Global Pricing

Challenges in Global Pricing

Introduction

Global Pricing is lot more complex than domestic pricing due to:International Currency FluctuationsPrice Escalations due to TariffsDifficulties to access credit risksPrice controls, Anti-dumping lawsRegulation on transfer pricingMethods 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 timeCompetitors influence the demand function

unpredictablyWhen 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 formulaExperience Curve Pricing I.e costs go down

as more units are producedCompetition Pricing: Discount or premium

pricing w.r.t competitionDemand 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 RiskTariffs & Price escalationDumping orSkimming Vs Penetration Pricing

Final price depends on product positioning in foreign markets

Multinational Pricing Factors

MNC’s have different pricing considerations apart from the pricing basicsCurrency to price, Exchange Rates, Hedging

risksTransfer Pricing for profit repatriationCounter trade/systems pricingPrice coordination to prevent gray tradePolycentric/Geocentric/Ethnocentric pricing

Currency Factors

Global companies have to sell in local currency.

This exposes company to exchange risksTo minimize risks, firms use hedging,

swaps or other financial instrumentsThere 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 exportingOr chose to supply from a different countryOr withdraw from that marketOr increase price if possible

Transfer Pricing

MNC’s have to determine transfer prices, I.e. the prices charged on subsidiaries for products, components and supplies.

Transfer pricing must be:Fair for local subsidiary’s performance

measurementHelp repatriate profitsSatisfy local tax laws governing transfer

pricingGlobal 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 planCompare third party transactions (arms-length

pricing) and Adjust prices accordinglyPrepare a financial model to test the method agreed

onEnsure everyone involved understands transfer

pricing issues

Guidelines Cont’d

Prepare Internal & External documentationSimulate pricing audit by outside advisorsSpot check the process within the companyEvaluate year-end tax position against goalsPrepare tax returns

Source: Davis 1994

Price Coordination

MNC’s have to coordinate prices in different geographic market such that:Eliminate gray trade & other distribution

channel conflictsIt does not limit local subsidiaries

performance or abilitiesRemain competitive in local marketsPricing 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 it’s 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 bundleUnbundled Pricing: Components of the

project is priced individuallyProfit 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 PositioningPrice-Quality Relationships (high price =

High Quality)Competitive Positioning : Premium or

discount w.r.t competitorsPurchasing 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 ImportsE.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 importersCentralizing price range within a narrow

bandwidthFormalizing the pricing decisions in all local

marketsCoordinating pricing decisions between

regional markets to reduce arbitrage

Coordinated Pricing Strategies

Economic Controls

FormalizationCentralization

Informal Coordination

Level of Marketing Standardization

High Low

Low

High

Str

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Loc

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Global Pricing Policies

Polycentric PricingMulti-Domestic firms give wide leverage for

subsidiaries on pricing resulting in different prices in different countries – Results in gray markets

Geocentric PricingUse a regional (global) standard pricing Plus a local

markup.Base price is derived from cost plus formulaAffected by local tax laws leading to gray marketsPricing 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 Cont’d

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 Cont’d

Ethnocentric PricingHave a common price all over the worldA global standard priceIdeal for big-ticket industrial items such as

Aircrafts, computers etc.Homogeneity of prices eliminated gray

marketsNot suitable when there is competition from

local manufacturers