Chapter 11 Pricing Decisions SUMMARY A. Pricing decisions are a critical element of the marketing mix that must reflect costs, competitive factors, and customer perceptions regarding value of the product. In a true global market, the law of one price would prevail. Pricing strategies include market skimming, market penetration, and market holding. Novice exporters frequently use cost-plus pricing. International terms of a sale such as ex-works, DDP, FCA, FAS, CFR, FOB, and CIF are known as Incoterms and specify which party to a transaction is responsible for covering various costs. These and other costs lead to export price escalation, the accumulation of costs that occurs when products are shipped from one country to another. B. Expectations regarding currency fluctuations, inflation, government controls, and the competitive situation must also be factored into pricing decisions. The introduction of the euro has impacted price strategies in the EU because of improved price transparency. Global companies can maintain competitive prices in world markets by shifting production sources as business conditions change. Overall, a company’s pricing policies can be categorized as ethnocentric, polycentric, or geocentric. C. Several additional pricing issues are related to global marketing. The issue of gray market goods arises because price variations between different countries lead to parallel imports. Dumping is another contentious issue that can result in strained relations between trading partners. Price fixing among companies is anticompetitive and illegal. D. Transfer pricing is an issue because of the sheer monetary volume of intra-corporate sales and because country governments are anxious to generate as much tax revenue as possible. Various forms of countertrade play an important role in today’s global environment. Barter, counter purchase, offset, compensation trading, and switch trading are the main countertrade options. LEARNING OBJECTIVES 1 Review the basic pricing concepts that underlie a successful global marketing pricing strategy. 2 Identify the different pricing strategies and objectives that influence decisions about pricing products in global markets. 3 Summarize the various Incoterms that affect the final price of a product. 4 List some of the environmental influences that impact prices. 5 Apply the ethnocentric/polycentric/geocentric framework to decisions regarding price. 6 Explain some of the tactics global companies can use to combat the problem of gray market goods. 7 Assess the impact of dumping on prices in global markets. 8 Compare and contrast the different types of price fixing. 9 Explain the concept of transfer pricing. 10 Define countertrade and explain the various forms it can take. DISCUSSION QUESTIONS 11-4. What are the basic factors that affect price in any market? What considerations enter into the pricing decision? Answer: One factor is the price floor, which can be linked to product cost or some other consideration. For example, in the fall of 1996, Florida tomato growers concerned about cheap tomatoes from Mexico persuaded the U.S. government to impose a price floor of 21 cents per pound on Mexican tomatoes. A second basic factor is the price ceiling, an upper limit created when comparable products are available. As industries globalize, consumers should enjoy lower prices unless national or regional protective barriers are erected to imports. The U.S. market for entry-level luxury cars is crowded with imported nameplates, and price competition in the entry-level category is fierce among Lexus, Infiniti, Mercedes-Benz, and BMW. In the Mercosur countries, on the other hand, external tariffs on motor vehicles are still as high as 70 percent. Thus, many consumers in Brazil, Argentina, Uruguay, and Paraguay must buy locally produced vehicles at high prices. Finally, between these two extremes there is an optimum price. Many Japanese companies have struggled to find the optimum price in view of a strong and fluctuating yen. Some pricing considerations include: • Whether or not a product’s quality is reflected in the price • How to price to different segments. • Determining the latitude to adjust prices if costs change. • Enforcement of dumping laws. 11-5. Define the various types of pricing strategies and objectives available to global marketers. Answer: The three strategies discussed in the chapter are market skimming, penetration pricing, and market holding or status quo pricing. Market skimming is appropriate in the introductory phase of the product life cycle if there is little competition or few acceptable substitutes. Skimming can be the quickest way for a company to recoup product development and marketing costs. When Thomson SA’s RCA unit launched its 18-inch Direct Satellite system in 1994, the basic unit sold for $699. By 1996, the price had fallen by several hundred dollars as competing DSS brands came onto the market. However, by that time RCA had already sold one million units at the higher price. With a penetration pricing strategy, a relatively low price is established in an effort to gain market share. This strategy has historically been favored by Japanese companies that take a longer-term view of profitability. RCA has clearly switched form skimming to penetration as DSS enters the growth phase of the product life cycle. Status quo pricing is particularly important in global marketing because currency fluctuations can drive up product prices in export markets. To avoid a sales decline, a company should be prepared to adjust prices. Another option is to try to cut fixed or variable costs. 11-6. Identify some of the environmental constraints on global pricing decisions. Answer: Currency fluctuations are an important consideration in global marketing. Inflation is another factor in the economic environment that may force a company to make frequent price changes. Government regulations can hinder or prohibit a company’s efforts to adjust costs. Finally, the presence or absence of competitors directly affects a company’s flexibility with prices. In the absence of competitive restraints, a company can charge whatever the market will bear. In Switzerland, for example, there is little competition for imported Chevy S pickup trucks, so the price per vehicle is nearly double the typical price paid in the U.S. 11-7. Why do price differences in world markets often lead to gray marketing? Answer: Price differentials mean opportunity to engage in arbitrage. “Buy low, sell high” is the operative phase, and many entrepreneurs are quick to capitalize on the chance to make some quick money. On the consumption side, many buyers jump at the chance to save money. They are willing to ignore issues such as buying from “authorized dealers.” 11-8. What is a transfer price? Why is it an important issue for companies with foreign affiliates? Why did transfer pricing in Europe take on increased importance in 1999? Answer: A transfer price if the price one unit of a company charges to another company unit for goods and services. Transfer prices can be determined on the basis of the market, or by negotiation between the company’s various units. Companies under the jurisdiction of U.S. tax laws must comply with Section 482, the portion of the Internal Revenue Code that deals with controlled intra-corporate transfers. 11-9. What is the difference between ethnocentric, polycentric, and global pricing strategies? Which one would you recommend to a company that has global market aspirations? Answer: An ethnocentric pricing policy calls for the price of a particular product to be the same in every part of the world. When management uses this approach it foregoes opportunities to set prices higher in countries where a lower price is required. A polycentric approach relies on adaptation of country managers who attempt to be as responsive as possible to local market conditions. One problem with the polycentric approach is that it creates conditions in which gray marketing can flourish. A geocentric pricing approach balances the desire for long-term returns on investment with shorter-term considerations such as market share. The geocentric approach is most appropriate for a company with a global strategy and global aspirations. 11-10. If you were responsible for marketing CAT scanners worldwide (average price, $1,200,000) and your country of manufacture was experiencing a strong and appreciating currency against almost all other currencies, what options are available to you to maintain your competitive advantage in world markets? Answer: The real issue here is not just options for adjusting prices, but options that will allow the marketer to maintain competitive advantage. One option is to shift manufacture to one or more weak-currency countries. If that is not feasible, another medical-products company could become license under license. Another is to keep manufacturing in the strong currency country, focusing on cost-cutting efficiencies and/or product innovation and improvements that will differentiate the scanners. A lower cost, “no frills” model can be developed for some markets. 11-11. Compare and contrast the different forms of countertrade. Answer: Companies barter when buyers are unable to pay in cash, or when a country’s currency is not freely convertible in foreign exchange markets. Barter is a category of countertrade in which goods, but no money, is exchanged. Other forms of countertrade, including countertrade, offset, and compensation trading, may also involve exchanging money or credit. OVERVIEW In general, two basic factors determine the boundaries within which prices should be set. The first is product cost, which establishes a price floor, or minimum price. Second, prices for comparable substitute products create a price ceiling, or maximum price. In many instances, global competition puts pressure on the pricing policies and related cost structures of domestic companies. The imperative to cut costs – especially fixed costs - is one of the reasons for the growth of outsourcing. in some cases, local market conditions such as low incomes force companies to innovate by creating new products that can be profitably sold at low prices. Between the lower and upper boundary for every product there is an optimum price, which is a function of the demand for the product as determined by the willingness and ability of customers to buy. In this chapter, we will review basic pricing concepts, and then discuss several pricing topics that pertain to global marketing. In the second half of the chapter, we will discuss gray market goods, dumping, price fixing, transfer pricing, and countertrade. ANNOTATED LECTURE/OUTLINE BASIC PRICING CONCEPTS √ (Learning Objective #1) Generally speaking, international trade results in lower prices for goods. Lower prices, in turn, help keep a country’s rate of inflation in check. In a true global market, the law of one price would prevail: All customers in the market could get the best product available for the best price. Because of differences in national markets, the global marketer must develop pricing systems and pricing policies that take into account price floors, price ceilings, and optimum prices. A firm’s pricing system and policies must also be consistent with other uniquely global opportunities and constraints. There is another important internal organizational consideration besides cost. Within the typical corporation, there are many interest groups and, frequently, conflicting price objectives. Divisional vice presidents, regional executives, and country managers are each concerned about profitability at their respective organizational levels. Similarly, the director of global marketing seeks competitive prices in world markets. The controller and financial vice president are concerned about profits. The manufacturing vice president seeks long production runs for maximum manufacturing efficiency. The tax manager is concerned about compliance with government transfer pricing legislation. Finally, company counsel is concerned about the antitrust implications of global pricing practices. Ultimately, price generally reflects the goals set by members or the sales staff, product managers, corporate division chiefs, and/or the company’s chief executive. GLOBAL PRICING OBJECTIVES AND STRATEGIES √ (Learning Objective #2) Whether dealing with a single home-country market or multiple country markets, marketing manages must develop pricing objectives as well as strategies for achieving those objectives. The pricing strategy for a particular product may vary from country to country; a product may be positioned as a low-priced, mass-market product in some countries and a premium-priced, niche product in others. Pricing objectives may also vary depending on a product’s life-cycle stage and the country-specific competitive situation. It is necessary to factor in external considerations such as the added cost associated with shipping goods long distances across national boundaries. The issue of global pricing can also be fully integrated in the product design process, an approach widely used by Japanese companies. Market Skimming and Financial Objectives Price can be used as a strategic variable to achieve specific financial goals, including return on investment, profit, and rapid recovery of product development costs. When financial criteria such as profit and maintained of margins are the objectives, the product must be part of a superior value proposition for buyers: price is integral to the total positioning strategy. The market skimming pricing strategy is often part of a deliberate attempt to reach a market segment that is willing to pay a premium price for a particular brand or for a specialized or unique product. (See Exhibit 11-2 and 11-3) Companies that seek competitive advantage by pursuing differentiation strategies or positioning their products in the premium segment frequently use market skimming. The skimming pricing strategy is appropriate in the introductory phase of the product life cycle when both production capacity and competition are limited. By setting a deliberately high price, demand is limited to innovators and early adopters who are willing and able to pay the price. This strategy has been used consistently in the consumer electronics industry. Penetration Pricing and Nonfinancial Objectives Some companies are pursuing nonfinancial objectives with their pricing strategy. Price can be used as a competitive weapon to gain or maintain market position. Market share or other sales based objectives are frequently set by companies that enjoy cost-leadership positions in their industry. A market penetration pricing policy strategy calls for setting price levels that are low enough to quickly build market share. Historically many companies that used this type of pricing were located in the Pacific Rim. Companion Products: "Razors and Blades" Pricing When formulating pricing strategies for products such as video game consoles, DVD players, and smartphones, it is necessary to view these products in a broader context. The biggest profits in the video industry come from sales of game software; even though Sony and Microsoft may actually lose money on each console, sales of hit video titles generate substantial revenues and profits. These examples illustrate the concept of companion products: A video game console has no value without video game software, and a DVD player has no value without movies on DVD. Additional examples abound. A razor handle has no value without blades; thus Gillette can sell a single Mach3 razor for less than $5—or even give the razor away for free. Over a period of years, the company will make significant profits from selling packages of replacement blades. As the saying goes, “If you make money on the blades, you can give away the razors.” Target Costing Japanese companies have traditionally approached cost issues in a way that results in substantial production savings and products that are competitively priced in the global marketplace. The process, sometimes known as design to cost, can be described as follows: Target costing ensures that development teams will bring profitable products to market not only with the right level of quality and functionality but also with appropriate prices for the target customer segments. It is a discipline that harmonizes the labor of disparate participants in the development effort, from designers and manufacturing engineers to market researchers and suppliers. In effect, the company reasons backward from customers’ needs and willingness to pay instead of following the flawed but common practice of cost-plus pricing. Western companies are beginning to adopt some of these money-saving ideas. The target costing approach can be used with inexpensive consumer nondurables. As shown in Figure 11-1, the target costing process begins with market mapping and product definition and positioning; this requires using concepts and techniques discussed in Chapters 6 and 7. The marketing team must do the following: • Determine the segment(s) to be targeted, as well as the prices that customers in the segment will be willing to pay. • Compute overall target costs with the aim of ensuring the company’s future profitability. • Allocate target costs to the product’s various functions. Calculate the gap between the target cost and the estimated actual production cost. • Obey the cardinal rule: If the design team can’t meet the targets, the product should not be launched. Using market research techniques such as conjoint analysis, the team seeks to better understand how customers will perceive product features and functionalities. Calculating Prices: Cost-Plus Pricing and Export Price Escalation In global marketing, the total cost will depend on the ultimate market destination, the mode of transport, tariffs, and various fees, handling charges, and documentations costs. Export price escalation is the increase in the final selling price of goods traded across borders that reflects these factors. The following is a list of eight basic considerations for setting prices on goods that cross borders: 1. Does the price reflect the product’s quality? 2. Is the price competitive, given local market conditions? 3. Should the firm pursue market penetration, market skimming, or another pricing objective? 4. What type of discount (trade, cash, quantity) and allowance (advertising, trade-off) should the firm offer its international customers? 5. Should prices differ with market segment? 6. What pricing options are available if the firm's costs increase or decrease? Is demand in the international market elastic or inelastic? 7. Are the firm’s prices likely to be viewed by the host-country government as reasonable or exploitative? 8. Do the foreign country’s dumping laws pose a problem? Companies frequently use a method known as cost-plus or cost-based pricing when selling goods outside their home-country markets. Cost-based pricing is based on an analysis of internal (e.g. materials, labor, testing) and external costs. Firms that comply with Western cost accounting principles typically use full absorption cost method; this defines per-unit product cost as the sum of all past or current direct and indirect manufacturing and overhead costs. However, when goods cross national borders, additional costs and expenses such as transportation, duties, and insurance are incurred. If the manufacturer is responsible for hem, they too must be included. By adding the desired profit margin to the cost-plus figure, managers can arrive at a final selling price. Companies using rigid cost-plus pricing set prices without regard to the eight considerations listed previously. They make no adjustments to reflect market conditions outside the home country. The obvious advantage of rigid cost-based pricing is its simplicity: Assuming that both internal and external cost figures are readily available, it is relatively easy to arrive at a quote. The disadvantage is that this approach ignores demand and competitive conditions in target markets; the risk is that prices will either be set too high or too low. If the rigid cost-based approach results in market success, it is only by chance. Flexible cost-plus pricing is used to ensure that prices are competitive in the context of the particular market environment. This approach is frequently used by experienced exporters and global marketers. Flexible cost plus sometimes incorporates the estimated future cost method to establish the future cost for all component elements. Managers who utilize flexible cost-plus pricing are acknowledging the importance of the eight criteria listed earlier. Flexible cost-plus pricing sometimes incorporates the estimated future cost method to establish the future cost for all component elements. Terms of the Sale Every commercial transaction is based on a contract of sale, and the trade terms in that contract specify the exact point at which ownership of merchandise is transferred from the seller to the buyer and which party in the transaction pays which costs. The following activities must be performed when goods cross international boundaries: 1. Obtaining an export license if required 2. Obtaining a currency permit if required 3. Packing the goods for export 4. Transporting the goods to the place of departure 5. Preparing a land bill of lading 6. Completing necessary customs export papers 7. Preparing customs or consular invoices as required by the country of destination 8. Arranging for ocean freight and preparation 9. Obtaining marine insurance and certificate of the policy Who is responsible for performing these tasks? The answer is “It depends on the terms of the sale.” THE CULTURAL TEXT Ethics, Religion, and Sustainable Production It’s a basic law of economics: When supply goes up, price goes down. Historically, coffee has been one of the most lucrative exports in many developing nations. Since the mid-1990s, Starbucks has pursued a policy of improving the working conditions of its suppliers; however, in 2011, Starbucks’ coffee purchases amounted to only 428 million pounds. Luckily, a number of different nongovernmental organizations have begun to address the situation faced by farmers who supply the broader coffee market. Fairtrade International (FLO; www.fairtrade.net), a certification authority based in Bonn, Germany, represents more than 1 million farmers and workers. FLO licenses its trademark to organizations such as the UK’s Fairtrade Foundation (www.fairtrade.org.uk). The Fairtrade label on a bag or can of coffee indicates that growers were paid a fair price for their crops. Fair Trade USA is a fair-trade certification organization in the United States (www.fairtradeusa.org). Coffee bearing the Fairtrade label is often marketed with the help of charitable organizations. Kraft signed an accord with the Rainforest Alliance in which Kraft, the purchaser of about 10 percent of the world’s coffee crop, agreed to buy beans that are certified as being produced with sustainable agricultural practices and then blend them into their mass-market brands. The purchases will amount to about $3.1 billion annually and will benefit farmers in Brazil, Colombia, Mexico, and Central America. Tensie Whelen, executive director for the Rainforest Alliance, hailed the accord, noting, “This step by Kraft marks the beginning of transforming the coffee industry. You have a company capable of shaping markets commit to buying a significant amount of coffee and to mainstreaming across their brands and not ‘ghettoising’ it in one brand.” The internationally accepted terms of trade are known as Incoterms (short for International Commercial Terms). √ (Learning Objective #3) Incoterms are classified into four categories: 1. Ex-works (EXW), the sole “E-Term” or “origin” term among Incoterms, refers to a transaction in which the buyer takes delivery at the premises of the seller; the buyer bears all risks and expenses from that point on. 2. Delivered duty paid (DDP). The seller has agreed to deliver the goods to the buyer at the place the names in the country of import, with all costs, including duties, paid. 3. Free carrier (FCA). Also known as “F-Terms” or “pre-main-carriage terms.” FCA is widely used in global sales. Under FCA, transfer from seller to buyer is effected when the goods are delivered to a specified carrier at a specified destination. a. FAS (free alongside ship) named port is the Incoterm for a transaction in which the seller places the shipment alongside, or available to, the vessel upon which the goods will be transported out of the country. b. FOB (free on board) named port. The responsibility and liability of the seller do not end until the goods have cleared the ship’s rail. 4. Several Incoterms are known as “C-Terms” or “main-carriage” terms. a. CIF (cost, insurance, freight) named port is the risk of loss or damage to goods is transferred to the buyer once the goods have passed the ship’s rail. The seller pays transportation and insurance. b. If the terms of the sale are CFR (cost and freight), the seller is not responsible for risk or loss at any point outside the factory. Table 11-1 is a typical example of the kind of export price escalation that can occur when some of the costs are added to the per-unit cost of the product itself. EMERGING MARKETS BRIEFING BOOK Demand in Asia Drives Fine Wine Prices As every student of microeconomics knows, when demand exceeds supply, prices tend to rise. The market for fine wine is a textbook example. Each year connoisseurs seek out wines from top estates such as France’s Château Lafite Rothschild. A single bottle from a top vintage—for example, 2009—can cost $1,000 or more. The world’s best wines need some time in the cellar and, as the years go by, the bottles appreciate in value. Today, a new customer has joined the global wine culture: affluent collectors in China and other Asian countries. Several factors have contributed to this trend. In 2008, the Hong Kong government reduced tariffs on wine imports from 40 percent to zero. Since then, a flourishing wine auction scene has emerged within the Special Administrative Region. As the Chinese economy has boomed, well-heeled consumers and collectors can’t seem to get enough of Château Lafite and other wines. How many Chinese are willing and able to buy expensive wine? Chinese wine drinkers do their homework; they have been known to check out the tasting scores and prices of wines they have been served. This, of course, reflects the importance of status in Asian culture. As one European wine exporter noted, “Every case of Chateau Lafite we purchase ends up in China.” ENVIRONMENTAL INFLUENCES ON PRICING DECISIONS √ (Learning Objective #4) Global marketers must deal with a number of environmental considerations when making pricing decisions. Among them are currency fluctuations, inflation, government controls and subsidies, and competitive behavior. Currency Fluctuations Currency fluctuations can create significant challenges and opportunities for any company that exports. A weakening of the home-country currency swings exchange rates in a favorable direction: a producer in a weak-currency country can choose to cut export prices to increase market share or maintain its prices and reap healthier profit margins. It is a different situation when a company’s home currency strengthens; this is an unfavorable turn of events for the typical exporter because overseas revenues are reduced when translated into the home country currency. In responding to currency fluctuations, global marketers can utilize other elements of the marketing mix besides price. The use of the flexible cost-plus method to reduce prices in response to unfavorable currency swings is an example of a market holding strategy and is adopted by companies that do not want to lose market share. Price transparency means that buyers will be able to comparison shop easily because goods will be priced in a single currency (Euros) as opposed to multiple currencies (marks, francs, or lira). Inflationary Environment Inflation, or a persistent upward change in price levels, is a problem in many countries markets and can be caused by an increase in the money supply. An essential requirement for pricing during inflation is the maintenance of profit margins When present, inflation requires price adjustments for a simple reason: Increased selling prices must cover rising costs. Regardless of cost accounting practices, if a company maintains its margins, it has effectively protected itself for the effects of inflation. Low inflation presents different pricing challenges. For example, though the U.S. had low inflation and strong demand in the 1990s, excess manufacturing, high European unemployment, and the Asian recession made price hikes difficult. Globalization, the Internet, a flood of low-cost imports from China, and a new cost- consciousness among buyers became constraining factors. Government Controls, Subsidies, and Regulations Governmental policies and regulations that affect pricing include dumping legislation, resale price maintenance legislation, price ceilings, and general reviews of price levels. Government action that limits price adjustment puts pressure on margins. Under certain conditions, government actions pose a threat to the profitability of a subsidiary operation. In a country with severe financial difficulties or crisis, government officials are under pressure to take action (e.g., Brazil). When selective controls are imposed, foreign companies are more vulnerable than local businesses particularly, if the outsiders lack the political influence over government decisions than local managers have. For example, Procter & Gamble encountered strict price controls in Venezuela in the late 1980s, receiving only 50 percent of the price increases requested. Government control can also take other forms. Companies are sometimes required to deposit funds in noninterest-bearing escrow accounts for a specified period of time if they wish to import products. Cash deposit requirements clearly create an incentive for a company to minimize the stated value of the imported goods; lower prices mean smaller deposits. Other government requirements that affect the pricing decision are profit transfer rules that restrict the conditions under which profits can be transferred out of a country. Under such rules, a high transfer price paid for imported goods by an affiliated company can be interpreted as a device for transferring profits out of a country. Government regulations can affect prices in other ways. The German government’s recent moves toward deregulation have improved the climate for market entry by foreign firms in a range of industries, including insurance, telecommunications, and air travel. Deregulation is also giving German companies their first experience with price competition in the domestic market. In some instances, deregulation represents a quid pro quo that will allow German companies wider access to other country markets. Competitive Behavior Pricing decisions are bounded not only by cost and the nature of demand but also by competitive action. If competitors do not adjust their prices in response to rising costs, management will be severely constrained in its ability to adjust prices accordingly. Conversely, if competitors are manufacturing or sourcing in a lower-cost country, it may be necessary to cut prices to stay competitive. Levi Strauss and Company jeans are under price pressures from several directions—in the U.S. and overseas. Using Sourcing as a Strategic Pricing Tool The global marketer has several options for addressing the problem of price escalation or the environmental factors. Product and market competition dictate the marketer’s choices. Manufacturers may be forced to switch to offshore sourcing to keep costs and prices competitive. China is quickly gaining a reputation as the “the world’s workshop” (e.g. U.S. bicycle manufacturers rely on production sources in China and Taiwan). Another option is an audit of the distribution structure in the target markets. A rationalization of the distribution structure can reduce markups required to achieve distribution. Rationalization may include selecting new intermediaries, reassigning responsibilities, or establishing direct. GLOBAL PRICING: THREE POLICY ALTERNATIVES √ (Learning Objective #5) There are three alternative positions a company can take on worldwide pricing. Extension or Ethnocentric The first can be called an extension or ethnocentric pricing policy. An extension or ethnocentric pricing policy calls for the per-unit price of an item to be the same no matter where in the world the buyer is located. In such instances, the importer must absorb freight and import duties. The extension approach has the advantage of extreme simplicity because no information on competitive or market conditions is required for implementation. The disadvantage of the ethnocentric approach is that it does not respond to the competitive and market conditions of each national market and therefore, does not maximize the company’s profits in each national market or globally. Adaptation or Polycentric The second policy, adaptation or polycentric pricing, permits subsidiary or affiliate managers or independent distributors to establish whatever price they feel is most appropriate in their market environment. There is no requirement that prices be coordinated from one country to the next. IKEA takes a polycentric approach to pricing. One recent study of European industrial exporters found that companies utilizing independent distributors were the most likely to utilize polycentric pricing. Such an approach is sensitive to local market conditions; however, valuable knowledge and experience within the corporate system concerning effective pricing strategies are not brought to bear on each local pricing decision. Arbitrage is also a potential problem with the polycentric approach; when disparities in prices between different country markets exceed the transportation and duty costs separating the markets. Geocentric The third approach, geocentric pricing, is more dynamic and proactive than the other two. A company using geocentric pricing neither fixes a single price worldwide, nor allows subsidiaries or local distributors to make independent pricing decisions. Instead, the geocentric approach represents an intermediate course of action. Geocentric pricing is based on the realization that unique local market factors should be recognized in arriving at pricing decisions. These factors include local costs, income levels, competition, and the local marketing strategy. Price must also be integrated with other elements of the marketing program. The geocentric approach recognizes that price coordination from headquarters is necessary in dealing with international accounts and product arbitrage. The geocentric approach also consciously and systematically seeks to ensure that accumulated national pricing experience is leveraged and applied wherever relevant. Local costs plus a return on invested capital and personnel fix the price floor for the long term. For consumer products, local income levels are critical in the pricing decision. GRAY MARKET GOODS √ (Learning Objective #6) Gray market goods are trademarked products that are exported from one country to another where they are sold by unauthorized persons or organizations. Parallel importing occurs when companies employ a polycentric, multinational pricing policy that calls for setting different prices in different country markets. Gray markets can flourish when a product is in short supply, when producers employ skimming strategies in certain markets, or when the goods are subject to substantial markups. Gray markets impose several costs or consequences on global marketers. These include: Dilution of exclusivity. Authorized dealers are no longer the sole distributors. Free riding. If the manufacturer ignores complaints from authorized channel members, those members may engage in free riding. That is, they may opt to take various actions to offset downward pressure on margins. Damage to channel relationships. Competition from gray market products can lead to channel conflict as authorized distributors attempt to cut costs, complain to manufacturers, and file lawsuits against the gray marketers. Undermining segmented pricing schemes. A variety of forces—including falling trade barriers, the information explosion on the Internet, and modern distribution capabilities—hamper a company’s ability to pursue local pricing strategies. Reputation and legal liability. Even though gray market goods carry the same trademarks as goods sold through authorized channels, they may differ in quality, ingredients, or some other way. Companies should develop proactive strategic responses to gray markets. DUMPING √ (Learning Objective #7) Dumping is an important global pricing strategy issue. GATT’s 1979 antidumping code defined dumping as the sale of an imported product at a price lower than that normally charged in a domestic market or country of origin. In addition, many countries have their own policies and procedures for protecting national companies from dumping. The U.S. Congress has defined dumping as an unfair trade practice that results in “injury, destruction, or prevention of the establishment of American industry.” In 2000, the U.S. Congress passed the so-called Byrd Amendment; this law calls for antidumping revenues to be paid to U.S. companies harmed by imported goods sold at below-market prices In Europe, antidumping policy is administered by the European Commission; a simple majority vote by the Council of Ministers is required before duties can be imposed on dumped goods. For positive proof that dumping has occurred in the United States, both price discrimination and injury must be demonstrated. Price discrimination is the practice of setting different prices when selling the same quantity of “like-quality” goods to different buyers. PRICE FIXING √ (Learning Objective #8) In most instances, it is illegal for representatives of two or more companies to secretly set similar prices for their products. Price fixing is generally held to be an anticompetitive act. In horizontal price fixing, competitors within an industry that make and market the same product conspire to keep prices high. Vertical price fixing occurs when a manufacturer conspires with wholesalers or retailers (i.e., channel members at different “levels” from the manufacturer) to ensure certain retail prices are maintained. TRANSFER PRICING √ (Learning Objective #9) Transfer pricing refers to the pricing of goods, services, and intangible property bought and sold by operating units or divisions of the same company. Transfer pricing concerns intra corporate exchanges, which are transactions between buyers and sellers that have the same corporate parent. For example, Toyota subsidiaries both sell to, and buy from, each other. In determining transfer prices to subsidiaries, global companies must address a number of issues, including taxes, duties, and tariffs, country profit transfer rules, conflicting objectives of joint venture partners, and government regulations. Tax authorities take a keen interest in transfer pricing policies. Three major alternative approaches can be applied to transfer pricing decisions: 1. A market-based transfer price is derived from the price required to be competitive in the global marketplace. 2. Cost-based transfer pricing uses an internal cost as the starting point in determining price. Cost-based transfer pricing can take the same forms as the cost-based pricing methods discussed earlier in the chapter. 3. Negotiated transfer price occurs when the organization’s affiliates determine the prices among themselves. This method may be employed when market prices are subject the frequent changes. (Table 11-4) Tax Regulations and Transfer Prices Because global companies conduct business in world characterized by different corporate tax rates, there is an incentive to maximize income in countries with the lowest tax rates and to minimize income in high-tax countries. In recent years, many governments have tried to maximize national tax revenues by examining company returns and mandating reallocation of income and expenses (see Table 11-7). Sales of Tangible and Intangible Property Each country has its own set of laws and regulations for dealing with controlled intracompany transfers. Whatever the pricing rationale, executives and managers involved in global pricing policy decisions must familiarize themselves with the laws and regulations in the applicable countries. COUNTERTRADE √ (Learning Objective #10) In recent years, many exporters have been forced to finance international transactions by taking full or partial payments in some form other than money. A number of alternative finance methods, known as countertrade, are widely used. In a countertrade transaction, a sale results in product flowing in one direction to a buyer; a separate stream of products and services, often flowing in the opposite direction, is also created. Countertrade generally involves a seller from the West and a buyer in a developing country. Countertrade flourishes when hard currency is scarce. Exchange controls may prevent a company from expatriating earnings; the company may be forced to spend money in-country for products that are then exported and sold in third-country markets. Historically, the single most important driving force behind the proliferation of countertrade was the decreasing ability of developing countries to finance imports through bank loans. Generally, several conditions affect the probability that some form of countertrade will be used: • The priority attached to the Western import. The higher the priority, the less likely it is that countertrade will be required. • The value of the transaction; the higher the value, the greater the likelihood that countertrade will be involved. • The availability of products from other suppliers can also be a factor. If a company is the sole supplier of a differentiated product, it can demand monetary payment. Barter The term barter describes the least complex and oldest form of bilateral, non-monetized countertrade. Simple barter is a direct exchange of goods or services between two parties. Although no money is involved, both partners construct an approximate shadow price for products flowing in each direction. Counterpurchase The counter purchase form of countertrade, also termed parallel trading or parallel barter, is distinguished from other forms in that each delivery in an exchange is paid for in cash. Offset Offset is a reciprocal arrangement whereby the government in the importing country seeks to recover large sums of hard currency spent on expensive purchases such as military aircraft or telecommunications systems. Distinguishing characteristics between offset and counter purchase: • Counterpurchase is characterized by smaller deals over shorter periods of time. • Offset is not contractual but reflects a memorandum of understanding that sets out the dollar value of products to be offset and the time period for completing the transaction. • Offsets have become a controversial facet of today’s trade environments. Compensation Trading Compensation trading, also called buyback, is a form of countertrade that involves two separate and parallel contracts. In one contract, the supplier agrees to build a plant or provide plant equipment, patents or licenses, or technical, managerial, or distribution expertise for a hard currency down payment at the time of delivery. In the other contract, the supplier company agrees to take payment in the form of the plant’s output equal to its investment (minus interest) for a period of as many as 20 years. Essentially, the success of compensation trading rests on the willingness of each firm to be both a buyer and a seller. Switch Trading Also called triangular trade and swap, switch trading is a mechanism that can be applied to barter or countertrade. In this arrangement, a third party steps into a simple barter or other countertrade arrangement when one of the parties is not willing to accept all the goods received in a transaction. The third party may be a professional switch trader, switch trading house, or a bank. The switching mechanism provides a "secondary market" for countertraded or bartered goods and reduces the inflexibility inherent in barter and countertrade. CASES Case 11-1: Global Companies Target Low-Income Consumers (B) Overview: The Logan is a case study in driving down costs. Established automakers in developing countries are racing to develop low-cost vehicles for the entry-level buyers. The question is: Can the auto companies come up with the optimal value proposition? 11-12. What is the key to the Logan’s low price? Answer: Logans are manufactured in seven countries so supply is close to demand; the company is driving down costs everywhere: Windshields are nearly flat, outside mirrors are identical, and the Logan shares an engine and gear box with Renault’s other models. All of these and other cost saving methods keep Logan’s price as low as possible. 11-13. Do you think Tata will be able to save the Nano? What steps should the company take? Answer: Since Tata’s target market is consumers in those emerging markets that currently travel by scooter, the Nano should be a success. It is in the emerging markets of India, China, Southern Asia, and other countries where consumers are seeing a rapid increase in their life-styles and consumer goods. The steps taken will vary by student. 11-14. Assess Carlos Ghosn’s plan to revive the Datsun nameplate. Can a car that sells for $ 3,000 make a profit for the parent company? Answer: Ghosn’s plan is based on his beliefs and his past. Thorough study of the consumer in his target market may not have been done. Does the consumer want transportation or does status play a role also? Can a $ 3000 car make a company profit – I don’t know. 11-15. Low-cost cars such as the Nano and Datsun lack the multilayered safety and quality features required by regulators in high-income markets. Is it appropriate to create “bare-bones” cars with fewer safety features for emerging markets? Answer: Student’s answers will vary on this question, but study of the consumer in the target market must be done for a complete analysis. Creating "bare-bones" cars for emerging markets can be appropriate if they address affordability and basic transportation needs. However, it's crucial to ensure that even minimal safety features meet regulatory standards and protect consumers. Balancing cost with essential safety and quality standards is key to providing value while safeguarding user well-being. Case 11-2: LVMH and Luxury Goods Marketing Overview: One fashion house that is changing with the times is LVMH Moët Hennessy Louis Vuitton SA, the largest marketer of luxury products and brands in the world. Chairman Bernard Arnault presides over a diverse empire of products and brands, sales of which totaled nearly $15 billion in 2002. Arnault, whom some refer to as “the pope of high fashion,” summed up the luxury business: “We are here to sell dreams. When you see a couture show on TV around the world, you dream. When you enter a Dior boutique and buy your lipstick, you buy something affordable, but it has the dream in it.” The company’s specialty group includes Duty Free Shoppers (DFS) and Sephora. DFS operates stores in international airports around the world; Sephora, which LVMH acquired in 1997, is Europe’s second-largest chain of perfume and cosmetics stores. 11-16. What were the possible risks of Louis Vuitton’s first-ever television advertising campaign? Answer: Executives raised wholesale prices in an effort to prevent discount retailers from purchasing designer products for resale in mass market outlets. They also raised prices in countries that have experienced currency devaluations. Finally, cutting back on advertising and other promotional expenses may have helped maintain profitability. 11-17. In March 2008, the euro/dollar exchange rate was €1 = $1.50. By November, the dollar had strengthened to €1 = $1.25. Assume that a European luxury goods marketer cuts the price of an $8,000 tweed suit by 10 percent to maintain holiday sales in December. How will revenues be affected when dollar prices are converted to Euros? Answer: An $8,000 suit in Euros is equal to 10,000 Euros at the $1.25 / 1 rate. With a 10% price cut, the $8,000 suit is now $7,200 but only 9,000 Euros. The seller “lost” 1,000 Euros for a $800 price decline. 11-18. Louis Vuitton executives raised prices in 2008, and sales continued to increase. What does this say about the demand curve of the typical Louis Vuitton customer? Answer: In most cases, luxury products are characterized by superior craftsmanship. Luxury goods prices are based on perceived exclusivity and differentiation of the brands. Certainly, the performance of the U.S. economy bodes well for luxury goods marketers. Consumer confidence runs high and the economy has shown resilience; naturally many will want “the best,” which means luxury brands. 11-19. Compare and contrast LVMH’s pricing strategy with that of Coach (chapter 6). Answer: Coach’s brand positioning can be described as “accessible luxury”, while LV describes itself as “selling dreams”. LV markets are small, niche brands catering to the very rich. Finally, while Coach has continued to sell leather-based products, LVMH has branched out to include wines and spirits, selective retailing, perfume and cosmetics, watches and jewelry in addition to its branded leather goods. Case 11-3: One Laptop per Child Overview: In 2005, after 20 years at the prestigious Media Labe at MIT, Nicolas Negroponte announced he was leaving to pursue an ambitious vision: bridging the digital divide between developed and developing nations by providing powerful PCs to schoolchildren in sub-Saharan Africa and other impoverished parts of the world. Negroponte named his initiative One Laptop Per Child (OLPC); his goal was to develop a $100 laptop that governments could buy in large quantities and distribute to schools. As Negroponte said, “My goal is not selling laptops. OLPC is not in the laptop business. It’s in the education business.” In April 2007, Negroponte announced that he hoped to have between 50 and 150 million children using the new computer by the end of 2008. In November 2007, in an effort to increase production, OLPC announced a promotion called “Give One. Get One.” Consumers in the United States and Canada were offered the opportunity to buy two OLPC computers for $399. Each buyer would keep one laptop; the second would go to a student in Haiti or another developing country. In 2008, faced with disappointing sales, Negroponte struck a deal with Microsoft. Starting in 2010, the OLPC laptops would be delivered with both the Microsoft Windows operating system and the non-proprietary Linux OS. Microsoft would provide the software for about $3 per computer, bringing the total selling price of each laptop to $199. 11-20. Why are Microsoft, Intel, and other leading for-profit companies interested in low-cost computers for the developing world? Answer: Several answers are available for this question and the students’ answers will vary. Corporate Social Responsibility to give back is one as is increased sales. Microsoft, Intel, and other leading companies are interested in low-cost computers for the developing world to expand their market reach and create future customer bases. These initiatives also foster global digital inclusion, drive growth in emerging markets, and align with corporate social responsibility goals by improving access to technology and education. 11-21. Do you agree with Negroponte’s decision to partner with Microsoft? Answer: Yes I agree with is decision as Microsoft is a forward-thinking organization and their presence will draw the attention of industry leaders globally. 11-22. Discuss the thinking behind the “Give One. Get One.” promotion. Do you think this is a good marketing tactic? Answer: The thinking behind this promotion was to give the consumers a chance to help others less fortunate than themselves. Yes it is a good marketing tactic as it appeals to the emotions of consumers. TEACHING TOOLS AND EXERCISES Activity: Students should be preparing or presenting their Cultural-Economic Analysis and Marketing Plan for their country and product as outlined in Chapter 1. Out-of-Class Reading: Nagle, Thomas T. and Reed Holden. The Strategy and Tactics of Pricing: A Guide to Profitable Decision Making 3/e. Upper Saddle River, New Jersey: Prentice Hall, 2002. Internet Exercise: Look up prices for some upscale watch brands (like Movado, Tag Heur, or Rolex) from traditional U.S.-based merchants like Macy’s or Saks Fifth Avenue. Then go to www.alibaba.com and checkout the prices for these “similar” products. What are the price differentials? Is the “price” for the genuine article worth the “difference” for the knockoffs? Go to www.overstock.com and check out the prices of these similar products through the “grey market. Again, is the price differential worth the monetary difference? Explain your rationale. Guest Speaker: Invite a local service provider (attorney, shopkeeper) and asked them to speak to the class about how they “price” there particular service. Compare and contrast “how” they price from the descriptions and strategies outlined in this chapter. SUGGESTED READING Books Abadallah, Wagdy M. International Transfer Pricing Policies: Decision Making Guidelines for Multinational Companies. New York: Quorum Books, 1989. Alexandrides, C. G. and B. L. Bowers. Countertrade: Practices, Strategies, and Tactics. New York: Wiley, 1987. Kashani, Kamran. Managing Global Marketing. Boston: PWS-Kent, 1992. Nagle, Thomas T. and Reed Holden. The Strategy and Tactics of Pricing: A Guide to Profitable Decision Making 3/e. Upper Saddle River, New Jersey: Prentice Hall, 2002. Schaffer, Matt.Winning the Countertrade War: New Export Strategies for America. New York: John Wiley & Sons, 1989. Articles Assmus, Gert, and Carsten Wiese. “How to Address the Gray Market Threat Using Price Coordination.” Sloan Management Review 36 (Spring 1995), pp. 31-41. Bateman, Connie Rae, Neil C. Herndon, Jr., and John P. Fraedrich. “The Transfer Pricing Decision Process for Multinational Corporations.” International Journal of Commerce and Management 7, no. 3 & 4 (1997), pp. 18-38. Bernstein, Jerry, and David Macias. “Engineering New-Product Success – The New-Product Pricing Process at Emerson.” Industrial Marketing Management 31, no. 1 (January 2002), pp. 51-64. Brooke, James. “Brazil Looks North from Trade Zone in Amazon.” New York Times (August 1, 1995), p. D2. Burns, Paul. “U.S. Transfer Pricing Developments.” International Tax Review 13, no. 4 (2003), 48-49. Butscher, Stephen A. “Maximizing Profits in Euroland.” Journal of Commerce (May 5, 1999), p. 5. Cavusgil S. Tamer. “Pricing for Global Markets.” Columbia Journal of World Business 31, No. 4 (Winter 1996), pp. 66-78. Cohen, Stephen S. and John Zysman. “Countertrade, Offsets, Barter and Buyouts.” California Management Review 28, no. 2 (1986), pp. 41-55. Choi, Chong Ju, Soo Hee Lee, and Jai Boem Kim. “A Note on Countertrade: Contractual Uncertainty and Transaction Governance in Emerging Economies.” Journal of International Business Studies 30, no. 1 (1999) pp. 189-201. Cooper, Robin, and W. Bruce Chew. “Control Tomorrow’s Costs Through Today’s Designs.” Harvard Business Review 74, no. 1 (January-February 1996), pp. 89-97. Kostecki, Michel M. “Marketing Strategies Between Dumping and Anti-Dumping Action.” European Journal of Marketing 25, no. 12 (1992), pp. 7-19. Lasagni, Andrea. “Does Country-targeted Anti-dumping Policy by the EU Create Trade Diversion?” Journal of World Trade 34, no. 4 (August 2000), pp. 137-59. Lindsay, Brink. “The U.S. Antidumping Law: Rhetoric Versus Reality.” Journal of World Trade 34, no. 1 (February 2000), pp. 1-38.pp. 1-38. Mehafdi, Messaoud. “The Ethics of International Transfer Pricing.” Journal of Business Ethics 28, no. 4 (December 2000) pp. 365-381. Mirus, Rolf and Bernard Yeung. “Why Countertrade? An Economic Perspective.” The International Trade Journal 7, no. 4 (1993), pp. 409-433. Prince, Melvin, and Mark Davies. “Seeing Red Over International Gray Markets.” Business Horizons 43, no. 2 (March-April 2000), pp. 71-74. Qureshi, Asif H. “Drafting Anti-Dumping Legislation: Issues and Tips.” Journal of World Trade 34, no. 6 (December 2000) pp. 19-32. Shoham, Aviv, and Dorothy A. Paun. “A Study of International Modes of Entry and Orientation Strategies Used in Countertrade Transactions.” Journal of Global Marketing 11, no. 3 (1998), pp. 5-19. Simon, Hermann. “Pricing Opportunities - And How to Exploit Them.” Sloan Management Review 33, no. 2 (Winter 1992), pp. 55-65. Sinclair, Stuart. “A Guide to Global Pricing.” Journal of Business Strategy 14, no. 3 (May-June 1993), pp. 16-19. Stöttinger, Barbara. “Strategic Export Pricing: A Long and Winding Road.” Journal of International Marketing 9, no. 1 (2001), pp. 40-63. Tomlinson, Richard. “Who’s Afraid of Wal-Mart?” Fortune (November 7, 1988), pp. 147-154. Solution Manual for Global Marketing Warren J. Keegan, Mark C. Green 9780133545005, 9781292017389
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