In many industries, it’s common for a firm’s headquarters to create a price list but grant local salespeople the ability to negotiate prices for individual transactions. For instance, when a consumer buys a car, the salesperson typically has room to negotiate the price, within limits set by the dealer. In theory, negotiations enable salespeople to use information about a buyer’s willingness-to-pay that was not available to headquarters when it set the list prices.
“A firm initially makes high-level decisions about what prices it’s going to charge based on its target consumer or the product itself,” says Professor Garrett van Ryzin, explaining what is known as uniform pricing. “But then it allows wiggle room for local salespeople to deviate from that price, with the idea that they can assess the individual customer, how willing the customer is to buy the product, what other alternatives the customer has, or uncover new information to exploit.”
“This type of pricing is very common in business-to-business settings but it is also found in a few consumer markets such as auto purchases, lending, and mortgages,” explains Professor Robert Phillips.
Despite how common this practice is, however, there’s long been debate about how much price discretion actually benefits firms. Is it worth putting such power in the hands of salespeople? “It’s expensive to train people to negotiate face-to-face,” van Ryzin says. “Many argue that salespeople don't do a good job of it, either because they’re not able to accurately assess somebody's willingness to pay or they don’t negotiate effectively; or they have other incentives to sell — they just want to close the deal to meet sales goals, rather than try to get the best price.”
Complicating the debate is the improved ability to use data to set prices more intelligently than ever before. A firm’s centralized headquarters typically has access to far more data than any individual salesperson, so it is better poised to use business analytics and data to determine the best prices to offer. “There is often tension within organizations between finance departments, which believe that pricing should be centralized, and sales departments, which believe that salespeople need more pricing discretion,” Phillips says.
To find which approach most benefits firms, Phillips, van Ryzin, and Serdar Simsek PhD ‘13 of Cornell University, investigated pricing data from a major auto lending company with local pricing discretion at its numerous individual dealerships. They applied a control function approach to determine the extent to which individual sales people were setting prices that were either better or worse than the prices recommended by headquarters. They found that local salespeople negotiated prices in a way that increased nationwide profits by approximately 10 percent on average; in other words, allowing salespeople price discretion did result in more profit for the firm than using the prices that were initially set by headquarters.
However, further analysis looked at what the company could have achieved if they had used the same information that they had initially used to set the list prices to recommend much more granular prices that were optimized for each market. This latter approach to customizing prices could potentially deliver even more benefit to the firm — an increase in profits of up to 27 percent over actual profits realized using localized price discretion. This suggests that centralized pricing — if appropriately optimized using today’s improved tools — can be more effective than price discretion in the field. The verdict: the benefits of a skilled sales force in earning maximum profits for firms may be diminishing in an increasingly data-driven world. This may explain why many industries, including hotels and retail, have moved away from local price discretion to centralized pricing.
“This casts light on an important issue facing many companies — how much pricing discretion to give to salespeople. When you don’t have very intelligently set prices to begin with, local salespeople’s negotiating abilities can add a lot of value,” says Phillips. “But the added value of negotiation is much more limited if you do a really clever, informed job of setting prices using data.”
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About the researcher
Garrett van Ryzin
Garrett van Ryzin is the Paul M. Montrone Professor Emeritus of Decision, Risk, and Operations at the Columbia University Graduate School of Business. In...Read more.