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Renting Goodwill in International Marketing Channels
By admin | July 24, 2008
This paper is concerned with the rental of goodwill in international marketing
channels. A game theoretic model is developed to investigate the optimal pricing strategies
of foreign manufacturers under conditions of asymmetric information. The reputation
of the domestic importer is formally incorporated into the analysis as are
differences in relative bargaining power between the foreign manufacturer and importer.
The paper also examines the conditions under which consumers would purchase a foreign
product over a domestic substitute, and the impact of product quality and importer
reputation on this decision. The analysis is relevant to experiential products where
quality is unknown to the consumer until after they are purchased and consumed
[Nelson, 1970].
An understanding of the impact of bargaining power and goodwill on pricing strategies
in international marketing channels is important. The pricing decision is central to
success in foreign markets [Stottinger, 2001]. Importers consider price to be one of the
central determinants of their decision to represent a foreign manufacturer in overseas
markets [Farrell, 2006; Ghymn et al., 1999]. It is also well known that, in many foreign
markets, exporters face considerable challenges in attracting and retaining the services
of reputable importers [Johansson, 2003]. Once established, however, relationships
between foreign manufacturers and their overseas distributors persist for significant
lengths of time and constitute an effective barrier to entry for new exporters [Matear
et al., 2000]. It is evident that goodwill has been established in these long-term, stable
exporterYimporter relationships often making the cost of switching unacceptably high for
both parties. Clearly, goal congruity, mutual trust and effective communication are
established between the parties over time [Anderson et al., 1987]. It is also known that
firms come into international exchange relationships with differing levels of bargaining
power, and that each party to the transaction must exercise some degree of power for an
effective exchange relationship to develop [Katsikeas and Percy, 1992]. In fact,
bargaining power has been shown to impact firms’ choice of market entry strategy and
hence success in export markets [Gao, 2004; Taylor et al., 2000]. The above provides the
motivation for the development of a model which integrates goodwill and bargaining
power into the international pricing decision. Such a model does not currently exist in
the academic literature.
A number of economic frameworks may be used to investigate the international
pricing strategies of foreign manufacturers in export markets, and the role of goodwill
and bargaining power. These frameworks include signaling models. The literature on
signaling models is well developed. The role of price, advertising and other marketing
mix variables in signaling unobservable product quality has been investigated by Akerlof
[1970] and Spence [1973]. Information asymmetry in marketing channels provides the
opportunity for sellers to make false claims about their capabilities. Signals serve as a
mechanism for parties to a transaction to address such moral hazard problems. Signals
are clearly relevant to the case of experiential products as information asymmetry
disappears once the buyer is able to consume the product and independently verify
quality. These models assume that in order for a signal to be credible the manufacturer
must stand a risk of loss. Should the seller’s claims turn out to be false, the firm must
incur a cost associated with making the false claim. The firm is considered to post a bond
which will be forfeit should its claim of quality turn out to be misleading. This bond may
take the form of a sunk investment in high quality packaging or expensive advertising.
Researchers have also investigated manufacturers’ use of money back guarantees and
warranties as signals of product quality [Moorthy and Srinivasan, 1995; Boulding and
Kirmani, 1993], while more recently Hellofs and Jacobson [1999] examined the impact of
a firm’s market share on customers’ perception of product quality.
A manufacturer may signal to consumers that its product is of high quality by selling
exclusively through reputable retailers [Chu and Chu, 1994]. Chu and Chu [1994] show
that in a separating equilibrium a manufacturer of high quality products, which does not
have a strong reputation, will signal quality by selling its products through a reputable
retailer while the manufacturer of low quality products will choose to sell its products
through retailers with no reputation. The manufacturer in the Chu and Chu [1994]
model rents the reputation of the retailer and is able to signal quality to consumers as a
result. Manufacturers may also signal product quality by renting the reputation of a
brand ally [Rao et al., 1999]. Established manufacturers with existing successful brands
also have the option of using the reputation of a successful brand to post a bond for a
newly introduced product [Wernerfelt, 1988]. Wernerfelt’s [1988] work explores the use
of umbrella brands as signaling mechanisms. The latter author considers the situation of
a multi-product manufacturing firm which is able to use the reputation of one of its
established products to post a bond for a newly introduced product.
Price and advertising as signals of product quality have been investigated by
Zhao [2000], Kihlstrom and Riordan [1984], Wolinsky [1983], Chu [1992], and Tellis
and Wernerfelt [1987]. Other researchers such as Desai [2000] and Lariviere and
Padmanabhan [1997] have investigated firms’ optimal use of advertising and slotting
fees as signals of product quality. Some work has also been done on the relationship
between bargaining power and reputation [Abreu and Gul, 2000]. In the present study,
however, goodwill is investigated as a signaling device.
In the analysis below we consider the case of a foreign manufacturer renting the
reputation of a domestic importing agent. The conditions under which the manufacturer
will enter into a contractual relationship with the importer are explored, as well as the
importer’s use of its reputation in the local market to signal product quality and create a
preference for the foreign product. The present work aims to contribute to the literature
by building on earlier research on signaling product quality by renting the reputation of
another agent. The authors consider the role of goodwill and bargaining power in the
international exchange process.
This study addresses three specific research objectives. These are as follows: first, to
investigate the pricing strategies of manufacturers in international markets where
product quality is unobservable and bargaining power is not symmetrically distributed in
the marketing channel. Second, to investigate the conditions under which a manufacturerYimporter
contract will be established given transaction costs and differences in
bargaining power between these agents. Third, to investigate the conditions under which
it is optimal for consumers to purchase a foreign over a domestic product given information
regarding the reputation of the importer, but uncertainty with respect to the
quality of the imported product.
The above objectives are addressed by the development of a game theoretic framework
that involves Nash [1953] bargaining between a foreign manufacturer and a domestic
importer. The model incorporates a domestic consumer making a choice between a
domestic and an imported product in an environment of uncertainty with respect to
product quality. The foreign manufacturer utilizes a combination of the domestic importer’s
knowledge of the local consumer and this agent’s goodwill in determining
whether or not to reach a bargaining outcome with the importer that improves upon a no
contract sub-game equilibrium. The importer maximizes profit by choosing the volume of
sales in the local market, given consumer demand. The importer and foreign
manufacturer bargain over the wholesale price and product quality given the planned
sales volume. Next, consumers choose between the local and imported product given
asymmetric information about the quality of the imported product. The importer’s
goodwill is known to local consumers and verifiable by the foreign manufacturer. The
study produces three major findings. First, assuming the consumer’s individual rationality
constraint is binding, the foreign manufacturer follows a mark-up pricing
strategy in which its gross margin and the quality premium over the domestic product
are shared with the importer. Second, a manufacturerYimporter contract occurs
only when the manufacturer’s bargaining power is within an admissible range which
shrinks as transaction costs increase. Third, the domestic consumer will only purchase
the foreign product if the importer’s goodwill in the domestic market is sufficiently
large.
This paper is organized into three major sections. A description of the model is presented
in the next section. The following section discusses the results, develops the
managerial implications of the analysis, and offers guidance for future research in this
area. Detailed derivations have been relegated to an appendix.
Conclusion
This paper has examined the optimal pricing strategies of foreign manufacturing
firms in international markets. A game theoretic model was developed that allows for an
investigation of the optimal strategies of manufacturing exporters under conditions in
which bargaining power and information are not symmetrically held in the international
marketing channel. The goodwill of the importer in the domestic market was explicitly
considered in the model. Three major findings emerge from the analysis. First, the foreign
manufacturer follows a mark-up pricing strategy in which its gross margin and the
quality premium over the domestic product are shared with the importer. Second, a
manufacturerYimporter contract occurs only when the manufacturer’s bargaining power
is within an admissible range which shrinks as transaction cost increases. Third, the
domestic consumer will only purchase the foreign product if the importer’s goodwill in
the domestic market is sufficiently large to signal quality.
The results of our analysis have implications for researchers interested in the incorporation
of bargaining power and goodwill into price signaling models, as well as for
marketing managers of both exporting and importing firms. The role of importer
goodwill and bargaining power in foreign market entry has been shown to be important,
and their influence on pricing strategies and equilibrium outcomes has been documented.
New exporters are keenly aware of the difficultly of securing effective representation
in foreign markets. Better positioned importers are often unwilling to handle
the products of a new exporter, effectively shutting these firms out of potentially lucrative
export markets. Our analysis indicates that effective importers, i.e., those with the
highest goodwill, require adequate compensation before risking their goodwill in the local
market. Importers will enter into a contract only when the gross margin exceeds the
expected loss of goodwill. The implication for new exporters is clear. An effective pricing
strategy must be a key element in their foreign market entry strategy. This is likely to be
particularly true in an environment of long-standing manufacturerYimporter relationships.
An exporter’s pricing strategy has an obvious and direct impact on importer
margins. Of course not all of the gross margin from competitive pricing will likely be
captured by the importer. Under a mark-up pricing mechanism this margin will be shared
with the manufacturer to an extent determined by each agent’s bargaining power.
From the importers’ perspective, our results suggest that these intermediaries have a
vested interest in developing high levels of goodwill in their local markets. It is only with
high levels of goodwill that such firms will be able to effectively represent foreign
manufacturers’ brands. Importer goodwill was shown to be an effective signal of product
quality, and it was demonstrated that consumers consider goodwill in their decisions to
purchase or not purchase a foreign product over a domestic substitute. Foreign manufacturers
will seek to negotiate contracts with those importers that can post a sufficiently
large goodwill as it is required for local agents to be able to generate sales of the
imported brand.
The present model offers insights into the role of bargaining power and goodwill in
the pricing decisions of importers and manufacturers. The paper contributes to the literature
on the role of bargaining power and reputation in international exchange relationships.
The work presented above is theoretical and no attempt has been made to
empirically test the study’s main conclusions. Empirical testing of the predictions of this
paper represents a fertile area for future researchers.
Topics: Marketing |
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