imm unit-06 (global pricing strategies)

07/06/10 1

By :

Prof. Amit Kumar

07/06/10 2

International marketing has become a major concern for business schools to develop global strategies to lead and sustain in the much expanded and

competitive arena. Liberalization thus catalyzing market competition, poses challenge for the

managers in handling the rigors of expanding global marketplace.

Syllabus aims at providing contemporary knowledge & skills on issues of global

marketing management.

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Importance of this course

Global Marketing Management

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Course: Global Marketing Management

1. Framework of Global Marketing Management

2. Global Marketing Research

3. Decision Making in International Marketing

4. Foreign Market Entry & Export Marketing

5. Product Planning & Development

6. Global Pricing Strategies

7. Global Distribution System

8. Promoting Product Internationally

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Global Marketing Management

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Global Marketing Management Global Pricing Strategies

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Contents

• International Pricing Compared to Domestic Pricing• International Pricing Objectives/ Strategies• International Pricing Framework• Pricing Approaches for International Markets

Cost-based Pricing Full-cost Pricing Marginal cost pricing Market-based Pricing

• Countertrade as a Pricing Tool• Terms of Payment in International Marketing

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International Pricing Compared to Domestic Pricing

In International markets, however, pricing decisions are much

more complex, because they are affected by a number ofadditional external factors, such as

• Fluctuation in Exchange Rates• Accelerating Inflation in Certain Countries• Use of alternative payment methods such as leasing,

barter and counter-trade

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International Pricing Objectives

In order to determine the price of a new product in the

international market, the objectives are as:

1. Maximum Current Profit

2. Maximum Market share

3. Maximum Market Skimming

4. Product-Quality Leadership

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SKIMMIMG

PENETRATION PRICING

High price

Low price

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International Pricing Framework

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INTERNAL EXTERNAL

Firm-Level Factors• Corporate & marketing objectives• Competitive strategy• Firm positioning• Product development• Production location• Market entry modes

Environmental Factor• Government influences and constraints: import control, taxes, price control• Inflation• Currency fluctuation• Business cycle stage

Product Factors• Stage in PLC• Place in product line• Important product features• Product positioning• Product cost structure (manufacturing, experience effects, etc)

Market Factors• Customers’ perceptions • Customers’ ability to pay• Nature of competition• Competitors’ objectives, strategies and relative SW• Grey market appeal

Pricing Strategies• Pricing level (first-time)

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International Pricing Framework

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INTERNAL EXTERNAL

Firm-Level Factors Environmental Factor

Product Factors Market Factors

Pricing Strategies• Pricing level (first-time)• Price changes over PLC• Pricing across products• Pricing across countries

Terms of business• Terms of sale• Terms of payment

Other elements of marketing mix

Firm performanceSales, shares, contribution margins, profits, image etc.

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Pricing Approaches for International Markets

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The various approaches/ strategies used for pricing in

international markets are as:

1. Cost-based Pricing

2. Full Cost Pricing

3. Marginal Cost Pricing

4. Market-based Pricing

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Pricing Approaches for International Markets: Cost-based Pricing

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• Costs are widely used by firms to determine prices in international markets especially in the initial stages.

• Generally, new exporters determine export prices on ‘ex-works’ price level and add a certain percentage of profit and other expenses depending upon the terms of delivery.

It is a popular myth that costs determine the price, specially in international markets.

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However, such cost-based pricing methods are not

Optimum because of following reasons: The price quoted by the exporter on the basis of

cost calculations may be too low vis-à-vis competitors, thus allowing importers to earn huge margins.

The price quoted by the exporters may be too high, making their goods uncompetitive and resulting in outright rejection of the offer.

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It is a popular myth that costs determine the price.

• In fact, it is the interaction of a variety of factors such as costs, competitive intensity, demand, structure, consumer behavior etc. that contributes to price determination in international markets.

• Therefore, a market-based pricing approach is generally preferred to a cost-based pricing approach.

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Pricing Approaches for International Markets: Full Cost Pricing

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• It includes adding a mark-up on the product’s cost to determine price.

• Now assume, manufacturer wants to earn a 20 % markup on sales. The manufacturer’s markup price is given by:

Markup price =

e.g. Phillips, wanted to make a profit on each player but Japanese competitors priced low and succeed in

building their market share rapidly.

UNIT COST

(1- Desired return on sales)

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Pricing Approaches for International Markets: Full Cost Pricing

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The major benefits of this approach are: It ensures fast recovery of investments.

It is useful for firms that are primarily dependent on the international markets and register very low sales in domestic markets.

It is widely used by exporters in the growth phases of international marketing.

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Pricing Approaches for International Markets: Marginal Cost Pricing

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• As the intensity of competition in international markets is much higher than the domestic market, competitive pricing becomes a precondition for success.

• A large number of firms adopt this pricing approach.

Marginal cost is the cost of producing and selling one more unit. It sets the lower limit to which a firm can

reduce its price without affecting its overall profitability.

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Variable Cost

Volume

Tot

al C

ost

Domestic Sales Exports

Fixed Cost

VariableCost

Total Costs

Marginal Cost(MC)

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Major reasons for adopting this approach are:

• In cases where foreign markets are used to dispose of surplus production, marginal cost pricing provides an alternate market outlet.

• Products from developing countries seldom compete on the basis of brand image or unique value, MCP is used as a tool to penetrate international markets.

Why it makes sense to use Marginal Costing in Export Pricing?

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Twinkle Illuminations is a Kolkata-based firm with an installed capacity of producing 10,000 units of

designer lamps per annum with a fixed cost of US$ 500,000. The variable cost is US$ 100 per unit. It

sells 5,000 units in domestic market at $230 per unit.

The firm receives an export order for 40,000 units @ US$ 130 per unit. Now the firm has to decide whether it would

be able to export 40,000 units at US$ 130 per unit.

Apparently, it does not cover the total cost of US$ 200 per unit.

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• The firm would receive a contribution of US$ 30 per unit for export.

Contribution = Selling Price – Variable Price

= US$ 30

It works out a total contribution on 40,000 units as US$ 1200,000. It would lose this contribution in case the firm does not accept the export order.

• The firm finds it difficult to sell beyond 5,000 units in domestic market; so it has to look for alternative marketing opportunities overseas.

The implication of accepting this order as follows:

Pricing Approaches for International Markets: Market-based Pricing

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INCOTERMS 2000 and its Applicability

Category Applicable forsea transport

only

Applicable for all modes of transport(including water)

Departure terms EXW (ex-works)

Shipment terms, main carriage unpaid

FAS (Free alongside ship)FOB (Free on board)

FCA (Free carrier)

Shipment terms, main carriage unpaid

CFR (cost and freight)CIF (cost, insurance and freight)

CPT (carriage paid to)CIP (carriage and insurance paid to)

Delivery terms DES (delivered ex ship)DEQ (delivered ex quay)

DAF (delivered at frontier)DDU (delivered duty unpaid)DDP (delivered duty paid)


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INCOTERMS 2000 and its Applicability

EXW (Ex Works) named place: It refers to any mode of transportation. The seller makes goods available to the buyer at the seller’s premises or other location, not cleared for export and not loaded on a vehicle. The buyer bears all risks and costs involved in taking the goods from the seller’s premises and thereafter.

FOB (Free on Board) named port of shipment: Maritime and inland waterway only; seller delivers when the goods pass the ship’s rail at the named port. The seller clears the goods for export.

CIF (Cost, Insurance and Freight) named port of destination: The seller delivers the goods when the goods pass the ship’s rail at the port of export. The seller pays cost and freight for bringing the goods to the foreign port, obtain insurance against the buyer’s risk of loss or damage, and clears the goods for export.

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Top-down Calculation for International PricingConsumer Price 1160

VAT 160 + 16%

Market Price minus VAT 1000

Margin retailer 250 = 25%

Price to retailer 750

Margin wholesaler 90 + 12%

Price to wholesaler 660

Margin to importer 33 + 05%

Landed-cost Price 627

Import duties 110 + 20%

Other costs (storage, banking) 17

CIF (port of destination) 500


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Top-down Calculation for International PricingCIF (port of destination) 500

Transportation costs 130

Insurance costs 6

FOB (port of shipment) 364

Transportation costs factory to port 34

Export price ex-works (EXW) 330

Factory cost price 300

Export profit (per unit) 30

The ‘ex-works’ price US$ 330 is 28.4% of the price paid by the consumer. It works out to be a ‘multiplier’ of 3.5. This

‘multiplier’ is used as a calculating aid while offering price quotations in international markets.

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Countertrade as a Pricing Tool

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Countertrade is a unique way of setting overseas transactions. At times, countries experience difficulty in generating enough foreign exchange to pay for imports. They,

therefore, need to devise creative ways to get the products they want.

For example, Canada and Australia found that they had to enter into special agreement with McDonnell Douglas to pay for military aircraft they wanted to purchase. Thus,

both MNCs and governments often are forced to resort to creative ways of setting payment, many of which involve trading of goods for goods as a part of the transaction.

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Different Types of Countertrade

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Countertrade occurs when a firm accepts something than money as payment for its goods or services. Thus,

countertrade is essentially a barter trade.

CounterTrade

Barter

SwitchTrading

CounterPurchase

OffsetBuy-back

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Barter:• Barter is the direct exchange of goods/services

between two parties without a cash transaction.

• In 1993, Eminence S A, one of France’s major cloth makers, launched a five-year deal to barter $25 million worth of US produced underwear and sportswear to customers in eastern Europe in exchange for a variety of goods/services.

• Though examples do exist, barter is not very common.


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Barter:• There are two-fold problems associated with barter:

First, if goods are not exchanged simultaneously, one party ends up financing the other for a period.

Secondly, firms engaged in barter run the risk of having to accept the goods they do not want, cannot use, or having difficulty reselling at a reasonable price.

• For these reasons, barter is viewed as the most restrictive countertrade arrangement.

• It is primarily used for one-time only deals in transactions with trading partners who are not creditworthy or trustworthy.


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Counterpurchase:

• This is reciprocal buying agreement.

• It occurs when a firm agrees to purchase a certain amount of materials back from a country to which a sale is made.

• Suppose a US firm sells some products to China. China pays the US firm in dollars, but in exchange, the US firm agrees to spend some of its proceeds from the sale on textiles produced by China.

Thus, although China must draw on its foreign exchange reserves to pay the US firm, it knows it will receive

some of these dollars back because of the counterpurchase agreement.


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Counterpurchase:

In one counterpurchase deal, Rolls Royce sold jet parts to Finland. As part of agreement, Rolls-Royce

agreed to use some of the proceeds from the sale of purchase Finish-manufactured TV sets that it would

sell in UK.

Brazil has long been exporting vehicles, steel and farm products to oil producing countries, from which it

buys oil in return.


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Offset:

• An example for an offset deal is that PepsiCo sells its cola syrup to Russia for roubles and agrees to buy Russian Vodka at a certain rate for sale in the US.

• Going by this example, offset resembles counterpurchase agreement. But there is difference. The difference is that Pepsi can fulfill the obligation with any firm in Russia.

• From an exporter’s perspective, offset is more attractive than a straight counterpurchase deal because it gives the exporter greater flexibility to choose the goods that it wished to purchase.


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Switch Trading:

• Switch trading refers to the use of a specialized third-party trading house in a countertrade agreement.

• When a firm enters a counterpurchase or offset deal with a country, it often ends up with what are called counterpurchase credits, which can be used to purchase goods from that country.

• Switch trading occurs when a third-party trading house buys the firm’s counterpurchase credits and sells them to another firm that can better use them.


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Switch Trading:

• For example, a US firm concludes a counterpurchase agreement with Poland for which it receives some number of counterpurchase credits for purchasing Polish goods.

• The US firm cannot and does not want any Polish goods, however it sells the credits to a third-party trading house at a discount. The trading house finds a firm that can use the credits and sells at a profit.


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Buyback:

• A buyback also called compensation occurs when a firm builds a plant in a country- or supplies technology, equipment, training, or other services to the country- and agrees to take a certain percentage of the plant’s output as partial payment for the deal.

• A US chemical company built a plant for an Indian company and accepted partial payment in cash and the reminder in chemicals manufactured at the plant.


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CONCLUSION

“Despite the inefficiencies, countertrade is common across nations and about 20 percent of the world trade is accounted for by the exchange of goods for goods. In fact, the governments of developing nations sometimes insists on a certain amount of countertrade. For example, all foreign companies contracted by Thai state agencies for work costing more than 500 million baht ($12.3 million) are required to accept at least 30 percent of their payment in Thai agriculture products. Between 1994 and mid-1998 foreign firms purchased 21 billion baht ($517 million) in Thai goods under countertrade”.


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• Every shipment abroad requires some kind of financing while in

transit. The exporter also needs funds to buy or manufacture its goods. Similarly, the importer has to carry these goods in inventory until they are sold.

• Usually, however, some in-between approach is chosen, involving a combination of financing by the exporter, the importer, and one or more financial intermediaries.

Terms of Payment in International Transaction

The terms of payment describe how and when the money should be transferred to the seller.

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Terms of Payment in International Transaction

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The Five Principal Means of Payment in international trade, ranked in order of increasing risk to the exporter, are:

1. Cash in Advance

2. Letter of Credit

3. Draft

4. Consignment

5. Open Account

InternationalTrade

Consignment

OpenAccount

Cash in Advance

Letter of Credit

Draft

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1. Cash in Advance• Cash in advance affords the exporter the greatest

protection because payment is received either before shipment or upon arrival of the goods (and presentation of documents).

• Political crises or exchange control in the purchaser’s country may cause payment delays. In addition, where goods are made to order, prepayment is usually demanded, both to finance production and to reduce marketing risks.

Payment Terms in International Marketing

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2. Letter of Credit• Letter of credit is a letter addressed to the seller, written

and signed by a bank acting on behalf of the buyer.

• In the letter, the bank promises that it will honor drafts drawn on itself if the seller confirms to the specific conditions set forth in the letter of credit.

• In exchange for the bank’s agreement, the importer promises to pay the bank the amount of transaction and an agreed fee.

• The letter of credit obviously becomes a financial contract between the issuing bank and a designated beneficiary that is separate from the commercial transaction.

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2. Letter of Credit: Advantage

1. A LOC reduces uncertainty. The exporter knows all the requirements for payment because they are stipulated on the letter of credit.

2. A LOC also reduces the danger that payment will be delayed or withheld due to exchange control or other political risk.

1. The LOC ensures that the exporter delivers goods and produces certain documents which are carefully examined by the bank.

2. Because a letter of credit is as good as cash, the importer can usually command better credit terms and/or prices.

Exporter

Importer

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2. Letter of Credit: Advantage

“ The letter of credit operations are quite simple. Consider the case of USA Importers Inc, of Los Angeles. The company is buying spare auto parts worth $38,000 from Japan Exporter Inc, of Tokyo, Japan. USA Importers applies for, and receives, letter of credit for $38,000

from its bank, Wells Fargo”.

The actual process is shown in figure as:

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2. Letter of Credit:

Wells FargoBank

Bank ofTokyo

USAImporters

JapanExporter

Process preceding creation of L/CProcess after creation of L/C

1. Purchase Order2.

L/C

ap

plic

atio

n

3. L/C delivered

4.

L/C

no

tifi

cati

on

5. Goods shipment

6.

L/C

, d

raft

&S

hip

pin

g d

ocu

men

ts

7. L/C draft & documents delivered

8. Draft accepted & funds remitted

9.

Pay

men

t

10. S

hip

pin

g D

oc

s.

forw

ard

ed

11. L

/C p

aid

at

mat

uri

ty

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3. Draft (also known as Bill of Exchange)• Draft is written by an exporter on the importer directing the

letter to pay a certain sum on a specified date for having goods shipped to the importer. The exporter submits the bill to its banker who collects the stated amount from the importer’s bank and remits the proceeds to the seller or to the bearer.

• Draft has three parties- exporter (drawer), importer (drawee) and the party who is entitled to receive payment is called the payee.

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3. Draft (also known as Bill of Exchange)

• Draft serves three important functions:

1. It provides written evidence of obligations in a comprehensive form.

2. It enables both parties to potentially reduce their costs of financing.

3. It is a negotiable and unconditional instrument.

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4. Consignment• Under the consignment the exporter sends goods, on

consignment, to the importer who arranges for the sale of goods and makes payment to the exporter, after deducing a specified commission.

• Goods on consignment are duly shipped to the importer, but they are not sold. The exporter (consignor) retains title to the goods until the importer (consignee) has sold them to a third party.

• This agreement is normally made only with a related company because of the high risks involved.

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5. Open Account• Open account selling is shipping goods first and billing the

importer later.

• The credit terms are arranged between the buyer and the seller but the seller has little evidence of the importer’s obligation to pay a certain sum at a certain date.

• Sales on open account, therefore, are made only to a foreign affiliate or to a customer with which the exporter has a long history of favorable business dealings.

• The benefits include greater flexibility (no specific payment dates are set) and involve lower costs, including fewer bank charges than with other modes of payment.

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imm unit-06 (global pricing strategies)

Leadership & Management

global strategies

pricing decisions

contents international

global marketing research

global marketplace

pricing tool terms of

global distribution

new product