A SIMPLE MICRO SIMULATION MODEL EXAMPLE: Cost chain and

trading price formation in international trade

Master Économie et Affaires InternationalesMaster Économie et Affaires InternationalesCours “Modèles de Simulation”Paris Dauphine –October 2009

Prof. Ramón MahíaApplied Economics Department

www.uam.es/ramon.mahia

A SIMPLE MICRO SIMULATION MODEL

EXAMPLE INTRODUCTION

When a trader decides to export a good, lots of decisions must be taken, from “fundamentals” to minor details:

How to pack, store and label the goods, were to export, which is the best port of origin, which route is the best for inland transport, which is the optimum route for international freight, which is the best insurance option and dealer, which transport company is the best (both inland and international),which INCOTERM is convenient and standard to reach and agreement…….

A SIMPLE MICRO SIMULATION MODEL

EXAMPLE THE NEED OF A SIMULATION TOOL

The amount of different choices in every matter produce lots of different eventual combinations that carry out different results: we need a kind of evaluation tool.

All these decisions are extremely inter – connected in a way that makes too complex to take isolate step by step decisions: we need a kind of optimization instrument.

To many “agents” are involved in the process that may change the (their) trade conditions rapidly and frequently forcing us to re - thinking our decisions and re compute costs: we need a kind of technical and fast tool for handing out changes in new solutions.

….. MAY BE WE NEED A SIMULATION MODEL

A SIMPLE MICRO SIMULATION MODEL

EXAMPLE DECISIONS AND COST CHAIN (I)

PreviousManipulation

Export arrangements

Inland Transport Storage and loading

International Transport

Downloading and store at destination

Inland TransportImport arrangements

•Packing•Labeling

•Export agent, brokerage•Permissions•Certifications•Custom arrangements

•Route•Mean of transport•Transport company•Insurance conditions

•Surveillance•Packing •Loading conditions

•Carrier•Insurance conditions

•Country•Mean of transport•Port of destination •Route

•Surveillance•Downloading conditions

•Custom clearance•Tariffs / Duties•Importer agent brokerage

•Route•Mean of transport•Transport company•Insurance conditions

A SIMPLE MICRO SIMULATION MODEL

EXAMPLE DECISIONS AND COST CHAIN (II)

PreviousManipulation

Export arrangements

Inland TransportStorage and loading

International Transport

Downloading and store at destination

Inland Transport

Import arrangements

•Packing•Labeling

•Export agent, brokerage•Permissions•Certifications•Custom arrangements

•Route•Surveillance•Packing •Loading conditions

•Insurance conditions

•Country

•Surveillance•Downloading conditions

•Custom clearance•Tariffs / Duties•Importer agent brokerage

•Route

•Mean

•Port of destination

•Route

•Carrier

•Mean of transport

•Transport company

•Insurance conditions

•Mean of transport

•Transport company

•Insurance conditions

A SIMPLE MICRO SIMULATION MODEL

EXAMPLE TRADE AGREEMENT: INCOTERMS (I)

Incoterms (International Commercial Terms): Standard definitions of international trade terms widely used used in international commercial transactions to divide transaction costs and responsibilities between buyer and seller, reflecting state-of-the-art transportation practices

INCOTERMS 2000 http://www.iccwbo.org/incoterms/id3040/index.html

•Group E – Departure: EXW •Group F – (Main Carriage Unpaid By Seller):FCA , FAS , FOB •Group C – (Main Carriage Paid By Seller): CFR , CIF , CPT , CIP•Group D – Arrival: DAF, DES ,DEQ, DDU, DDP

A SIMPLE MICRO SIMULATION MODEL

EXAMPLE TRADE AGREEMENT: INCOTERMS (II)

A SIMPLE MICRO SIMULATION MODEL

EXAMPLE TRADE AGREEMENT: INCOTERMS (III)

A SIMPLE MICRO SIMULATION MODEL

EXAMPLEBASIC ELEMENTS OF A THE SIMPLE SIMULATION MODEL

PURPOSE OF THE MODEL:

Evaluate the total and unitary cost of exporting a given good to a given destination country for different choices of packing, routes, carriers, and INCOTERMS.

And then, as a result, support the pricing decision of the exported good and the estimation of margins available for different alternatives in an imported price is previously negotiated.

Observe in a detailed and relative way (comparing costs) the cost formation chain (markup of different agents) helping decisions in terms of negotiations and cost saving optimization.

A SIMPLE MICRO SIMULATION MODEL

EXAMPLEBASIC ELEMENTS OF A THE SIMPLE SIMULATION MODEL

Pure decision INPUTS: Factory PriceUnits to exportType of packaging and labeling Type of international freight (Plane, Ship) (Partially conditioned) Port of origin (Partially conditioned) Carrier for international freight

Exogenous INPUTS:Cost of packaging for each of the types, warehouse storage and services cost, cost of loading charges at point of origin, export agent fees, cost of export documentation, cost of inland road transportation, distances to different ports of destination, forwarding fees for different ports, cost of loading in different ports, number of carriers available, cost of international freight for 4 different carriers, availability of carriers in different locations, cost of international insurance, import duties and tariffs, destination port forwarding costs and inland transport in destination country.

Main final OUTPUTS: Total and per- unit cost of the product for the different stages of the price (cost) formation chain.

A SIMPLE MICRO SIMULATION MODEL

EXAMPLE QUESTIONS THAT CAN BE ASWERED

Which is the total, and per - unit cost connected to the main different stages to be accomplished in an export operation? Which are the relative importance of these the different costs chapters? Which are the sensibility of each of the cost chapters for different means of transport, points of origin, routes or carriers? Which is the cost - level price for the different INCOTERMS?

Which is the minimum number of units to export for reaching the minimum fixed unit price?Which is the best choice of inland and international transport routes and carriers for a given INCOTERM?.

A SIMPLE MICRO SIMULATION MODEL

EXAMPLE FROM SIMPLICITY TO REALISM

Real decisions are evaluated in a “multilevel” basis: Different countries of destination, different types of products to export (eventually with common stages in the export process), transport can be multimodal, more alternatives for transport and insurance (points of origin, but overall, lots of companies)….

Lots of additional inputs (costs) should be considered: excess of supply or domestic demand, financial services costs and availability, market research costs, solvency studies of buyers,..Final cost is not the only OUTPUT of real interest: TIME use to be crucial (as intermediate input and as a CRUCIAL final output) Lots of intermediate inputs and exogenous variables are much more difficult to measure. For example, there are lots of price alternatives depending on size, quantity, value and a high degree of negotiation. Some critical inputs or outputs are not measurable at all (expertise of a given trade channel, evaluation of the risk of failure, quality of exporting services)