Justifying profitable pricing

Abstract

Economic theory depicts a price‐setter who is cognizant of both the incremental profit implications of changing price and likely competitive reactions. Marketplace observations suggest otherwise; several studies and anecdotal evidence find a tendency for pricing to be driven by cost and market share rather than marginal profit. Further, recent evidence suggests that competitive reactions are often overlooked. This paper develops an explanation of these observations via decision accountability. The literature on accountability is based on the premise that in any social or organizational context, people are compelled to make decisions that can be justified. This justification involves searching for criteria on which those decisions will be judged by others and decision making which can be rationalized on those criteria. New evidence reviewed here suggests that people tend to justify decisions on the basis of more familiar and less ambiguous criteria, giving too little weight to more ambiguous but important considerations. The omission of future profit projections and competitive behavior in decision making, then, can be explained by ambiguity surrounding the estimation of these factors (relative to more concretely measured and familiar internal criteria). I examine three case studies that illustrate how firms have changed information strategy, culture, and competitive thinking in the interest of making profitability and competitive information more justifiable inputs for pricing decisions.

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