Global Pricing Challenges in Global Pricing Introduction q

Global Pricing Challenges in Global Pricing

Introduction q. Global Pricing is lot more complex than domestic pricing due to: ØInternational Currency Fluctuations ØPrice Escalations due to Tariffs ØDifficulties to access credit risks ØPrice controls, Anti-dumping laws ØRegulation on transfer pricing ØMethods of payment

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

Pricing Basics q. Basic Principle of pricing considers: ØCosts or Cost-Plus formula ØExperience Curve Pricing I. e costs go down as more units are produced ØCompetition Pricing: Discount or premium pricing w. r. t competition ØDemand factored pricing q. For Global Pricing, there are several other factors to be considered in addition to the basics

Export Pricing Considerations q. In addition to pricing basics such as costs, demand, competition etc Export pricing has to consider other factors q. Factors affecting export pricing are: ØCurrency Risk & Credit Risk ØTariffs & Price escalation ØDumping or ØSkimming Vs Penetration Pricing q. Final price depends on product positioning in foreign markets

Multinational Pricing Factors q. MNC’s have different pricing considerations apart from the pricing basics ØCurrency to price, Exchange Rates, Hedging risks ØTransfer Pricing for profit repatriation ØCounter trade/systems pricing ØPrice coordination to prevent gray trade ØPolycentric/Geocentric/Ethnocentric pricing

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

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

Transfer Pricing q. MNC’s have to determine transfer prices, I. e. the prices charged on subsidiaries for products, components and supplies. q. Transfer pricing must be: ØFair for local subsidiary’s performance measurement ØHelp repatriate profits ØSatisfy local tax laws governing transfer pricing q. Global firms are setting up market related transfer prices to satisfy local laws

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

Guidelines Cont’d Ø Prepare Internal & External documentation Ø Simulate pricing audit by outside advisors Ø Spot check the process within the company Ø Evaluate year-end tax position against goals Ø Prepare tax returns Source: Davis 1994

Price Coordination q. MNC’s have to coordinate prices in different geographic market such that: ØEliminate gray trade & other distribution channel conflicts ØIt does not limit local subsidiaries performance or abilities ØRemain competitive in local markets ØPricing strategy is a part for global marketing strategy

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

Issues with Counter Trade q Counter Trade arises when a country does not have sufficient foreign exchange or its currency is not freely convertible q Counter Trade is like a Barter, and the exchanged goods then has to be sold to realize any profits Ø E. g: Pepsi for Stolichnaya Vodka in USSR q Counter trade can arise from counter purchase agreements to buy back a part of local production for the right to export into that country Ø Product Buyback e. g : Hundai exporting cars from India Ø Third goods buy back e. g: Pepsi exporting potato chips from India q Major Problem is accessing the value of the bartered goods

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

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

Turnkey Pricing q. Turnkey Projects are usually of 2 types: ØBundled Pricing : Entire project is priced as one bundle ØUnbundled Pricing: Components of the project is priced individually q. Profit Sharing or Penalties for nonperformance is usually used in pricing strategy q. Component prices are based on competitive positions, market entry decisions and FSA factors

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

Global Coordination q. Pricing disparities between regions leads to “Gray Market” or parallel Imports ØE. g: Cameras imported to US from Singapore or Japan is cheaper than the official price from the Japanese subsidiary q. Gray markets leads to channel conflicts and loss of goodwill q. Gray markets also results in after sales service problems

Eliminate gray trade q. Firms can eliminate gray trade by Minimizing arbitrage between regions via: ØTough economic control over importers ØCentralizing price range within a narrow bandwidth ØFormalizing the pricing decisions in all local markets ØCoordinating pricing decisions between regional markets to reduce arbitrage

Coordinated Pricing Strategies Strength of Local Resources Level of Marketing Standardization High Low High Economic Controls Informal Coordination Low Centralization Formalization

Global Pricing Policies q Polycentric Pricing Ø Multi-Domestic firms give wide leverage for subsidiaries on pricing resulting in different prices in different countries – Results in gray markets q Geocentric Pricing Ø Use a regional (global) standard pricing Plus a local markup. Ø Base price is derived from cost plus formula Ø Affected by local tax laws leading to gray markets Ø Pricing an entire product line is a problem. Markup on one product in one country may not be inline with other products Ø Ideal for FTA zones

Pricing Policies Cont’d q. Geocentric Pricing ØE. 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 ØIBM discounts products where they have competition, but to prevent gray market, IBM sells services at a higher price for gray goods

Pricing Policies Cont’d q. Ethnocentric Pricing ØHave a common price all over the world ØA global standard price ØIdeal for big-ticket industrial items such as Aircrafts, computers etc. ØHomogeneity of prices eliminated gray markets ØNot suitable when there is competition from local manufacturers