Pricing in Marketing Channels

This paper provides a critical review of research on pricing within a channel environment. We first describe the literature in terms of increasing time horizons of decision making in a channel setting: (1) retail pass-through (2) pricing contracts and (3) channel design; all of which occur within a given market environment. We then describe the emerging empirical literature on structural econometric models of channels and its use in (1) inferring channel participant behavior and (2) policy simulations in a channel setting. We also discuss potential areas for future research in each area. Pricing in Marketing Channels “Price” and “Channel” are two of the four elements of the marketing mix that managers control, yet they differ fundamentally in how managers can use them to impact market demand. While price is the most flexible, in that managers can change it most easily to impact short-run demand, the distribution channel through which firms reach their end consumer is the least flexible and perhaps the costliest to change in the short run. Therefore, channel design is viewed as part of a firm’s long run strategy. Most importantly, in the presence of a typically decentralized distribution channel, an upstream price change by a manufacturer does not affect consumer demand directly, but only through how this upstream price change affects the retail price set downstream in the channel. In his review of the pricing literature, Rao (1984) stated that “the issues of pricing along the distribution channel... have not received much attention in the literature.” However, over the last 25 years, this gap has been remedied substantially. The tools of game theory have revolutionized the theoretical analysis of pricing within the channel and clarified the many issues about how prices are set within a channel; more importantly, these analyses have given insights on the optimal long-term channel strategy, given how prices will be set within the channel. A smaller but emerging empirical literature on structural models of channels has provided us insights on the behavior of channel participants and tools to perform policy analysis in a channel setting. The purpose of this article is to provide a critical review of this literature, identify the key themes of understanding that have emerged from research to-date and to identify important gaps in our knowledge that would benefit from future research. Given the short-run nature of price and the long-run nature of the channel, we organize the literature in terms of three key issues of managerial interest that progressively increase in their time horizons for the decision. The three sets of questions are: 1. Conditional on the distribution channel (which is fixed in the short run) and other market characteristics, how can a change in upstream price affect the downstream price seen by the end consumer? This question of “pass-through” is the most short-term of the three sets of decisions we consider. Pass-through is of interest to an upstream manager because it determines the extent to which the upstream manufacturer will change prices.