were highly in-
3
During the five years preceding this study (1989-1994), twenty-two volved in the pricing decision they describe. On a
surveys of managers were published in the Journal of Marketing Re- seven-point scale (7 = high, 1 = low), the average self-
search (JMR). The average sample for all of the surveys was 284. reported involvement was 5.98.
During the same period, the Journal of Marketing (JM) published 41 Median firm size was between $15 and $50 million
articles involving surveys of managers. The average sample for all
of the surveys was 270.
4
1n the period 1989-1994, response rates were often unreported for
studies in JMR and JM. Managerial survey studies in the JM articles
had average gross response rates of about 32% and usable response with the gross response rate of about 40% and the usable response
rates of 29%. In the JMR articles, the response rates were higher, rate of 37%.
in annual sales. These firms compete in highly concen- average price level no different from the overall mean,
trated markets with an average 3-firm concentration as we expected (2-tailed test). Finally, three of the five
ratio of about 70%. pricing strategies with expected relatively low prices
had average price levels that were significantly lower
Strategy Measure Cross-V alidation One of the than the overall average. Based on these results, we
limitations of previous studies of pricing objectives is the conclude that the self-reported measures of pricing
lack of an objective measure to cross-validate the strategies are robust.
pricing objective indicated by the respondent. For ex-
ample, a firm whose objective is to maximize profits
may have a relatively low price or a relatively high Survey Analysis
price depending on its strategy (penetration versus Model Specification
skim pricing). Therefore, the price charged by the firm We collected information from managers on the pric-
cannot be used to cross-validate the self-reported mea- ing strategies they used as well as the prevailing pric-
sure of pricing objective. ing environment. These data have a special structure
For most pricing strategies, however, there is sorne that make them different from the usual discrete choice
relationship between the relative price level in the mar- data. Therefore, we had to make sorne important mod-
ketplace and the pricing strategy. Strategies leading to eling decisions, which are discussed next.
relatively high prices include leader pricing and skim First, our pricing framework contains two levels: the
pricing. Relatively low prices should be expected from pricing situation and the pricing strategies within each
those firms employing the penetration pricing, expe- situation. lt would appear that a nested logit model
rience curve pricing, complementary product pricing, would be appropriate. However, note that the inde-
customer value pricing, or low-price supplier strate- pendent variables differ across individuals, not their
gies. Market-equivalent prices should result from par- choices as in the case of typical multiple-stage con-
ity pricing. sumer choice model. With data varying across individ-
For bundling pricing, we do not have a prior expec- uals and not choices, the nested logit model is not
tation since the product is priced as part of a bundle. identified.
Similarly, the relationship between the relative price At the same time, respondents can use more than
level and cost-plus pricing will be based on relative one strategy within a given situation. Almost ten per-
costs which are known and profitability levels which cent (25/270) of the respondents did, in fact, exercise
are not. this option. Typically, such observations are dropped
We asked the respondents to indicate the relative or one choice is indicated using a tie-breaking mech-
price of their product in addition to their pricing strat- anism. Therefore, even if we could identify a multi-
egies. The scale ranged from 1 = 5% or less than the nomial choice model for the second stage of the deci-
market to 5 = 5% or more than the market. sion, we may be ignoring crucial information by
We compared the average response from managers dropping these observations.
indicating that they used a given strategy with the av- Given the data, we chose to model this as a "pick k
erage response for the entire sample. We used a 1-tail from n" situation. To begin, we constructed three ob-
t-test with the overall average as the population mean servations for each respondent, one each for the three
for all but the comparison for parity pricing. Since the strategies within the pricing situation. For the new
null hypothesis is that there is no difference between product situation, for example, if the respondent as-
the price level for firms using this strategy and the signed a positive weight to skim pricing, the depen-
overall relative price for all firms, we used a 2-tailed t- dent variable for the first observation was 1 and O oth-
test. The results are in Table 5. erwise. The dependent variables for the second and
The two groups with an expected high relative price third observations depended on whether or not the re-
are indeed higher than the average for all respondents spondent assigned a positive weight to the corre-
(skim pricing, leader pricing). Parity pricing had an sponding pricing strategies.
Note: p-value calculated far 1-tail t-test except far * * which is the p-value far the 2-tailed t-test. * * * This is based on the responses far 270 firms. Note
that each respondent may have chosen more than one strategy.
Since the signs of the determinants varied across the observations are zero. Such a formulation fits our data
strategies, the independent variables for the determi- well.
nants were all estimated as interaction terms. For ex- However, McDonald and Moffitt (1980) show that
ample, we constructed three cost variables, one for for low incidence choices, most of the information in
each observation. The first cost variable corresponded the tobit model explains whether or not the dependent
to the cost level indicated by the respondent in the first variable is positive rather than saying anything about
observation only. It was set to zero otherwise. The sec- differences in magnitude. In our sample, the contri-
ond cost variable was zero for the first and third ob- bution of the determinants to explaining whether or
servations and set to the cost level given by the re- nota given strategy was chosen in a tobit model ranges
spondent for the second observation and so on. from 75% (parity pricing) to 89% (low-price supplier
Similarly, we defined the interaction terms for the and complementary product pricing) (Roncek 1992).
other variables. Therefore, we feel the loss of information by using
The determinants of the pricing situation are com- choices rather than magnitudes is minimal compared
mon to all of the strategies. Each of these variables was to the advantages gained through the "stacked" binary
present in each observation. logit procedure discussed above. A logit model is es-
We estimated the importance of the determinants of timated separately for each of the four pricing
the pricing situation and individual pricing strategies situations.
simultaneously by estimating a single logit model for In the following sections, we discuss the estimation
all of the observations (3 x 270 = 810). This "stacked" results organized by the pricing situation.
binary logit formulation is similar to the approach The New Product Pricing Situation
used in SURE for cross-equation constraints. The determinant for the new product situation was the
While this approach does allow us to use all of our time of introduction of the current model of the prod-
responses while retaining the "pick k from n" nature uct being priced. The possible answers range from 1
of our data, we do have to use a binary response vari- (not yet available) to 6 (10 years or more). We expect
able rather than importance weights assigned by the this variable to be negatively associated with the prob-
respondents. One alternative would have been to es- ability of choosing any of the new product strategies.
tmate separate tobit models (Tobin 1958) for each in- The estimation results are presented in Table 6.
dividual strategy. In a tobit model, the response vari- New product strategies were chosen 93 times by 32%
able is either zero or a positive value and most (87) of the respondents. The logit model was significant
Table 6 New Product Pricing Situation: Logit Model Eslimation Penetration pricing is used more often by firms with
cost advantages dueto scale (p < O.OS) and those facing
Determinants Estimate a high level of market elasticity (p < 0.01) as well as a
(Expected Sign) (Prob > Chi2)
low level of brand elasticity (p < 0.01). These latter two
results may indicate that Penetration pricing is being
New Product Pricing
Situation Product Age ( - ) - 0.26 (0.00) used in the early stages in the product life cycle when
Skim Pricing Product Differentiatian ( +) 0.31 (0.01) there are few direct competitors and competition
Majar Product Change ( +) - 0.33 (0.43) comes primarily from substitutes.
Costs ( +) 0.08 (0.61)
Cost disadvantage: Scale ( +) 0.71 (0.08) Experience Curve Pricing. Eleven percent of re-
Cast disadvantage: Learning ( +) -1.10 (0.17) spondents (31 /270) used experience curve pricing. The
Market Elasticity ( - ) Brand - 0.00 (0.96) median positive importance weight for experience
Elasticity ( - ) Capacity -0.14 (0.23)
curve pricing was 60%. Fully 30% of respondents
Utilizatian ( +) Product 0.05 (0.62)
Oifferentiatian ( - ) Majar 0.12 (0.38)
choosing this strategy gave it an importance weight of
Penetration Pricing
Product Change ( - ) Costs - 0.28 (0.58) 100%.
(-) - 0.20 (0.28) Experience curve pricing is chosen more often in
Cast advantage: Scale ( +) 1.14 (0.01) markets with high levels of product differentiation (p
Market Elasticity ( + ) 0.48 (0.00) < 0.08), for products which are not majar revisions (p
Brand Elasticity ( +) - 0.43 (0.00)
< 0.04), and firms with low capacity utilization (p <
Capacity Utilizatian ( +) 0.07 (0.59)
O.OS).
Experience Curve
Pricing Product Oifferentiatian ( - ) 0.21 (0.08) While the latter two results are consistent with pre-
Majar Product Change ( - ) -1.05 (0.04) vious research, the use of this strategy in markets with
Costs (-) -0.00 (0.99) high levels of product differentiation is not. One pos-
Cost advantage: Learning ( +) 0.12 (0.76) sible explanation is that firms using this strategy are
Market Elasticity ( +) 0.06 (0.62)
market followers who are cutting prices now to build
Brand Elasticity ( +) 0.16 (0.19)
Capacity Utilizatian ( +) - 0.20 (0.09) volume and drive clown costs in anticipation of the
Model lntercept - 2.25 (0.00) future commoditization of the market. This is one
mode of competition in the computer chip industry
when clone chip producers introduce their products at
much lower prices to shift the focus of competition
at the p < 0.01 level. The choice of any of the three new
from performance only to a price-performance condi-
product pricing strategies was negatively and signifi-
tion. At that point, the clone manufacturers try to build
cantly (p < 0.00) related to the age of the product being an advantage over the innovating firm by lowering
priced. their costs via large volumes. Unfortunately, firms us-
Skim Pricing. We found that about 14% of respon- ing this approach might also be "leaving money on the
dents (37 / 270) chose skim pricing. The median posi- table" by cutting prices to build volume if the expected
ti ve importance weight for skim pricing was 70%. price-dominant phase of competition does not
More than 40% of respondents choosing this strategy materialize.
gave it an importance weight of 100%.
The Competitive Pricing Situation
Skim pricing was chosen in markets with high levels
For the competitive pricing situation, the first deter-
of product differentiation (p < 0.00) by firms with a
minant is the stage of the product life cycle. This vari-
cost disadvantage due to scale (p < 0.08).
able ranged from 1 for products in their introductory
Penetration Pricing. Nine percent of respondents stage to 4 for products in decline. We expect the prod-
(25/270) indicated that they used this strategy. The uct life cycle to be positively related to the probability
median positive importance weight for penetration of choosing any one of the three competitive pricing
pricing was 40%. strategies or leader, parity, or low-price supplier. In
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449
NOBLE
NOBLE AND
ANO GRUCA
GRUCA
Industrial
Industrial Pricing
Pricing
addition, we expect that at least one of the competitive determinants of leader pricing was significant at the
pricing strategies will be chosen when demand is easy 0.10 level.
to determine (Jain 1993). The estimation results for this This is unfortunate since it would be interesting to
pricing situation are presented in Table 7. see if size still mattered in being a leader or whether
The competitive pricing strategies were chosen 137 cost position or even the level of innovation had be-
times by a total of 127 (47%) of the respondents. The come more important.
overall model was significant at the p < 0.01 level. The Parity Pricing. Parity pricing was used by 30%
managers' choices of the three competitive pricing
(82/270) of respondents. The median positive impor-
strategies were positively and significantly (p < 0.01) tance weight for parity pricing was 50%. However,
related to the stage of product life cycle. The relation- more than 25% of those choosing parity pricing gave
ship with the ease of estimating demand was not dif-
it an importance weight of 100%.
ferent from zero.
We see that parity pricing is more likely to be used
Leader Pricing. Eleven percent of respondents by firms with high costs (p < 0.00), that have low mar-
(31 /270) used leader pricing. Leader pricing has a me- ket shares (p < 0.01), and high levels of capacity utili-
dian positive importance weight of 50%. None of the
zation (p < 0.07). Parity pricing is more likely to be
used in markets with low levels of product differenti-
ation (p < 0.02). Contrary to expectations, parity pric-
Table 7 Competitive Pricing Situation: Logit Model Estimation
ing is used in markets with high levels of overall elas-
Determinants Estmate
ticity (p < 0.07) and brand elasticity (p < 0.00).
(Expected Sign) (Prob > Chi2) This is an interesting result since it suggests that
sorne determinants might be binding while others are
Competitive Pricing not. The characteristics of the firm (high cost, low mar-
Ease of Estimating Demand ( - ) - 0.01 (0.91) ploit an otherwise favorable externa! condition (high
Leader Pricing Market Share ( +) 0.04 (0.70)
demand elasticity). An interesting direction for future
Costs ( +) 0.11 (0.46)
Cost advantage: Scale ( + ) 0.61 (0.15) pricing research would be to identify those conditions
Cost advantage: Learning ( + ) 0.56 (0.19) which constrain the choices faced by the firm and those
Ease of Detecting Price Changes ( +) 0.07 (0.50) which are merely favorable to a given strategy.
Market Elasticity ( - ) - 0.10 (0.36)
Low-Price Supplier.
Capacity Utilization ( +) -0.04 (0.76)
Parity Pricing Market Share ( - ) - 0.22 (0.01) About 9% (24/270) of respondents followed the low-
Costs ( +) 0.48 (0.00) price supplier strategy. The median positive impor-
Cost disadvantage: Scale ( +) 0.08 (0.82) tance weight for the low-price supplier strategy was
Cost disadvantage: Learning ( +) 0.41 (0.38) 70%. Almost 30% of those choosing this strategy gave
Ease of Detecting Price Changes ( +) -0.32 (0.71) it an importance weight of 100%.
Market Elasticity ( - ) 0.17 (0.07)
The low-price supplier strategy was chosen more of-
Capacity Utilization ( +) 0.05 (0.57)
Product Differentiation ( - ) - 0.23 (0.03)
ten to firms with low capacity utilization (p < 0.08),
Brand Elasticity ( +) 0.34 (0.00) firms with low costs overall (p < 0.00), and firms with
Low-Price Supplier Market Share ( - ) - 0.04 (0.75) cost advantages dueto scale (p < 0.07). The low-price
Costs (-) - 0.65 (0.00) supplier strategy is also used more often in markets
Cost advantage: Scale ( +) 0.96 (0.07) with a high level of brand elasticity (p < 0.07). In such
Cost advantage: Learning ( +) - 0.36 (0.49)
a market, a firm with low overall costs has the ability
Ease of Detecting Price Changes ( - ) 0.18 (0.15)
Market Elasticity ( + )
to price low, and low factory capacity utilization pro-
0.01 (0.95)
Capacity Utilization ( - ) - 0.25 (0.08) vides the incentive.
Product Differentiation ( - ) 0.117 (0.23) The Product Line Pricing Situation
Brand Elasticity ( +) 0.28 (0.07) To determine if the firm sells other supplementary or
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NOBLE
NOBLE AND
ANO GRUCA
GRUCA
Industrial
Industrial Pricing
Pricing
we asked the managers if the firm produced either sub- Complementary Product Pricing.
stitute or complementary products. We used their an- About 9% (24/270) of respondents incorporated com-
swers to construct a single dummy variable with a plementary product pricing into their overall strategy.
value of one if the firm also produced such products, The median positive importance weight for this strat-
and zero otherwise. We expect that this variable will egy was 20%.
be positively related to the probability of choosing one Of its determinants, it is the high profitability of ac-
of the product line pricing strategies. The estimation companying sales which influences the probability of
results for this pricing situation are presented in Table this strategy being chosen (p < 0.02). Note also that the
8. relative price for this strategy is low (Table 5). This is
Product line strategies were used least often (88 very consistent with what we predict with razor-and-
times by 76, or 28%, of the respondents). The logit blade type products and durables which require the
model was significant at the p < 0.01 level. As ex- eventual purchase of captive spare parts in large
pected, these strategies were used when the firm also quantities.
offered other substitutable products or complementary
products (p < 0.06). Customer Value Pricing. Customer value pricing
was used by 11 % (29 /270) of respondents. The median
Price Bundling. Thirteen percent of respondents positive importance weight for customer value pricing
(35/270) chose bundling. The median positive impor- was 30%.
tance weight was 20%. The results for this strategy suggest that customer
Bundling is more likely to be chosen when firms are value pricing is used more often for products which
pricing each sale or contract individually (p < 0.01) would appeal to a narrow segment (p < 0.10). It is also
and in markets where brand elasticity is high (p < used more often in markets where price changes are
0.02). As in the earlier avionics example, the product difficult to detect (p < 0.02). The results imply that
composition of many industrial purchases is unique these firms may be using the customer value strategy
from one order to the next. Bundling allows the sup- to secretly cut prices for a specific segment without
plier to address the unique needs of the customer and taking the risks associated with straight price reduc-
remain highly competitive in a price-sensitive market. tions which might spark a costly price war.
Contrary to expectations, customer value pricing is when each sale is priced separately and complemen-
used in high-growth rather than low-growth markets tary product pricing is used more often when profits
(p < 0.10). This may indicate that customer value pric- from supplementary sales are high. Finally, customer
ing is being used in new, higher-growth channels as in value pricing is more important when price changes
the cases of Pella and Hon mentioned above rather are hard to detect and the product appeals to a narrow
than as a spur to boost sales in a stagnant market. market segment.
In addition to these results, we also have identified
The Cost-Based Pricing Situation conditions under which various strategies are used in
The sole determinant for the cost-based pricing situa- pricing industrial products. Since these conditions are
tion is the ease of determining demand in the market. not unique to a given strategy, they should be viewed
We expect that this variable will be positively related with sorne caution if used to predict which strategy a
to probability of choosing the cost-plus strategy. The firm might use. The same conditions might be appro-
results are also presented in Table 8. priate for another strategy but this relationship was not
The overall model was significant at the p < 0.09 confirmed by our data.
level. The choice of cost-based pricing was positively
and significantly related to the difficulty in estimating
demand (p < 0.10). Firms in markets where demand is Limitations and Directions for
very difficult to estimate are almost 40% more likely Future Research
to choose cost-based pricing than those in markets While the results reported above are very exciting,
where demand is easy to estimate (66.5% v. 48.3%). they are not complete dueto the sample in our verifi-
cation study. We are limited in the types of products
Cost-Plus Pricing. Consistent with previous re-
(industrial capital goods), customers (domestic U.S.),
search, cost-plus pricing was the prevalent pricing
and companies (offering products for sale in domestic
strategy. A majority of respondents (152/270 = 56%)
U.S. markets) studied. For example, there is little vari-
reported using a cost-based pricing strategy in their
ation in the sample in concentration and height of en-
decision. The median positive importance for cost-plus
try barriers. Concentration affects the degree of pricing
pricing was 60%. More than a third of respondents
discrimination possible in the market while the height
choosing this strategy gave it an importance weight of
of entry barriers affects whether or nota firm considers
100%.
potential as well as current rivals in its pricing strategy.
Summary of Results Clearly, these factors may have a strong influence on
The results from the study of managerial pricing prac- pricing strategy and should be examined in future
tice are summarized in Table 9. research.
The results above provide insight into what pricing In addition, there was very little variation in self-
strategies managers use under different situations. In evaluated product quality. The average rating was 5.79
sorne cases, the unique determinants for each strategy out of 7 (std. dev. = 1.08). This is not surprising given
can help better predict which strategy will be used in a manager's bias towards his/her own firm's products.
a given situation. For example, in the competitive pric- However, keep in mind that these are very highly con-
ing situation, firms with relatively high costs are more centrated markets from which firms with marginal
likely to choose parity pricing while those with low quality might have already been eliminated.
capacity utilization are more likely to choose low-price The empirical study of pricing managers provides
supplier pricing. For new products, penetration pric- sorne important insights into current pricing practices.
ing is more likely to be used when a firm has costad- One of the more interesting results is the varied im-
vantages due to scale while skim pricing is more likely portance of different pricing strategies. Sorne strategies
to be used when the firm is ata cost disadvantage due tend to have higher importance weights when chosen
to scale, and product differentiation is high. As ex- while others seem to have consistently low importance
pected, bundling pricing was more likely to be used weights.
New Product Pricing New model Skimming High product differentiation in the High
(Premium pricing, market
Value-in-use pricing) Cost disadvantage due to scale
Product Line Pricing Firm sells substitute or Bundling (System pricing) Per sale/contract pricing
complementary products Elastic brand demand
The skim, experience curve, and low-priced supplier observed distribution lies outside of middle of the
strategies all tend to be important if they are part of scale (30%-80%).
the manager's pricing decision as is cost-plus pricing. In contrast, the pricing strategies in the product line
Parity pricing is an interesting split. While its median situation are seldom very important as measured by
is the same as leader pricing (50%), almost half of the their importance weights. This may indicate that other
pricing situations, i.e., introducing a new product, be- mative research and actual managerial pricing
ing in a mature market, or having little information practice.5
about demand, are more important than product line
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The authors contributed equally to this paper. A previous version
retention) or financia! results would be another fruitful of this paper was presented at the 1995 INFORMS lnternational Con-
avenue of research. ference in Singapore. The authors would like to thank the Editor,
In their 1988 article, Bonoma et al. stated that man- Associate Editor and three anonymous reviewers for their helpful
comments and suggestions. They also thank Gary Russell, Gerry
agers find little of the pricing research in marketing to
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be of any practica! help. We hope this study answers research was supported in part by the Institute for the Study of Busi-
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This paper was received January 15, 1998, and has been with the authors 4 months far 2 revisions; processed by Gary Lilien.