Vertical strategic interaction: Implications for channel pricing strategy

Lee, Eunkyu; Staelin, Richard
September 1997
Marketing Science;1997, Vol. 16 Issue 3, p185
Academic Journal
This paper examines two strategic pricing decisions within channels: using foresight (i.e., price leadership) and considering category implications (i.e., product line pricing). Are price leadership and product line pricing always the best pricing strategies for a channel member? If not, when does this occur and why? By investigating these questions, we address some major concerns of both marketing practitioners and scholars interested in channel management issues. In addition, this study provides an indepth discussion on why previous analytic studies produced answers to these questions that depend upon the choice of the form of demand functions. As such, this study should significantly resolve the debate among analytic marketing modelers about the "right" demand specification. At the core of our discussion lies the concept of vertical strategic interaction, which is defined in terms of the direction of a channel member's reaction to the actions of its channel partner within a given demand structure. Specifically, if a channel member's best reaction is to reduce its margin when its channel partner increases its margin, the type of vertical strategic interaction is referred to as vertical strategic substitutability (VSS). If the best reaction is to increase the margin, the environment is referred to as vertical strategic complementarity (VSC). If the best reaction is no margin change, it is referred to as vertical strategic independence (VSI). Using a game theoretic approach, we demonstrate that these three types of vertical strategic interactions represent a key driving force for optimal decisions on channel price leadership and product line pricing. Our investigation involves mathematical analyses of an industry model composed of two manufacturers selling competing products, both carried by two competing retailers. As such, the model allows for retailer product line pricing as well as manufacturer and retailer level competition. In addition, this general model can be used to analyze three more restrictive industry settings often found in the channels literature, i.e., a bilateral monopoly (Jeuland and Shugan 1983), two competing manufacturers selling through competing franchised retailers (McGuire and Staelin 1983), and two competing manufacturers selling through one common retailer using product line pricing (Choi 1991). Unlike many other channel studies, most of our analyses are performed without assuming particular functional forms of demand curves. Thus, this paper provides greater assurance that the insights from this stream of research are broadly applicable, not only across industry structures but also across demand conditions. The paper starts out by defining three different rules for how prices are set: The manufacturer uses foresight, the retailer uses foresight, and neither channel member uses foresight. We then show a one-to-one mapping between the type of vertical strategic interaction and the optimality of channel price leadership. Specifically, a channel member finds it profitable to be a price leader for VSS but prefers to be a follower for VSC. For VSI, channel members are indifferent to the channel price leadership issue, as it has no effect on channel member profits. We also show that there exist conditions under which a retailer might see a reduction in profits when it changes its policy from non-product line pricing to product line pricing. Such conditions arise when the retailer is not a price leader and the environment is characterized by VSS or VSC. At a more general level, this study suggests not only the value but also the cost to a firm for using superior knowledge (i.e., foresight and/or product line pricing) in making strategic marketing decisions. In this way, "ignorance can be bliss." We also explore the link between demand characteristics and. the three types of vertical strategic interaction. We show that the type of vertical strategic interaction present in a given environment is closely related with the convexity of the demand curve and the level of demand for a given price. Interestingly, we find that linearity of demand is not a necessary condition for any of the three types of vertical strategic demand function. Consequently, in evaluating the robustness of analytic analyses, it may be more important to determine the type of vertical strategic interaction assumed instead of whether the demand is linear or nonlinear. Finally, our results are limited to situations where the channels are not coordinated and the retailer's precommitment to particular pricing policy and decision is credible. Although such situations still capture a significant portion of reality, we acknowledge that the insights from this study might not be applicable in all situations.


Related Articles

  • Product-Line Competition: Customization vs. Proliferation. Mendelson, Haim; Parlakt�rk, Ali K. // Management Science;Dec2008, Vol. 54 Issue 12, p2039 

    We study a market with customers who have heterogeneous preferences for product attributes. We consider two types of firms that compete on price and product variety: A traditional firm, which chooses a limited set of product configurations, and a customizing firm, which can produce any...

  • Assimilation and Contrast in Brand and Product Evaluations: Implications for Marketing. W�nke, Michaela; Bless, Herbert; Schwarz, Norbert // Advances in Consumer Research;1999, Vol. 26 Issue 1, p95 

    The paper describes a framework according to which the same piece of information may elicit assimilation or contrast in the evaluation of a target. Thus, a brand extension may either help or hurt the brand and vice versa, a top-of-the-line product may in-crease or decrease the attractiveness of...

  • Cadbury unveils first multi-brand Christmas marketing campaign. Joseph, Sebastian // Marketing Week (Online Edition);7/25/2013, p2 

    The article reports that the British confectionery maker Cadbury will launch its first multibrand Chrsitmas marketing campaign in late 2013. It informs that the company has revamped its entire product line-up for the Christmas season, including its top Dairy Milk and Roses brands under a...

  • Silver Medal: Marcal. Garry, Michael // SN: Supermarket News;10/6/2008, Vol. 56 Issue 40, p40 

    The article focuses on the effort of Marcal Paper Mills Inc. in absorbing the Sunrise brand into the company's line of products in the U.S. According to M. J. Jolda, senior vice president of marketing of Marcal, the company will be marketing the product line with the Marcal name. Mike Hoffman,...

  • KTM READIES THE ROAD. Ebert, Guido // Dealernews;Oct2008, Vol. 44 Issue 10, p16 

    The article offers information on the changes made by KTM on its product lines in the U.S. The company wants to clean up its existing floor stock and let its dealers focus on streetbike sales. The move is undertaken to concentrate on its ready-to-race brand philosophy and build on the assets of...

  • The finWEEK: INTERNATIONAL.  // Finweek;10/19/2006, p12 

    The article offers international news briefs. Foster's Brewing Group Ltd. is looking to cut its product lines by up to 20% to rejuvenate its business. Female scrap paper merchant Zhang Yin was named China's richest person with personal wealth of U.S.$3.4 million. The European Central Bank...

  • Breeding competitive strategies. Midgley, David F.; Marks, Robert E.; Cooper, Lee C. // Management Science;Mar97, Vol. 43 Issue 3, p257 

    We show how genetic algorithms can be used to evolve strategies in oligopolistic markets characterized by asymmetric competition. The approach is illustrated using scanner tracking data of brand actions in a real market. An asymmetric market-share model and a category-volume model are combined...

  • Pricing Strategy. Holden, Reed K. // Sales & Service Excellence Essentials;Jul2007, Vol. 7 Issue 7, p10 

    The article discusses the three possible pricing strategies for products or services, namely, skim, penetration, and neutral. Skim pricing is high relative to competitors to reflect the high value or exclusivity of certain products, while penetration pricing is low relative to competitors and is...

  • When Is Price Discrimination Profitable? Anderson, Eric T.; Dana, Jr., James D. // Management Science;Jun2009, Vol. 55 Issue 6, p980 

    We consider a general model of monopoly price discrimination and characterize the conditions under which price discrimination is and is not profitable. We show that an important condition for profitable price discrimination is that the percentage change in surplus (i.e., consumers' total...


Read the Article


Sorry, but this item is not currently available from your library.

Try another library?
Sign out of this library

Other Topics