Pricing for International Markets Factors-05.02

8/7/2019 Pricing for International Markets Factors-05.02

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Pricing for InternationalMarkets Factors


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Factors Influencing Pricing

Decisions in International Markets

1. Cost

2. Competitions

3. Irregular or Unaccounted Payments in Export

Import

4. Purchasing Power

5. Buyers Behaviour6. Foreign Exchange Fluctuations.


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1. Cost

A large number of exporters in initial stagesuse cost-based pricing, which is hardly thebest way to determine price in internationalmarkets

However, the cost is often a key determinantof the profitability of a firm in marketing theproduct

Firms located in different countries do havesignificant variations in their cost of production

and marketing but the price in internationalmarkets is determined by the market forces

Therefore, the profitability among internationalfirms varies widely depending upon their

costing.


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2. Competitions

The competition is much higher ininternational markets compared to thedomestic markets

The competitive intensity and its nature varywidely in international markets

In a large number of markets, the competitionis from international firms while the local firms

or local subsidies of multi-nationals competeonly in a few markets.


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3. Irregular or Unaccounted Payments

in Export Import

In international trade, a firm is often requiredto make certain irregular payments that vary

widely among the countries Although such irregular payments are

unethical, they form an integral part of marketaccess that needs to be taken into account

while carrying out costing and marketfeasibility analysis.


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4. Purchasing Power

Purchasing power of customers varies widelyamong the countries

A firm operating in international markets

should take into consideration the buyingpower of the consumers while making pricingdecisions

McDonalds prices its products in international

markets depending upon the countryspurchasing power

The hamburger prices vary from US$ 1.2 inChina to US$ 4.52 in Switzerland


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The theory of purchasing power parity states thatin the long run the exchange rate should movetowards rates that would equalize the prices of an

identical basket of goods and services in any twocountries

The economist invented the Big Mac Index in

September 1986 as a light-hearted guide for cross-country comparison of currencies based onMcDonalds Big Mac, which is produced locallyand simultaneously in almost 120 countries

The purchasing power parity is calculated bydividing the price of Big Mac in a country with theprice in US$.


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5. Buyers Behaviour

Buyers from high-income countries are moredemanding and knowledgeable, and thebuying decision is primarily based on superiorperformance attributes, whereas the buyersfrom low-income countries have beenreported to make choices based on the priceof the products and services.


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6. Foreign Exchange Fluctuations

A firm operating in international markets hasto keep a constant vigil on fluctuations ofexchange rates while making pricingdecisions

The currency of price quotation has to bedecided by watching its movements over aperiod.


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Pricing Approaches for International

Markets

1. Cost-based Pricing

2. Full Cost Pricing

3. Marginal Cost Pricing

4. Market-based Pricing


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1. Cost-based Pricing

Costs are widely used by firms to determineprices in international markets especially inthe initial stages

Generally, new exporters determine export

prices on ex-works price level and add acertain percentage of profit and otherexpenses depending upon the terms ofdelivery

However, such cost-based pricing methodsare not optimum because of the followingreasons

The price quoted by the exporter on thebasis of cost calculations may be too


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vis--vis competitors, thus allowing importersto earn huge margins

The price quoted by the exporters may betoo high, making their goods incompetitiveand resulting in outright rejection of the offer.


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2. Full Cost Pricing

It is the most common pricing approach usedby exporters in the initial stages of theirinternationalization

It includes adding a mark-up on the total costto determine price

The major benefits of the full cost pricingapproach are as follows:

It is widely used by exporters in theinitial phases of international marketing

It ensures fast recovery of investments

It is useful for firms that are primarily


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dependent on international markets andregister very low or negligible sales indomestic markets

It eases operation and implementation ofmarketing strategies

However, the following bottlenecks are alsoassociated with the full cost pricing approach:

It often overlooks the prevailing pricestructure in international markets that mayeither make the product uncompetitive orprevent the firm from charging higher prices

As competitors often use price-cuttingstrategies to penetrate or gain share ininternational markets, the full cost pricingapproach may result in making the product

price uncompetitive in international markets.


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3. Marginal Cost Pricing

In view of the huge size of internationalmarkets as compared to the domestic market,export activities are regarded as outlets forthe disposal of surplus production that a firm

finds difficult to sell in the domestic market As the intensity of competition in international

markets is much higher than in the domesticmarket, competitive pricing becomes a pre-

condition for success Therefore, a large number of firms adopt the

marginal cost pricing approach for pricingdecisions in international markets.


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Marginal cost is the cost of producing andselling one more unit

It sets the lower limit to which a firm canreduce its price without affecting its overallprofitability

The major reasons for adopting pricing costing on

marginal cost are as follows: In cases where foreign markets are used to

dispose of surplus production, marginal costpricing provides an alternate market outlet

Products from developing countries seldomcompete on the basis of brand image orunique value; marginal cost pricing is usedas a tool to penetrate international markets


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Marginal cost pricing provides someadvantage that the firm would forego if itdoes not export at the marginal-cost-based

price.

However, the major limitations of the marginal costpricing approach are as follows:

In case the firm is selling most of its output ininternational markets, it cannot use marginalcost pricing as the fixed cost also has to berecovered

Pricing based on marginal cost may becharged, as dumping in overseas markets isliable to action and subject to investigations

Such pricing tends to trigger a price war in


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the overseas market and leads to priceunder-cutting among suppliers

Use of marginal cost pricing with littleinformation on prevailing market prices leadsto unrealistically low price quotations.


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4. Market-based Pricing

As developing countries are marginalsuppliers of goods in most markets, theyrarely have market shares large enough toinfluence prices in international markets

Thus, the exporters in developing countriesare generally price followers rather than pricesetters

Besides, the products offered by them are

seldom unique so as to enable them to dictateprices

In such market situations, pricing decisions byprice followers from developing countriesinvolve assessment involve assessment of


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prevailing prices in international markets anda top-down calculation as follows:

Establish the current market price forcomparative and/or substitutiveproducts in the target market

Establish all the elements of the market

price, such as VAT, margins for thetrade and the importer, import duties,freight and insurance costs, etc.

Make a top-down calculation,

deducting all the elements of theexpected market price of the product(s) in order to arrive at the ex-works ,ex-factory , or ex-warehouse price


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Assess if this can be met

If not, re-calculate the cost price by findingways to decrease costs in the factory or

organization or to decrease the marketingbudget, which also burdens export-marketprice

Estimate total sales over a three-year

period, add total planned expenses,including those of the export department andthe travelling, and canvassing efforts

Make a bottom-up calculation per product

item, dividing the supporting budgets overthe total number of items to be sold

Set the final market price

Test the price (through market research).


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Transfer Pricing in InternationalMarkets

The concept of transfer pricing, which wasearlier limited to foreign multinationalcompanies, is becoming increasingly significantfor Indian companies as a result of their

increasing internationalization Indian firms enter international markets by wayof joint ventures, wholly-owned subsidiaries,etc. Companies own distribution systems ininternational markets, which makes transfer

pricing crucial for formulating an internationalpricing strategy. The price of an international transaction

between related parties is called transfer price(figure 1)


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A

B C

Related Unrelated

parties parties

Arms length priceTransfer price

Concept ofTransfer Pricing


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The objectives of transfer pricing are as follows:

Maximizing overall after-tax profits

Reducing incident of customs duty payments Circumventing the quota restrictions (in value

terms) on imports

Reducing exchange exposure, circumventing

exchange controls, and restricting profitrepatriation so that transfer firms affiliates tothe parent can be maximized

Transferring of funds in locations so as to suitcorporate working capital policies

Window dressing operations to improve theapparent (i.e., reported) financial position of an

affiliate so as to enhance its credit ratings.


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The objective of transfer price apparently seemssimple allocation of profits among the subsidiariesand the parent company, but the differences in the

taxation patterns in various markets makes it acomplex phenomenon

Transfer prices come under the scrutiny of taxationauthorities when it is different from the arms lengthprice to unrelated parties

Transfer pricing involves the following stake-holders:

Parent company

Foreign subsidiary or joint venture or anyother strategic alliance

Strategic alliance partners

Home country and overseas managers


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Home country governments

Host country government

International transactions based on intra-companytransfer pricing involves conflicting interests ofvarious stake-holders

Therefore, in view of the diverse interests of

stake-holders, transfer-pricing decisions become aformidable task

The factors influencing transfer pricing include:

Market conditions in the foreign country

Competition in the foreign country

Reasonable profit for the foreign affiliate

Home country income taxes

Economic conditions in the foreign country


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Import restrictions

Customs duties

Price controls Taxation in the host country, e.g., withholding

taxes

Exchange controls, e.g., repatriation of

profits.


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Types ofTransfer Pricing

Market based transfer pricing: It is referred toas arms length pricing, wherein the salestransactions occur between the two unrelated(arms length) parties

Arms length pricing is preferred by taxationauthorities

Transfer pricing comes under the scrutiny of tax

authorities when it is different from the arms lengthprice to unrelated firms.

Non-market pricing: Pricing policies that deviatefrom market-based arms length pricing are known

as non-marketing based pricing.


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Pricing at direct manufacturing costs:

It refers to the intra-firm transactions thattake palace at the marketing cost.

A number of transnational corporations have re-invoicing centres at low tax countries (popularlyknown as tax heavens), such as, Jamaica,Cayman Islands, Bahamas, etc. to co-ordinatetransfer pricing around the world

These re-invoicing centres are used to carry outintra-corporate transactions between two affiliates

of the same parent company or between theparent and the affiliate companies

These re-invoicing centres take title of the goodssold by the selling unit and re-sell it to the

receiving units


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The prices charged to the buyer and the pricesreceived by the seller are determined so as toachieve the transfer pricing objectives

In such cases, the actual shipments of goods takeplace from the seller to the buyer while the two-stages transfer is shown only in documentation

The basic objective of such transfer pricing is tosiphon profits away from a high-tax parentcompany or its affiliate to low-tax affiliates andallocate funds to locations with strong currencies

and virtually no exchange controls.


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Pricing for International Markets Factors-05.02