Customer country and competitorcountry features

© Professor Daniel F. Spulber

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• Customer preferences• Elasticity of demand • Income per capita and income distribution• Customer knowledge• Distribution infrastructure • Society and culture• Political, legal and regulatory climatePredict effect on earnings and choose

target countries

Customer country featuresDistribution and sales

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• Home country: Compare advantages and disadvantages

• Customer countries footprint: Global or local competitor

• Supplier countries: Global or local manufacturing and procurement

• Partner countries: Complementary products, technologies, capabilities

• Political, legal and regulatory climate – compare effects trade agreements, home-country policies

Competitor countriesEvaluation of competitive advantage

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Tailor products and pricing

Emerging market trend of “Sachet Marketing”• Recognizes low income of mass of consumers

and tailors offerings – 2/3 of world population makes $1,500 or less per year

• Affordable sizes and products• Maintain quality and extend appeal of brands

See reading on-line: Four Billion Customers

(trendwatching.com, 2005)

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Low-cost branded products

• Unilever Ala – low-income laundry detergent brand sold in Brazil

• Microtravel – appeal of sachets to travelers of all income levels

• Whirlpool – low-cost washing machines in China and India (less than $200)

• Nokia 1100 -- popular in rural India

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Customer country features Elasticity of demand

Elasticity of excess demand faced by the firm has two components:

• Price responsiveness of firm’s customers:Market demand elasticity

• Price responsiveness of firm’s competitors:Competitor supply elasticity

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Elasticity of Demand: Price Responsiveness of Customers

Different across countries:

• Consumer tastes and incomes differ

• Consumer knowledge of goods and services differs

• Past consumption patterns affects switching costs:Installed base of product and competing products differ

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Elasticity of Demand:Price Responsiveness of Competitors

Different across countries:

• Different labor supply elasticities

• Different operating costs across countries

• Extent of domestic competition among suppliers differs due to trade barriers and domestic regulations

• Experience and technology of suppliers differs

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Do you think that Coca-Cola prices will differ?

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11

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Elastic Demand if E > 1Example 1– Price increase from

10 to 11, that is 10%– Suppose quantity

sold falls from 200 to 160 units, that is 20%

E = 20/10 = 2

Inelastic Demand if E < 1Example 2– Price increase from 10 to

11, 10%– Suppose quantity sold

falls from 200 to 190 units, that is 5%

E = 5/10 = ½

Elasticity of Demand The percentage change in quantity sold divided by the percentage change in price PP

QQE

/

/

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Revenue Effects of the Two Examples

P1

P2

Change

in P

Q1

Q2

Change in Q

R1

R2

Change in R

10

11

10%

200

160

20%

2000

1760

(240)

10

11

10%

200

190

5%

2000

2090

90

Inelastic Demand: E = ½

Elastic Demand: E= 2

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Elasticity of demand: Optional Review

Revenue:R = P Q

Marginal revenue -- change in revenue per unit change in output:

MR = P + QΔP/ΔQ = P(1 + (Q/ΔQ)(ΔP/P))

So,MR = P(1 − 1/E).

Consumer benefit if elasticity is a constant: B(Q) = Q (E – 1)/E.

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Revenue effects

• Observe that marginal revenue is less than the price.

MR = P(1 − 1/E).

This is because raising the price affects revenue in two ways:– More is earned per unit sold– fewer units are sold

• The relative influence of these two effects is measured by the elasticity

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Revenue effects

• If the elasticity of demand is greater than one, a price increase lowers revenue (a price cut increases revenue)

• If elasticity of demand is less than one, a price increase also increases your revenue (and a price drop cuts your revenue)

Managers should try to estimate elasticity of demand numbers (formally or informally) in pricing across different countries

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Pricing by a firm with market power: Review

D(P)

Q

MR

PM

MC

PC

P

QM QC

PM(1 − 1/E) = MC.

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Pricing to market

• Prices to satisfy the profit-maximizing conditions in each country:

• PA, PF = Prices in country A and F

• EA, EF = Price elasticities of demand in country A and F

• MC = Marginal Cost

.11 MCEPA

A

.11 MCEPF

F

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Pricing to market

At the Zara stores, price tags stated in many currencies and for multiple countries.

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Pricing to market

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Pricing to market

Advantages of Uniform Pricing

• Consistent pricing across countries

• Lowers transaction costs• Avoids gray market

arbitrage• Avoids customer

complaints• Global product::

standardize marketing, sales, product features

• Problem: dealing with exchange rate fluctuations

Advantages of Pricing to Market

• Meet or beat local competition

• Price leader or product differentiation strategies may differ by market served

• Maximize profit by market segment

• Tailoring marketing, sales, service and product features to local market

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Limits on Pricing to Market

• Legal restrictions on price discrimination, most-favored-nation agreements

• Limited legal protections for original seller allow gray market arbitrage

• Low trade costs allow arbitrage: Price difference must be less than cost of trade between countries A and F to avoid arbitrage:

• Differences in the elasticity of demand (responsiveness of demand to price changes) must be large enough to justify different prices in different markets

TPP FA

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Markups in the European Car Industry

Verboven (1996):• Studies 5 European

countries• Estimates relative

markups• Looks at the

wholesale level• Estimates elasticities

for different groups of cars

• Recall the price equations:

• Rewrite as relative markup:

.11 MCEPA

A

.1AA

AEP

MCP

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Markups in the European Car Industry

• Consider markup equation at the wholesale level• Customers are dealers, sellers are the

manufacturers

Pij: wholesale price in market i for model j

MCij: Marginal cost in market i for model j

• Table 3: Relative markups for selected cars• Example (100 – 95)/100 = 0.05 = 5 % = 1/20.

.1

ijij

ijij

EPMCP

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Markups in the

European Car

Industry

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Markups in the European Car Industry

• Lerner Index:

• Elasticity of demand Eik is for market i and car model in segment k

• Example:E = 20 (elastic demand)L = 1/20 = 0.05 = 5 %

• With the exception of Italy, Lerner indices increase with the class of models

.1ikE

L

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Markups in the European Car Industry

Verboven (1996):• Finds that price discrimination follows the Lerner-

indices, that is price discrimination follows demand elasticities

• Degree of price discrimination is more pronounced the lower the class - it is greater on smaller models!

• Note that Italy’s lower elasticities (higher Lerner-indices) reflect FIAT market power and high import quota restrictions

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Markups in the European Car Industry

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Markups in the European Car Industry

Verboven (1996) concludes:• Domestic car companies are able to exploit

domestic market power in lower segments

• Import quotas have stronger effects on smaller and inexpensive cars than on large and expensive cars

• The degree of price discrimination is more pronounced the lower the class

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Summary and take-away points

• Managers should perform target country analysis to estimate customer demand elasticity and competitor supply response

• Pricing to market based on differences in demand elasticities across countries, reflects customer country demand and competitor supply responses

• International business managers should weigh benefits and costs of uniform pricing versus pricing to market

• Lower costs of trade tend to enforce uniform pricing