Today we're talking about pricing, which is particularly challenging in a channel context. We have quite a bit of ground to cover. So let's get started. Now pricing strategy on its own is challenging. Some programs offer semester courses on this topic, and it's the Goldilocks dilemma. Some prices are too high, some are too low but only one is just right. The chief difficulty is that the right price is difficult to pin down. On one hand, it needs to be low enough to make it appealing to purchase, and on the other hand it has to be high enough to generate profits. There's also a lot of psychology around price, it acts as a signal of quality, high price signals high-quality and low-price cues low-quality. In channel systems, the price must also be high enough to fund channel activities and profits for all channel members. Remember from the first day of class, that the consumer's job is to inject the cash needed to make this whole channel system run, and when we talk about supporting channel activities, we're not just talking about margins and how the members should share the pie. That's part of it. But we're also talking about being able to support the technologies and infrastructure that the channel needs to be competitive. Another thing that you'll learn today is that the price that channel members want to set is often much higher than the profit maximizing price for the whole channel system. So this leads us to the idea that prices must be coordinated. In other words, there is an optimal price that exists that will maximize all channel members sales and profits while still being good for customers, and this is the price that would occur if the entire channel were vertically and ungraded and only one firm influenced the final price set for end users. Think about that. If that sounds counter-intuitive, that's because it is. But by the end of today's session, you'll understand why. Apart from these reasons, there are other factors that make channel pricing more complicated than everyday pricing problems, and the chief reason is that most of the time manufacturers and suppliers cannot set the end-users price for products sold to the channel, in other words the retail price. Why? Well, there are several reasons. The first is that when a supplier uses a channel as a Raul to market, the title and ownership is often transferred to the downstream member, whether that be the wholesaler or the retailer. So whoever owns the product is the one who sets the price to the next downstream member. Once man's center sells its chemical products to wholesalers, it can no longer set the price on those products. The second issue is the problem of double marginalization. In a nutshell, each channel member will attempt to maximize its margins which will ironically lower total channel sales, profits, and market outputs. In other words, everyone will be worse off. Finally, we've talked in the past about how channel functions can be dis-aggregated and reside at multiple levels of the channel system and with different members, and it is exactly this heterogeneity among the channel members that makes it difficult to determine what the right price should be. In other words, differences in channel members makes it hard to compare the firms and impossible to standardize the price. So this is why we have stressed up to now the importance of understanding the value of each channel function needed, it's cost, and the equity principle, which is the compensate channel members according to their channel flow and function contribution. So now we're going to talk about the solutions to each of these channel challenges. But what you must always bear in mind is that the number one way to deal with all of these challenges is for the manufacturer to vertically integrate. In other words, to own its own channel. Now, there have been many Nobel Prizes in economics that have been awarded for work that examines this option. However, the reality for most firms is edit is often too expensive to purchase a downstream channel member, and frankly many firms don't want the hassle of having to manage a channel function that they have no expertise in. So even if Samsung could purchase the best buy retail chain, do they really want to be in the business of managing retail operations? It's a different ballgame from manufacturing hardware. So we will focus on the non-vertical integration options, which is working with an independent firms to come up with the coordinated pricing strategy that will maximize profits for every member of the channel system. Here is an important learning point that you do not want to miss. The natural tendency of every channel system is to note price optimally. It's like a ruled wild nature. Left to their own devices, channel members will seek to maximize the profits which creates a divergence between the real and the optimal prices to end users. So the channel strategists task is to reduce this divergence through its negotiations with channel members and it's use of incentives and policies, and these are the tools at the channel strategists disposal.
