CHAPTER -3
International Pricing
Important objectives of Pricing
Price is an integral part of a product. A product cannot exist without a price.
Price affects demand. Price also affects even the economy of a nation as rapid
price increases lead to galloping inflation.
Important objectives of Pricing
Pricing strategy begins with the determination of objectives. Pricing objectives
reflect the overall goals a firm wants to accomplish through pricing. In
international marketing, pricing objectives may vary, depending on a product
life cycle stage and the country specific competitive situation. The important
pricing objectives are discussed under the following headings:
1. Market penetration
2. Market skimming
3. Market share
4. Meeting competition
5. Preventing potential competitors
6. Early recoupment of the investment
7. Quick cash recovery
8. Discharging export obligation
9. Disposal of surplus
[Link] on investment; and
[Link] maximization
1. Market penetration: In penetration and pricing, price is used as a
competitive weapon to gain market position. Penetrative pricing means a
product may even be sold at a loss for a certain length of time. So, companies
new to exporting cannot absorb such losses. A low price is charged in the initial
period or until the product gains acceptance of the buyers. This method of
pricing attracts buyers who are sensitive to price, effects large volume of sales,
avoids competition and stabilizes the price.
2. Market skimming: In skimming, a high initial price is charged in a market
segment which is willing to pay a premium price for a product. In skimming
pricing, the product must create a high value for the buyers. This is often used
in the introductory phase of the product life cycle when both production
capacity and competition are limited. Sony used skimming strategy when it
introduced Betamax video cassette recorders in the United States.
3. Market share: The efficiency of the product may be evaluated in terms of
market share it holds. Increasing the market share is a sure way to lower costs.
A larger market share might increase profitability because of greater
economies of scale.
4. Meeting competition: The present market is highly competitive. When a
product is introduced in a competitive market, meeting competition can be an
important objective. The price must remain competitive in order to gain a
competitive edge in the market.
5. Preventing potential competition: The objective of pricing may be to
prevent the entry of new competitors into the market. When a low price is set
on the product, the marketer may incur loss. This discourages the competitors
to gain an entry into the market with similar product.
6. Early recoupment of investment: Some products may have short product
life cycle. They may also be affected by swift technological changes. There may
also be potential danger of political threats and cut throat competition. In such
a situation, the marketer may have the objective of recouping his investment
as early as possible. Prices bring revenue to the firm. A high price determined
in the initial period may help the manufacturer recoup the investment in the
project early.
7. Quick cash recovery: When a firm has liquidity problem, it may prefer to
generate quick cash flow. The pricing method adopted by it may liquidate the
stock quickly thereby encouraging channel members and buyers to make
prompt payment.
8. Discharging export obligation: Having gained a good market share in the
domestic market, the firm may be willing to foray into foreign market. Entering
foreign market and meeting export obligation may not be easy for all firms.
Sometimes, even by charging a price lower than the cost, the firm gains a share
in the foreign market.
9. Disposal of surplus: When a firm has surplus stock, it may resort to
dumping. Dumping is an important global pricing strategy. It is the sale of an
imported product at a price lower than that is normally charged in a domestic
market or country of origin. The firm views export sales as passive contribution
to sales volume.
10. Return on Investment: Price is the only source of revenue to the firm. The
firm has to earn sufficient revenue in order to meet the needs of stakeholders.
It may set a target rate of return on its investment. Pricing serves to secure the
target rate of return on the investment.
11. Profit maximization: Profit is by far the most important pricing objective.
Prices are viewed as active instrument for profit maximization. In general,
pricing is a tool of accomplishing marketing objectives. The firm may use price
to achieve a specific objective, whether a targeted rate of return on profit, a
targeted market share or some other specific goal.
International Pricing Strategies
International pricing is often considered the most critical and complex issue in
international marketing. When talking about the price of a product, it is
important to notice that it is a sum of all monetary and non-monetary assets
the customer has to spend in order to obtain the benefits it provides. The
main pricing decisions in international marketing comprise the following
(Mühlbacher/Leihs/Dahringer 2006, pp. 661-662):
■ The overall international pricing strategy determines general rules for setting
(basic) prices and using price reductions, the selection of terms of payment,
and the potential use of countertrade.
■ The price setting strategy determines the basic price of a product, the price
structure of the product line, and the system of rebates, discounts or refunds
the firm offers.
■ The terms of payment are contractual statements fixing, for example, the
point in time and the circumstances of payment for the products to be
delivered.
A company's pricing strategy is a highly cross-functional process that is based
on inputs from finance, accounting, manufacturing, tax and legal issues
(Kotabe/Helsen 2014, pp. 358-360), which can be diverse in an international
context.
It thus is not sufficient to place sole emphasis on ensuring that sales revenue at
least covers the cost incurred (e.g. cost of production, marketing or
distribution); it is important to take many other factors into consideration that
may differ internationally (Doole/Lowe 2012, pp. 361-362). The most
important factors that influence international pricing strategy are summarised
in Table 21.2.
There are several options in terms of general price determination. They
represent different levels of adaptation to local requirements.
A standard pricing strategy is based on setting a uniform price for a product,
irrespective of the country where it is sold. This strategy is very simple and
guarantees a fixed return. However, no response is made to local conditions
(Doole/Lowe 2012, p. 368).
With standard formula pricing, the company standardises by using the same
formula to calculate prices for the product in all country markets. There are
different ways to establish such a formula. For example, full-cost
pricing consists of taking all cost elements (e.g. production plus marketing,
etc.) in the domestic market and adding additional costs from international
transportation, taxes, tariffs, etc. A direct cost plus contribution margin
formula implies that additional costs due to the non-domestic marketing
process and a desired profit margin are added to the basic production cost.
The most useful approach in standard formula pricing is the differential
formula. It includes all incremental costs resulting from a non-domestic
business opportunity that would not be incurred otherwise and adds these
costs to the production cost (Mühlbacher/Leihs/Dahringer 2006, p. 664).
While these strategies accentuate elements of international standardisation in
pricing, in price adaptation strategies prices are typically set in a decentralised
way (e.g. by the local subsidiary or local partner). Prices can be established to
match local conditions. While this ability to comply with local
requirements constitutes a clear advantage, there can be difficulties in
developing a global strategic position.
Additionally, the potential for price adaptation is limited
by interconnections between the diverse international markets. Therefore it is
necessary to coordinate the pricing strategy across different countries because
otherwise reimports, parallel market or grey market situations can emerge. In
these situations, products are sold outside of their authorised channels of
distribution. As a specific form of arbitrage, grey markets develop when there
are price differences between the different markets in which products are sold.
If these differences emerge, products are shipped from low-price to high-price
markets with the price differences between these markets allowing the goods
to be resold in the high-price market with a profit. Parallel markets, while legal,
are unofficial and unauthorised and can result in the cannibalisation of sales in
countries with relatively high prices, damaging relationships with authorised
distributors.
To avoid these drawbacks in totally standardised or differentiated
approaches, geocentric pricing approaches can be chosen. There is no single
fixed price, but local subsidiaries are not given total freedom over setting
prices. For example, firms can set price lines that set the company's prices
relative to competitors' prices (i.e. standardised price positioning) or they can
centrally coordinate pricing decisions in the MNC (Doole/Lowe 2012, pp. 368-
369).
In this context, it is important to notice that international pricing decisions also
depend on the degree of industry globalisation. Global industries are
dominated by a few, large competitors that dominate the world markets
(Solberg/Stöttinger/Yaprak 2006). Which international pricing strategy is
appropriate depends on the firm's ability to respond to the diverse external,
market-related complexities of international markets
PRICING METHOD
Definition: The Pricing Methods are the ways in which the price of goods and
services can be calculated by considering all the factors such as the
product/service, competition, target audience, product’s life cycle, firm’s vision
of expansion, etc. influencing the pricing strategy as a whole.
The pricing methods can be broadly classified into two parts:
1. Cost Oriented Pricing Method
2. Market Oriented Pricing Method
Cost-Oriented Pricing Method: Many firms consider the Cost of Production as
a base for calculating the price of the finished goods. Cost-oriented pricing
method covers the following ways of pricing:
Cost-Plus Pricing: It is one of the simplest pricing method wherein the
manufacturer calculates the cost of production incurred and add a certain
percentage of markup to it to realize the selling price. The markup is the
percentage of profit calculated on total cost i.e. fixed and variable cost.
E.g. If the Cost of Production of product-A is Rs 500 with a markup of 25% on
total cost, the selling price will be calculated asSelling Price= cost of production
+ Cost of Production x Markup Percentage/100
Selling Price=500+500 x 0.25= 625
Thus, a firm earns a profit of Rs 125 (Profit=Selling price- Cost price)
Markup pricing- This pricing method is the variation of cost plus pricing
wherein the percentage of markup is calculated on the selling price.E.g. If the
unit cost of a chocolate is Rs 16 and producer wants to earn the markup of 20%
on sales then mark up price will be:
Markup Price= Unit Cost/ 1-desired return on sales
Markup Price= 16/1-0.20 = 20
Thus, the producer will charge Rs 20 for one chocolate and will earn a profit of
Rs 4 per unit.
Target-Return pricing– In this kind of pricing method the firm set the price to
yield a required Rate of Return on Investment (ROI) from the sale of goods and
services.E.g. If soap manufacturer invested Rs 1,00,000 in the business and
expects 20% ROI i.e. Rs 20,000, the target return price is given by:
Target return price= Unit Cost + (Desired Return x capital invested)/ unit
salesTarget Return Price=16 + (0.20 x 100000)/5000Target Return Price= Rs 20
Thus, Manufacturer will earn 20% ROI provided that unit cost and sale unit is
accurate. In case the sales do not reach 50,000 units then the manufacturer
should prepare the break-even chart wherein different ROI’s can be calculated
at different sales unit.
Market-Oriented Pricing Method: Under this method price is calculated on the
basis of market conditions. Following are the methods under this group:
Perceived-Value Pricing: In this pricing method, the manufacturer decides the
price on the basis of customer’s perception of the goods and services taking
into consideration all the elements such as advertising, promotional tools,
additional benefits, product quality, the channel of distribution, etc. that
influence the customer’s perception.
E.g. Customer buy Sony products despite less price products available in the
market, this is because Sony company follows the perceived pricing policy
wherein the customer is willing to pay extra for better quality and durability of
the product.
Value Pricing: Under this pricing method companies design the low priced
products and maintain the high-quality offering. Here the prices are not kept
low, but the product is re-engineered to reduce the cost of production and
maintain the quality simultaneously.
E.g. Tata Nano is the best example of value pricing, despite several Tata cars,
the company designed a car with necessary features at a low price and lived up
to its quality.
Going-Rate Pricing- In this pricing method, the firms consider the competitor’s
price as a base in determining the price of its own offerings. Generally, the
prices are more or less same as that of the competitor and the price war gets
over among the firms.
E.g. In Oligopolistic Industry such as steel, paper, fertilizer, etc. the price
charged is same.
Auction Type pricing: This type of pricing method is growing popular with the
more usage of internet. Several online sites such as eBay, Quikr, OLX, etc.
provides a platform to customers where they buy or sell the
commodities. There are three types of auctions:
1. English Auctions-There is one seller and many buyers. The seller puts the
item on sites such as Yahoo and bidders raise the price until the top best price
is reached.
2. Dutch Auctions– There may be one seller and many buyers or one buyer and
many sellers. In the first case, the top best price is announced and then slowly
it comes down that suit the bidder whereas in the second kind buyer
announces the product he wants to buy then potential sellers competes by
offering the lowest price.
3. Sealed-Bid Auctions: This kind of method is very common in the case of
Government or industrial purchases, wherein tenders are floated in the
market, and potential suppliers submit their bids in a closed envelope, not
disclosing the bid to anyone.
Differential Pricing: This pricing method is adopted when different prices have
to be charged from the different group of customers. The prices can also vary
with respect to time, area, and product form.
E.g. The best example of differential pricing is Mineral [Link] price of
Mineral Water varies in hotels, railway stations, retail stores.
Thus, the companies can adopt either of these pricing methods depending on
the type of a product it is offering and the ultimate objective for which the
pricing is being done.
Steps for transfer price
Steps for determining transfer price
A typical transfer pricing process is illustrated by the nine steps set out in the
OECD’s guidelines. These steps reflect good practice but aren’t explicitly
compulsory to attain a result corresponding to arm’s length value.
Step 1: determination of the years to be covered.
Step 2: broad-based analysis of the taxpayer’s circumstances (sector,
competition, economic and regulatory environment etc) – placing the
transaction in a context that may be material from the standpoint of the
parties’ pricing.
Step 3: understanding the controlled transactions, based on functional and risk
analysis. This is used to define the tested party, the transfer pricing method
most appropriate to the circumstances of the case, financial indicators to be
tested (in the case of a transactional profit method) and to identify significant
comparability actors that should be taken into account.
As a rule, it can be said that the more important the functions fulfilled by the
party and the higher the business risks it takes, the greater its expectation as
to the transactional profit.
Step 4: review of existing internal comparables, if any, (i.e. the taxpayer's own
transaction prices, mark-up percentages, net margins etc.) with independent
persons comparable to the transactions conducted between the controlled
related parties.
Step 5: determination of available sources of information on external
comparables, where such comparables are needed, taking into account their
relative reliability (i.e. comparable transaction prices, mark-up rates and net
margins between unconnected parties in market conditions).
Step 6: selection of the most appropriate transfer pricing method and,
depending on the method, determination of the relevant financial indicator
(e.g. determination of the relevant net profit indicator in case of the
transactional net margin method).
A more detailed overview of the methods can be found in Minister of Finance
regulation n. 53 sections 11‒17
([Link]
Step 7: identification of potential comparables: determining the key
characteristics to be met by any uncontrolled transaction in order to make a
comparison to determine an arm’s length price for the controlled transaction
in accordance with step 3 and the OECD guidelines 1.38-1.64 (see below.)
Step 8: making comparability adjustments where appropriate.
Step 9: interpretation and use of data collected, determination of the arm’s
length remuneration.
Determination of steps as comparability analysis
In very general terms, the transfer pricing process can be seen as comparability
analysis. Comparability of a controlled transaction between related parties and
comparable transaction between not related parties are influenced by a
number of conditions and transactional circumstances. In accordance with
subsection 3 (2) of Ministry of Finance regulation no. 53, when making
decisions on comparability, all of the characteristics of a transaction, parties
and environment that can have an influence on the transaction value are
analysed. Above all, the following are compared:
1) characteristics of the object of the transaction;
2) functions fulfilled in the context of the transaction that are identified in the
course of analysis of activity;
3) transaction conditions;
4) economic conditions that influence fulfilment of the transaction;
5) business strategies of the parties to the transaction.
In practice, transfer pricing thus means quite a complex analysis centred on
finding appropriate comparables reflecting arm's length value (i.e. depending
on the selected method, the price of comparable transaction between
unconnected parties, mark-up percentage added to the expenses, profit
margin and other information). Several databases and software programs can
aid in this process, e.g. TP Catalyst[3] developed by Bureau van Dijk, which is
also used by Grant Thornton in its advisory services.
Grant Thornton’s specialists are happy to share additional information and
help their customers in analysing, documenting and controlling transfer prices.
INCOTERMS
What Are Incoterms?
To facilitate commerce around the world, the International Chamber of
Commerce (ICC) publishes a set of Incoterms, officially known as international
commercial terms. Globally recognized, Incoterms prevent confusion in foreign
trade contracts by clarifying the obligations of buyers and sellers. Parties
involved in domestic and international trade commonly use them as a kind of
shorthand to help understand one another and the exact terms of their
business arrangements. Some Incoterms apply to any means of transportation;
others apply strictly to transportation across water.
Understanding Incoterms
The International Chamber of Commerce (ICC) developed Incoterms in
1936 and updates them periodically to conform to changing trade practices.
The ICC's mission is to promote open markets and ensure global economic
prosperity through trade. Because it is a networked business organization that
reaches over 6 million businesses in 100 countries, the ICC is seen as having
unparalleled expertise in establishing rules to guide international trade. While
the adherence to its Incoterms is voluntary, the ICC-established rules are
commonly used by buyers and sellers as a regular part of trade transactions.
Incoterms provide a universal set of rules and guidelines that help facilitate
trade. In essence, they provide a common language traders can use to set the
terms for their trades. Buyers and sellers can use Incoterms in a variety of
activities necessary to conduct business. Typical activities that call for the use
of Incoterms include filling out a purchase order, labeling a shipment for
transport, completing a certificate of origin, or documenting a free carrier
agreement (FCA).
Incoterms Rules for Any Mode of Transport
Some common examples of Incoterms rules for any mode of transportation
include Delivered at Terminal (DAT), Delivered Duty Paid (DDP), and Ex Works
(EXW).
DAT indicates the seller delivers the goods to a terminal and assumes all the
risk and transportation costs until the goods have arrived and been unloaded.
After that, the buyer assumes the risk and transportation costs of the goods
from the terminal to the final destination.
DDP indicates the seller assumes all the risk and transportation costs. The
seller must also clear the goods for export at the shipping port and import at
the destination. Moreover, the seller must pay export and import duties
for goods shipped under DDP.
Under Incoterm Ex Works (EXW), the seller is only required to make the goods
available for pickup at the seller's business location or another specified
location. Under EXW, the buyer assumes all the risk and transportation costs.
Real World Examples of Incoterms
In 2010, the two main categories of Incoterms were updated and classified by
modes of transport. The first classification applies to any mode of transport,
while the second classification only applies to sea and inland waterway
transport.
Group 1 Incoterms: Apply to Any Mode of Transport
EXW Ex Works
FCA Free Carrier
CPT Carriage Paid To
CIP Carriage and Insurance Paid To
DAT Delivered at Terminal
DAP Delivered at Place
DDP Delivered Duty Paid
Group 2 Incoterms: Apply to Sea and Inland Waterway Transport
FAS Free Alongside Ship
FOB Free on Board
CFR Cost and Freight
CIF Cost, Insurance, and Freight
The ICC has specific Incoterms rules for inland waterway and sea
transport such as cost, insurance, and freight (CIF) and free on board (FOB).
Free on board shipment terms indicate the seller delivers the goods on board a
designated vessel named by the buyer. The buyer or seller may assume all the
risk and transportation costs depending on whether the goods are sold under
FOB shipping point or FOB destination point.
Cost, insurance, and freight (CIF) terms indicate the seller must deliver the
goods to a designated port and load them on a specified vessel, assuming
responsibility for paying all transportation, insurance, and loading costs. After
that, the buyer assumes the cost and risk associated with transporting the
cargo from the designated port to its warehouse or business.
