On the Optimality of Delegating Pricing Authority to the Sales Force

Abstract

An important decision facing sales managers today is precisely how much pricing authority should be delegated to the sales force. Received theory suggests that the salesperson's superior information about customers' valuations will invariably make price delegation profitable for the firm. The empirical evidence, however, reveals that firms that grant full pricing authority generate lower profits than firms that limit pricing authority. Given this state of affairs, the author develops and analyzes a formal model that examines the optimality of delegating pricing authority to the sales force. The model preserves the notion of superior information assumed in the literature but considers as well a negative feature of much concern to practitioners, namely, the suboptimal substitution of selling effort by price discounting. The model reveals that providing the salesperson with full pricing authority is not always optimal. Specifically, in some environments, it is appropriate to limit pricing authority because this decision forces the salesperson to target high-valuation customers. In addition, the model predicts that the commission rate offered to the salesperson should be higher when pricing authority is fimited. The author concludes by summarizing the context, calculus, and implications of the model with a view to assisting managers charged with the price-delegatiori decision.

Price Delegation in Sales Organizations: An Empirical Investigation

“…In particular, when O is relatively high or relatively low, delegating pricing authority to the sales force is the optimal strategy. However, when O takes on intermediate values, limiting pricing authority is the optimal strategy (please see basis for H1a arrow in Figure 1, taken from Joseph (2001). The intuition behind this finding is as follows: When O is relatively low, the salesperson is willing to invest effort on prospecting because prospecting is not that expensive in terms of effort costs.…”

“…Since our hypotheses here depend heavily on the work of Joseph (2001), it is instructive to review it in some detail. In his model, the market consists of two segments: A and B.…”

“…2 Clearly, O determines how expensive prospecting effort is -a given level of prospecting effort incurs greater effort cost in those environments where O is higher. Following this analysis, the main insight offered by Joseph (2001) is as follows: He finds that price delegation is not optimal in all parts of the parameter space. Specifically, for a given value of the competitive intensity parameter, G, the optimality of delegating pricing authority varies nonmonotonically with the effort cost of following a high-quality prospecting strategy.…”

“…Agency costs refer to the inefficiencies arising from a lack of perfect goal alignment between employees and owners, thereby lowering firm profit. The work by Joseph (2001) is particularly germane in this connection. His model reveals that salespeople have a tendency to make trade-offs between effort and price discounting that are inconsistent with the profit objective of the firm.…”

“…Finally, we summarize our contributions and conclude by outlining directions for future research. Joseph (2001) considers the impact of two forces that could potentially influence the optimality of price delegation. On the one hand, providing pricing authority to individual salespeople empowers them to use their superior information about customer willingness-to-pay and thereby conclude a greater number of transactions.…”