Pricing in Business

Douglas Hague

• Publisher: Routledge
• Year: 2018
• ISBN:
  9781351249683
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

This book, first published in 1971, reports on the first detailed study of pricing decisions ever made in the UK. Based on case studies, it shows precisely how thirteen pricing decisions were taken. In doing so, it reveals the objectives pursued by these firms and how conflicts between these objectives were resolved. The assessments of the pricing decisions show the strengths and weaknesses of the procedures used by the firms, and the relative importance of economic and organizational elements in such decisions.

CHAPTER 1

What the Book is About

1.1 OUR AIMS

This book contains the findings from a study of pricing carried out in a number of member firms of the Centre for Business Research, which is linked to Manchester University. The subject was chosen because of the interest of member firms in pricing and because the Centre had some expertise in the field.

We must emphasize at once that we realize that pricing is only part of the much broader activity of marketing. We shall therefore have a good deal to report about these broader issues as well, but we do not pretend that our comments about marketing are systematic. Our real interest is in pricing. It is an important enough business problem to be worth looking at for its own sake, quite apart from any light that we may be able to throw on the related problems of marketing. In particular, a study of pricing tells us a great deal about the internal information system of the firm; about human and organizational relationships within the firm; and about problems in analysing the firm’s external environment, present and future. Pricing decisions are among the most demanding ones that a manager has to take, not least because they require an understanding of the uncertain and changing external environment. This is why pricing is so well worth studying.

The main aim of this study was to add to our knowledge of how prices are fixed and so increase our understanding of the practical and theoretical problems of pricing. We feel that the study will do this in two ways. First, it will help those (whether they are practising managers, consultants or business-school teachers) who are actively engaged in pricing or in helping business to improve its pricing procedures. By seeing what was done in a number of firms, we were able to see where their approaches to pricing were similar, and where they differed. Because we were not directly involved in pricing in these firms, we were able to take a dispassionate view, to pinpoint weaknesses in their pricing procedures and to suggest ways of dealing with them. We acknowledge that because we did not have continuous, detailed contact with these firms and their markets over a long period of time, we may have been tempted to over-simplify a number of complex situations. However, we have tried not to let this happen.

Business-school teachers and consultants are involved in prescription—in explaining what businessmen should do in setting prices if they are to improve their pricing methods. To say this is not to condemn British industry. In every firm, there is always scope for learning, room for improvement. However, there are good reasons why this may be a time when more firms than usual are interested in improving their pricing methods. First, large sections of British industry, including some of the firms we studied, have until recently been protected by collective pricing agreements from the full effects of price competition within their home markets. Most of these agreements have been outlawed by the Restrictive Practices Court since 1958. The result is that many British firms have effectively been ‘learning’ to price again in the home market at some time during the period since 1958. Second, bodies like the Prices and Incomes Board have been forcing firms to look afresh at their pricing practices.

Apart from helping teachers, consultants and businessmen, we think that this book can also help economists to improve their theories about the role which prices play in individual firms, industries or in the economy as a whole. We shall leave most of what we have to say to economists for articles in the learned journals. However, it will pay us to spend a little time now giving a brief outline of those concepts from the economic theory of pricing that will be useful to us.

1.2 PRICING DECISIONS

In this section, we do not pretend to give a complete account even of the parts of economic theory that are relevant to pricing. We simply describe those economic concepts which will help us in this book. It must be emphasized, at the outset, that some of these concepts are also used by operational researchers and others studying these problems. The fact that the concepts we shall describe are used by economists certainly does not mean that economists have an exclusive right to them.

Perhaps the most convenient way of putting what we have to say into a conceptual context will be to look first at the broad characteristics of pricing problems. Indeed, the main elements of every pricing problem are the same, in principle, as the main elements of all business decision problems.

First, there are the objectives. Unless the firm knows what objectives it is pursuing, no rational pricing decision is possible. Second, there is the structure of the pricing problem. Every pricing decision affects a number of variables, some or all of which will be related to each other in some way. Indeed, both economists and operational researchers often set out the relationships between relevant variables by constructing a ‘model’. Such a model isolates the key variables in in the problem and ignores the remainder. The model goes on to specify the broad character of the relationships between these key variables, expressing them in equations or diagrams. For example, in most pricing problems one needs to know what kind of relationship there is between the prices that might be charged and the quantity of product which would be sold at each of those prices. All this is done in the model-building stage.

This leads at once to the estimation stage. One has to discover the actual size of the variables in the specific problem and the precise nature of the relationships between them.

Third, the decision must be taken. In some cases this may be very easy. Given the particular pricing problem set out in the model, and the firm’s objectives, it simply tries to find which course of action will best achieve those objectives. However, it may not be as simple as that. Firms may not want to take optimal decisions—those which come closest to achieving the firm’s objectives. Even if they do, they may lack the necessary information; or human and organizational factors may impede optimal decision taking. Nor, of course, may firms use models of this kind at all. These are issues we shall have to consider as we proceed.

Our immediate task is to look a little more fully at the main elements in pricing problems, in order to introduce the concepts that we shall need in the remainder of the book. We must emphasize that, at this stage, we are not necessarily implying that firms do, or should, use ‘models’ in pricing.

1.2.1 Objectives

Economic theory has concerned itself very largely with the problems of what we shall describe as a ‘competitive industry’, where large numbers of smallish firms compete with each other. Indeed, a good deal of jargon has been developed to describe such industries, much of which we shall ignore because it is too esoteric. In this chapter we shall use the simple words ‘competition’ and ‘competitive industry’ to describe a situation where large numbers of firms compete in a market. It is essential to remember that we are using these words in a special sense.

The first assumption that economists have made in looking at ‘competitive industries’ is that each firm seeks to maximize profits. The reason why economists began to make this assumption was that it enabled them to predict what firms would do if economic conditions changed. They could then assume that the firm would react to any change in such a way that it would continue to earn maximum profits. Fortunately or unfortunately, the idea of profit maximization has spilt over into everyday discussions of business objectives, despite the fact that ours is a world where many industries contain only small numbers of firms. One difficulty which results is that profit maximization usually becomes a ‘non-operational’ objective. By a non-operational objective we mean one which does not tell a businessman precisely what action to take in given circumstances in pursuing an objective. This is a concept we shall look at in more detail in Chapter 4. The reason why the profit maximization is usually a non-operational objective in real-world industry is largely that the businessman does not know enough about the alternative courses of action between which he is choosing to be able to say which of those alternatives would give him maximum profit.

More precisely, there are four main reasons why firms find it hard to maximize profit. First, this is a world where ‘competitive industries’ rarely, if ever, exist. The result is ignorance about the present position of the firm. Especially if firms are large and complex, they will lack information about what their competitors are doing; even about what prices they are charging. Second, there is uncertainty about how the firm’s position will change as a result of taking any given decision. Third, there are problems in organizing complex organizations to take good decisions, even where decision takers have the necessary information. Fourth, most human beings find it difficult to understand problems which involve relationships between a number of variables. The human brain works efficiently in two dimensions at most.

Our aim in this study is therefore to try to answer a number of questions about how ignorance, uncertainty and complexity of both organizations and pricing problems are overcome in practice. Are routines developed which eliminate some alternatives and so simplify the decision? Do organizations, and human beings, devise ways of using two-dimensional brains to solve multi-dimensional problems? Does the organization set itself the objective of reaching satisfactory rather than maximum solutions? Does the fact that the firm is a coalition of individuals, rather than a unitary organism affect the kind of objective that is set? Can one say anything about how far away from the optimal solution one reached by these methods is?

In recent years, a good deal of work has been done on these problems in the USA, especially at Carnegie Tech. under the influence of Professors Simon, Cyert and March. These last two have recently given an explicit description of what they term ‘satisficing behaviour’, where firms set a less demanding objective than maximizing profit. Cyert and March do this in their book A Behavioral Theory of the Firm.¹ As we shall see later, Cyert and March introduce other concepts which are extremely helpful in describing and understanding how firms operate, but the notion of satisficing underlies the whole of their analysis. Satisficing is an extreme form of choosing not to maximize profits. One cannot predict what results satisficing behaviour will have without a detailed understanding of how the firm takes its decisions. This means that no general theory of the satisficing firm yet exists, and that perhaps none ever will. However, the only way in which economists will be able to learn more about whether such a theory can be devised at all is by learning more about how firms do behave. We hope that the research described in this book will make a small contribution to this.

The second assumption made by the traditional economic theory of the ‘competitive industry’ is that the profit-maximizing firm is run by ‘the entrepreneur’. The attraction of this second assumption has been that it has enabled economists to assume away all the complications which arise where there are differences of opinion between members of boards of directors, or other groups of managers, over what pricing (and other) decisions should be. Of course, the ideas of ‘competition’ and ‘the entrepreneur’ go together. In industries where competition is keen, it can be assumed that there is little scope for choosing any action other than the profit-maximizing one, even if the firm is run by a number of managers, each with his own solutions to its problems, rather than by a single entrepreneur. The assumption that ‘the entrepreneur’ runs the firm is then a reasonable one. Choosing any other course of action than the profit-maximizing one sooner or later leads to bankruptcy. Of course, in an industry with a large number of small firms, some of these really will be one-man firms. There, at least, such conflicts are impossible.

In reality, there will be many situations where small numbers of firms, or even one firm, are selling in a given market. The firm can then choose whether or not it will try to maximize profits. If it is the only firm in its market—if it is a ‘monopolist’—it can make this decision for itself, though it may have to take into account anti-monopoly laws or the reactions of the Government. The biggest problems for economic analysis and prediction arise where there are several firms in the industry, but not so many that there is ‘competition’. In these circumstances, the firm’s freedom of choice is limited because it has to take into account what its competitors—or at least the biggest of them—are doing. Nevertheless, choices still have to be made, not only about whether to maximize profits but also about how the firm should seek to maintain or improve its competitive position by using various price, or other, weapons. The greater the room for choice, the greater will be the room for disagreement between managers about what choices to make, particularly since there will be few ‘one-man’ businesses in industries with small numbers of firms.

Cyert and March have contributed a good deal to our understanding of all this. They emphasize that the modern firm is typically run by a collection of individuals. They go on to argue that while individuals have goals, collections of individuals do not. They therefore see the firm as a ‘coalition’ of managers, workers, shareholders and others. The various members of the coalition have their own individual objectives and play changing roles in the coalition. Our study will throw a little more light on these issues. We shall find that the firms we have studied are best seen as organizations where managers have to act both as individuals and as members of the coalition.

1.2.2 The Structure of the Problem

We have seen that economists (and indeed business school teachers) assume that the best way of looking at business decision problems is to build models of them. To do this, one has to consider relevant relationships within those models. With pricing problems, these relationships will be between variables like cost, revenue and output. Obviously, it will not always be easy to calculate relevant costs or revenues, especially if the firm is producing many products, each of them in competition with the products of fairly small numbers of other ...

Table of contents

• Cover
• Half Title
• Title Page
• Copyright Page
• Table of Contents
• ACKNOWLEDGEMENTS
• 1 WHAT THE BOOK IS ABOUT
• 2 THE CHECK LIST ANALYSED
• 3 THE PRICING CHECK LIST
• 4 THE FIRM’S OBJECTIVES
• 5 PRICING OBJECTIVES
• 6 SOME CONCLUSIONS ABOUT OBJECTIVES
• 7 EXTERNAL INFORMATION FOR PRICING DECISIONS
• 8 INTERNAL INFORMATION REQUIRED FOR PRICING DECISIONS
• 9 THE PRICING DECISION
• 10 THE PRICING DECISIONS
• 11 CONCLUSIONS
• 12 RECOMMENDATIONS
• Case Study
• INDEX