978-0134129945 Chapter 11 Lecture Note Part 1

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CHAPTER 11

PRICING DECISIONS

SUMMARY

A. Pricing decisions are a critical element of the marketing mix that must reflect costs,

competitive factors, and customer perceptions regarding value of the product. In a true

global market, the law of one price would prevail. Pricing strategies include market

skimming, market penetration, and market holding. Novice exporters frequently use

cost-plus pricing. International terms of a sale such as ex-works, DDP, FCA, FAS,

CFR, FOB, and CIF are known as Incoterms and specify which party to a transaction is

responsible for covering various costs. These and other costs lead to export price

escalation, the accumulation of costs that occurs when products are shipped from one

country to another.

B. Expectations regarding currency fluctuations, inflation, government controls, and the

competitive situation must also be factored into pricing decisions. The introduction of the

euro has impacted price strategies in the EU because of improved price transparency.

Global companies can maintain competitive prices in world markets by shifting

production sources as business conditions change. Overall, a company’s pricing policies

can be categorized as ethnocentric, polycentric, or geocentric.

C. Several additional pricing issues are related to global marketing. The issue of gray

market goods arises because price variations between different countries lead to parallel

imports. Dumping is another contentious issue that can result in strained relations

between trading partners. Price fixing among companies is anticompetitive and illegal.

D. Transfer pricing is an issue because of the sheer monetary volume of intracorporate

sales and because country governments are anxious to generate as much tax revenue as

possible. Various forms of countertrade play an important role in today’s global

environment. Barter, counterpurchase, offset, compensation trading, and switch

trading are the main countertrade options.

LEARNING OBJECTIVES

1 Review the basic pricing concepts that underlie a successful global marketing pricing

strategy.

2 Identify the different pricing strategies and objectives that influence decisions about

pricing products in global markets.

3 Summarize the various Incoterms that affect the final price of a product.

4 List some of the environmental influences that impact prices.

5 Apply the ethnocentric/polycentric/geocentric framework to decisions regarding price.

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6 Explain some of the tactics global companies can use to combat the problem of gray

market goods.

7 Assess the impact of dumping on prices in global markets.

8 Compare and contrast the different types of price fixing.

9 Explain the concept of transfer pricing.

10 Define countertrade and explain the various forms it can take.

OVERVIEW

In general, two basic factors determine the boundaries within which prices should be set.

The first is product cost, which establishes a price floor, or minimum price.

Second, prices for comparable substitute products create a price ceiling, or maximum price. In

many instances, global competition puts pressure on the pricing policies and related cost

structures of domestic companies. The imperative to cut costs – especially fixed costs – is one of

the reasons for the growth of outsourcing. In some cases, local market conditions such as low

incomes force companies to innovate by creating new products that can be profitably sold at low

prices.

Between the lower and upper boundary for every product there is an optimum price, which is a

function of the demand for the product as determined by the willingness and ability of customers

to buy.

In this chapter, we will review basic pricing concepts, and then discuss several pricing topics that

pertain to global marketing. In the second half of the chapter, we will discuss gray market goods,

dumping, price fixing, transfer pricing, and countertrade.

ANNOTATED LECTURE/OUTLINE

BASIC PRICING CONCEPTS

√ (Learning Objective #1)

Generally speaking, international trade results in lower prices for goods.

Lower prices, in turn, help keep a country’s rate of inflation in check. In a true global market, the

law of one price would prevail: All customers in the market could get the best product available

for the best price.

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Because of differences in national markets, the global marketer must develop pricing systems

and pricing policies that take into account price floors, price ceilings, and optimum prices.

A firm’s pricing system and policies must also be consistent with other uniquely global

opportunities and constraints.

There is another important internal organizational consideration besides cost. Within the typical

corporation, there are many interest groups and, frequently, conflicting price objectives.

Divisional vice presidents, regional executives, and country managers are each concerned about

profitability at their respective organizational levels. Similarly, the director of global marketing

seeks competitive prices in world markets. The controller and financial vice president are

concerned about profits. The manufacturing vice president seeks long production runs for

maximum manufacturing efficiency. The tax manager is concerned about compliance with

government transfer pricing legislation. Finally, company counsel is concerned about the

antitrust implications of global pricing practices.

Ultimately, price generally reflects the goals set by members or the sales staff, product managers,

corporate division chiefs, and/or the company’s chief executive.

GLOBAL PRICING OBJECTIVES AND STRATEGIES

√ (Learning Objective #2)

Whether dealing with a single home-country market or multiple country markets, marketing

manages must develop pricing objectives as well as strategies for achieving those objectives.

The pricing strategy for a particular product may vary from country to country; a product may be

positioned as a low-priced, mass-market product in some countries and a premium-priced, niche

product in others.

Pricing objectives may also vary depending on a product’s life-cycle stage and the country-

specific competitive situation.

It is necessary to factor in external considerations such as the added cost associated with

shipping goods long distances across national boundaries. The issue of global pricing can also be

fully integrated in the product design process, an approach widely used by Japanese companies.

Market Skimming and Financial Objectives

Price can be used as a strategic variable to achieve specific financial goals, including return on

investment, profit, and rapid recovery of product development costs. When financial criteria

such as profit and maintained of margins are the objectives, the product must be part of a

superior value proposition for buyers: price is integral to the total positioning strategy.

The market skimming pricing strategy is often part of a deliberate attempt to reach a market

segment that is willing to pay a premium price for a particular brand or for a specialized or

unique product. (See Exhibit 11-2 and 11-3)

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Companies that seek competitive advantage by pursuing differentiation strategies or positioning

their products in the premium segment frequently use market skimming.

The skimming pricing strategy is appropriate in the introductory phase of the product life cycle

when both production capacity and competition are limited. By setting a deliberately high price,

demand is limited to innovators and early adopters who are willing and able to pay the price.

This strategy has been used consistently in the consumer electronics industry.

Penetration Pricing and Nonfinancial Objectives

Some companies are pursuing nonfinancial objectives with their pricing

strategy. Price can be used as a competitive weapon to gain or maintain

market position. Market share or other sales based objectives are frequently

set by companies that enjoy cost-leadership positions in their industry.

A market penetration pricing policy strategy calls for setting price levels that are low enough

to quickly build market share. Historically many companies that used this type of pricing were

located in the Pacific Rim.

Companion Products: “Razors and Blades” Pricing

When formulating pricing strategies for products such as video game consoles, DVD players,

and smartphones, it is necessary to view these products in a broader context. The biggest profits

in the video industry come from sales of game software; even though Sony and Microsoft may

actually lose money on each console, sales of hit video titles generate substantial revenues and

profits.

These examples illustrate the concept of companion products: A video game console has no

value without video game software, and a DVD player has no value without movies on DVD.

Additional examples abound. A razor handle has no value without blades; thus Gillette can sell a

single Mach3 razor for less than $5—or even give the razor away for free. Over a period of

years, the company will make significant profits from selling packages of replacement blades. As

the saying goes, “If you make money on the blades, you can give away the razors.”

Target Costing

Japanese companies have traditionally approached cost issues in a way that results in substantial

production savings and products that are competitively priced in the global marketplace.

The process, sometimes known as design to cost, can be described as follows:

Target costing ensures that development teams will bring profitable products to market not only

with the right level of quality and functionality but also with appropriate prices for the target

customer segments. It is a discipline that harmonizes the labor of disparate participants in the

development effort, from designers and manufacturing engineers to market researchers and

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suppliers. In effect, the company reasons backward from customers’ needs and willingness to pay

instead of following the flawed but common practice of cost-plus pricing.

Western companies are beginning to adopt some of these money-saving ideas.

The target costing approach can be used with inexpensive consumer nondurables.

The target costing process begins with market mapping and product definition and positioning;

this requires using concepts and techniques discussed in Chapters 6 and 7. The marketing team

must do the following:

Determine the segment(s) to be targeted, as well as the prices that customers in the

segment will be willing to pay.

Compute overall target costs with the aim of ensuring the company’s future profitability.

Allocate target costs to the products various functions. Calculate the gap between the

target cost and the estimated actual production cost.

Obey the cardinal rule: If the design team can’t meet the targets, the product should not

be launched.

Calculating Prices: Cost-Plus Pricing and Export Price Escalation

In global marketing, the total cost will depend on the ultimate market destination, the mode of

transport, tariffs, and various fees, handling charges, and documentations costs.

Export price escalation is the increase in the final selling price of goods traded across borders

that reflects these factors.

The following is a list of eight basic considerations for setting prices on goods that cross borders:

1. Does the price reflect the product’s quality?

2. Is the price competitive, given local market conditions?

3. Should the firm pursue market penetration, market skimming, or another pricing

objective?

4. What type of discount (trade, cash, quantity) and allowance (advertising, trade-off)

should the firm offer its international customers?

5. Should prices differ with market segment?

6. What pricing options are available if the firm’s costs increase or decrease? Is demand in

the international market elastic or inelastic?

7. Are the firm’s prices likely to be viewed by the host-country government as reasonable or

exploitative?

8. Do the foreign country’s dumping laws pose a problem?

Companies frequently use a method known as cost-plus or cost-based pricing when selling goods

outside their home-country markets. Cost-based pricing is based on an analysis of internal (e.g.

materials, labor, testing) and external costs.

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Firms that comply with Western cost accounting principles typically use full absorption cost

method; this defines per-unit product cost as the sum of all past or current direct and indirect

manufacturing and overhead costs.

However, when goods cross national borders, additional costs and expenses

such as transportation, duties, and insurance are incurred. If the

manufacturer is responsible for them, they too must be included. By adding

the desired profit margin to the cost-plus figure, managers can arrive at a

final selling price.

Companies using rigid cost-plus pricing set prices without regard to the eight considerations

listed previously. They make no adjustments to reflect market conditions outside the home

country. The obvious advantage of rigid cost-based pricing is its simplicity: Assuming that both

internal and external cost figures are readily available, it is relatively easy to arrive at a quote.

The disadvantage is that this approach ignores demand and competitive conditions in target

markets; the risk is that prices will either be set too high or too low.

Flexible cost-plus pricing is used to ensure that prices are competitive in the context of the

particular market environment. This approach is frequently used by experienced exporters and

global marketers.

Flexible cost plus sometimes incorporates the estimated future cost method to establish the

future cost for all component elements. Managers who utilize flexible cost-plus pricing are

acknowledging the importance of the eight criteria listed earlier. Flexible cost-plus pricing

sometimes incorporates the estimated future cost method to establish the future cost for all

component elements.

INNOVATION, ENTREPRENEURSHIP AND THE GLOBAL STARTUP

Dr. Dre and Jimmy Iovine – Beats Electronics and Beats Music

Dr. Dre and Jimmy Ivoine are entrepreneurs. Working as a team, they started a company, created

a brand, developed an innovative product, and began to manufacture and market it.

By applying the basic tools and principles of modern marketing, Dre and Ivoine have achieved

remarkable success.

As is true with many entrepreneurs, their breakthrough idea was based on their recognition of a

problem that needed to be solved. Both were music industry veterans who identified an

opportunity to develop high quality consumer headphones that would enhance the music

playback experience while also serving as a fashion accessory.

By 2013, Beats by Dre had grown into a $ 1 billion-plus global business. Beats had quickly

become the top-selling brand in dozens of countries. Meanwhile, Dre and Iovine were turning

their attention to streaming music. They acquired online music service Mog in 2012. In 2014, in

conjunction with Nine Inch Nails frontman Trent Reznor, they launched Beats Music, a

subscription streaming service. Beats Music is a $ 10-per-month subscription service that offers

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users access to millions of songs.

Incoterms

√ (Learning Objective #3

Every commercial transaction is based on a contract of sale, and the trade terms in that contract

specify the exact point at which ownership of merchandise is transferred from the seller to the

buyer and which party in the transaction pays which costs.

The following activities must be performed when goods cross international boundaries:

1. Obtaining an export license if required

2. Obtaining a currency permit if required

3. Packing the goods for export

4. Transporting the goods to the place of departure

5. Preparing a land bill of lading

6. Completing necessary customs export papers

7. Preparing customs or consular invoices as required by the country of destination

8. Arranging for ocean freight and preparation

9. Obtaining marine insurance and certificate of the policy

Who is responsible for performing these tasks? The answer is “It depends on the terms of the

sale.”

The internationally accepted terms of trade are known as Incoterms (short for International

Commercial Terms).

Incoterms are classified into four categories:

1. Ex-works (EXW), the sole “E-Term” or “origin” term among Incoterms, refers to a

transaction in which the buyer takes delivery at the premises of the seller; the buyer bears

all risks and expenses from that point on.

2. Delivered duty paid (DDP). The seller has agreed to deliver the goods to the buyer at the

place the names in the country of import, with all costs, including duties, paid.

3. Free carrier (FCA). Also known as “F-Terms” or “pre-main-carriage terms.” FCA is

widely used in global sales. Under FCA, transfer from seller to buyer is effected when the

goods are delivered to a specified carrier at a specified destination.

a. FAS (free alongside ship) named port is the Incoterm for a transaction in which

the seller places the shipment alongside, or available to, the vessel upon which the

goods will be transported out of the country.

b. FOB (free on board) named port. The responsibility and liability of the seller do

not end until the goods have cleared the ship’s rail.

4. Several Incoterms are known as “C-Terms” or “main-carriage” terms.

a. CIF (cost, insurance, freight) named port is the risk of loss or damage to goods

is transferred to the buyer once the goods have passed the ship’s rail. The seller

pays transportation and insurance.

b. If the terms of the sale are CFR (cost and freight), the seller is not responsible

for risk or loss at any point outside the factory.

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Table 11-1 is a typical example of the kind of export price escalation that can occur when some

of the costs are added to the per-unit cost of the product itself.

ENVIRONMENTAL INFLUENCES ON PRICING DECISIONS

√ (Learning Objective #4)

Global marketers must deal with a number of environmental considerations when making pricing

decisions. Among them are currency fluctuations, inflation, government controls and subsidies,

and competitive behavior.

Currency Fluctuations

Currency fluctuations can create significant challenges and opportunities for any company that

exports. A weakening of the home-country currency swings exchange rates in

a favorable direction: a producer in a weak-currency country can choose to

cut export prices to increase market share or maintain its prices and reap

healthier profit margins.

It is a different situation when a company’s home currency strengthens; this is an unfavorable

turn of events for the typical exporter because overseas revenues are reduced when translated

into the home country currency.

In responding to currency fluctuations, global marketers can utilize other elements of the

marketing mix besides price.

EMERGING MARKETS BRIEFING BOOK

Demand in Asia Drives Fine Wine Prices

As every student of microeconomics knows, when demand exceeds supply, prices tend to rise.

The market for fine wine is a textbook example. Each year connoisseurs seek out wines from top

estates such as France’s Chateau Rothschild.

Today, a new customer has joined the global win culture: affluent collectors in China and other

Asian countries (see Exhibit 11-6). Several factors have contributed to this trend. In 2008, the

Hong Kong government reduced tariffs on wine imports from 40 percent to zero. Although China

still imposes ad valorem taxes on wine, hand-carried bottles crossing the border from Hong

Kong are not taxed. This has created a business opportunity for entrepreneurial individuals to

hire “mules” to transport wine to the mainland.

Chinese wine drinkers do their homework; they have been known to check out the tasting scores

and prices of wines they have been served. This, of course, reflects the importance of status in

Asian cultures.

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The use of the flexible cost-plus method to reduce prices in response to unfavorable currency

swings is an example of a market holding strategy and is adopted by companies that do not

want to lose market share.

Price transparency means that buyers will be able to comparison shop easily because goods

will be priced in a single currency (Euros) as opposed to multiple currencies (marks, francs, or

lira).

Inflationary Environment

Inflation, or a persistent upward change in price levels, is a problem in many countries markets

and can be caused by an increase in the money supply.

An essential requirement for pricing during inflation is the maintenance of profit margins

When present, inflation requires price adjustments for a simple reason: Increased selling prices

must cover rising costs. Regardless of cost accounting practices, if a company maintains its

margins, it has effectively protected itself for the effects of inflation.

Low inflation presents different pricing challenges.

For example, though the U.S. had low inflation and strong demand in the 1990s, excess

manufacturing, high European unemployment, and the Asian recession made price hikes

difficult. Globalization, the Internet, a flood of low-cost imports from China, and a new cost-

consciousness among buyers became constraining factors.

Government Controls, Subsidies, and Regulations

Governmental policies and regulations that affect pricing include dumping legislation, resale

price maintenance legislation, price ceilings, and general reviews of price levels.

Government action that limits price adjustment puts pressure on margins. Under certain

conditions, government actions pose a threat to the profitability of a subsidiary operation.

In a country with severe financial difficulties or crisis, government officials are under pressure to

take action (e.g., Brazil).

When selective controls are imposed, foreign companies are more vulnerable than local

businesses particularly, if the outsiders lack the political influence over government decisions

than local managers have. For example, Procter & Gamble encountered strict price controls in

Venezuela in the late 1980s, receiving only 50 percent of the price increases requested.

Government control can also take other forms. Companies are sometimes required to deposit

funds in noninterest-bearing escrow accounts for a specified period of time if they wish to import

products.

Cash deposit requirements clearly create an incentive for a company to minimize the stated value

of the imported goods; lower prices mean smaller deposits. Other government requirements that

affect the pricing decision are profit transfer rules that restrict the conditions under which profits

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can be transferred out of a country. Under such rules, a high transfer price paid for imported

goods by an affiliated company can be interpreted as a device for transferring profits out of a

country.

Government regulations can affect prices in other ways. The German government’s recent moves

toward deregulation have improved the climate for market entry by foreign firms in a range of

industries, including insurance, telecommunications, and air travel.

Deregulation is also giving German companies their first experience with price competition in

the domestic market. In some instances, deregulation represents a quid pro quo that will allow

German companies wider access to other country markets.

Competitive Behavior

Pricing decisions are bounded not only by cost and the nature of demand but also by competitive

action. If competitors do not adjust their prices in response to rising costs, management will be

severely constrained in its ability to adjust prices accordingly.

Conversely, if competitors are manufacturing or sourcing in a lower-cost country, it may be

necessary to cut prices to stay competitive.

Levi Strauss and Company jeans are under price pressures from several directions—in the U.S.

and overseas.

Using Sourcing as a Strategic Pricing Tool

The global marketer has several options for addressing the problem of price escalation or the

environmental factors.

Product and market competition dictate the marketer’s choices.

Manufacturers may be forced to switch to offshore sourcing to keep costs and prices competitive.

China is quickly gaining a reputation as the “the world’s workshop” (e.g. U.S. bicycle

manufacturers rely on production sources in China and Taiwan).

Another option is an audit of the distribution structure in the target markets. A rationalization of

the distribution structure can reduce markups required to achieve distribution.

Rationalization may include selecting new intermediaries, reassigning responsibilities, or

establishing direct.

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