Global Pricing

Chap

ter

14

© 2006 The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

Outline

Pricing BasicsGlobal Pricing IssuesCountertradePricing Strategies to Control Gray TradeGlobal Pricing StrategiesTakeaways.

Basic Factors in Pricing

Costs

Experience Curve

Competition

Demand

Pricing Basics

The Role of CostsThe standard pricing procedure for exporting consists of

A cost-plus formulaPrice 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” effectThe experience curve shows how unit costs go down as

successively more units of a product are producedExperience 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

CompetitionThe 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.

DemandThe 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$24,000 FINAL PRICE

Competitive Value Pricing

EXPORT PRICING MULTINATIONAL PRICING

CURRENCY RISK, CREDIT RISK EXCHANGE RATES, HEDGING

TARIFFS, PRICE ESCALATIONTRANSFER PRICE

DUMPINGCOUNTERTRADE, 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

Penetration price

Skimming 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-positioning After 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:

Barter The direct exchange of goods/services between trading partners

Compensation Deals Involve payment both in goods and in cash; the inclusion of some amount of cash makes the deal more attractive to the seller.

Counterpurchases

The most typical version of countertrade; two contracts are negotiated, one to sell the product (which constitutes the initial agreement) at an agreed cash price, and one to buy goods from the purchaser at an amount equal to the amount in the initial transaction.

Product Buy-backs May take two forms; 1) seller agrees to accept some amount of output as full or partial payment, 2) seller agrees to buy back some output at a later date.

Offset Deals The seller contracts to invest in local production or procurement to partially offset the sale price.

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

High

Low

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

$

YDM

Geocentric Pricing

POLYCENTRIC PRICING

Local prices, in local currency

PROS: locally adapted

CONS: not coordinated, more gray trade

DM

$

Y

Y

$DM

kk

PP

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