Chapter 12 Pricing for International and Global Markets

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 12 | Slide 2 International Marketing Dilemma Product Pricing Standardization Product Pricing Adaptation versus

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 12 | Slide 3 Simple planning and budgeting Develop global brand image Meet local buyers price expectations created by –Travel –Global media –Internet –International operations (organizational buyers) Prevent gray markets Price Standardization Advantages

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 12 | Slide 4 PRESSURES FOR PRICE ADAPTATION Competition and corporate strategy Local production and operation costs Economic development Government regulations Transportation costs Recoup costs of taxes, tariffs and other barriers to trade Distribution middlemen Exchange rate fluctuations

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 12 | Slide 5 Profit and Cost Factors Transportation Costs –Variation in pricing among transportation methods –Sensitivity of transportation costs to price of oil

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 12 | Slide 6 Profit and Cost Factors (contd) Tariffs –Still significant for certain products in particular markets, despite efforts of GATT and WTO –Price escalation effects –Reclassification may avoid or lessen costs Land Rovers Range Rover was reclassified as a light truck to avoid 25% tariff

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 12 | Slide 7 Profit and Cost Factors (contd) Taxes –EUs Value-added tax (VAT) – Assessment based on production value-added at each stage –2002 EU Internet tax – Non-EU companies must register in an EU nation and pay taxes on all Internet sales –Sin taxes – Assessed on products that are legal but discouraged by society (i.e. cigarettes, alcohol)

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 12 | Slide 8 VAT Example With a North American (Canadian provincial and U.S. state) sales tax With a 10% sales tax: The manufacturer pays $1.00 for the raw materials, certifying it is not a final consumer. The manufacturer charges the retailer $1.20, checking that the retailer is not a consumer, leaving the same profit of $0.20. The retailer charges the consumer $1.65 ($ $1.50x10%) and pays the government $0.15, leaving the same profit of $0.30. With a value added tax With a 10% VAT: The manufacturer pays $1.10 ($1 + $1x10%) for the raw materials, and the seller of the raw materials pays the government $0.10. The manufacturer charges the retailer $1.32 ($ $1.20x10%) and pays the government $0.02 ($0.12 minus $0.10), leaving the same profit of $0.20. The retailer charges the consumer $1.65 ($ $1.50x10%) and pays the government $0.03 ($0.15 minus $0.12), leaving the profit of $0.30 ( ).

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 12 | Slide 9 Profit and Cost Factors (contd) Local production costs –Operational costs for raw materials, wages, energy, and/or financing may differ widely country to country Channel costs –Different channel lengths, distribution margins, and logistics also account for differing costs across markets

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 12 | Slide 10 Medical Tourism: Foreign Patients Can Be a Lucrative Market Thailand India Cuba Mexico

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 12 | Slide 11 Market Factors Income level –GNP per capita –GDP per capita –Disposable income (think PPP!) –Price elasticity High income = lower elasticity Lower income = higher elasticity

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 12 | Slide 12 Competition –Intensity and power of competition can affect price levels in a 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 Market Factors (contd)

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 12 | Slide 13 Environmental Factors Exchange rate fluctuations –When currency weakens, firms exports are more attractive –When currency strengthens, firms exports are less attractive Inflation rates –In high-inflation countries, companies may price in a stable currency

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 12 | Slide 14 Environmental Factors (contd) Price controls –Instituted by the government and regulatory agencies –Two types: Across-the-board Industry-specific

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 12 | Slide 15 Dumping – Selling a product at a price below actual costs –WTO antidumping actions allowed if Sales at less than fair value Material injury to domestic industry –Limits firms price flexibility in overseas markets but protects domestic market from foreign competition Environmental Factors (contd)

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 12 | Slide 16 Lower cost of goods –Lower manufacturing costs –Eliminate functional features –Lower quality Lower tariffs –Product modification –Partial assembly or repackaging Lower distribution costs –Shorten channels of distribution –Lower shipping costs Other –Foreign trade zones –Lobbying for tariff reduction Approaches to Lessening Price Escalation

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 12 | Slide 17 Transfer Pricing Transfer price – Price paid by importing or buying unit of a firm to the exporting unit of the same firm –Not an arms-length transaction frequently differ from market prices (much higher or lower)

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 12 | Slide 18 Firms may deviate from market prices to maximize profits or minimize risk and uncertainty –Accumulate more profits in a low-tax country –Repatriate profits from a country with limits on profit repatriation –Move profits out of country with macroeconomic instability –Reduce tariff duties by quoting low transfer prices to high-tariff country Transfer Pricing (contd)

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 12 | Slide 19 Issues to consider –Internal considerations Compensating managers based on profit Company resource allocation may be insufficient based on transfer price structures –External problems U.S. Revenue Act 1962, Section 482 Market prices preferred by IRS Transfer Pricing (contd)

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 12 | Slide 20 Most liquid market, approximately $1.5 trillion daily volume 24 hour market Largely unregulated The Foreign Exchange Market

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 12 | Slide 21 Transaction risk – Risk that a change in exchange rates may occur between the invoicing date and the settlement date of the transaction Foreign exchange price quotations: –Spot price – Number of dollars to be paid for a particular foreign currency purchased or sold today –Forward price – Number of dollars to be paid for a foreign currency bought or sold 30, 90, or 180 days from today Quoting Prices in a Foreign Currency

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 12 | Slide 22 Quoting Prices in a Foreign Currency Pricing options –Uncovered position – Pay spot price on the due date –Covering through the money market – Borrowing funds in currency at risk for the time until settlement –Hedging – Contract through financial intermediaries for future delivery of foreign currency at a set price, regardless of spot price at the time Expected spot versus present forward rate

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 12 | Slide 23 Spot Contract Example 1.ABC Company (U.S.) must pay an invoice from a British supplier for 1,500,000 British Pounds. 2.ABC contracts with its bank to buy BP 1,500,000 at The bank delivers the BP per ABCs instructions. 4.ABC pays bank $2,197,500 on the spot date.

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 12 | Slide 24 Hedging - Forward Contracts Forward Contract Example 1.XYZ, a U.S. exporter, contracts with a Swiss company to ship a custom machinery order upon completion in 3 months. 2.Payment terms are open account with payment due after shipment in Swiss Francs. 3.U.S. exporter chooses to lock in the dollar value of the Swiss francs to be received in order to protect profit margin. 4.XYZ enters into a forward contract to sell Swiss Francs at pre- specified exchange rate to U.S. dollars in 90 days. 5.In 90 days, XYZ exercises the contract and receives the pre- specified amount of $US for its Swiss Francs received from the customer, or opts to cancel the contract at a penalty cost (if allowed).

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 12 | Slide 25 Hedging – Currency Options Currency Options Example 1.XYZ, a U.S. exporter, contracts with a Swiss company to ship a custom machinery order upon completion in 3 months. 2.Payment terms are open account with payment due after shipment in Swiss Francs. 3.XYZ wants to protect profit margin by purchasing the right to sell the Swiss Francs at a pre-specified rate in 90 days. 4.XYZ purchases a Put: the right to convert Swiss Francs to U.S. $ at a pre-specified exchange rate in 90 days. 5.In 90 days, XYZ can exercise the put and convert at the pre- specified rate, or exchange the Swiss Francs it receives for $U.S. at the current spot exchange rate, or do nothing.

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 12 | Slide 26 Letter of Credit (L/C) Most frequently used method of payment for international transactions Players = Exporter and his/her bank; importer and his/her bank Bank promises to pay a specified amount of $ on presentation of documents stipulated in the L/C –e.g., bill of lading, consular invoice, or description of goods

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 12 | Slide 27 Letter of Credit Process Steps in the process 1.Purchase - Purchase agreement made between exporter and importer 2.Opening L/C - Importer applies for L/C, his/her bank opens L/C with exporters bank, exporter notified

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 12 | Slide 28 Letter of Credit Process 3. Shipment - Exporter ships goods and sends documents to his/her bank, who forwards them to importers bank, who notifies importer goods are on the way 4. Payment - Importer remits payment (cash or credit); importers bank sends funds to exporters bank; and exporter is notified

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 12 | Slide 29 Letter of Credit Benefits exporter –Substitutes the credit of the bank for the credit of buyer Benefits importer –Do not need to pay until documents (and order) actually arrive, providing additional float and assurance Main Benefit: L/Cs function as international escrow and clearing accounts

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 12 | Slide 30 Parallel Imports When prices for goods across markets are vastly different, entrepreneurs can buy products in low-price countries and sell them in high-price countries. This creates… Also known as parallel imports

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 12 | Slide 31 Gray Markets Gray markets can cause problems for manufacturers because they… –Cannibalize companys sales –Hurt relationships with authorized dealers –Undermine ability to charge different prices in different markets in order to maximize global profits Governments have been ambivalent,. even positive about gray markets.

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 12 | Slide 32 Gray Markets (contd) Causes Exchange rates Regional currencies Competitive pricing Problems synchronizing supply and demand Ease of moving products across border The Internet How to combat Confront distributors Cut price Interfere with supply Establish price corridors Lobby for legal change Advertise

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 12 | Slide 33 Gray Markets Governments take different stands on gray markets –At issue – right of a trademark owner to manage the sale of a trademarked product versus the ability of consumers to enjoy lower prices of parallel imports –Once a good is sold, what prevents someone from re-selling it to someone else?

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 12 | Slide 34 Exhaustion principal – Establishes the conditions under which a trademark owner relinquishes its right to control the re-sale of its product Exhaustion means once product is originally sold in an area, its re-sale cannot be restricted in the country –National exhaustion – least liberal policy –Regional exhaustion – i.e. EU region –International exhaustion – most liberal policy Policy means that parallel imports are welcomed to encourage lower prices Typically employed by developing countries where the number of local firms holding valuable trademarks are few Exhaustion Principle

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 12 | Slide 35 Drugs and Parallel Imports The U.S. and Canada European Union –European governments cap drug prices to keep healthcare budgets in check. Companies respond by withholding product. –Prices higher in Germany, UK, Netherlands, and Nordic countries compared to southern countries –Differences in price lead to parallel imports (made easier by EU pacts) Companies respond by moving production out of EU.

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 12 | Slide 36 Setting Global Prices Uniform pricing strategy –Requires a company to charge the same price everywhere when that price is translated into a base currency –Difficult to achieve because of different taxes, trade margins, customs duties, and currency fluctuations (i.e. external factors) Modified uniform pricing strategy –Carefully monitoring price levels in each country and avoiding large gray-trade-enticing gaps

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 12 | Slide 37 Countertrade Barter – Exchange of real goods Compensation Arrangement – Value of export delivery partially offset by an import transaction, or vice versa Offset – Selling company guarantees to use some products or services of the buying country in the final product Cooperation agreements – Buyback arrangement wherein payment for input good is paid for by output goods

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 12 | Slide 38 Why use countertrade? To Preserve Foreign Exchange To Improve Balance of Trade To Gain Access to New Markets & Partners To Upgrade Manufacturing Capabilities To Maintain Prices of Export Goods

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 12 | Slide 39 Challenges of Countertrade Complex and time-consuming –Valuing goods received Difficulty in finding a buyer –Merchandise may be of low quality –Exporter may have to sell the merchandise at a deep discount Like 1/3 of product value!!

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 12 | Slide 40 Exporters Engaging in Countertrade Should Consider Obtaining a very clear understanding of merchandise offered –Origin, quality, quantity, and delivery schedules should be spelled out Raising the price of the export contract to cover potential discounts Creating company unit dedicated to countertrade