Polk Bros. Chair in Retailing; Professor of Marketing; Director Kellogg-McCormick MBAi
Emeritus Professor of Marketing
Savvy shoppers scour the Internet for the lowest price on a digital camera. But new research shows that equally savvy manufacturers use sophisticated channel-pricing policies to control downstream prices and competition from unauthorized resellers.
Manufacturers of durable goods like electronics, housewares, toys, and sporting equipment often set Minimum Advertised Price (MAP) policies for retailers to follow. These policies help manufacturers coordinate prices across online and brick-and-mortar retailers, and protect their brand from being perceived as too cheap. They also grant manufacturers greater control of the margins available to their downstream retail channel partners, so that retailers do not have to skimp on providing service and training to customers. Manufacturers would not want Dad to leave the store without knowing how to work his new smartphone, for example.
In return for complying with MAP pricing, manufacturers might offer an authorized retailer some financial help in the form of shared advertising funding, or preferential treatment when new products are released. In some cases, compliance is a condition for a retailer’s continued access to the manufacturer’s goods, with violators losing shipments of products to sell.
Unauthorized retailers—those with no formal relationship with the manufacturer—are not bound by MAP policies. But even they can be punished indirectly if they lose product shipments from an authorized (but MAP-violating) seller further up the supply chain that has been outed as their supplier and subsequently penalized.
Still, not all retailers, authorized or otherwise, adhere to MAP policies. MAP compliance is examined in new research conducted by recent Kellogg doctoral graduate Ayelet Israeli (now at Harvard Business School) and Kellogg School marketing professors Eric Anderson and Anne Coughlan.
The researchers note a great deal of variability in terms of compliance with MAP pricing. Twenty percent of retailers in the researchers’ dataset always complied, while nearly forty percent never did. So which retailers comply? And what can manufacturers do to stamp out noncompliance?
Map Pricing for Authorized vs. Unauthorized Retailers
Researchers first interviewed a series of managers about their beliefs about MAP violations and then analyzed a dataset (from a large manufacturer that sold 226 unique products through over 900 authorized and unauthorized retailers) to test these beliefs.
They found that conventional wisdom among manufacturers is that authorized retailers are less likely to violate MAP. After all, they have the most to gain from playing by the rules. Conventional wisdom also holds that unauthorized retailers are the most likely to violate MAP and thus should be the focus of enforcement efforts, because when they lower their prices, all retailers, both authorized and unauthorized, follow suit and the manufacturer loses control of pricing.
“When manufacturers impose punishments that seem too draconian, retailers do not believe that they will be punished upon violating MAP, which leads to MAP violations.”
Think about a digital camera whose manufacturer sets a MAP price of $200 and whose authorized retailers comply. Now suppose unauthorized retailers on Amazon or eBay start selling that camera at $190. “Manufacturers believe that once this happens it cascades through the entire market, and so more authorized and unauthorized retailers will start to price below $200,” Israeli says.
She and her colleagues found that unauthorized retailers are indeed more likely to violate MAP agreements than authorized retailers. Fifty-three percent of unauthorized retailers violate the policies, while just fifteen percent of authorized retailers do so.
Managers were also correct in their belief that MAP violations cascade across the market. However, the researchers’ analysis suggests that violations by authorized retailers lead to violations by other authorized retailers, while violations by unauthorized retailers do the same for other unauthorized retailers.
In other words, authorized and unauthorized retailers operate largely independently of one another. Thus, it is not the case that pesky unauthorized retailers are entirely responsible for low compliance among authorized retailers. If manufacturers want to keep their authorized retailers in line—those over whom they have the most leverage—they need to focus their efforts on delinquent authorized retailers.
The researchers’ thorough examination of MAP policies, the first of its kind, also revealed that authorized retailers who carry a wide range of products from a manufacturer are less likely to violate MAP than those with a much narrower range. This is because the benefits of compliance, or punishments for lack of compliance, are greater for retailers who are very committed to the manufacturer. (This is not the case for unauthorized retailers, where no relationship with the manufacturer exists.)
The researchers further looked at the relationship between shipping charges and MAP violations. The majority of retailers in the study offered free shipping. However, those who charged for shipping were more likely to violate MAP policies than those with free shipping.
“The margins they lose because they offer a lower price are gained back through overcharging you with shipping,” Coughlan says.
It seems these retailers tacked on shipping costs to obfuscate the actual price customers were paying for a product. Online retailers often reveal shipping charges only at the very end of a transaction, after a buyer has clicked through multiple checkout pages, which reduces consumers’ tendencies to abandon the purchase.
So how can manufacturers get more retailers to follow their MAP policies? Israeli’s ongoing work focuses on this question.
Credible punishments help. That is, manufacturers can maintain better control by ensuring the punishment fits the MAP-related crime.
“When manufacturers impose punishments that seem too draconian, retailers do not believe that they will be punished upon violating MAP, which leads to MAP violations,” says Israeli. Today, many manufacturers threaten first-time offenders with small or middling punishments, with the expectation that punishments will increase for subsequent violations. “This really helped in making the punishment itself seem more credible,” she says.
Moreover, a little flexibility in MAP pricing definitions can benefit all parties. Manufacturers increasingly understand that retailers are competing for business and that lowering prices is one way to attract customers. So a manufacturer might stipulate that a retailer is in violation only if it prices a specific product at least $10 lower than the MAP. Such flexibility might help direct manufacturers’ limited resources at more egregious MAP violations. Similarly, manufacturers routinely implement MAP “holidays” during high-volume shopping periods such as the pre-Christmas season, to facilitate sales in the competitive online environment.
Overall, the researchers urge manufacturers to focus on both authorized and unauthorized retailers when it comes to MAP violations. “You can’t really assume that addressing the violations only through eliminating the unauthorized channel will help you with your authorized channel,” says Israeli.
Israeli, Ayelet, Eric T. Anderson, and Anne T. Coughlan. Forthcoming. “Minimum Advertised Pricing: Patterns of Violation in Competitive Retail Markets.” Marketing Science.