DIFFUSION OF INNOVATION

IntroductionIn general terms price is a component of an exchange or transaction that takes place between two parties and refers to what must be given up by one party (i.e., buyer) in order to obtain something offered by another party (i.e., seller).7/18/2015PRICING DECISIONS1 PRICING DECISIONS

1To provide a satisfying marketing-mix, companies must set a price that is acceptable to target market members (Pride and Ferrell, 2011). Price is the value paid for a product or service in the market; 7/18/2015PRICING DECISIONS2

Pricing Decisions Definition

it is a key element in the marketing-mix and one that generally is the only variable that can be quickly changed to react to market changes such as competitor actions or demand variations, for example.

7/18/2015PRICING DECISIONS3Cont...Pricing decisions can have important consequences for the marketing organization and the attention given by the marketer to pricing is just as important as the attention given to more recognizable marketing activities. 7/18/2015PRICING DECISIONS4Importance of Price/Pricing Decisions Some reasons pricing is important include:Most Flexible Marketing Mix VariableFor marketers price is the most adjustable of all marketing decisions. Unlike product and distribution decisions, which can take months or years to change, or some forms of promotion which can be time consuming to alter (e.g., television advertisement), price can be changed very rapidly

7/18/2015PRICING DECISIONS5Cont..Cont.The flexibility of pricing decisions is particularly important in times when the marketer seeks to quickly stimulate demand or respond to competitor price actions. For instance, a marketer can agree to a field salespersons request to lower price for a potential prospect during a phone conversation. 7/18/2015PRICING DECISIONS6Likewise a marketer in charge of online operations can raise prices on hot selling products with the click of a few website buttons.

7/18/2015PRICING DECISIONS7Cont..Setting the Right PricePricing decisions made hastily without sufficient research, analysis, and strategic evaluation can lead to the marketing organization losing revenue. Prices set too low may mean the company is missing out on additional profits that could be earned if the target market is willing to spend more to acquire the product.7/18/2015PRICING DECISIONS8Cont..Additionally, attempts to raise an initially low priced product to a higher price may be met by customer resistance as they may feel the marketer is attempting to take advantage of their customers Prices set too high can also impact revenue as it prevents interested customers from purchasing the product.

7/18/2015PRICING DECISIONS9Setting the right price level often takes considerable market knowledge and, especially with new products, testing of different pricing options.

7/18/2015PRICING DECISIONS10Cont...Trigger of First ImpressionsOften times customers perception of a product is formed as soon as they learn the price, such as when a product is first seen when walking down the aisle of a store. While the final decision to make a purchase may be based on the value offered by the entire marketing offering (i.e., entire product), 7/18/2015PRICING DECISIONS1111Cont.it is possible the customer will not evaluate a marketers product at all based on price alone. It is important for marketers to know if customers are more likely to dismiss a product when all they know is its price. If so, pricing may become the most important of all marketing decisions if it can be shown that customers are avoiding learning more about the product because of the price.

7/18/2015PRICING DECISIONS12Important Part of Sales PromotionMany times price adjustments are part of sales promotions that lower price for a short term to stimulate interest in the product. However, marketers must guard against the temptation to adjust prices too frequently since continually increasing and decreasing price can lead customers to be conditioned to anticipate price reductions and, consequently, withhold purchase until the price reduction occurs again..

7/18/2015PRICING DECISIONS13The final price for a product may be influenced by many factors which can be categorized into two main groups:Internal Factors When setting price, marketers must take into consideration several factors which are the result of company decisions and actions. To a large extent these factors are controllable by the company and, if necessary, can be altered.

7/18/2015PRICING DECISIONS14Factors Affecting Pricing Decisions14Cont..However, while the organization may have control over these factors making a quick change is not always realistic. For instance, product pricing may depend heavily on the productivity of a manufacturing facility (e.g., how much can be produced within a certain period of time). The marketer knows that increasing productivity can reduce the cost of producing each product and thus allow the marketer to potentially lower the products price.

7/18/2015PRICING DECISIONS15But increasing productivity may require major changes at the manufacturing facility that will take time (not to mention be costly) and will not translate into lower price products for a considerable period of time.

7/18/2015PRICING DECISIONS16Cont.External FactorsThere are a number of influencing factors which are not controlled by the company but will impact pricing decisions. Understanding these factors requires the marketer conduct research to monitor what is happening in each market the company serves since the effect of these factors can vary by market.

7/18/2015PRICING DECISIONS171) Marketing Objectives Marketing decisions are guided by the overall objectives of the company. All marketing decisions, including price, work to help achieve company objectives.Corporate objectives can be wide-ranging and include different objectives for different functional areas (e.g., objectives for production, human resources,etc7/18/2015PRICING DECISIONS18Internal Factors: Cont..While pricing decisions are influenced by many types of objectives set up for the marketing functional area, there are four key objectives in which price plays a central role. In most situations only one of these objectives will be followed, though the marketer may have different objectives for different products. The four main marketing objectives affecting price include:Return on Investment (ROI) A firm may set as a marketing objective the

7/18/2015PRICING DECISIONS19 Cont...requirement that all products attain a certain percentage return on the organizations spending on marketing the product. This level of return along with an estimate of sales will help determine appropriate pricing levels needed to meet the ROI objective. Cash Flow Firms may seek to set prices at a level that will insure that sales revenue will at least cover product production and marketing costs.

7/18/2015PRICING DECISIONS20Cont..This is most likely to occur with new products where the organizational objectives allow a new product to simply meet its expenses while efforts are made to establish the product in the market. This objective allows the marketer to worry less about product profitability and instead directs energies to building a market for the product. 7/18/2015PRICING DECISIONS21Market Share The pricing decision may be important when the firm has an objective of gaining a hold in a new market or retaining a certain percent of an existing market. For new products under this objective the price is set artificially low in order to capture a sizeable portion of the market and will be increased as the product becomes more accepted by the target market. 7/18/2015PRICING DECISIONS2222 Cont..For existing products, firms may use price decisions to insure they retain market share in instances where there is a high level of market competition and competitors who are willing to compete on price.Maximize Profits Older products that appeal to a market that is no longer growing may have a company objective requiring the price be set at a level that optimizes profits. 7/18/2015PRICING DECISIONS23Cont..This is often the case when the marketer has little incentive to introduce improvements to the product (e.g., demand for product is declining) and will continue to sell the same product at a price premium for as long as some in the market is willing to buy..2) Marketing Strategy Marketing strategy concerns the decisions marketers make to help the company satisfy its target market and attain its business and marketing objectives. 7/18/2015PRICING DECISIONS24Cont..Price, of course, is one of the key marketing mix decisions and since all marketing mix decisions must work together, the final price will be impacted by how other marketing decisions are made. For instance, marketers selling high quality products would be expected to price their products in a range that will add to the perception of the product being at a high-level.

7/18/2015PRICING DECISIONS25It should be noted that not all companies view price as a key selling feature. Some firms, for example those seeking to be viewed as market leaders in product quality, will deemphasize price and concentrate on a strategy that highlights non-price benefits (e.g., quality, durability, service, etc.). Such non-price competition can help the company avoid potential price wars that often break out between competitive firms that follow a market share objective and use price as a key selling feature.

7/18/2015PRICING DECISIONS263) Costs For many for-profit companies, the starting point for setting a products price is to first determine how much it will cost to get the product to their customers. Obviously, whatever price customers pay must exceed the cost of producing a good or delivering a service otherwise the company will lose money.7/18/2015PRICING DECISIONS27Cont.When analyzing cost, the marketer will consider all costs needed to get the product to market including those associated with production, marketing, distribution and company administration (e.g., office expense). These costs can be divided into two main categories:Fixed Costs - Also referred to as overhead costs, these represent costs the marketing organization incurs that are not affected by level of production or sales.

7/18/2015PRICING DECISIONS28Variable CostsThese costs are directly associated with the production and sales of products and, consequently, may change as the level of production or sales changes. Typically variable costs are evaluated on a per-unit basis since the cost is directly associated with individual items. Determining individual unit cost can be a complicated process. While variable costs are often determined on a per-unit basis, applying fixed costs to individual products is less straightforward.

7/18/2015PRICING DECISIONS291) Elasticity of Demand Marketers should never rest on their marketing decisions. They must continually use market research and their own judgment to determine whether marketing decisions need to be adjusted. When it comes to adjusting price, the marketer must understand what effect a change in price is likely to have on target market demand for a product.Understanding how price changes impact the market requires the marketer have a firm

7/18/2015PRICING DECISIONS30External Factors:30Cont..understanding of the concept economists call elasticity of demand, which relates to how purchase quantity changes as prices change. Elasticity is evaluated under the assumption that no other changes are being made (i.e., all things being equal) and only price is adjusted. The logic is to see how price by itself will affect overall demand. Obviously, the chance of nothing else changing in the market

7/18/2015PRICING DECISIONS31Cont. ..but the price of one product is often unrealistic. For example, competitors may react to the marketers price change by changing the price on their product. Despite this, elasticity analysis does serve as a useful tool for estimating market reaction. Elasticity deals with three types of demand scenarios:Elastic DemandProducts are considered to exist in a market that exhibits elastic

7/18/2015PRICING DECISIONS32Cont..demand when a certain percentage change in price results in a larger and opposite percentage change in demand. For example, if the price of a product increases (decreases) by 10%, the demand for the product is likely to decline (rise) by greater than 10%. Inelastic DemandProducts are considered to exist in an inelastic market when a certain percentage change in price results in a smaller and opposite percentage 7/18/2015PRICING DECISIONS33 Cont.....change in demand. For example, if the price of a product increases (decreases) by 10%, the demand for the product is likely to decline (rise) by less than 10%.Unitary Demand This demand occurs when a percentage change in price results in an equal and opposite percentage change in demand. For example, if the price of a product increases (decreases) by 10%, the demand for the product is likely to decline (rise) by 10%.

7/18/2015PRICING DECISIONS3434For marketers the important issue with elasticity of demand is to understand how it impacts company revenue. In general the following scenarios apply to making price changes for a given type of market demand:For Elastic Markets increasing price lowers total revenue while decreasing price increases total revenue.For Inelastic Markets increasing price raises total revenue while decreasing price lowers total revenue.For Unitary Markets there is no change in revenue when price is changed.

7/18/2015PRICING DECISIONS35 2) Customer Expectations Possibly the most obvious external factors that influence price settings are the expectations of customers and channel partners. When it comes to making a purchase decision customers assess the overall value of a product much more than they assess the price. When deciding on a price marketers need to conduct customer research

7/18/2015PRICING DECISIONS36Cont.to determine what price points are acceptable. Pricing beyond these price points could discourage customers from purchasing.Firms within the marketers channels of distribution also must be considered when determining price. Distribution partners expect to receive financial compensation for their efforts, which usually means they will receive a percentage of the final selling price. 7/18/2015PRICING DECISIONS37Cont.This percentage or margin between what they pay the marketer to acquire the product and the price they charge their customers must be sufficient for the distributor to cover their costs and also earn a desired profit.3) Competitive and Other Products Marketers will undoubtedly look to market competitors for indications of how price should be set.

7/18/2015PRICING DECISIONS38Cont.For many marketers of consumer products researching competitive pricing is relatively easy, particularly when Internet search tools are used. Price analysis can be somewhat more complicated for products sold to the business market since final price may be affected by a number of factors including if competitors allow customers to negotiate their final price. Analysis of competition will include pricing by direct competitors, related products and primary products.

7/18/2015PRICING DECISIONS39Direct Competitor PricingAlmost all marketing decisions, including pricing, will include an evaluation of competitors offerings. The impact of this information on the actual setting of price will depend on the competitive nature of the market For instance, products that dominate markets and are viewed as market leaders may not be heavily influenced by competitor pricing 7/18/2015PRICING DECISIONS40Cont.since they are in a commanding position to set prices as they see fit. On the other hand in markets where a clear leader does not exist, the pricing of competitive products will be carefully considered. Marketers must not only research competitive prices but must also pay close attention to how these companies will respond to the marketers pricing decisions. For instance, in highly competitive 7/18/2015PRICING DECISIONS41Cont.industries, such as gasoline or airline travel, competitors may respond quickly to competitors price adjustments thus reducing the effect of such changes.Related Product Pricing Products that offer new ways for solving customer needs may look to pricing of products that customers are currently using even though these other products may not appear to be direct competitors.

7/18/2015PRICING DECISIONS42Cont.For example, a marketer of a new online golf instruction service that allows customers to access golf instruction via their computer may look at prices charged by local golf professionals for in-person instruction to gauge where to set their price. While on the surface online golf instruction may not be a direct competitor to a golf instructor, marketers for the online service can use the cost 7/18/2015PRICING DECISIONS43Cont..of in-person instruction as a reference point for setting price.Primary Product Pricing Marketers may sell products viewed as complementary to a primary product. For example, Bluetooth headsets are considered complementary to the primary product cellphones. The pricing of complementary products may be affected by pricing changes7/18/2015PRICING DECISIONS44Cont..made to the primary product since customers may compare the price for complementary products based on the primary product price. For example, companies that sell accessory products for the Apple iPod may do so at a cost that is only 10% of the purchase price of the iPod. However, if Apple were to dramatically drop the price, for instance by 50%, the accessory at its present price would now be 20% of the of iPod price. 7/18/2015PRICING DECISIONS45Cont..This may be perceived by the market as a doubling of the accessorys price. To maintain its perceived value the accessory marketer may need to respond to the iPod price drop by also lowering the price of the accessory.

7/18/2015PRICING DECISIONS464 Government Regulation Marketers must be aware of regulations that impact how price is set in the markets in which their products are sold. These regulations are primarily government enacted meaning that there may be legal ramifications if the rules are not followed. Price regulations can come from any level of government and vary widely in their requirements. 7/18/2015PRICING DECISIONS4747Cont..For instance, in some industries, government regulation may set price ceilings (how high price may be set) while in other industries there may be price floors (how low price may be set). Additional areas of potential regulation include: deceptive pricing, price discrimination, predatory pricing and price fixing.

7/18/2015PRICING DECISIONS48Finally, when selling beyond their home market, marketers must recognize that local regulations may make pricing decisions different for each market. This is particularly a concern when selling to international markets where failure to consider regulations can lead to severe penalties. Consequently marketers must have a clear understanding of regulations in each market they serve.7/18/2015PRICING DECISIONS49Transfer pricing is the setting of the price for goods and services sold between controlled (or related) legal entities within an enterprise. For example, if a subsidiary company sells goods to a parent company, the cost of those goods is the transfer price. Legal entities considered under the control of a single corporation include branches and companies that are wholly or majority owned ultimately by the parent corporation. 7/18/2015PRICING DECISIONS50TRANSFER PRICING50Cont...Certain jurisdictions consider entities to be under common control if they share family members on their boards of directors. It can be used as a profit allocation method to attribute a multinational corporation's net profit (or loss) before tax to countries where it does business. Transfer pricing results in the setting of prices among divisions within an enterprise. In principle a transfer price should match

7/18/2015PRICING DECISIONS51Cont..either what the seller would charge an independent, arm's length customer, or what the buyer would pay an independent, arm's length supplier. While unrealistic transfer prices do not affect the overall enterprise directly, they become a concern when they are misused to lower profits in a division of an enterprise that is located in a country that levies high taxes and raise profits7/18/2015PRICING DECISIONS5252Cont.in a country that is a tax haven that levies no or low taxes. Transfer pricing is the major tool for corporate tax avoidance also referred to as Base Erosion and Profit Shifting (BEPS)

7/18/2015PRICING DECISIONS53If two unrelated companies trade with each other, a market price for the transaction will generally result. This is known as arms-length trading, because it is the product of genuine negotiation in a market. This arms length price is usually considered to be acceptable for tax purposes. But when two related companies trade with each other, they may wish to artificially distort the price at which the trade is recorded, to minimize the overall tax bill. This might, for example, help it record as much of its profit as possible in a tax haven with low or zero taxes.7/18/2015PRICING DECISIONS54The Arms Length principleA transfer pricing system is required to meet the following purposes:To provide information that motivates divisional managers to make good economic decision. This will happen when actions that divisional managers take to improve the reported profit of their divisions also improves the profit of the company as a whole.7/18/2015PRICING DECISIONS55Purposes of Transfer PricingCont....To provide information that is useful for evaluating the managerial and economic performance of the divisions.To intentionally move profits between divisions or locations.To ensure that divisional autonomy is not undermined.

7/18/2015PRICING DECISIONS56Methods of transfer pricingThe methods of pricing usually employed in industry when goods or services are transferred from one unit to the other can be broadly classified under the following three categories:1At cost or variants of cost e.g. actualmanufacturing cost; standard cost; full cost and full cost plus mark up.2At market price.3At bargained or negotiated prices.

7/18/2015PRICING DECISIONS57Pricing at Cost:7/18/2015PRICING DECISIONS58(a) Actual manufacturing cost:In this method goods or services are transferred at their actual cost of production.This method is the simplest of all the methods used. It is useful for those units where the responsibility of profit performance is centralized. Under this method, it is difficult to measure the performance of each profit center.

(b) Standard cost:Under this method all transfers of goods and services are made at their standard cost. Any difference between actual and standard cost viz., variances are usually absorbed by the supplying unit. In some cases, variances are transferred to the user unit as well. This will result in the inventory being carried at identical standard cost by both the supplying and receiving units. Here also the profit performance responsibility is centralized and thus it cannot be measured for individual units involved.

7/18/2015PRICING DECISIONS59(c) Full cost:Under this method goods or services are supplied to a sister unit at full cost. Here full cost means cost of production plus expenses like selling and distribution, administration, research and development cost etc. In this method, the supplying unit is not allowed to make any profit on transfers to other units. But it is free to earn profit on outside sale. One good thing about this method is that the supplying unit is allowed to recover the full cost of the goods/services transferred.

7/18/2015PRICING DECISIONS60d) Full cost plus mark up:Under this method the supplying unit transfers goods and services at full cost plus some mark-up. The markup added to full cost is either expressed as a percentage of full cost or of capital employed. Selling expenses here are recovered by the supplying unit without incurring them, especially when the goods/services are transferred internally. Due to this defect the use of full cost plus method is not appreciated by the internal receiving units. 7/18/2015PRICING DECISIONS61 Cont.. To overcome this defect either the use of standard cost plus or actual cost plus are preferred. Use of either of the preceding method facilitates the task of measuring profit performance and efficiency of the units involved.Pricing at market price:Under this method, the transfer prices of goods/services transferred to other units/divisions are based on market prices. 7/18/2015PRICING DECISIONS62ContIn a competitive market goods/services cannot be transferred to its users at a higher price. Such a competitive market provides an incentive to efficient production. Since market prices will, by and large be determined by demand and supply in the long run, it is claimed that profits which results under this method, will provide a good indicator of the overall efficiency of the various units. 7/18/2015PRICING DECISIONS63ContCompetitive market prices provide reliable measures of divisional income because these prices are established independently rather than by individuals who have an interest in the results. The main limitations of this method are:Difficulty in obtaining just market prices. Sometime it is difficult to obtain at all any market price for those vary products which are manufactured only for internal consumption.7/18/2015PRICING DECISIONS64Difficulty in determining the elements of selling and distribution expenses such as commission, discounts, advertisement and sales promotion etc., so that necessary adjustment may be made in the market price to provide benefit of these expenses, to the profit centre, receiving the goods.Example 1: SV Ltd. manufactures a product which is obtained basically from a series of mixing operations. 7/18/2015PRICING DECISIONS65Cont.The finished product is packaged in the company-made glass bottles and packed in attractive cartons. The company is organized into two independent divisions viz. one for the manufacture of the end-product and the other for the manufacture of glass bottles. The product manufacturing division can buy all the bottle requirements from the bottle manufacturing division. 7/18/2015PRICING DECISIONS66Cont.The General Manager of the bottle manufacturing division has obtained the following quotations from the outside manufacturers for the supply of empty bottles.

7/18/2015PRICING DECISIONS67Cont..There has been considerable discussion at the corporate level as to the use of proper price for transfer of empty bottles from the bottle manufacturing division to product manufacturing division. This interest is heightened because a significant portion of the Divisional General Managers salary is in incentive bonus based on profit centre results. As the corporate management accountant responsible for defining the proper transfer

7/18/2015PRICING DECISIONS68Cont..prices for the supply of empty bottles by the bottle manufacturing division to the product manufacturing divisionRequired:Show for the two levels of volumes of 800,000 and 1,200,000 bottles, the profitability by using(i) Market price(ii) Shared profit relative to the costs involved basis for the determination of transfer prices.7/18/2015PRICING DECISIONS69Cont.The profitability position should be furnished separately for the two divisions and the company as a whole under each method. Discuss also the effect of these methods on the profitability of the two divisions.Solution:

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7/18/2015PRICING DECISIONS71Cont..From the above computations, it is observed that shared profit relative to the cost involved is Sh. 221,276 (Sh. 0.2766 per bottle) at 800,000 production level and Sh.214,964 (Sh. 0.179 per bottle) at 1,200,000 production level. The profit of Product Mfg. Division is Sh. 1,378,724 (Sh. 1.723 per bottle) at 800,000 production level and Sh. 1,445,036 (Sh. 1.2042 per bottle) at 1,200,000 production level.

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7/18/2015PRICING DECISIONS73Observations:1) Market price methods gives a better profitability to Bottle Mfg. Division at both the production levels.2) Market price method gives a lower profitability to Product Mfg. Division as compared to Bottle Mfg. Division.3) Under Cost-based method, there is a better profit at lower level of production in Bottle Mfg. Division.

7/18/2015PRICING DECISIONS74Cont.However in Product Mfg. Division 1,200,000 production level gives a higher profit. But in Market price method, the position is quite reverse.Example 2:Fasteners Ltd. is having production shops reckoned as cost centres. Each shop charges other shops for material supplied and services rendered. The shops are motivated through goal congruence, autonomy and management efforts.7/18/2015PRICING DECISIONS75Cont.Fastner Limited is having a welding shop and painting shop. The welding shop welds annually 75,000 purchased items with other 150,000 shop made parts into 12,000 assemblies.The assemblies are having variable cost of Sh. 9.50 each and are sold in market at Sh. 12 per assembly. Out of the total production, 80% is diverted to painting shop at same price ruling in the market. Welding shop incurs a fixed cost of Sh. 25,000 per annum. 7/18/2015PRICING DECISIONS767/18/2015PRICING DECISIONS77The painting shop is having fixed cost of Sh. 30,000 and its cost of painting including transfer price from welding shop comes to Sh. 20 per unit. This shop sells all units transferred to it by welding shop at Sh. 25 per assembly.Required:(a) Find out profit of individual cost centres and overall profitability of the concern.7/18/2015PRICING DECISIONS78(b) Recommend course of action if painting shop wishes to purchase its full requirement(at market price which is Sh. 10 per assembly) either from open market or from welding shop at market price of Sh. 10 per assembly. Give reasons for your recommendations.Solution:

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7/18/2015PRICING DECISIONS80*It is given in the question that cost of painting including transfer price from welding shop is Sh. 20 per unit. The transfer price from welding shop is Sh. 12 per unit. Therefore, the variable cost of Sh. 8 (Sh. 20 Sh. 12) is incurred by painting shop exclusively. The painting shop will be purchasing its requirement from open market at Sh. 10 per unit. Therefore, the variable cost per unit in painting shop willbe Sh. 18 (Sh. 10 + Sh. 8). This point should be noted carefully.7/18/2015PRICING DECISIONS81

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7/18/2015PRICING DECISIONS83Cont..Alternative (b) (ii) should be accepted due to the following reasons:(a) It gives a maximum overall profit of Sh. 23,000. Discussion is confined to eitherb (i) or b (ii).(b) Each shop is treated as a separate cost centre and not a profit centre.(c) The policy of overall goal congruence of the company is followed.

7/18/2015PRICING DECISIONS84Multinational transfer pricingAs multinationals become more sophisticated in employing transfer pricing techniques in their tax planning, the revenue authorities have increased their scrutiny of arrangements, putting transfer pricing at the forefront of international tax concerns.Suppose a division in a high-income-tax-rate country produces a sub-assembly for another division in a low-income-tax-rate country.

7/18/2015PRICING DECISIONS85Cont..By setting a low transfer price, the company can recognize most of the profit from the production in the low-income-tax-rate country, thereby minimizing taxes. Likewise, items produced by divisions in a low-income-tax-rate country and transferred to a division in a high-income-tax-rate country should have a high transfer price to minimize taxes.

7/18/2015PRICING DECISIONS86Cont..Sometimes import duties offset income tax effects. Most countries base import duties on the price paid for an item, whether bought from an outside company or transferred from another division. Therefore, low transfer prices generally lead to low import duties. Consider a populated PCB manufactured by Alcatel Ltd. (Switzerland) with an 8% income tax rate and transferred to a division in India with a 40% income tax rare. 7/18/2015PRICING DECISIONS87Cont.In addition, suppose India imposes an import duty equal to20% of the price of the item and that Alcatel cannot deduct this import duty for tax purposes. Suppose the full unit cost of a populated PCB is Sh. 100, and the variable cost is Sh. 60. If tax authorities allow either variable- or full-cost transfer

7/18/2015PRICING DECISIONS88Cont.prices, which should Alcatel choose? By transferring at Sh. 100 rather than at Sh. 60, the company gain Sh. 4.80 per unit:Effect of Transferring at Sh. 100 instead of at Sh. 60 Income of the Swiss division is Sh. 40higher; therefore it pays 8% x Sh. 40 more income taxes (Sh. 3.20) Income of the Indian division is Sh. 40 lower; therefore it pays 40% x Sh. 7/18/2015PRICING DECISIONS89Cont.40 less income taxes (Sh. 16.00) Import duty is paid by the India division on an additional Sh. 100 - Sh. 60 = Sh. 40; therefore it pays 20% x Sh. 40 more duty (Sh. 8). Net saving from transferring at Sh. 100 instead of Sh. 60 is Sh. 4.80.Financial restrictions imposed by some governments may be avoided by an effective use of transfer price. 7/18/2015PRICING DECISIONS9090Cont.For example, in case a country restricts the amount of dividend paid to foreign owners, it may be easier for a company to get cash from a foreign division in form of payments for product transferred rather than cash dividend.

7/18/2015PRICING DECISIONS917/18/2015PRICING DECISIONS92THANK YOU THANK YOU