Global Pricing Chapter 14 © 2006 The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

Outline Pricing Basics Global Pricing Issues Countertrade Pricing Strategies to Control Gray Trade Global Pricing Strategies Takeaways.

Basic Factors in Pricing Costs Experience Curve Competition Demand

Pricing Basics The Role of Costs The standard pricing procedure for exporting consists of A cost-plus formula Price escalation: The added costs in exporting mean that export prices tend to escalate over the domestic prices. Experience Curve Pricing Use of cost-based pricing has increased due to the “experience curve” effect The experience curve shows how unit costs go down as successively more units of a product are produced Experience curve pricing has been adopted primarily by companies entering an existing market in the maturity stage, because of the need to be competitive.

UNIT COST P** BREAKEVEN TIME PROFIT MARGIN < 0 PROFIT MARGIN > 0 ACCUMULATED PRODUCTION = q The Experience Curve Effect

Pricing Basics Competition The premium price differential refers to the degree to which the firm might be granted a higher price by the market because of the particular strengths of its product. Because of competition, prices in foreign market are sometimes lower than at home, contrary to the price escalation effect. Demand The strength of demand tends to vary with the PLC stage, the growth stage typically showing strongest demand. Demand and supply: Whether or not price can be high in a strong demand market, is also determined by the supply from competitors.

SETTING A PRICE PREMIUM ON THE BASIS OF DIRECT COMPARISONS WITH COMPETITION (Caterpillar example) $ 20,000 IS THE COMPETITOR’S PRICE $ 3,000 IS THE PREMIUM FOR SUPERIOR DURABILITY $ 2,000 IS THE PREMIUM FOR SUPERIOR RELIABILITY $ 2,000 IS THE PREMIUM FOR SUPERIOR SERVICE $ 1,000 IS THE PREMIUM FOR LONGER WARRANTY $28,000 IS THE TOTAL VALUE $ 4,000 DISCOUNT $24,000 FINAL PRICE Competitive Value Pricing

EXPORT PRICINGMULTINATIONAL PRICING CURRENCY RISK, CREDIT RISK EXCHANGE RATES, HEDGING TARIFFS, PRICE ESCALATION TRANSFER PRICE DUMPING COUNTERTRADE, SYSTEMS PRICING SKIMMING VS. PENETRATION PRICING PRICE COORDINATION, GRAY TRADE POLYCENTRIC PRICING, GEOCENTRIC PRICING, ETHNOCENTRIC PRICING POSITIONING PRICE, PRICE/QUALITY FINAL PRICE Global Pricing: Added to the Pricing Basics…

Unit sales Time in local market Profitability Time in local market Penetration price Skimming price Skimming vs Penetration Pricing

Economy Performance Brand C Brand B Brand A (high price) Economy Performance Brand C Brand B Brand A (low price) Before Re-positioningAfter Re-positioning This is the PREFERENCE VECTOR. This shows that the market wants high performance AND high economy (strong quality/price ratio) Re-positioning via a Price Reduction

EXCHANGE RATES – firms must be wary of devaluations; exchange rate fluctuations affect the performance of local subsidiaries HEDGING – purchasing insurance against losses because of currency fluctuations, firms make use of “forward contracts” or “swaps” GOVERNMENT INTERVENTION – various nations introduce stabilizing measures into financial systems via selective price controls and price discrimination laws Financial Issues

TRANSFER PRICE – the price paid for products shipped between units of the same organization when the shipment crosses national borders so that the correct duties & related fees can be paid Transfer prices should reflect the prices the subsidiary might encounter in the open market, also known as “arm’s length prices” Transfer prices are also used to shift resources within a firm to offset inflation in country subsidiaries, to support a subsidiary’s local competitive position, and in other cases for profit repatriation. This has resulted in accounting firms developing strict guideline for the transfer pricing process. Transfer Pricing

COUNTERTRADE – transactions in which all or part of the payment is made in kind rather than cash. Examples are as follows: Countertrade

For the seller evaluating a countertrade proposal, the following points must be considered: 1.Is this the only way the order can be secured? 2.Can the received goods be sold? 3.How can we maximize the cash portion? 4.Does the invoiced price incorporate extra transaction costs? 5.Are there import barriers to the received goods? 6.Could there be currency exchange problems if we repatriate the earnings from sales in a third country? Evaluating a Countertrade Offer

Profit sharing or penalty for nonperformance Package Price System discounts? Get supplier discounts? Bundled? Pricing of turnkey package Unbundled No firm-specific advantages Components where firm has FSA's Price taker Price maker Competitors: stand- alone profit centers? Competitive entry? Make or buy? Component prices? No profit sharing or penalty for nonperformance Systems Pricing in Turnkey Sales

Gray Trade Gray trade is the sales of genuine branded goods through unauthorized channels. Gray trade involves shipments from overseas plants that enter a market via entry points not easily controlled. Examples include shipments from the Asian manufacturers who produce for Western companies and whose products can be diverted to ports in one country before entering the market country. Gray trade is acute in trade areas where barriers have been recently dismantled & exchange rates fluctuate, creating big arbitrage opportunities and “consumer tourism”.

ECONOMIC CONTROLS – influencing price setting in local markets via changing shipping prices or by rationing the product CENTRALIZATION – forming price-corridors, setting limits for local prices FORMALIZATION – standardizing the process of planning and implementing pricing decisions INFORMAL COORDINATION – via articulation of corporate values & culture, human resource exchanges Pricing Actions against Gray Trade

Economic controls Informal coordination FormalizationCentralization High Low Level of Marketing Standardization Strength of Local Resources Controlling Gray Trade: Coordinating Pricing Strategies

ETHNOCENTRIC PRICING One global price, in one currency PROS: no gray trade CONS: no local adaptation $ Ethnocentric Pricing

GEOCENTRIC PRICING One price in each region, common regional currency PROS: some coordination, little gray trade, some adaptation CONS: not locally adapted $ Y DM Geocentric Pricing

POLYCENTRIC PRICING Local prices, in local currency PROS: locally adapted CONS: not coordinated, more gray trade DM $ Y Y $ k k P P Polycentric Pricing

Although centrally coordinated prices interfere with the local subsidiary’s ability to target its market, it is necessary and possible to coordinate pricing at least by regions or trading areas. Takeaways

To discourage gray trade, which attempts to take advantage of currency exchange shifts & local price differentials, companies try to keep prices in different countries within a narrow band or “corridor”. Takeaways

Transfer prices between a global firm’s plants in different countries can seldom be used to shift profits but should be used to motivate subsidiaries & measure performance, while remaining supportable to local tax authorities. Takeaways

Countertrade, including barter, is a frequent pricing option in countries with a lack of hard currency, especially when global financial turmoil puts domestic currencies under pressure. Takeaways

Global pricing still has to pay attention to basic issues such as competition, price-quality relationships, & stage of the product life cycle. Takeaways