1. Customer country and competitor country features © Professor Daniel F. Spulber

2. 2 Customer preferences Elasticity of demand Income per capita and income distribution Customer knowledge Distribution infrastructure Society and culture Political, legal and regulatory climate Predict effect on earnings and choose target countries Customer country features Distribution and sales

3. 3 Home country: Compare advantages and disadvantages Customer countries footprint: Global or local competitor Supplier countries: Global or local manufacturing and procurement Partner countries: Complementary products, technologies, capabilities Political, legal and regulatory climate – compare effects trade agreements, home-country policies Competitor countries Evaluation of competitive advantage

4. 4 Tailor products and pricing Emerging market trend of “Sachet Marketing” Recognizes low income of mass of consumers and tailors offerings – 2/3 of world population makes $1,500 or less per year Affordable sizes and products Maintain quality and extend appeal of brands See reading on-line: Four Billion Customers (trendwatching.com, 2005)

5. 5 Low-cost branded products Unilever Ala – low-income laundry detergent brand sold in Brazil Microtravel – appeal of sachets to travelers of all income levels Whirlpool – low-cost washing machines in China and India (less than $200) Nokia 1100 -- popular in rural India

6. 6 Customer country features Elasticity of demand Elasticity of excess demand faced by the firm has two components: Price responsiveness of firm’s customers: Market demand elasticity Price responsiveness of firm’s competitors: Competitor supply elasticity

7. 7 Elasticity of Demand: Price Responsiveness of Customers Different across countries: Consumer tastes and incomes differ Consumer knowledge of goods and services differs Past consumption patterns affects switching costs: Installed base of product and competing products differ

8. 8 Elasticity of Demand: Price Responsiveness of Competitors Different across countries: Different labor supply elasticities Different operating costs across countries Extent of domestic competition among suppliers differs due to trade barriers and domestic regulations Experience and technology of suppliers differs

9. 9 Do you think that Coca-Cola prices will differ?

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12. 12 Elastic Demand if E > 1 Example 1 –Price increase from 10 to 11, that is 10% –Suppose quantity sold falls from 200 to 160 units, that is 20% E = 20/10 = 2 Inelastic Demand if E < 1 Example 2 –Price increase from 10 to 11, 10% –Suppose quantity sold falls from 200 to 190 units, that is 5% E = 5/10 = ½ Elasticity of Demand The percentage change in quantity sold divided by the percentage change in price

13. 13 Revenue Effects of the Two Examples Inelastic Demand: E = ½ Elastic Demand: E= 2

14. 14 Elasticity of demand: Optional Review Revenue: R = P Q Marginal revenue -- change in revenue per unit change in output: MR = P + QΔP/ΔQ = P(1 + (Q/ΔQ)(ΔP/P)) So, MR = P(1 − 1/E). Consumer benefit if elasticity is a constant: B(Q) = Q (E – 1)/E.

15. 15 Revenue effects Observe that marginal revenue is less than the price. MR = P(1 − 1/E). This is because raising the price affects revenue in two ways: –More is earned per unit sold –fewer units are sold The relative influence of these two effects is measured by the elasticity

16. 16 Revenue effects If the elasticity of demand is greater than one, a price increase lowers revenue (a price cut increases revenue) If elasticity of demand is less than one, a price increase also increases your revenue (and a price drop cuts your revenue) Managers should try to estimate elasticity of demand numbers (formally or informally) in pricing across different countries

17. 17 Pricing by a firm with market power: Review D(P) Q MR PMPM MC PCPC P QMQM QCQC P M (1 − 1/E) = MC.

18. 18 Pricing to market Prices to satisfy the profit-maximizing conditions in each country: P A, P F = Prices in country A and F E A, E F = Price elasticities of demand in country A and F MC = Marginal Cost

19. 19 Pricing to market At the Zara stores, price tags stated in many currencies and for multiple countries.

20. 20 Pricing to market

21. 21 Pricing to market Advantages of Uniform Pricing Consistent pricing across countries Lowers transaction costs Avoids gray market arbitrage Avoids customer complaints Global product:: standardize marketing, sales, product features Problem: dealing with exchange rate fluctuations Advantages of Pricing to Market Meet or beat local competition Price leader or product differentiation strategies may differ by market served Maximize profit by market segment Tailoring marketing, sales, service and product features to local market

22. 22 Limits on Pricing to Market Legal restrictions on price discrimination, most-favored- nation agreements Limited legal protections for original seller allow gray market arbitrage Low trade costs allow arbitrage: Price difference must be less than cost of trade between countries A and F to avoid arbitrage: Differences in the elasticity of demand (responsiveness of demand to price changes) must be large enough to justify different prices in different markets

23. 23 Markups in the European Car Industry Verboven (1996): Studies 5 European countries Estimates relative markups Looks at the wholesale level Estimates elasticities for different groups of cars Recall the price equations: Rewrite as relative markup:

24. 24 Markups in the European Car Industry Consider markup equation at the wholesale level Customers are dealers, sellers are the manufacturers P ij : wholesale price in market i for model j MC ij : Marginal cost in market i for model j Table 3: Relative markups for selected cars Example (100 – 95)/100 = 0.05 = 5 % = 1/20.

25. 25 Markups in the European Car Industry

26. 26 Markups in the European Car Industry Lerner Index: Elasticity of demand E ik is for market i and car model in segment k Example: E = 20 (elastic demand) L = 1/20 = 0.05 = 5 % With the exception of Italy, Lerner indices increase with the class of models

27. 27 Markups in the European Car Industry Verboven (1996): Finds that price discrimination follows the Lerner-indices, that is price discrimination follows demand elasticities Degree of price discrimination is more pronounced the lower the class - it is greater on smaller models! Note that Italy’s lower elasticities (higher Lerner-indices) reflect FIAT market power and high import quota restrictions

28. 28 Markups in the European Car Industry

29. 29 Markups in the European Car Industry Verboven (1996) concludes: Domestic car companies are able to exploit domestic market power in lower segments Import quotas have stronger effects on smaller and inexpensive cars than on large and expensive cars The degree of price discrimination is more pronounced the lower the class

30. 30 Summary and take-away points Managers should perform target country analysis to estimate customer demand elasticity and competitor supply response Pricing to market based on differences in demand elasticities across countries, reflects customer country demand and competitor supply responses International business managers should weigh benefits and costs of uniform pricing versus pricing to market Lower costs of trade tend to enforce uniform pricing