Legal and Ethical Issues in Pricing
Businesses can often be faced with ethical issues in pricing. Price gouging happens when a seller suddenly increases prices when its products are in demand. Arguments against price gouging include that it involves coercion (forcing or threatening) and exploitation (unfair treatment). Arguments for price gouging include conservation, which means people tend to save and ration more when prices are high. Predatory pricing is when an organization prices below the average variable cost, or costs that can change depending on the output, to decrease competition. The purpose behind predatory pricing is not to maximize profits. Instead, it is to drive a competitor out of business. An organization engaging in predatory pricing typically experiences a financial loss at first, but as competition is driven out, it can raise its prices more than would have been possible with competition.
Price-fixing can occur vertically or horizontally. Vertical price-fixing is an illegal agreement between two parties that are at different levels of production and distribution to control market prices. For example, consider that ABC Manufacturing sells its units to Big Box Department Store. ABC Manufacturing requires Big Box Department Store to sell its products for $40 per unit. This is an example of vertical price-fixing because a manufacturer dictated the price at which the retailer sold the product. Horizontal price-fixing involves collusion between two or more competitors to set prices for a product or service, either directly or indirectly. For example, consider Bob's Furniture LLC and Jason's Furniture LLC. The companies do business in the same market and are relatively small suppliers. They seek to increase their market share and agree to charge the same price for their furniture pieces. This is an example of horizontal price-fixing, as two competitors illegally agreed to set a price for a product. The main difference between vertical price-fixing and horizontal price-fixing is that vertical price-fixing happens between sellers and buyers, compared to horizontal price-fixing, which occurs among competitors. Vertical price-fixing can decrease competition in the market just as horizontal price-fixing can because the price is being manipulated—although parties in the production and distribution chain control prices with vertical price-fixing while competitors control horizontal price-fixing. Nonetheless, this price-fixing is usually carried out to eliminate competition and increase market share.
Price discrimination is when sellers charge different customers different prices for the same product based on what they are willing to pay. Ethically, price discrimination can be troubling on the basic principle of fairness. The retailer is selling the same product at higher and lower rates merely on the basis of willingness to pay and not based on the product's quality or features. Additionally, price discrimination makes customers distrust retailers because they fear that they may be taken advantage of. Organizations that engage in price discrimination do so because it is profitable and allows them access to consumer surplus. Price discrimination can be based on the number of units being purchased, variation among market segments, and hurdle pricing. Hurdle pricing is when an organization sells a product for a higher price on its initial release but lowers the price after the product has been on the market. This type of pricing is most common with technology products.Failure to disclose full price happens when advertised prices do not inform the customer of other fees or costs the customer will have to pay as part of the purchase. Bait-and-switch is the practice of sellers advertising products that are generally not available. Sellers do this in the hopes that interested people will buy other products. The customers are "baited" by the advertisement displaying a low price, and when they try to buy the advertised service or product, they are "switched" to a similar but more expensive product or service.
Risks for Organizations Engaging in Unethical Behavior
Unethical behavior may create short-term profits, but the long-term consequences can be vast. The behavior may subject the organization to fines or reparation of damages (money or action to make amends for a wrong) imposed by a legal authority or regulatory agency, such as the Food and Drug Administration or the Environmental Protection Agency. Customers may boycott the organization, resulting in a decrease of sales and profits. This decrease in profit can affect the organization's stock price, which also affects whether future stakeholders will want to invest in the organization and whether current stakeholders will continue to support the organization.
An organization also risks losing valuable employees if it behaves unethically. An employee of an organization engaging in unethical behavior can remain loyal to the organization, exit, voice their concern to the organization, or describe the unethical behavior to a news media outlet or government agency.
Employees may remain loyal because they want to keep their jobs and feel they are part of the organization. However, if employees are making or observing decisions that make them uncomfortable, their ethical principles may cause them to examine the situation. Another option is for the employee to exit. This can involve the employee leaving the organization or just removing themselves from the unethical situation. Last, the employee can voice a concern and help provide alternative practices—either by sharing concerns with management or with a news agency or governmental unit.
The risks of an organization engaging in unethical behavior can be seen in the subprime mortgage crisis beginning in 2007, when unverified income for home loans enabled people to borrow debt beyond their ability to pay when mortgage interest rates rose. This created the housing crisis. A subprime mortgage is normally issued by a lending institution to borrowers with low credit ratings. Borrowers expected that they could always sell a house for more than they paid, simply because trends indicated that the value of homes steadily increased over time. Mortgage lenders issued mortgages without verifying the borrower's financial information or the true value of the home and provided subprime mortgages at high interest rates to customers who had poor credit. At times, lenders encouraged loans that they knew the borrowers could not repay. When the housing market crashed, many homeowners were unable to pay back their loans. Banks pursued foreclosures, causing housing prices to fall further.
In response to the subprime mortgage crisis and the housing crisis, Congress amended the Truth in Lending Act (TILA), which prohibits unfair, abusive, or deceptive home mortgage lending practices. The Consumer Financial Protection Bureau established criteria in accordance with the act for lenders to determine whether the borrower can afford to repay the loan. A borrower's debt cannot exceed 43 percent of their income, up-front fees are limited to three percent, and rapidly rising "balloon payments," or large one-time payments due at the end of a loan period, are restricted.