On the Optimality of Delegating Pricing Authority to the Sales Force

Abstract

An important decision facing sales managers today is precisely how much pricing authority should be delegated to the sales force. Received theory suggests that the salesperson's superior information about customers' valuations will invariably make price delegation profitable for the firm. The empirical evidence, however, reveals that firms that grant full pricing authority generate lower profits than firms that limit pricing authority. Given this state of affairs, the author develops and analyzes a formal model that examines the optimality of delegating pricing authority to the sales force. The model preserves the notion of superior information assumed in the literature but considers as well a negative feature of much concern to practitioners, namely, the suboptimal substitution of selling effort by price discounting. The model reveals that providing the salesperson with full pricing authority is not always optimal. Specifically, in some environments, it is appropriate to limit pricing authority because this decision forces the salesperson to target high-valuation customers. In addition, the model predicts that the commission rate offered to the salesperson should be higher when pricing authority is limited. The author concludes by summarizing the context, calculus, and implications of the model with a view to assisting managers charged with the price-delegation decision.