Pricing Issues in

Channel Management
Objective 1:

The Importance of Pricing

Pricing
Pricingdecisions
decisionscause
causetop-level
top-levelmarketing
marketing
executives
executivesmore
moreconcern
concernthan
thanany
anyother
other
strategic marketing decision area.
strategic marketing decision area.

Pricing is viewed as having a more direct

link to the firm’s bottom line.
 Calculating

Selling Prices
and
Channel Margins

3
 Calculating Selling Prices
and Channel Margins

The goal of this tutorial is to help you…

• Learn how to calculate selling prices from costs and margins,

and vice versa

• Discover how to “chain” margins and make these same

calculations for an entire distribution channel

A “distribution channel” is a “set of interdependent organizations involved in the process

of making a product or service available for use or consumption by the consumer or
business user.” (Kotler and Armstrong, Principles of Marketing, 9 Ed., p. 432.)
th

4
 Formulas

Remember these formulas:

• Rs/$ Margin = SP – Cost

• % Margin = (SP – Cost)/SP = Rs/ $Margin/SP

• SP = Cost / (1 - % Margin)

• Cost = SP*(1-%Margin)

5
 Priced to Sell

How do you determine an item’s selling price? 6

 Priced to Sell

Cost to Produce + Profit Margin = Selling Price

Desired
Margin
Rs/$
=
Selling
Price
Cost to 100%
Produce
Rs/$

If Ifthe
theSelling
SellingPrice
Priceis isRs.10.00
$10.00 and the Cost is Rs.4.00,
$4.00, then
thenhow much
Profit is theis
Margin
Profit Margin in $$$ ?
Rs.6.00.
SP – Cost = Profit Margin
Rs.10.00 – Rs.4.00 = Rs.6.00 7
 Priced to Sell

Cost to Produce + Profit Margin = Selling Price

Selling Price (100%) – Cost to Produce (%) = Profit (%)

Desired
Margin
?%
=
Selling
Price
Cost to 100%
Produce
?%

Or, since the Selling Price always equals 100%, if Cost = .40 (40%), then
Profit Margin equals .60 (60%)
1.00 - .40 = .60 or
100% - 40% = 60% 8
The Profit Pie: How Big Is Your Slice?

9
 Rules of Thumb
• Channel and percentage margins are almost always
calculated as a percentage (decimal) of the selling
price
Why use decimals for margins in lieu of percentages?
Calculations can get pretty messy if one has to use
percentages. See what happens if we use percentage
margins…
SP = Cost / (1-%Margin) = Cost / (100% – Margin as %)
SP = $6.00 / (100% – 75%)
= $6.00 / 25% = 100 x ($6.00 / 25)
= $24.00.
The alternative is SP = $6.00 / (1-0.75) = $6.00 / 0.25 = $24.00.
10
Decimals are much easier!
 Rules of Thumb
• Channel and percentage margins are almost always
calculated as a percentage (decimal) of the selling
price
• In a few instances, the term “markup” will be used
instead of “margin.” When dollar values are used,
markup and margin are exactly the same
• If percentages or decimals are used, you should
distinguish between “markup on cost” (can be over
100%) and markup as a percentage of selling price
(can never be more than 100%)
11
 Sample Problem #1
• A manufacturer sells watches for $20 each.
His percentage margin is 25%. What is his
cost?
Press any key for the answer

The % Margin = (SP – Cost)/SP.

We know that 0.25 = (20 - Cost)/20.
0.25 x 20 = 20 – Cost
5 = 20 – Cost
Cost = 20 – 5
Thus, the manufacturer’s cost is $15!
12
 Calculating Selling Prices Across the Channel
Adding a Link to the Chain
% Margin = (SP – Cost)/SP At each pause, Retailer Selling
Or, click to continue Price =
Retailer Customer Purchase
% Margin = $ Margin/SP Margin Price = $2.00
$.50 Reseller Selling
Price =
Reseller Retailer Purchase
Margin Price = $1.50
Manufacturer
$.50 Selling Price = Reseller
Manuf. Retailer Purchase Price = $1.00
Margin Cost
$0.40 Reseller $1.50
Cost
Manuf.
$1.00
Cost
$.60

Manufacturer Reseller
What is the Retailer
What is the
% Profit Margin = % Profit Margin = % Profit Margin =
Reseller’s Retailer’s
$0.40/ $1.00 $0.50 / $1.50 $0.50 / $2.00 13
= .40 (40%) =%.33 (33%)
Profit Margin? =%.25 (25%)
Profit Margin?
 Calculating Selling Prices
Across the Channel

To calculate selling prices across the distribution

channel, the key formula is:
SP = Cost / (1 - % Margin)

Manufacturer Cost = MSP * (1 - % Manufacturer Margin)

Manufacturer Selling Price = DSP * (1 - % Distributor Margin)

Distributor Selling Price = WSP * (1 - % Wholesale Margin)

Wholesale Selling Price = RSP * (1 - % Retail Margin)

Retail Selling Price = $$.xx

14
 Channel Surfing Without a Remote: The Knee Bone’s Connected to the…

Suppose a distribution channel for the sale of Peruvian wine includes a manufacturer, an importer, a
distributor, and a retailer. The retailer sells the wine to consumers for $18.00 a bottle.

We use the RSP and the Retail % Margin to calculate the Distributor Selling Price. Then we use the
Distributor Selling Price and the Distributor % Margin to calculate the Importer Selling Price.

Can you guess what comes next?

Manufacturer Importer Distributor Retailer

% Margin = .50 .333 .25 .333
Selling Price ?? ?? ?? $18.00
Selling Price ?? ?? $12.00$18.00
Selling Price ?? $9.00 $12.00$18.00

Selling Price $6.00 $9.00 $12.00$18.00

Calculating
Hint:
Importer
Manufacturer
Distributor
Selling
Manufacturer
Selling
Price
Selling
Price
= Distributor
Price
Cost…
= Importer
is alsoCost
theCost
Retail Cost
Manufacturer
Distributor
Importer
Cost Cost
=Retail
Manufacturer
Cost
= Cost
Importer
= Distributor
= RSPSelling
* (1Selling
-%Price
Retail
Price
* (1Margin)
*- (1
% Importer
Manufacturer
- % Distributor
Margin)
Margin)
Margin)
Manufacturer
Distributor
Importer
CostRetail
Cost
= Cost
$6.00
Cost
= =$9.00
*$12.00
=(1.00
$18.00
* (1.00
–*0.50)
(1.00
* (1.00
– 0.33)
– 0.25)
– 0.33)
Manufacturer
Distributor
Importer
Cost Cost
=Retail
Cost
$6.00
= Cost
=$9.00
*$12.00
0.50
= 0.66
* 0.66
= *$3.00
*0.75
$18.00
= $6.00
= $9.00
==$12.00
Manufacturer
= Importer
= Distributor
Selling
Selling
Price
Selling
Price Price
15
 Sample problem #2
• A manufacturer sells electric staplers for $5 each to a
distributor. The distributor’s dollar margin is $2.00. The
distributor sells to a retailer. The retailer’s dollar margin
is $3.00. What is the retail sales price to the consumer?

Press any key for the answer

The $ Margin = SP – Cost.

We know that the distributor’s cost is equal to the manufacturer’s selling price, or
$5.00.
The distributor’s $ Margin is given as $2.00, so the distributor’s selling price = $5.00 +
$2.00 = $7.00.
We know that the retailer’s cost is equal to the distributor’s selling price, or $7.
The retailer’s selling price to the consumer is equal to the retailer’s cost plus the
retailer’s $ margin, or $7 + $3, which equals $10. 16
 Sample problem #3
• A retailer sells gourmet pickles for $8 a jar. The retailer’s
percentage margin is 25%. The wholesaler’s percentage
margin is 33%. The manufacturer’s percentage margin is
50%. What is the manufacturer’s cost?

Press any key for the answer

Here, you need to chain the margins using the formula SP = Cost / (1-% Margin).

Retail SP = Cost / (1-% Margin). Thus, $8 = Cost / (1-0.25). Retail Cost = $6

Wholesale SP = Cost / (1-% Margin). $6 = Cost / (1-0.33). Wholesale Cost = $4.
Manufacturer SP = Cost / (1-% Margin). $4 = Cost / (1-0.50). Manu. Cost = $2.

The manufacturer’s cost then is equal to $2.00. 17

 Sample problem #4
• A distribution chain for hotel room art includes the artist, a wholesaler, the hotel chain, and the
individual hotel franchise owner. The artist sells each painting to the wholesaler for $80, realizing a
percentage margin on the selling price of 75%. The wholesaler sells the art to the hotel chain for a
percentage margin of 50%. The hotel chain then sells the art to its individual hotel franchise
owners, and earns a percentage margin of 20%.

• If the cost to the artist doubles due to a shortage in canvas, what is the new cost to the hotel
franchise owner if every member of the distribution chain maintains the same DOLLAR margin?

Press any key for the answer 18

 Sample problem #4
First, you will need to chain your margins and calculate everyone’s dollar margin.
The artist sells paintings for $80 and earns a % Margin of 75%. To calculate his costs…
$80 = Cost / (1-0.75). The artist’s cost = $20.
If his cost = $20 and his selling price = $80, then his $ Margin = $60.
The wholesaler’s cost equals the artist’s selling price, or $80, and the % margin is given
as 50%. Thus, the wholesaler’s SP = $80 / (1-0.5) = $160. The wholesaler’s $ Margin
then is the % Margin x SP, or 0.50 x $160 = $80.
The hotel chain’s cost equals the wholesaler’s selling price, of $160, and the % margin is
given as 20%. Thus, the hotel chain’s SP = $160 / (1-0.2) = $200. The hotel chain’s $
Margin then is the % Margin x SP, or 0.20 x $200 = $40.
The cost to the hotel franchise owner is thus $200.
Now that we have all of the dollar margins, we can begin the second part of the
problem…

Press any key to continue… 19

 Sample problem #4
The problem asks “If the cost to the artist doubles due to a shortage in canvas, what is
the new cost to the hotel franchise owner if every member of the distribution chain
maintains the same DOLLAR margin?”

The artist’s cost was calculated as $20. If his cost doubles due to a shortage in canvas,
then his new cost is $40.

All of the members of the distribution channel are keeping the same $ margins. Recall,
the artist’s is $60, the wholesaler’s is $80, and the hotel chain’s is $40.

Therefore, the new selling price to the wholesaler is $40 + $60, or $100.
The new selling price to the hotel chain is $100 + $80, or $180.

Finally, the new selling price to the individual hotel franchise owner then is $180 + 40, or
$220.

20
 Summary

Remember the following formulas:

• $ Margin = SP – Cost
• % Margin = (SP – Cost)/SP = $Margin/SP
• SP = Cost / (1 - % Margin)
• Cost = SP*(1-%Margin)

21
 Calculating Selling Prices
and Channel Margins

There is a theory Behind the practice!

22
Objective 2:
Anatomy of Channel
Pricing Structure

Channel
Channelparticipants
participantseacheach
want
want a part of the totalprice
a part of the total price
sufficient
sufficienttotocover
covertheir
their
costs and provide
costs and provide a a
desired
desiredlevel
levelofofprofit.
profit.
 The “Golden Rule”
of Channel Pricing

ItItisisnot
notenough
enoughtotobase
basepricing
pricingdecisions
decisionssolely
solelyon
on
the
themarket,
market,internal
internalcost
costconsiderations,
considerations,andand
competitive factors. Rather, for those firms
competitive factors. Rather, for those firms usingusing
independent
independentchannelchannelmembers,
members,explicit
explicitconsideration
consideration
ofofhowhow pricing decisions affect channelmember
pricing decisions affect channel member
behavior is an important part of pricing strategy.
behavior is an important part of pricing strategy.

=
Pricing decisions can have a
substantial impact
on channel member performance.
Objective 3:
Influencing Pricing Strategy

The major challenge for the channel manager:

To
Tohelp
helpfoster
fosterpricing
pricingstrategies
strategiesthat
that
promote
promotechannel
channelmember
membercooperation
cooperationandand
minimize
minimizeconflict
conflict
 Channel Manager’s Role
Major areas of consideration in a
manufacturer’s pricing decision

Internal Target Competitive Channel

cost market considerations considerations
considerations considerations

Channel manager must focus

on the channel considerations
and work to incorporate them
into the firm’s pricing decisions
 Channel Manager’s Role

To
Tofind
findout
outabout
aboutchannel
channelmember
memberviews
views
and to appraise their
and to appraise their
effects
effectsononchannel
channel
member performance
member performance
 Channel Manager’s Role

Have
Have Such
Suchaction
actionanticipates
anticipates
channel
channelmembers’
members’ and
andhopefully
hopefullyavoids
avoids
viewpoints
viewpointsononpricing
pricingissues
issuesincluded
included problems
problemsthat
thatmay
may
as
asan
anintegral
integralpart
partofofthe
the arise
ariseafter
afterpricing
pricing
manufacturer’s
manufacturer’sprice-making
price-makingprocess
process decisions have
decisions have
taken
takeneffect
effect
Objective 4:
Channel Pricing Guidelines

Why?

1.1. To
Tohelp
helpthose
thoseinvolved
involvedininpricing
pricingdecisions
decisionstoto
focus
focusmore
moreclearly
clearlyon
onthe
thechannel
channelimplications
implications
ofoftheir pricing decisions
their pricing decisions

2.2. To
Toprovide
providegeneral
generalprescriptions
prescriptionsononhow
howtoto
formulate
formulatepricing
pricingstrategies
strategiesthat
thatwill
willhelp
helppromote
promote
channel
channel member cooperation and minimizeconflict
member cooperation and minimize conflict
 Profit Margins

Guideline
Guideline#1:
#1:Each
Eachefficient
efficientreseller
resellermust
mustobtain
obtain
unit
unit profit margins in excess of unit operatingcosts.
profit margins in excess of unit operating costs.

OR

Channel
Channelmembers
memberswhowhobelieve
believethat
thatthe
themanufacturer
manufacturerisisnot
notallowing
allowingthem
them
sufficient
sufficientmargins
marginsare
arelikely
likelyto
toseek
seekout
outother
othersuppliers
suppliersor
orestablish
establishand
andpromote
promote
their
theirown
ownprivate
privatebrands.
brands.
 Different Classes of Resellers

Guideline
Guideline#2:
#2:Each
Eachclass
classofofreseller
resellermargins
marginsshould
shouldvary
vary
ininrough proportion to the cost of the functions the
rough proportion to the cost of the functions the
reseller
resellerperforms.
performs.

1.1. Do
Dochannel
channelmembers
membersholdholdinventories?
inventories?
2.2. Do
Dothey
theymake
makepurchases
purchasesininlarge
largeor
orsmall
smallquantities?
quantities?
3.3. Do
Dothey
theyprovide
providerepair
repairservices?
services?
4.4. Do
Dothey
theyextend
extendcredit
creditto
tocustomers?
customers?
5.5. Do
Dothey
theydeliver?
deliver?
6.6. Do
Dothey
theyhelp
helptrain
trainthe
thecustomers’
customers’sales
salesforce?
force?
 Rival Brands

Guideline
Guideline#3:
#3:AtAtallallpoints
pointsininthe
thevertical
verticalchain
chain
(channel
(channel levels), prices charged must be in linewith
levels), prices charged must be in line with
those
thosecharged
chargedforforcomparable
comparablerivalrivalbrands.
brands.

Channel
Channelmanagers
managersshould
shouldattempt
attemptto
toweigh
weighany
anymargin
margindifferentials
differentialsbetween
betweentheir
their
own
ownand
andcompetitive
competitivebrands
brandsininterms
termsofofwhat
whatkind
kindofofsupport
supporttheir
theirfirms
firmsoffer
offerand
and
what
whatlevel
levelofofsupport
supportthey
theyexpect
expectfrom
fromchannel
channelmembers.
members.
 Special Arrangements

Guideline
Guideline#4:
#4:Special
Specialdistribution
distributionarrangements—
arrangements—
variations
variations in functions performedorordepartures
in functions performed departures
from
from the usual flow of merchandise—shouldbe
the usual flow of merchandise—should be
accompanied
accompaniedby bycorresponding
correspondingvariations
variationsinin
financial
financialarrangements.
arrangements.

The
Themargin
marginstructure
structureshould
shouldreflect
reflectany
anychanges
changesininthe
theusual
usualallocation
allocationofofdistribution
distribution
tasks
tasksbetween
betweenthe
themanufacturer
manufacturerand
andthethechannel
channelmembers.
members.
 Conventional Norms in Margins

Guideline
Guideline#5:
#5:Margins
Marginsallowed
allowedtotoany
anytype
typeofof
reseller
resellermust
mustconform
conformtotothe
theconventional
conventional
percentage
percentagenorms
normsunless
unlessaavery
verystrong
strongcase
casecan
canbebe
made for departing from the norms.
made for departing from the norms.

Exceptions
Exceptionsare
arepossible
possibleififthey
theycan
canbe
bejustified
justifiedininthe
theeyes
eyesofofthe
thechannel
channelmembers.
members.
However,
However,ititisisthe
thejob
jobofofthe
thechannel
channelmanager
managerto toattempt
attemptto toexplain
explainto
tothe
the
channel
channelmembers
membersany anymargin
marginchanges
changesthat
thatdeviate
deviatedownward
downwardfrom fromthe
thenorm.
norm.
 Margin Variation on Models

Guideline
Guideline#6:
#6:Variations
Variationsininmargins
marginson onindividual
individual
models
models and styles of a line are permissibleand
and styles of a line are permissible and
expected. However, they must vary around
expected. However, they must vary around the the
conventional
conventionalmargin
marginfor
forthe
thetrade.
trade.

Channel
Channelmembers
membersare
areoften
oftenamenable
amenableto toaccepting
acceptingthe
thelower
lowermargins
marginsassociated
associated
with
withpromotional
promotionalproducts
productsso solong
longas
asthey
theyare
areconvinced
convincedofofthe
thepromotional
promotional
value
valueofofthe
theproduct
productininbuilding
buildingpatronage.
patronage.
 Price Points

Guideline
Guideline#7:
#7:AAprice
pricestructure
structureshould
shouldcontain
contain
offerings
offerings at the chief price points, wheresuch
at the chief price points, where such
price points exist.
price points exist.

Price
Pricepoints
pointsare
arespecific
specificprices,
prices,usually
usuallyatatthe
theretail
retaillevel,
level,to
towhich
whichconsumers
consumershavehave
become
becomeaccustomed.
accustomed.Failure
Failureto
torecognize
recognizeretail
retailprice
pricepoints
pointscan
cancreate
createproblems
problems
for
forthe
themanufacturer
manufactureras aswell
wellas
asits
itschannel
channelmembers
membersififconsumers
consumersexpect
expecttotofind
find
products
productsatatparticular
particularprice
pricepoints
pointsand
andsuch
suchproducts
productsare
arenot
notoffered.
offered.
 Product Variations

Guideline
Guideline#8:
#8:AAmanufacturer’s
manufacturer’sprice
pricestructure
structure
must
must reflect variations in the attractivenessofof
reflect variations in the attractiveness
individual
individualproduct
productofferings.
offerings.

IfIfthe
theprice
pricedifferences
differencesare
arenot
notclosely
closelyassociated
associatedwith
withvisible
visibleor
oridentified
identifiedproduct
product
features,
features,the
thechannel
channelmembers
memberswill
willhave
haveaamore
moredifficult
difficultselling
sellingjob.
job.
Objective 5:
Guideline Caveat

There is no
Guarantee

Particular circumstances and situations exist

in which these guidelines will not apply or
will be irrelevant.
Objective 6:

Other Channel Pricing Issues

Exercising control in channel pricing

Changing price policies

Passing price increases through the channel

Using price incentives in the channel

Dealing with the gray market & with free riding

 Exercising Control in Pricing
Because channel members typically view pricing
as the area over which they have total control. . .

First: Rule out any type of coercive approaches

to controlling channel member pricing policies.

Second: The manufacturer should encroach on the

domain of channel member pricing policies only if
the manufacturer believes that it is in his or her
vital long-term strategic interest to do so.

Finally: If the manufacturer believes that it is necessary to

exercise some control over member pricing, he or she
should do so through “friendly persuasion.”
 Changing Price Policies

Changes in
manufacturer pricing policies
or related terms of sale cause
reactions among
channel members.

Channel members fear such changes because they have

become accustomed to the strategy, or their own pricing
strategies may be closely tied to those of the manufacturer.
 Passing Price Increases Through the
Channel
Strategies for channel members to use in order
to avoid simply passing along price increases
through the channel:

First: Manufacturers should consider the long- and the

short-term implications of such increases versus
maintaining the current prices.

Second: Manufacturers should do whatever possible if

passing on the price increase is unavoidable.

Finally: Manufacturers could change their strategies in

other areas of the marketing mix to help offset
the effects of such increases.
 Using Price Incentives in the Channel

Manufacturers face difficulties gaining strong

retailer acceptance and follow-through on
pricing promotions.

Possible Solutions:

• Make pricing promotions as simple and

straightforward as possible.

• Design price-promotion strategies to be at least as

attractive to retailers as they are to consumers.
 Gray Market & Free Riding

Gray Market Free Riding

The sale of brand-name Describes the behavior of
products at very low prices distributors & dealers who offer
by unauthorized extremely low prices but little
distributors or dealers service to customers

Channel design decisions that result in closely controlled channels and

selective distribution as well as changing buyer preferences may help limit the
growth of the gray market and free riding.