Quiz 4 - Pricing for International and Global Markets, Intl. Mkt

Company Internal Factors

• Most companies begin pricing deliberations on the basis of their own internal cost structure.

• Variable costs: variable costs vary directly with output

  • E.g., direct labor, direct materials, etc.

• Fixed costs: do not change over a given range of output

  • E.g., sales and marketing overhead, general administration cost, R&D, etc.

• Cost-based approaches to international pricing

  • Full-cost pricing

    • Each product must bear its full share of the total fixed and variable cost.

  • Variable-cost (or marginal) pricing

    • Firms regard foreign sales as bonus sales and assume that any return over their variable cost makes a contribution to net profit.

    • This approach may be subject to charges of dumping.

Additional costs when sending the product overseas

• Transportation costs

  • Varied by:

  • Distance • Mode of transportation (air, truck, rail, water, pipeline)

  • Oil price

• Tariffs

  • Usually levied on the landed costs of a product, including shipping costs. •

  • May change substantially based on product classification code, trade agreements

• Taxes

  • Varied by countries

  • E.g., value-added tax (VAT), sin taxes for products that are legal but are discouraged by the society

Market Factors

four main factors to consider

1. Income

2. Buyer Power

3. Culture and consumer preferences

4. Competition

Income

• Income per capita determines the amount and type of products bought.

  • GDP/GNP per capita (PPP) – Purchasing power parity should be considered.

  • Discretionary income: leftover after necessities of food, shelter and clothing.

• Keeping prices low in developing countries

  • Decreasing sizes, product-costs savings, redesigning products (e.g., modularity design, reverse engineering)

  • Example: Cadbury designed a new chocolate product for the low end of the Indian market:  Small sized package, production outside of Mumbai, local cocoa production support.

Buyer Power

• #Buyers:

  • Fewer buyers in a market → the more powerful they become (better able to bargain for lower prices)

  • Purchase volume:

    • Large individual buyers demand lower prices.

Culture and consumer preferences

• Cultural meanings of numbers have important implication for pricing and promotion.

• Strong association between price and quality

  • Special Japanese price: A BMW that lists for $56,000 in USA can cost $84,000 in Japan

• Bargaining for a better price is common in some cultures

  • E.g., Turkey, China (group buying) Opening: 8/8/2008 at 8:08pm

Competition

• The number and type of competitors greatly influence pricing strategy in any market.

  • Sole suppliers enjoy greater pricing flexibility

  • Large numbers of competitors can encourage price wars

• Sometimes price levels are manipulated by cartels or other agreements among local competitors

  • U.S. companies are forbidden by U.S. law to participate in cartels!

Inflation Rates

• Inflation refers to a sustained increase in the general level of prices for goods and services in a country.

• In high-inflation countries, companies are under pressure to increase prices to keep up with increased costs.

  • Unfortunately, consumer incomes often lag inflation

Government price controls

• Instituted by the government and regulatory agencies

• Two types:

  • Across-the-board price controls (applied to an entire economy to combat inflation) are rare.

  • Industry-specific controls are more common (e.g., pharmaceuticals, fuel)

Dumping regulations

• Dumping refers to selling a product at a price below actual costs

• Because of potential injuries to domestic manufacturers, most governments have adopted regulations against dumping.

  • Limits firms’ price flexibility in overseas markets

  • But protects domestic market from foreign competition

Credit and collection infrastructure

• Extending credit to buyers costs money. In turn, it can affect the pricing decision

• Letters of credit (L/C) - Payment guaranteed by the buyer’s bank.

  • Most frequently used method of payment for international transactions

• The infrastructure for consumer credit may be absent or underdeveloped in some poorer countries

Export Price Escalation

• Price escalation refers to the disproportionate difference in product selling price between the exporting country and the importing country

Approaches to lessening price escalation

• Lowering Cost of Goods

  • Firms can lower tariffs by categorizing products in classifications where the tariffs are lower or by modifying a product or packaging to qualify for a lower tariff rate.

• Lowering Tariffs

  • Firms can design channels that are shorter with fewer middlemen to reduce or eliminate middleman markups.

• Lowering Distribution Costs

  • Firms can design channels that are shorter with fewer middlemen to reduce or eliminate middleman markups

• Using Foreign Trade Zones (FTZs)

  • Firms can manufacture products in free trade zones where the incentive offered is the exemption from duties on labor and overhead costs incurred in the FTZ in assessing the value of goods

Transfer Pricing

• Price paid by importing or buying unit of a firm to the exporting unit of the same firm

• The price may be negotiated by the units involved or may be set centrally by the MNC. Hence, it frequently differs from free-market price.

• Thanks to different tax, tariff or subsidy structures among countries, firms may deviate from market prices to:

• Maximize profits (through low transfer prices)

  • Accumulate more profits in a low-tax country.

  • Reduce tariff duties paid in a high-tariff country

• Minimize risk or uncertainty (through high transfer prices) • Repatriate profits from a country with limits on profit repatriation • Move profits out of country with macroeconomic instability

Transfer Pricing (issues to consider)

• Internal considerations

  • It’s hard to motivate subsidiary managers whose profits are artificially reduced.

     Company resource allocation may become inefficient, because funds are appropriated to units whose profits are artificially increased.

• External problems

  • Governments do not look favorably on transfer pricing mechanisms aimed at reducing their tax revenues.

    • U.S. Revenue Act 1962, Section 482 provides an accurate allocation of costs, income and capital among related enterprises to protect U.S. tax revenue.

    • Market prices preferred by IRS.

    • The IRS requires all companies to maintain detailed explanations of the rationale and analysis supporting their transfer pricing policy.

Price quotations

• A quotation should include

  • Product description

    • Quantity such as tons (in metric units when appropriate).

    • Quality specifications

  • Terms of sales (Incoterms)

  • Terms of payment

  • Total charges to be paid by customer (in currency to be used)

    • Unit price; discount (if any); insurance; and shipping costs

  • Others such as documentation required, shipping date, validation period for quotation, delivery point, etc.

Terms of sales

Specify the exact point at which the ownership of merchandise is transferred from the seller to the buyer and which party in the transaction pays which costs. E.g., FOB, CIF

Terms of Payment

• Cash in advance

  • Payment guaranteed by the buyer’s bank.

• Letters of credit (L/C)

  • Payment facilitated but NOT guaranteed by banks.

• Draft

  • Payment facilitated but NOT guaranteed by banks

• Open Account

  • Payment made after delivery.

Quoting Prices in a Foreign Currency

• Although the majority of U.S. exporters quote prices in dollars, there are situations in which customers may prefer quotes in their own national currency.

  • When two currencies are involved in a market transaction, there is the risk that a change in exchange rates may occur between the invoicing date and the settlement date for the sale.

• Pricing options

  • Uncovered position – Pay spot price on the due date

  • Hedging – Contract through financial intermediaries for future delivery of foreign currency at a set price, regardless of spot price at the time

  • Sometimes not available for a currency in crisis

Parallel Imports or Gray Markets

Gray market goods are trademarked products that are exported from one country to another where they are sold by unauthorized persons or organizations.

• Conditions for a parallel market

  • Trade restrictions such as import quotas and high tariffs

  • Internet trade

  • Exclusive distribution

• Parallel imports

  • Hurt relationships with authorized dealers.

  • Undermine a company’s ability to charge different prices in different markets to maximize global profits.

Setting Global Prices

• Market-by-market pricing policy

  • This allows subsidiaries or local partners to set their own prices based on local market conditions, cost, and competition.

  • Commonly used by firms in the early part of their international development.

• Pros:

  • Adapting to local conditions (such as income, competition)

  • Flexibility: Local managers can respond quickly to market changes and customer preference

• Cons:

  • Potential problem of arbitrage (parallel imports)

  • Potential brand dilution (weakening the global brand image)

• Uniform pricing policy

  • Setting a uniform price for a product across all international markets.

  • Pros:

    • Simple

    • Preferred by global customers

  • Cons:

    • Ignoring local market conditions such as local taxes, trade margins, custom duties, and competitive pressure.

• Modified uniform pricing policy

  • Carefully monitoring price levels in each country and avoiding large gaps that encourage parallel imports.