Pricing for International Markets
1. Pricing Policy (Pricing Objectives; Parallel Imports)
2. Approaches to International Pricing (Full-Cost versus Variable-Cost Pricing; Skimming versus Penetration Pricing)
3. Price Escalation (Costs of Exporting; Taxes, Tariffs, and Administrative Costs; Inflation; Deflation; Exchange Rate Fluctuations; Varying Currency Values; Middlemen and Transportation Costs)
4. Sample Effects of Price Escalation
5. Approaches of Lessening Price Escalation (Lowering Costs of Goods; Lowering Tariffs; Lowering Distribution Costs; Using Foreign Trade Zones to Lessen Price Escalation)
6. Leasing in International Markets
7. Countertrade as a Pricing Tool (Types of countertrade; Problems of Countertrading; the Internet and the Countertrade; Proactive Countertrade Strategy)
8. Transfer Pricing Strategy
9. Price Quotations
Administered Pricing (Cartels; Government – Influenced Pricing)
Chapter Learning Objectives
What you should learn from Chapter 10:
Components of pricing as competitive tools in international marketing
The pricing pitfalls directly related to international marketing
How to control pricing in parallel imports or grey markets
Price escalation and how to minimize its effect
Countertrading and its place in international marketing practices
The mechanism of price quotations
Setting the right price for a product can be the key to success or failure. Even when the international marketer produces the right product, promotes it correctly, and initiates the proper channel of distribution, the effort fails if the product is not properly priced. Although the quality of Canadian products is widely recognized in global markets, foreign buyers, like domestic buyers, balance quality and price in their purchase decisions. A product’s price must reflect the quality and value the consumer perceives in the product. Of all the tasks facing the international marketer, determining what price to charge is one of the most difficult. It is further complicated when the company sells its product to customers if different country markets.
As the globalization of world markets continues, competition intensifies among multinational and home-based companies. All are seeking a solid competitive position so they can prosper as markets reach full potential. The competition for the diaper market between Kimberly-Clark, P&G, and the smaller companies illustrates how price becomes increasingly important as a competitive tool and how price competition changes the structure of a market. Whether exporting or managing overseas operations, the manager’s responsibility is to set and control the actual price of goods in different markets in which different sets of variables are found: different tariffs, costs, attitudes, competition, currency fluctuations, and methods of price quotation.
This chapter focuses on the basic pricing policy questions that arise from the special cost, market, and competitive factors found in foreign markets. A discussion of price escalation and its control and factors associated with price setting and leasing is followed by a discussion of the use of countertrade as a pricing tool and a review of the mechanics of international price quotation.
1. PRICING POLICY
Active marketing in several countries compounds the number of pricing problems and variables relating to price policy. Unless a firm has a clearly thought-out, explicitly defined price policy, expediency rather than design establishes prices. The country in which business is being conducted, the type of product, variations in competitive conditions, and other strategic factors affect pricing activity. Price and terms of sale cannot be based on domestic criteria alone.
In general, price decisions are
viewed two ways: pricing as an active instrument of accomplishing marketing
objectives, or pricing as a static element in a business decision. If prices
are viewed as an active instrument, the company uses price to achieve a specific
objective, whether a targeted return on profit, a targeted market share, or
some other specific goal. The company that follows the second approach, pricing
as a static element, probably exports only excess inventory, places a low
priority on foreign business, and views its export sales as passive
contributions to sales volume. When
The more control a company has over the final selling price of a product, the better it is able to achieve its marketing goals. However, it is not always possible to control end prices. The broader the product line and the larger the number of countries involved, the more complex the process of controlling prices to the end user.
Besides having to meet price competition country by country and product by product, companies have to guard against competition with their own subsidiaries or branches. Because of the different prices possible in different country markets, a product sold in one country may be exported to another and undercut the prices charged in that country. For example, to meet economic conditions and local competition, a Canadian pharmaceutical company might sell its drugs in a developing country at a low price and then discover that these discounted drugs are being exported to a third country, where, as parallel imports, they are in direct competition with the same product sold for higher prices by the same firm.
Parallel imports develop when importers buy products from distributors in one country and sell them in another to distributors who are not part of the manufacturer’s regular distribution system. This practice is lucrative when wide margins exist between prices for the same products in different countries. A variety of conditions can create a profitable opportunity for a parallel market.
Restrictions brought about by import quotas and
high tariffs also can lead to parallel imports and make illegal imports
The possibility of a
parallel market occurs whenever price differences are greater than the cost of
transportation between two markets. In
The drug industry tried to stop parallel trade
Grey market pharmaceutical sales from
Naturally, drug companies that are hit the
hardest want to put a stop to the traffic. Glaxo SmithKline, the prescription
drug maker, asked all Canadian pharmacies and wholesalers to “self-certify”
that they are not exporting its drugs outside
Exclusive distribution, a practice often used by companies to maintain
high retail margins in order to encourage retailers to provide extra service to
customers, to stock large assortments, or to maintain the exclusive-quality
image of a product, can create a favourable condition for parallel importing.
Perfume and designer brands such as Gucci and Cartier are especially prone to
grey markets. To maintain the image of quality and exclusivity, prices for such
products traditionally include high profit margins at each level of
distribution; characteristically, there are differential prices among markets
and limited quantities of product, and distribution is restricted to upscale
retailers. Wholesale prices for exclusive brands of fragrances are often 25
percent more in
The high-priced designer
sportswear industry is also vulnerable to such practices. Nike, Adidas, and
Calvin Klein were incensed to find their products being sold in one of
Exhibit 1 How Grey-Market Goods End Up in Canadian Store
A major manufacturer agrees to sell its products, at a price competitive for an overseas market, to “Buyer X” who promises to sell the products overseas.
The manufacturer ships the goods to Buyer X.
Buyer X has a local freight forwarder at the port take possession of the goods.
Instead of shipping the goods to their supposed
destination, the freight forwarder (at the behest of Buyer X) sends them to
smaller distributors and discount outlets in
The freight forwarder sends a bogus bill of landing to the manufacturer, so the company believes the goods have been sold overseas.
Companies that are serious about restricting
the grey market must establish and monitor controls that effectively police
distribution channels. In some countries they may get help from the courts. A
Where differences in prices between markets
occur, the Internet makes it easy for individuals to participate in the grey
market. Music CDs are especially vulnerable because of price differentials. Six
foreign-owned record companies that maintain high prices through limited
distribution dominate the Australian market and create a situation ripe for the
grey market. CDs retail there for an average of $30 but can be purchased for
about 25 to 30 percent less from the many e-stores on the Internet. It is
estimated that CDs purchased directly from the
Parallel imports can do long-term damage in the market for trademarked products. Customers who unknowingly buy unauthorized imports are not sure of the quality of the item they buy, of warranty support, or of authorized service or replacement parts. Purchasers of computer, for example, may not be able to get parts because authorized dealers have no obligation to service these computers. In the case of software, the buyer may be buying counterfeit product and will not be authorized for technical support. Further, when a product fails, the consumer blames the owner of the trademark, and the quality image of the product is sullied.
With global brands and the euro making price comparison easier and the Internet facilitating purchasing, it is increasingly more difficult to differentiate prices among European markets. Companies must either harmonize prices among member states or contend with parallel imports where there are profitable differences in selling prices. Brand harmonization and price harmonization must be addressed simultaneously.
2. APPROACHES TO INTERNATIONAL PRICING
Whether the orientation is toward control over end prices or over net prices, company policy relates to the net price received. Cost and market considerations are important; a company cannot sell goods below cost of production and remain in business, nor can it sell goods at a price unacceptable in the marketplace. Firms unfamiliar with overseas marketing and firms producing industrial goods orient their pricing solely on a cost basis. Firms that employ pricing as part of the strategic mix, however, are aware of such alternatives as market segmentation from country to country or market to market, competitive pricing in the marketplace, and other market-oriented pricing factors.
Firms that orient their price thinking around cost must determine whether to use variable cost or full cost in pricing their goods. In variable-cost pricing, the firm is concerned only with the marginal or incremental cost of producing goods to be sold in overseas markets. Such firms regard foreign sales as bonus sales and assume that any return over their variable cost makes a contribution to net profit. These firms may be able to price most competitively in foreign markets, but because they are selling products abroad at lower net prices than they are selling them in the domestic market, they may be subject to charges of dumping. In that case, they open themselves to antidumping tariffs or penalties that take away from their competitive advantage. Nevertheless, variable-cost (or marginal-cost) pricing is a practical approach to pricing when a company has high fixed costs and unused production capacity. Any contribution to fixed cost after variable costs are covered is profit to the company.
On the other hand, companies following the full-cost pricing philosophy insist that no unit of a similar product is different from any other unit in terms of cost and that each unit must bear its full share of the total fixed and variable cost. This approach is suitable when a company has high variable costs relative to its fixed costs. In such cases, prices are often set on a cost-plus basis, that is, total costs plus a profit margin. Both variable-cost and full-cost policies are followed by international marketers.
Firms must also decide when to follow a skimming or a penetration policy. Traditionally, the decision of which policy to follow depends on the level of competition, the innovativeness of the product, and market characteristics.
A company uses skimming when the
objective is to reach a segment of the market that is relatively price
insensitive and thus willing to pay a premium price for the value received. If
limited supply exists, a company may follow a skimming approach in order to
maximize revenue and to match demand to supply. When a company is the only
seller of a new or innovative product, a skimming price may be used to maximize
profits until competition forces a lower price. Skimming often is used in those
markets where there are only two income levels; the wealthy and the poor. Costs
prohibit setting a price that is attractive to the lower-income market, so the
marketer charges a premium price and directs the product to the high-income,
relatively price-insensitive segment. Apparently this was the policy of Johnson
&Johnson’s pricing of diapers in
A penetration pricing policy is used to stimulate market growth and capture market share by deliberately offering products at low prices. Penetration pricing most often is used to acquire and hold share of market as a competitive maneuver. However, in country markets experiencing rapid and sustained economic growth, and where large shares of the population are moving into middle-income classes, penetration pricing may be used to stimulate market growth even with minimum competition. Penetration pricing may be a more profitable strategy than skimming if it maximizes revenues and builds market share as a base for the competition that is sure to come.
Regardless of the formal pricing policies and strategies a company uses, it must be remembered that the market sets the effective price for a product. Said another way, the price must be set at a point at which the consumer perceives value received, and the price must be within reach of the target market. As a consequence, many products are sold in very small units in some markets in order to bring the unit price within reach of the target market. Warner-Lambert’s launch of its five-unit pack of Bubbaloo bubble gum in Brazil failed – even though bubble gum represents over 72 percent of the overall gum sector – because it was priced above the target market. A relaunch of a single-unit “pillow” pack brought the price within range and enabled the brand to quickly gain a respectable market share.
As a company’s economy grows and there is a
more equitable distribution of wealth, multiple income levels develop, distinct
market segments emerge, and multiple price levels and price/quality perceptions
increase in importance. As an example, the market for electronic consumer goods
Sony of Japan, the leading foreign seller of the high-priced consumer electronic goods, was upstaged in the Chinese market when Aiwa, a competitor, recognized the emergence of a new middle tier market for good-quality, modestly priced electronic goods. As part of a global strategy focused on slim margins and higher turnover, Aiwa of Korea began selling hi-fi systems at prices closer to Chinese brands than to Sony’s. Aiwa’s product quality was not far behind that of Sony and was better than top Chinese brands, and the product resembled Sony’s high-end systems. Aiwa’s recognition of a new market segment and its ability to tap into it resulted in a huge increase in overall demand for Aiwa products.
Similarly, Mattel was successful in selling its
Barbie dolls to the upper-end market in much of the world for years. However,
sales of new product extensions such as the Holiday Barbie that were highly
Pricing decisions that were appropriate when
companies directed their marketing efforts toward single market segments will
give way to more sophisticated practices. As incomes rise in many foreign
markets, the pricing environment a company encounters will be similar to that
3. PRICE ESCALATION
People traveling abroad often are surprised to find goods
that are relatively inexpensive in their home country priced outrageously high
in other countries. Because of the natural tendency to assume that such prices
are a result of profiteering, manufacturers often resolve to begin exporting to
crack these new, profitable foreign markets only to find that, in most cases,
the higher prices reflect the higher costs of exporting. A case in point is the
pacemaker for heart patients that for $2,000 in
Excess profits exist in some international markets, but generally the cause of the disproportionate difference in price between the exporting country and the importing country, here termed price escalation is the added costs incurred as a result of exporting products from one country to another. Specifically, the term relates to situations in which ultimate prices are raised by shipping costs, insurance, packing, tariffs, longer channels of distribution, larger middleman margins, special taxes, administrative costs, and exchange rate fluctuations. The majority of these costs arise as a direct result of moving goods across borders from one country to another and often to escalate the final price to a level considerably higher than in the domestic market.
A tariff, or duty is a special form of taxation. Like other forms of taxes, a tariff may be levied for the purpose of protecting a market or for increasing government revenue. A tariff is a fee charged when goods are bought into a country from another country. Recall that the level of tariff is typically expressed as the rate of duty and may be levied as specific, ad valorem, or compound. A specific duty is a flat charged per physical unit imported, such as 15 cents per bushel of rye. Ad valorem duties are levied as a percentage of the value of the goods imported, such as 20 percent of the value of imported watches. Compound duties include both a specific and an ad valorem charge, such as $1 per camera plus 10 percent of its value. Tariff and other forms of import taxes serve to discriminate against all foreign goods.
Fees for import certificates or for other administrative processing can assume such level that they are, in fact, import taxes. Many countries have purchase or excise taxes, which apply to various categories of goods; value-added or turnover taxes, which apply as the product goes through a channel of distribution; and retail sales taxes. Such taxes increase the end price of goods but, in general, do not discriminate against foreign goods. Tariffs are the primary discriminatory tax that must be taken into account in reckoning with foreign competition.
In addition to taxes and tariffs, there are a variety of administrative costs directly associated with exporting and importing a product. Export and import licences, other documents, and the physical arrangements for getting the product from port of entry to the buyer’s location mean additional costs. Although such costs are relatively small, they add to the overall cost of exporting.
In countries with rapid inflation or exchange variations,
the selling price must be related to the cost of goods sold and the cost of
replacing the items. Goods are often sold below their cost of replacement plus
overhead, and are sometimes sold below replacement cost. In these instances,
the company would be better off not to sell the products at all. When payments
is likely to be delayed for several months or is worked out on a long-term
contract, inflationary factors must be figures onto the price. Inflation and
lack of control over price were instrumental in the unsuccessful new-product
Because inflation and price controls imposed by a country are beyond the control of companies, they use a variety of techniques to inflate the selling price to compensate for inflation pressure and price controls. They may charge for extra services, inflate costs in transfer pricing, or break up products into components and price each component separately.
Inflation causes consumer prices to escalate
and the consumer is faced with rising prices that eventually exclude many
consumers from the market. On the other hand, deflation results in decreasing
prices creating a positive result for consumers, but both put pressure to lower
costs on everyone in the supply chain. Canadian consumers are forced to spend
more to buy less as inflation eats away their incomes. During the inflationary
periods, however, the problem is not limited to Canadian consumers; Canadian
exporters have to adjust prices in foreign markets based on host-country
inflation rates. During the Asian crisis, for example, exporters had to adjust
prices downward as inflation eliminated almost fifty percent of consumers’
purchasing power in
The Japanese economy has been in a deflationary spiral for a number of
years. In a country better known for $10 melons and $100 steaks, McDonald’s now
sells hamburgers for 65 cents, down from $1.30, a flat screen 32-inch colour
television is down from $5,000 to $3,000, and clothing stores compete to sell
fleece jackets for $10, down from $32 two years earlier. Prices have dropped to
a point that consumer prices are similar to those previously found only on
overseas shopping trips. The high prices prevalent in
In a deflationary market, it is essential for a company to keep prices low and raise brand value to win the trust of consumers. Whether deflation or inflation, an exporter must emphasize controlling price escalation.
At one time, world trade contracts could be easily written because
payment was specified in a relatively stable currency. The U.S. dollar was the
standard and all transactions could be related to the dollar. Now that all
major currencies are floating freely relative to one another, no one is quite
sure of the future value of any currency. Increasingly, companies are insisting
that transactions be written in terms of the vendor company’s national
currency, and forward hedging is becoming more common. If exchange rates are
not carefully considered in long-term contracts, companies find themselves
unwittingly giving 15 to 20 percent discount. The added cost incurred by
exchange rate fluctuation on a day-to-day basis must be considered, especially
where there is a significant time lapse between signing the order and delivery
of the goods. Exchange rate differentials mount up. Whereas Hewlett-Packard
gained nearly half a million dollars additional profit through exchange rate
fluctuations in one year, Nestlé lost a million dollars in six months. Other
companies lost or gained even larger amounts. In
In addition to risks from exchange rate variations, other risks result
from the changing values of a country’s currency relative to other currencies.
Consider the situation in
When the value of the
dollar is weak relative to the buyer’s currency (i.e., it takes fewer units of
the foreign currency to buy a dollar), companies generally employ cost-plus
pricing. To remain price comparative when the dollar is strong (i.e., when it
takes more units of the foreign currency to buy a dollar), companies must find
ways to offset the higher price caused by currency values. When the rupee in
Currency exchange rate swings are considered by many global companies to be a major pricing problem. Because the benefits of a weaker dollar are generally transitory, firms need to take a proactive stance one way or the other. For a company with long-range plans calling for continued operation in foreign markets, yet wanting to remain price competitive, price strategies need to reflect variations in currency values. Interestingly, whenever currencies fluctuate dramatically over short time periods, regulatory authorities are pressed by public opinion to intervene in order to stabilize currency relationships. In Canada, with the Canadian dollar’s deep slide relative to the U.S. currency in 1999-2000, and its dramatic rebound in 2002-2003, more and more people are calling for the authorities to fix the exchange rate, or abandon the Canadian dollar altogether for a common North American currency union. Among the major adherents for a common currency union are the five chartered banks, and the leading Canadian multinational companies – organizations that are likely to experience sharp changes in their financial asset positions as currency values fluctuate.
Exhibit 2 Export strategies Under Varying Currency Conditions
When domestic Currency is WEAK
When Domestic Currency is STRONG
Stress price benefits
Engage in non-price competition by improving quality, delivery, and aftersale service
Expand product line and add more-costly features
Improve productivity and engage in vigorous cost reduction
Shift sourcing and manufacturing to domestic market
Shift sourcing and manufacturing overseas
Exploit export opportunities in all markets
Give priority to exports to relatively strong-currency countries
Conduct conventional cash-for-goods trade
Deal in countertrade with weak-currency countries
Use full-costing approach, but use marginal-cost pricing to penetrate new/competitive markets
Trim profit margins and use marginal-cost pricing
Speed repatriation of foreign-earned income and collections
Keep the foreign-earned income in the host country and slow collections
Minimize expenditures in local, host-country currency
Maximize expenditures in local, host country currency
Buy needed services (advertising, insurance, transportation, etc.) in domestic market
Bill needed services abroad and pay for them in local currencies
Minimize local borrowing
Borrow money needed for expansion in local market
Bill foreign customers in domestic currency
Bill foreign customers in their own currency
Innumerable cost variables can be identified
depending on the market, the product, and the situation. The cost, for example,
of reaching a market with relatively small potential may be high. High
operating costs of small specialty stores like those in
Channel length and marketing patterns vary widely, but in
most countries channels are longer and middleman margins higher than in
customary in the
Besides channel diversity, the fully integrated marketer operating abroad faces various unanticipated costs because marketing and distribution channel infrastructures are underdeveloped in many countries. The marketer can also incur added expenses for warehousing and handling of small shipments and may need to bear increased financing costs when dealing with under-financed middleman.
Because no convenient source of data on
middleman costs is available, the international marketer must rely on
experience and marketing research to ascertain middleman costs. The Campbell
Soup Company found its middleman and physical distribution costs in the
Exporting also incurs increased transportation costs when moving goods from one country to another. If the goods go over water, there are additional costs for insurance, packing, and handling not generally added to locally produced goods. Such costs add yet another burden because import tariffs in many countries are based on the landed cost, which includes transportation, insurance, and shipping charges. These costs add to the inflation of the final price. The next section details how a reasonable price in the home market may more than double in the foreign market.
SAMPLE EFFECTS OF PRICE ESCALATION
Exhibit 3 illustrates some of the effects the factors discussed previously may have on the end price of a consumer item. Because costs and tariffs vary so widely from country to country, a hypothetical but realistic example is used. It assumes that a constant net price is received by the manufacturer, that all domestic transportation costs are absorbed by the various middlemen and reflected in their margins, and that the foreign middleman have the same margins as the domestic middlemen. In some instances, foreign middlemen margins are lower, but it is equally probable that these margins could be greater. In fact, in many instances, middlemen use higher wholesale and retail margins for foreign goods than for similar domestic goods.
Exhibit 3 Sample Causes and Effects of price Escalation
Foreign Example 1: Assuming the Same Channels with wholesaler Importing Directly
Foreign Example 2: Importer and Same Margins and Channels
Foreign Example 3: Same as 2 but with 10 Percent Cumulative Turnover Tax
Tariff (20 percent CIF value)
Importer margin when sold to wholesaler (25 percent) on cost
Wholesaler pays landed cost
Wholesaler margin (33.3 percent on cost)
Retailer margin (50 percent on cost)
Unless some of the costs that create price
escalation can be reduced, the marketer is faced with a price that may confine
sales to a limited segment of wealthy, price-insensitive customers. In many
markets, buyers have less purchasing power than in
5. APPROACHES OF LESSENING PRICE ESCALATION
Three methods used to reduce costs and lower price escalation are lowering cost of goods, lowering tariffs, and lowering distribution costs.
If the manufacturer’s price can be
lowered, the effect is felt throughout the chain. One of the important reasons
for manufacturing in a third country is to attempt to reduce manufacturing
costs and thus price escalation. The impact can be profound if you consider
that the hourly cost of skilled labour in a Mexican maquiladora is less than $3.50
an hour including benefits, compared with more than $12 in
Eliminating costly functional features or even
lowering overall product quality is another method of minimizing price
escalation. For certain manufactured products, the quality and additional
features required for the more developed home market may not be necessary in
countries without the same level of development or consumer demand. In the
price war between P&G and Kimberly-Clark in
When tariffs account for a large part of price escalation, as they often do, companies seek ways to lower the rate. Some products can be reclassified into a different, and lower, customs classification. A good customs broker will determine the lowest possible import duty for the products you are importing. In many cases, a product can be imported under a few different tariffs classifications. The customs broker will provide you with a power of attorney form for you to fill out and sign, authorizing that company to act as your representative.
How a product is classified is often a judgment
call. The difference between an item being classified as jewelry or art means
paying no tariff for art or a 26 percent tariff for jewelry. For example, a
Besides having a product reclassified into a
lower tariff category, it may be possible to modify a product quality for a lower
tariff rate without a tariff classification. In the footwear industry, the
difference between “foxing” and “foxlike” on athletic shoes makes a substantial
difference in the tariff levied. To protect the domestic footwear industry from
an onslaught of cheap sneakers from the
There are often differential rates between fully assembled, ready-to use products and those requiring some assembly, further processing, the addition of locally manufactured component parts, or other processing that adds value to the product and can be performed within the foreign country. For example, a ready-to-operate piece of machinery with a 20 percent tariff may be subject to only a 12 percent tariff when imported unassembled. An even lower tariff may apply when the product is assembled in the country and some local content is added.
Repackaging also may help to lower tariffs.
Shorter channels can help keep prices under
control. Designing a channel that has fewer middlemen may lower distribution
costs by reducing or eliminating markup. Besides eliminating markups, fewer
middlemen may mean lower overall taxes. Some countries levy a value-added tax
on goods as they pass through channels. Goods are taxed each time they change
hands. The tax may be cumulative or noncumulative. A cumulative value-added tax
is based on total selling price and is assessed every time the goods change
hands. Obviously, in countries where value-added tax is cumulative, tax alone
provides a special incentive for developing short distribution channels. Where
that is achieved, tax is paid only on the difference between the middlemen’s
cost and the selling price. While many manufacturers had to cut prices in the
Some countries have established
foreign or free trade zones (FTZs) or free ports to facilitate international
trade. There are more than 400 of these facilities in operation throughout the
world where imported goods can be stored or processed. As free trade policies
in Africa, Latin America,
Utilizing FTZs can to some extent control price escalation resulting from the layers of taxes, duties, surcharges, freight charges, and so forth. Foreign trade zones permit many of these added charges to be avoided, reduced, or deferred so that the final price is more competitive. One of the more important benefits of the FTZ in controlling prices is the exemption from duties on labour and overhead costs incurred in the FTZ in assessing the value of goods.
By shipping unassembled goods to an FTZ in an importing country, a marketer can lower costs in a variety of ways:
Tariffs may be lower because duties are typically assessed at a lower rate for unassembled versus assembled goods.
If labour costs are lower in the importing country, substantial savings may be realized in the final product cost.
Ocean transportation rates are affected by weight and volume, thus, unassembled goods may qualify for lower freight rates.
If local content, such as packaging or components parts, can be used in the final assembly, there may be a further reduction on tariffs.
All in all, a foreign or free trade zone is an important method for controlling price escalation. Incidentally, all the advantages offered by an FTZ for an exporter are also advantages for an importer. Importers use FTZs to help lower their costs of imported goods. See Exhibit 4 for illustrations of how FTZs are used.
A logical outgrowth of a market policy in international business is goods priced competitively at widely differing prices in various markets. Marginal (variable) cost pricing, as discussed earlier, is a way prices can be reduced to stay within a competitive price range. The market and economic logic of such pricing policies can hardly be disputed, but the practices often are classified as dumping and are subject to severe penalties and fines. Various economists define dumping differently. One approach classifies international shipments as dumped if the products are sold below their cost of production. The other approach characterizes dumping as selling goods in a foreign market below the price of the same goods in the home market.
World Trade Organization (WTO) rules allow for the imposition of a dumping duty when goods are sold at a price lower than the normal export price or less than the cost in the country of origin, increased by a reasonable amount for their cost of sales and profits when this is likely to be prejudicial to the economic activity of the importing country. A countervailing duty or minimum access volume (MAV) which restricts the amount a country will import, may be imposed on foreign goods benefiting from subsidies whether in production, export, or transportation.
Exhibit 4 How Are Foreign Trade Zones Used?
Foreign Trade Zones (FTZs) exist in many countries.
Companies use them to postpone the payment of tariffs on products while they are in the FTZ. Here are some examples of how FTZs are used.
A Japanese firm assembles motorcycles, jet skis, and three-wheel
all-terrain vehicles for import as well as for export to
A manufacturer of hair dryers stores its product in an FTZ, which it
uses as its main distribution center for products manufactures in
A European-based medical supply company manufacturers kidney dialysis machines
and sterile tubing using raw materials from
A Canadian company assembles electronic teaching machines using
In all these examples, tariffs are postponed until the products leave the FTZ and enter foreign countries. Further, in most situations the tariff is at lower rate for component parts and raw materials versus the higher rate that would be charged if products were imported directly as finished goods.
For countervailing duties to
be invoked, it must be shown that prices are lower in the importing country
than in the exporting country and that producers in the importing country are
being directly harmed by the dumping. A report by the U.S. Department of
Agriculture indicated that levels of dumping by the
Dumping is rarely an issue when world markets are strong. In the 1980s and 1990s dumping became a major issue for a large number of industries when excess production capacity relative to home-country demand caused many companies to price their goods on a marginal-cost basis. In a classic case of dumping, prices are maintained in the home-country market and reduced in foreign markets.
Today, tighter government enforcement of dumping legislation is causing international marketers to seek new routes around such legislation. Assembly in the importing country is a way companies attempt to lower prices and avoid dumping charges. However, these screw-driver plants, as they are often called, are subject to dumping charges if the price differentials reflect more than the cost savings that result from assembly in the importing country.
Another subterfuge is to alter the product so that the technical description fits a lower duty category. To circumvent a 16.9 percent countervailing duty imposed on Chinese gas-filled, nonrefillable pocket flint lighters, the manufacturer attached a useless valve to the lighters so than they fell under the “nondisposable” category, thus avoiding the duty. Countries do see through many such subterfuges and impose taxes. For example, the EC imposed a $27 to $58 dumping duty per unit on a Japanese firm that assembled and sold electronic typewriters in the EC. The firm was charged with valuing imported parts for assembly below cost.
6. LEASING IN INTERNATIONAL MARKETS
An important selling technique to alleviate high prices
and capital shortages for capital equipment is the leasing system. The concept
of equipment leasing is increasingly important as a means of selling capital
equipment in overseas markets. In fact, it is estimated that $50 billion worth
(original cost) of equipment is on lease in
The system of leasing used by industrial exporters
is similar to the typical lease contracts used in
Leasing opens the door to a large segment of nominally financed firms that can be sold on a lease option but might be unable to buy for cash.
Leasing can ease the problems of selling new, experimental equipment, because less risk is involved for the users.
Leasing helps guarantee better maintenance and service on overseas equipment.
Equipment leased and in use helps to sell other companies in that country.
Lease revenue tends to be more stable over a period of time than direct sales would be.
The disadvantages of shortcomings take on international flavour. Besides the inherent disadvantages of leasing, some problems are compound by international relationships. In a country beset with inflation, lease contracts that include maintenance and supply parts (as most do) can lead to heavy losses toward the end of the contract period. Further, countries where leasing is most attractive are those where spiraling inflation is most likely to occur. The added problems of currency devaluation, expropriation, or other political risks are operative longer than if the sale of the same equipment is made outright. In light of these perils, there is greater risk in leasing than in outright sale; however, there is definite trend toward increased use of this method of selling internationally.
COUNTERTRADE AS A PRICING TOOL
Countertrade is a pricing tool that every international marketer must be ready to use, and the willingness to accept a countertrade often gives the company a competitive advantage. The challenges of countertrade must be viewed from the same perspective as all other variations in international trade. Marketers must be aware of which markets require countertrades just as they must be aware of social customs and legal requirements. Assessing this factor along with all other market factors enhances a marketer’s competitive position.
One of the earliest barter arrangements occurred
Although cash may be the preferred method of
payment, countertrades are an important part of trade with
Countertrade includes four distinct transactions: barter, compensation deals, counter-purchase, and buy-back. Barter is the direct exchange of goods between two parties in a transaction. For example, the Malaysian government bought 20 diesel-electric locomotives from General Electric. Officials of the government said that GE will be paid with palm oil to be supplied by a plantation company. The company will supply about 200,000 metric tons of palm oil over a period of 30 months. This was GE’s first barter deal for palm oil and palm products, although its division GE Trading has several other countertrade agreements worldwide. No money changed hands, nor were any third parties involved. Obviously, in a barter transaction, the seller must be able to dispose of the goods at a net price equal to the expected selling price in a regular, for-cash transaction. Further, during the negotiation stage of a barter deal, the seller must know the market and the price for the items offered in trade. In the General Electrical example, palm oil has an established price and a global market for palm oil and palm products. But not all bartered goods have an organized market and products can range from hams to iron pellets, mineral water, furniture, or olive –all somewhat more difficult to price and to find customers.
Barter may also be used to reduce a country’s foreign debt. To save exchange reserves, the Philippine government offered some creditors canned tuna to repay part of a state-owned $4-billion. If tuna was not enough, coconut oil and a seaweed extract, carrageen, used as an additive in foods, toothpaste, cosmetics, and ice cream were offered. The seaweed and tuna exporters will be paid with pesos so no currency leaves the country.
Exhibit 5 Why Purchasers Impose Countertrade?
To preserve hard currency. Countries with nonconvertible currencies look to countertrade as a way of guaranteeing that hard currency expenditures (for foreign imports) are offset by hard currency (generated by the foreign party's obligations to purchase domestic goods).
To improve balance of trade. Nations whose exports have not kept pace with imports increasingly rely on countertrade as a means to balance bilateral trade ledgers.
To gain access to new markets. As a nonmarket or developing country increases its production of exportable goods, it often lacks a sophisticated marketing channel to sell the goods to the West for hard currency. By imposing countertrade demands, foreign trade organizations utilize the marketing organizations and expertise of Western companies to market their goods for them.
To upgrade manufacturing capabilities. By entering compensation arrangements under which foreign 8usuallz Western) firms provide plant and equipment and buy back resultant products, the trade organizations of less-developed countries can enlist Western technical cooperation in upgrading industrial facilities.
To maintain prices to export goods. Countertrade can be used as a means to dispose of goods at prices that market would not bear under cash-for-goods terms. Although the Western seller absorbs the added cost by inflating the price of the original sale, the nominal price of counterpurchased goods is maintained, and the seller need not concede what the value of the goods would be in the world supply-and-demand market. Conversely, if the world price for a commodity is artificially high, such as the price of crude oil, a country can barter its oil for Western goods (e.g., weapons) so that the real price the Western partner pays is below the world price.
To force reinvestment of proceeds from weapons deals. Many Arab countries require that a portion of proceeds from weapons purchases be reinvested in facilities designated by the buyer – everything from pipelines to hotels and sugar mills.
Compensation deals involve payment in goods and in cash. A seller
delivers lathes to a buyer in
An advantage of a compensation deal over barter is the immediate cash settlement of a portion of the bill; the remainder of the cash is generated after successful sale of the goods received. If the company has a use for the goods received, the process is relatively simple and uncomplicated. On the other hand, if the seller has to rely on a third to find a buyer, the cost involved must be anticipated in the original compensation negotiation if the net proceeds to the seller are the equal the market price.
Counterpurchase, or offset trade, is probably the most frequently used type pf countertrade. For this trade, the seller agrees to sell a product at a set price to a buyer and receives payment in cash. However, two contracts are negotiated. The first contract is contingent on a second contract that is an agreement by the original seller to buy goods from the buyer for the total monetary amount involved in the first contract or for a set percentage of that amount. This arrangement provides the seller with more flexibility than the compensation deal because there is generally a time period – 6 to 12 months or longer – for completion of the second contract. During the time that markets are sought for the goods in the second contract, the seller has received full payment for the original sale. Further, the goods to be purchased in the second contract are generally of greater variety than those offered in a compensation deal. Even greater flexibility is offered when the second is nonspecific; that is the books on sales and purchases need to be clearly only at certain intervals. The seller is obliged to generate enough purchases to keep the books balanced or clear between purchases and sales.
Offset trades are becoming more prevalent among
economically weak countries. Several variations of counterpurchase or offset
have developed to make it more economical for the selling company. For example,
the Lockheed Martin Corporation entered into an offset trade with the United
Arab Emirates (UAE) in a $6.4 billion deal for 80 F-16 fighter plans called
Desert Falcons. Lockheed agreed to make a $160 million cash investment in a gas
pipeline running from
McDonnell Douglas actively engages in all types
of countertrades. A $100 million sale of DC-9s to
Product buy-back agreement is the fourth type
of countertrade transaction. This type of agreement is made when the sale
involves goods or services that produce other goods and services, that is,
production plant, production equipment, or technology. The buy-back agreement
usually involves one of two situations. The seller agrees to accept as partial
payment a certain portion of the output, or the seller receives full price
initially but agrees to buy back a certain portion of the output. One North
American farm equipment manufacturer sold a tractor plant to
An interesting buy-back arrangement was agreed on between the Rice Growers Association of California (RGAC) and the Philippine government. The RGAC will invest in Philippine farmlands and bring new technologies to enhance local rice production. In return, the RGAC will import rice and other food products in payment. A major drawback to product buy-back agreements comes when the seller finds that the products bought back are in competition with its own similarly produced goods. On the other hand, some find that a product buy-back agreement provides them with a supplemental source in areas of the world where there is demand but where they have no available supply.
The crucial problem confronting a seller in a countertrade negotiation is determining the value of the potential demand for the goods offered. Frequently there is inadequate time to conduct a market analysis; in fact, it is not unusual to have sales negotiations almost completed before countertrade is introduced as a requirement in transaction.
Although such problems are difficult to deal with, they can be minimized with proper preparation. In most cases where losses occurred in countertrades, the seller was unprepared to negotiate in anything other than cash. Some preliminary research should be done in anticipation of being confronted with a countertrade proposal. Countries with a history of countertrading are identified easily, and the products most likely to be offered in a countertrade often can be ascertained. For a company trading with developing countries, these facts and some background on handling countertrades should be a part of every pricing tool kit. Once goods are acquired, they can be passed along to institutions that assist companies in selling bartered goods.
Barter houses specialize in trading goods acquired through
barter arrangements and are the primary outside source of aid for companies
beset by the uncertainty of a countertrade. Although barter houses, most of
which are found in
The Internet may become the most important venue for countertrade activities. Finding markets for bartered merchandise and determining market price are two of the major problems with countertrades. Several barter houses have Internet auction sites, and a number of Internet exchanges are expanding to include global barter.
Some speculate that the Internet may become the
vehicle for an immense online electronic barter economy, to complement and
expand the offline barter exchanges that take place now. In short, some type of
electronic trade dollar would replace national currencies in international
trade transactions. This would make international business considerably easier
for many countries because it would lessen the need to acquire sufficient
TradeBanc, a market-making service, introduced
a computerized technology that enables members of trade exchanges to trade
directly, online, with members of other trade exchanges anywhere in the world,
as long as their barter company is a TradeBanc affiliate (www.tradebanc.com/home.taf). The
medium of exchange could be the Universal Currency proposed by the
international Reciprocal Trade Association (IRTA), (www.irta.com) an association of trade exchange
with members including
D. Proactive Countertrade Strategy
Currently most companies have a reactive strategy; that is, they use countertrade when they believe it is the only way to make a sale. Even when these companies include countertrade as a permanent feature of their operations, they use it to react to a sales demand rather than using countertrade as an aggressive marketing tool for expansion. Some authorities suggest, however, that companies should have a defined countertrade strategy as part of their marketing strategy rather than be caught unprepared when confronted with a countertrade proposition.
A proactive countertrade strategy is
the most effective strategy for global companies that market to exchange-poor
countries. Economic development plans in eastern European countries, the
Commonwealth of Independent States (CIS), and much of
Successful countertrade transactions require that the marketer accurately establish the market value of the goods being offered and dispose of the bartered goods once they are received. Most unsuccessful countertrades result from not properly resolving one or both of these factors.
In short, unsuccessful countertrades are generally the result of inadequate planning and preparation. One experienced countertrade suggests answering the following questions before entering into a countertrade agreement: (1) Is there a ready market for the goods bartered? (2) Is the quality of the goods offered consistent and acceptable? (3) Is an expert needed to handle the negotiations? (4) Is the contract price sufficient to cover the cost of barter and net the desired revenue?
Capital-poor countries striving to
industrialize account for much of the future demand for goods.
8. TRANSFER PRICING STRATEGY
As companies increase the number of worldwide subsidiaries, joint ventures, company-owned distributing systems, and other marketing arrangements, the price charged to different affiliates becomes a preeminent question. Prices of goods transferred from a company’s operations or sales units in one country to its units elsewhere, known as intracompany pricing or transfer pricing, may be adjusted to enhance the ultimate profit of the company as a whole. The benefits are as follows:
Lowering duty costs by shipping goods into high-tariff countries at minimal transfer prices so that duty base and duty are low.
Reducing income taxes in high-tax countries by overpricing goods transferred to units in such countries; profits are eliminated and shifted to low-tax countries. Such profit shifting may also be used for “dressing up” financial statement by increasing reported profits in countries where borrowing and other financing are undertaken.
Facilitating divided repatriation when divided repatriation is curtailed by government policy. Invisible income may be taken out in the form of high prices for products or components shipped to units in that country.
Government authorities have not overlooked the tax and financial manipulation possibilities of transfer pricing. Transfer pricing can be used to hide subsidiary and to escape foreign-market taxes. Intracompany pricing is managed in such a way that profit is taken in the company with the lowest tax rate. For example, a foreign manufacturer makes a VCR for $50 and sells it to its subsidiary for $150. The subsidiary sells it to a retailer for $200, but spends $50 on advertising and shipping so that it shows no profit and pays no taxes. Meanwhile, the parent company makes a $100 gross margin on each unit and pays at a lower tax rate in the home country. If the tax rate were lower in the country where the subsidiary resides, the profit would be taken in the foreign country and no profit taken in the home country.
When customs and tax regimes are high, there is a strong incentive to trim fiscal liabilities by adjusting the transaction value of goods and services between subsidiaries. Pricing low cuts exposure to import duties; declaring a higher value raises deductible costs and thereby lightens the corporate tax burden. The key is to strike the right balance that maximizes savings overall.
The overall objectives of the intracompany pricing system include maximizing profits for the corporation as a whole; facilitating parent-company control; and offering management at all levels, both in the product divisions and in the international divisions, an adequate basis for maintaining, developing, and receiving credit for their own profitability. Transfer prices that are too low are unsatisfactory to the product divisions because their overall results look poor; prices that are too high make the international operations look bad and limit the effectiveness of foreign managers.
An intracompany pricing system should use sound accounting techniques and be defensible to the tax authorities of the countries involved. All of these factors argue against a single uniform price or even a uniform pricing system for all international operations. Four arguments for pricing goods for intracompany transfer are as follows:
Sales at the local manufacturing cost plus a standard markup.
Sales at the cost of the most efficient producer in the company plus a standard markup.
Sales at negotiated prices.
Arm’s-length sales using the same prices as quoted to independent customers.
Of the four, the arm’s-length transfer is most acceptable to tax authorities and most likely to be acceptable to foreign divisions, but the appropriate basis for intracompany transfers depends on the nature of the subsidiaries and market conditions.
Although the practices described in this section
are not necessarily improper, they are being scrutinized more closely by both
home and host countries concerned about the loss of potential tax revenues from
foreign firms doing business in their countries as well as domestic firms
underreporting foreign earnings.
Underreporting profits is a serious offence in
9. PRICE QUOTATIONS
In quoting the price of goods for international sale, a contract may include specific elements affecting the price, such as credit, sales terms, and transportation. Parties to the transaction must be certain that the quotation settled on appropriately locates responsibilities fro the goods during transportation and spells out who pays transportation charges and from what point. Price quotations must also specify the currency to be used, credit terms, and the type of documentation required. Finally, the price quotation and contract should define quantity and quality. A quantity definition might be necessary because different countries use different units of measurement. In specifying a ton, for example, the contract should identify it as metric or an English ton, and as a long or short ton. Quality specifications can also be misunderstood if not completely spelled out. Furthermore, there should be complete agreement on quality standards to be used in evaluating the product. For example, “customary merchantable quality”, may be clearly understood among Canadian customers but have a completely different interpretation in another country. The international trader must review all terms of the contract; failure to do so may have the effect of modifying prices even though such a change was not intended.
Administrated pricing is an attempt to establish prices for an entire market. Such prices may be arranged through the cooperation of competitors, through national, state, or local government, or by international agreement. The legality of administered pricing arrangements of various kinds differs from country to country and from time to time. A country may condone price fixing for foreign markets but condemn it for the domestic market, for instance.
In general, the end goal of all administered pricing activities is to reduce the impact of price competition or eliminate it. Pricing fixing by business is not viewed as an acceptable practice (at least in the domestic market), but when governments enter the field of price administration, they presume to do it for the general welfare to lessen the effects of destructive competition.
The point at which
competition becomes destructive depends largely on the country in question. To
the Japanese, excessive competition is any competition in the home market that
disturbs the existing balance of trade or gives rise to market disruptions. Few
countries apply more rigorous standards in judging competition as excessive
The pervasiveness of price-fixing attempts in business is reflected by the diversity of the language of administered prices; pricing arrangements are known as agreements, arrangement, combines, conspiracies, cartels, communities of profit, profit pools, licensing, trade association, price leadership, customary pricing, or informal interfirm agreements. The arrangements themselves vary from the completely informal, with no spoken or acknowledged agreement, to highly formalized and structured arrangements. Any type of price-fixing arrangement can be adapted to international business, but of all the forms mentioned, cartels are the most directly associated with international marketing.
A cartel exists when various companies producing similar products or services work together to control markets for the types of goods and services they produce. The cartel association may use formal agreements to set prices, establish levels of production and sales for the participating companies, allocate market territories, and even redistribute profits. In some instances, the cartel organization itself takes over the entire selling function, sells the goods of all the producers, and distributes the profits.
The economic role of cartels is highly debatable, but their proponents argue that they eliminate cutthroat competition and rationalize business, permitting greater technical progress and lower prices to consumers. However, in the view of most experts, it is doubtful that the consumer benefits very often from cartels.
The Organization of Petroleum Exporting Countries (OPEC) is probably the best-known international cartel. Its power in controlling the price of oil resulted from the percentage of oil production is controlled. In the early 1970s, when OPEC members provided the industrial world with 67 percent of its oil, OPEC was able to quadruple the price of oil. The sudden rise in price from $10 or $12 a barrel to $50 or more a barrel was a primary factor in throwing the world into a major recession. In 200, OPEC members lowered production, and oil prices rose from $10 to $30, creating a dramatic increase in gasoline prices. Non-OPEC oil-exporting countries benefit from the price increases while net importers of foreign oil face economic repercussions.
One important aspect of cartels is their inability to maintain control for indefinite periods. Greed by cartel members and other problems generally weaken the control of the cartel. OPEC members tend to maintain a solid front until one decides to increase supply, and then others rapidly follow suit. In the short run, however, OPEC can affect global prices.
A lesser-known cartel,
but one that directly impact international trade, is the shipping cartel that
exists among the world’s shipping companies. Every two weeks about 20
shipping-line managers gather for their usual meeting to set rates on tens of
billion of dollars of cargo. They do not refer to themselves as a cartel but
rather operate under such innocuous names as “The Trans-Atlantic Conference
Agreement”, (ww.tacaconf.com). Regardless of the name, they set the rates on
about 70 percent of the cargo shipped between North America and
Another cartel is the diamond cartel controlled by DeBeers. For more than a century, DeBeers smoothly manipulated the diamond market by keeping a tight control over world supply. The company mines about half the world’s diamonds and takes in another 25 percent through contracts with other mining companies. In an attempt to control the other 25 percent, DeBeers runs an “outside buying office” where it spends million buying up diamonds to protect prices. The company controls most of the world’s trade in rough gems and uses its market power to keep prices high.
The legality of cartels
at present is not clearly defined. Domestic cartelization is illegal in
Although the EU member countries have a long history of tolerating price fixing, the European Commission is beginning to crack down in the shipping, automobile, and cement industries, among others. The unified and the single currency have prompted the move. As countries open free trade, powerful cartels that artificially raise prices and limit consumer choice are coming under closer scrutiny. However, the EU trust-busters are fighting tradition – since the trade guilds of the Middle Ages, cozy cooperation has been the norm. In each European country, companies banded together to control prices within the country and to keep competition out.
B. Government – Influenced Pricing
Companies doing business in foreign countries encounter a number of different types of government price setting. To control prices, governments may establish margins, set prices and floor or ceiling, restrict prices changes, compete in the market, grant subsidies, and act as a purchasing monopsony or selling monopoly. The governments may also influence prices by permitting, or even encouraging, businesses to collude in setting manipulative prices.
The Japanese government
has traditionally encouraged a variety of government-influenced price-setting
schemes. However, in a spirit of deregulation that is gradually moving through
Governments of producing and consuming countries play an ever-increasing role in the establishment of international prices for certain basic commodities. There is, for example, an international coffee agreement, an international cocoa agreement, and an international sugar agreement. And the world price of wheat has long been at least partially determined by negotiations between national governments.
Despite the pressure of business, government, and international price agreements, most marketers still have wide latitude in their pricing decisions for most products and markets.
Pricing is one of the most complicated decision areas encountered by international marketers. Rather than deal with one set of market condition, one group of competitors, one set of cost factors, and one set of government regulations, international marketers must take all these factors into account, not only for each country in which they are operating, but often for each market within a country. Market prices at the consumer level are much more difficult to control in international than in domestic marketing, but the international marketer must still approach the pricing task on a basis of established objectives and policy, leaving enough flexibility for tactical price movements. Controlling costs that led to price escalation when exporting products from one country to another is one of the most challenging pricing tasks facing the exporter. Some of the flexibility in pricing is reduced by the growth of the Internet, which has a tendency to equalize price differentials between country markets.
The continuing growth of
Pricing in the international marketplace requires a combination of intimate knowledge of market costs and regulations, an awareness of possible countertrade deals, infinite patience for detail, and a shrewd of market strategy.
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