pricing for international markets factors-05.02
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Pricing for InternationalMarkets Factors
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Factors Influencing Pricing
Decisions in International Markets
1. Cost
2. Competitions
3. Irregular or Unaccounted Payments in Export
Import
4. Purchasing Power
5. Buyers Behaviour6. Foreign Exchange Fluctuations.
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1. Cost
A large number of exporters in initial stagesuse cost-based pricing, which is hardly thebest way to determine price in internationalmarkets
However, the cost is often a key determinantof the profitability of a firm in marketing theproduct
Firms located in different countries do havesignificant variations in their cost of production
and marketing but the price in internationalmarkets is determined by the market forces
Therefore, the profitability among internationalfirms varies widely depending upon their
costing.
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2. Competitions
The competition is much higher ininternational markets compared to thedomestic markets
The competitive intensity and its nature varywidely in international markets
In a large number of markets, the competitionis from international firms while the local firms
or local subsidies of multi-nationals competeonly in a few markets.
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3. Irregular or Unaccounted Payments
in Export Import
In international trade, a firm is often requiredto make certain irregular payments that vary
widely among the countries Although such irregular payments are
unethical, they form an integral part of marketaccess that needs to be taken into account
while carrying out costing and marketfeasibility analysis.
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4. Purchasing Power
Purchasing power of customers varies widelyamong the countries
A firm operating in international markets
should take into consideration the buyingpower of the consumers while making pricingdecisions
McDonalds prices its products in international
markets depending upon the countryspurchasing power
The hamburger prices vary from US$ 1.2 inChina to US$ 4.52 in Switzerland
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The theory of purchasing power parity states thatin the long run the exchange rate should movetowards rates that would equalize the prices of an
identical basket of goods and services in any twocountries
The economist invented the Big Mac Index in
September 1986 as a light-hearted guide for cross-country comparison of currencies based onMcDonalds Big Mac, which is produced locallyand simultaneously in almost 120 countries
The purchasing power parity is calculated bydividing the price of Big Mac in a country with theprice in US$.
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5. Buyers Behaviour
Buyers from high-income countries are moredemanding and knowledgeable, and thebuying decision is primarily based on superiorperformance attributes, whereas the buyersfrom low-income countries have beenreported to make choices based on the priceof the products and services.
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6. Foreign Exchange Fluctuations
A firm operating in international markets hasto keep a constant vigil on fluctuations ofexchange rates while making pricingdecisions
The currency of price quotation has to bedecided by watching its movements over aperiod.
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Pricing Approaches for International
Markets
1. Cost-based Pricing
2. Full Cost Pricing
3. Marginal Cost Pricing
4. Market-based Pricing
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1. Cost-based Pricing
Costs are widely used by firms to determineprices in international markets especially inthe initial stages
Generally, new exporters determine export
prices on ex-works price level and add acertain percentage of profit and otherexpenses depending upon the terms ofdelivery
However, such cost-based pricing methodsare not optimum because of the followingreasons
The price quoted by the exporter on thebasis of cost calculations may be too
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vis--vis competitors, thus allowing importersto earn huge margins
The price quoted by the exporters may betoo high, making their goods incompetitiveand resulting in outright rejection of the offer.
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2. Full Cost Pricing
It is the most common pricing approach usedby exporters in the initial stages of theirinternationalization
It includes adding a mark-up on the total costto determine price
The major benefits of the full cost pricingapproach are as follows:
It is widely used by exporters in theinitial phases of international marketing
It ensures fast recovery of investments
It is useful for firms that are primarily
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dependent on international markets andregister very low or negligible sales indomestic markets
It eases operation and implementation ofmarketing strategies
However, the following bottlenecks are alsoassociated with the full cost pricing approach:
It often overlooks the prevailing pricestructure in international markets that mayeither make the product uncompetitive orprevent the firm from charging higher prices
As competitors often use price-cuttingstrategies to penetrate or gain share ininternational markets, the full cost pricingapproach may result in making the product
price uncompetitive in international markets.
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3. Marginal Cost Pricing
In view of the huge size of internationalmarkets as compared to the domestic market,export activities are regarded as outlets forthe disposal of surplus production that a firm
finds difficult to sell in the domestic market As the intensity of competition in international
markets is much higher than in the domesticmarket, competitive pricing becomes a pre-
condition for success Therefore, a large number of firms adopt the
marginal cost pricing approach for pricingdecisions in international markets.
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Marginal cost is the cost of producing andselling one more unit
It sets the lower limit to which a firm canreduce its price without affecting its overallprofitability
The major reasons for adopting pricing costing on
marginal cost are as follows: In cases where foreign markets are used to
dispose of surplus production, marginal costpricing provides an alternate market outlet
Products from developing countries seldomcompete on the basis of brand image orunique value; marginal cost pricing is usedas a tool to penetrate international markets
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Marginal cost pricing provides someadvantage that the firm would forego if itdoes not export at the marginal-cost-based
price.
However, the major limitations of the marginal costpricing approach are as follows:
In case the firm is selling most of its output ininternational markets, it cannot use marginalcost pricing as the fixed cost also has to berecovered
Pricing based on marginal cost may becharged, as dumping in overseas markets isliable to action and subject to investigations
Such pricing tends to trigger a price war in
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the overseas market and leads to priceunder-cutting among suppliers
Use of marginal cost pricing with littleinformation on prevailing market prices leadsto unrealistically low price quotations.
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4. Market-based Pricing
As developing countries are marginalsuppliers of goods in most markets, theyrarely have market shares large enough toinfluence prices in international markets
Thus, the exporters in developing countriesare generally price followers rather than pricesetters
Besides, the products offered by them are
seldom unique so as to enable them to dictateprices
In such market situations, pricing decisions byprice followers from developing countriesinvolve assessment involve assessment of
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prevailing prices in international markets anda top-down calculation as follows:
Establish the current market price forcomparative and/or substitutiveproducts in the target market
Establish all the elements of the market
price, such as VAT, margins for thetrade and the importer, import duties,freight and insurance costs, etc.
Make a top-down calculation,
deducting all the elements of theexpected market price of the product(s) in order to arrive at the ex-works ,ex-factory , or ex-warehouse price
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Assess if this can be met
If not, re-calculate the cost price by findingways to decrease costs in the factory or
organization or to decrease the marketingbudget, which also burdens export-marketprice
Estimate total sales over a three-year
period, add total planned expenses,including those of the export department andthe travelling, and canvassing efforts
Make a bottom-up calculation per product
item, dividing the supporting budgets overthe total number of items to be sold
Set the final market price
Test the price (through market research).
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Transfer Pricing in InternationalMarkets
The concept of transfer pricing, which wasearlier limited to foreign multinationalcompanies, is becoming increasingly significantfor Indian companies as a result of their
increasing internationalization Indian firms enter international markets by wayof joint ventures, wholly-owned subsidiaries,etc. Companies own distribution systems ininternational markets, which makes transfer
pricing crucial for formulating an internationalpricing strategy. The price of an international transaction
between related parties is called transfer price(figure 1)
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A
B C
Related Unrelated
parties parties
Arms length priceTransfer price
Concept ofTransfer Pricing
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The objectives of transfer pricing are as follows:
Maximizing overall after-tax profits
Reducing incident of customs duty payments Circumventing the quota restrictions (in value
terms) on imports
Reducing exchange exposure, circumventing
exchange controls, and restricting profitrepatriation so that transfer firms affiliates tothe parent can be maximized
Transferring of funds in locations so as to suitcorporate working capital policies
Window dressing operations to improve theapparent (i.e., reported) financial position of an
affiliate so as to enhance its credit ratings.
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The objective of transfer price apparently seemssimple allocation of profits among the subsidiariesand the parent company, but the differences in the
taxation patterns in various markets makes it acomplex phenomenon
Transfer prices come under the scrutiny of taxationauthorities when it is different from the arms lengthprice to unrelated parties
Transfer pricing involves the following stake-holders:
Parent company
Foreign subsidiary or joint venture or anyother strategic alliance
Strategic alliance partners
Home country and overseas managers
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Home country governments
Host country government
International transactions based on intra-companytransfer pricing involves conflicting interests ofvarious stake-holders
Therefore, in view of the diverse interests of
stake-holders, transfer-pricing decisions become aformidable task
The factors influencing transfer pricing include:
Market conditions in the foreign country
Competition in the foreign country
Reasonable profit for the foreign affiliate
Home country income taxes
Economic conditions in the foreign country
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Import restrictions
Customs duties
Price controls Taxation in the host country, e.g., withholding
taxes
Exchange controls, e.g., repatriation of
profits.
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Types ofTransfer Pricing
Market based transfer pricing: It is referred toas arms length pricing, wherein the salestransactions occur between the two unrelated(arms length) parties
Arms length pricing is preferred by taxationauthorities
Transfer pricing comes under the scrutiny of tax
authorities when it is different from the arms lengthprice to unrelated firms.
Non-market pricing: Pricing policies that deviatefrom market-based arms length pricing are known
as non-marketing based pricing.
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Pricing at direct manufacturing costs:
It refers to the intra-firm transactions thattake palace at the marketing cost.
A number of transnational corporations have re-invoicing centres at low tax countries (popularlyknown as tax heavens), such as, Jamaica,Cayman Islands, Bahamas, etc. to co-ordinatetransfer pricing around the world
These re-invoicing centres are used to carry outintra-corporate transactions between two affiliates
of the same parent company or between theparent and the affiliate companies
These re-invoicing centres take title of the goodssold by the selling unit and re-sell it to the
receiving units
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The prices charged to the buyer and the pricesreceived by the seller are determined so as toachieve the transfer pricing objectives
In such cases, the actual shipments of goods takeplace from the seller to the buyer while the two-stages transfer is shown only in documentation
The basic objective of such transfer pricing is tosiphon profits away from a high-tax parentcompany or its affiliate to low-tax affiliates andallocate funds to locations with strong currencies
and virtually no exchange controls.
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