Global Pricing

Challenges in Global Pricing

Introduction
Global Pricing is lot more complex than domestic pricing due to:
International Currency Fluctuations Price Escalations due to Tariffs Difficulties to access credit risks Price controls, Anti-dumping laws Regulation on transfer pricing Methods of payment

Limits of Microeconomic Theory

Microeconomic theory of pricing has its limits because:
Demand & Cost curves are not easy to estimate & are not stable over time Competitors influence the demand function unpredictably When a Firm produces for more than one market, the prices cant be changed instantaneously due to organizational constrains

Pricing Basics
Basic Principle of pricing considers:
Costs or Cost-Plus formula Experience Curve Pricing I.e costs go down as more units are produced Competition Pricing: Discount or premium pricing w.r.t competition Demand factored pricing

For Global Pricing, there are several other factors to be considered in addition to the basics

Export Pricing Considerations

In addition to pricing basics such as costs, demand, competition etc Export pricing has to consider other factors Factors affecting export pricing are:
Currency Risk & Credit Risk Tariffs & Price escalation Dumping or Skimming Vs Penetration Pricing

Final price depends on product positioning in foreign markets

Multinational Pricing Factors

MNCs have different pricing considerations apart from the pricing basics
Currency to price, Exchange Rates, Hedging risks Transfer Pricing for profit repatriation Counter trade/systems pricing Price coordination to prevent gray trade Polycentric/Geocentric/Ethnocentric pricing

Currency Factors
Global companies have to sell in local currency. This exposes company to exchange risks To minimize risks, firms use hedging, swaps or other financial instruments There may be additional constrains such as inability to freely convert local currency to other currencies, limitations on foreign exchange transfers etc

Currency Fluctuations
Exchange Rates are never constant, appreciating or depreciating currency affects profitability. Exchange rates affects exporters ability to competitively price their products in the long run If exchange rates remain unfavorable for a long time, Firm may:
Chose to manufacture locally instead of exporting Or chose to supply from a different country Or withdraw from that market Or increase price if possible

Transfer Pricing
MNCs have to determine transfer prices, I.e. the prices charged on subsidiaries for products, components and supplies. Transfer pricing must be:
Fair for local subsidiarys performance measurement Help repatriate profits Satisfy local tax laws governing transfer pricing

Global firms are setting up market related transfer prices to satisfy local laws

How to Transfer Income?

Transfer pricing has come under strict government rules & regulations, so here are some guidelines from Accounting firms:
Before beginning the annual business cycle, meet with outside advisors and agree on a game plan Compare third party transactions (arms-length pricing) and Adjust prices accordingly Prepare a financial model to test the method agreed on Ensure everyone involved understands transfer pricing issues

Guidelines Contd
Prepare Internal & External documentation Simulate pricing audit by outside advisors Spot check the process within the company Evaluate year-end tax position against goals Prepare tax returns

Source: Davis 1994

Price Coordination
MNCs have to coordinate prices in different geographic market such that:
Eliminate gray trade & other distribution channel conflicts It does not limit local subsidiaries performance or abilities Remain competitive in local markets Pricing strategy is a part for global marketing strategy

Counter trade & Systems Pricing

When local currency is not freely convertible, firms resort to counter trade. Exchange local currency for some other goods that is then sold for US$ or other currency Systems pricing or Pricing for turnkey projects have several subcomponents that may be separately priced or priced as a bundle

Issues with Counter Trade

Counter Trade arises when a country does not have sufficient foreign exchange or its currency is not freely convertible Counter Trade is like a Barter, and the exchanged goods then has to be sold to realize any profits
E.g: Pepsi for Stolichnaya Vodka in USSR

Counter trade can arise from counter purchase agreements to buy back a part of local production for the right to export into that country
Product Buyback e.g : Hundai exporting cars from India Third goods buy back e.g: Pepsi exporting potato chips from India

Major Problem is accessing the value of the bartered goods

Evaluation of Counter Trade

Counter Trade is done if its the only option for trade Firms use trading houses to dispose of the goods received in trade Firms need to be extra cautious in fixing the barter exchange rates as international value of certain goods is difficult to valuate Counter Trade is a reality in Global markets

Points to Consider in Counter Trade

Is this the only way to make a deal? Can the received goods be sold? How to maximize cash returns? Are there any import restrictions in getting the goods back? Are there other ways of converting the local currency?

Turnkey Pricing
Turnkey Projects are usually of 2 types:
Bundled Pricing : Entire project is priced as one bundle Unbundled Pricing: Components of the project is priced individually

Profit Sharing or Penalties for nonperformance is usually used in pricing strategy Component prices are based on competitive positions, market entry decisions and FSA factors

Price and Positioning

Final selling price depends on Positioning
Price-Quality Relationships (high price = High Quality) Competitive Positioning : Premium or discount w.r.t competitors Purchasing power : How much customers are able to pay? Product Life Cycle & Price Skimming : High price during introduction & falling prices later on Penetration Pricing : Discount to gain market share

Global Coordination
Pricing disparities between regions leads to Gray Market or parallel Imports
E.g: Cameras imported to US from Singapore or Japan is cheaper than the official price from the Japanese subsidiary

Gray markets leads to channel conflicts and loss of goodwill Gray markets also results in after sales service problems

Eliminate gray trade

Firms can eliminate gray trade by Minimizing arbitrage between regions via:
Tough economic control over importers Centralizing price range within a narrow bandwidth Formalizing the pricing decisions in all local markets Coordinating pricing decisions between regional markets to reduce arbitrage

Coordinated Pricing Strategies

Level of Marketing Standardization
High High
Economic Controls

Low
Informal Coordination

Low

Centralization

Formalization

Global Pricing Policies

Polycentric Pricing
Multi-Domestic firms give wide leverage for subsidiaries on pricing resulting in different prices in different countries Results in gray markets

Geocentric Pricing
Use a regional (global) standard pricing Plus a local markup. Base price is derived from cost plus formula Affected by local tax laws leading to gray markets Pricing an entire product line is a problem. Markup on one product in one country may not be inline with other products Ideal for FTA zones

Pricing Policies Contd

Geocentric Pricing
E.g: HP uses a global standard price in USD plus regional markup. This avoids gray trade but loses competitive position when competitors discount their products IBM discounts products where they have competition, but to prevent gray market, IBM sells services at a higher price for gray goods

Pricing Policies Contd

Ethnocentric Pricing
Have a common price all over the world A global standard price Ideal for big-ticket industrial items such as Aircrafts, computers etc. Homogeneity of prices eliminated gray markets Not suitable when there is competition from local manufacturers