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Global Marketing

Tenth Edition

Chapter 11

Pricing Decisions

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Learning Objectives (1 of 2)

11.1 Review the basic product concepts that underlie a successful global marketing product strategy.

11.2 Identify the different pricing strategies and objectives that influence decisions about pricing products in global markets.

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

11.4 List some of the environmental influences that impact prices.

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

The product “P” of the marketing mix is at the heart of the challenges and opportunities facing global companies today: Management must develop product and brand policies and strategies that are sensitive to market needs, competition, and company ambitions and resources on a global scale. Effective global marketing often entails finding a balance between the payoff from extensively adapting products and brands to local market preferences and the benefits that come from concentrating company resources on relatively standardized global products and brands.

Learning Objectives (2 of 2)

11.6 Explain some of the tactics global companies can use to combat the problem of gray market goods.

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

11.8 Compare and contrast the different types of price fixing.

11.9 Explain the concept of transfer pricing.

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

Basic Pricing Concepts (1 of 2)

Law of One Price

All customers in the market get the best product for the best price

Global markets

Diamonds

Crude oil

Commercial aircraft

Integrated circuits

National markets

Costs

Competition

Regulation

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. As Lowell Bryan and his collaborators note in Race for the World, a global market exists for certain products such as crude oil, commercial aircraft, diamonds, and integrated circuits. All other things being equal, a Boeing 787 costs the same worldwide. By contrast, beer, compact discs, and many other products that are available around the world are actually offered in markets that are national rather than global in nature; that is, these are markets where national competition reflects differences in factors such as costs, regulations, and the intensity of the rivalry among industry members. The beer market, for one, is extremely fragmented; even though Budweiser is the leading global brand, it commands less than 4 percent of the total market. The nature of the beer market explains why, for example, a six-pack of Heineken varies in price by as much as 50 percent (adjusted for purchasing power parity, transportation, and other transaction costs) depending on where it is sold. In Japan, for example, the price is a function of the competition between Heineken, other imports, and five national producers—Kirin, Asahi, Sapporo, Suntory, and Orion—which collectively command 60 percent of the market.

There is another important internal consideration besides cost. Internal groups may have conflicting price objectives. Division VPs, regional executives, and country managers are each concerned about profitability at their respective organizational levels. The director of global marketing seeks competitive prices in world markets. The controller and Financial VP are concerned about profits. The manufacturing VP seeks long production runs for maximum manufacturing efficiency. The tax manager is concerned about regulations regarding transfer pricing. The General Counsel considers antitrust regulation.

Whether dealing with a single home country market or multiple country markets, marketing managers must develop pricing objectives as well as strategies for achieving those objectives. The overall goal may be to contribute to an internal performance measure such as unit sales, market share, or return on investment. However, a number of pricing issues are unique to global marketing. This chapter will cover many of these issues. 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.

Basic Pricing Concepts (2 of 2)

The Global Manager must develop systems and policies that address

Price Floor: minimum price

Price Ceiling: maximum price

Optimum Prices: function of demand

Must be consistent with global opportunities and constraints

Be aware of price transparency created by Euro zone, Internet

Global Pricing Objectives & Strategies

Managers must determine the objectives for the pricing objectives

Market share

Return on investment

Profit

Rapid recovery of product development costs

They must then develop strategies to achieve those objectives

Penetration pricing

Market skimming

A number of pricing issues are unique to global marketing. 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. Stella Artois beer is a case in point. Pricing objectives may also vary depending on a product’s life-cycle stage and the country-specific competitive situation. In making global pricing decisions, it is also 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 & Financial Objectives

Market Skimming

Charging a premium price

May occur at the introduction stage of product life cycle

Luxury goods marketers use price to differentiate products

L V M H, Reebok in India

By setting a deliberately high price, demand is limited to innovators and early adopters who are willing and able to pay the price. When the product enters the growth stage of the life cycle and competition increases, manufacturers start to cut prices. This strategy has been used consistently in the consumer electronics industry; for example, when Sony introduced the first consumer VCRs in the 1970s, the retail price exceeded $1,000. The same was true when compact disc players were launched in the early 1980s. Within a few years, prices for these products dropped well below $500. This pattern was evident in the fall of 1998, when HDTV sets went on sale in the United States with prices starting at about $7,000. This price both maximizes revenue on limited volume and matches demand to available supply. Now next generation factories in Asia bring in lower costs and increased production capacity. In 2005, Sony introduced a 40-inch HDTV for $3,500; by the end of 2006, comparable sets were selling for about $2,000. Today, sets cost less than $1,000.

LVMH and other luxury goods marketers that target the global elite market segment use skimming strategies (see Case 11-3). As Muktesh Pant, the first CEO of Reebok India, noted about aspirational buyers of the company’s relatively high-priced shoes, “For Rs2,000 to Rs3,000, people feel they can really make a statement. It’s cheaper than buying a new watch, for instance, if you want to make a splash at a party. And though our higher-priced shoes put us in competition with things like refrigerators and cows, the upside is that we’re now being treated as a prestigious brand.”

Penetration Pricing & Non-Financial Objectives

Penetration Pricing

Charging a low price in order to penetrate market quickly

Appropriate to saturate market prior to imitation by competitors

Packaged food product makers, with products that do not merit patents, may use this strategy to get market saturation before competitors copy the product

Some companies are pursuing nonfinancial objectives with their pricing strategy. In particular, price can be used as a competitive weapon to gain or maintain market position. Market share or other sales-based objectives are frequently pursued by companies that enjoy cost-leadership positions in their industry. A market penetration pricing 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. Scale-efficient plants and low-cost labor allowed these companies to blitz the market.

A first-time exporter is unlikely to use penetration pricing. The reason is simple: Penetration pricing often means that the product may be sold at a loss for a certain length of time. Many companies, especially those in the food industry, launch new products that are not innovative enough to qualify for patent protection. When this occurs, penetration pricing is recommended as a means of achieving market saturation before competitors copy the product. Historically, many companies that used this type of pricing were located in the Pacific Rim. Scale-efficient plants and low-cost labor allowed these companies to blitz the market.

Companion Products: Captive or “Razors and Blades” Pricing

Companion products

Products whose sale is dependent upon the sale of primary product

Video games are dependent upon the sale of the game console

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

Cellular service providers subsidize the phone and make money on calling plans

The biggest profits in the video industry come from sales of game software; thus, even though Sony and Microsoft may lose money on console sales, games are generating substantial revenues and profits. This illustrates the notion of companion products: a video game console is worthless without games, a DVD player is worthless without movies, a razor handle is worthless without blades, a cellular phone is worthless without a calling plan, and so on.

Cellular service providers like Vodaphone and AT&T buy handsets from Nokia, Motorola, etc. and subsidize the cost by locking customers into long-term contracts and charging extra for text messaging, roaming, etc. However, this approach does not always work globally.

For example, in the United States, Apple’s iPhone 5 was priced at the equivalent of $199 when combined with a 2-year phone service contract. In India and other markets, however, consumers don’t like to be locked into long-term contracts. In addition, electronics imports are heavily taxed. That helps explain why the least-expensive iPhone, the SE, costs about $325, and an entry-level 16GB iPhone 6Ssells for the equivalent of $955. Moreover, Apple distributes the iPhone in India

exclusively through stores operated by Airtel, an Indian carrier, and Vodaphone. Indian sales of the iPhone have been slow because consumers in that country tend to choose lower-priced models from Nokia and Samsung that are distributed through more retailers. In the product’s early days, a significant number of $199 iPhone 5s made the trip from the United States to India in tourist luggage! Today, all the major handset manufacturers are designing lower-priced versions for

emerging markets.

Target Costing

Use by Japanese companies to control costs, save on production expense, & create competitively priced global products

Also called Design to Cost

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. Toyota, Sony, Olympus, and Komatsu are some of the well-known Japanese companies that use target costing.

Western companies are beginning to adopt some of these money-saving ideas. Target costing was used in the development of Renault’s Logan, a car that retails for less than $10,000 in Europe. Nissan also used target costing to develop a $3,000 Datsun (see Case 11-1). According to Luc-Alexandre Ménard, chief of Renault’s Dacia unit, the design approach prevented technical personnel from adding features that customers did not consider absolutely necessary. For example,

the first-generation Logan’s side windows had relatively flat glass; curved glass is more attractive, but it adds to the cost. The Logan was originally targeted at consumers in Eastern Europe; to the company’s surprise, it has proved popular in Germany and France as well.

The Target-Costing Process

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 the target costs to the product’s 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.

How are segments targeted? Using market research techniques such as conjoint analysis, the team seeks to better understand how customers will perceive product features and functionalities.

How are target costs calculated? Think of debits and credits in accounting: Because the target cost is fixed, additional funds allocated to one subassembly team for improving a particular function must come from another subassembly team.

Example: Western companies are beginning to adopt some of these money-saving ideas. For example, target costing was used in the development of Renault’s Logan, a car that retails for less than $10,000 in Europe (see Case 11-1). According to Luc-Alexandre Ménard, chief of Renault’s Dacia unit, the design approach prevented technical personnel from adding features that customers did not consider absolutely necessary. For example, the Logan’s side windows have relatively flat glass; curved glass is more attractive, but it adds to the cost. The Logan was originally targeted at consumers in Eastern Europe; to the company’s surprise, it has also proven to be popular in Germany and France.

The target costing approach can be used with inexpensive consumer nondurables. In Mexico and other emerging markets, Procter & Gamble (P&G) managers know that workers are often paid a daily wage; its Mexican customers generally carry 5- and 10-peso coins. To keep prices of shampoo and detergent below, say, 11 or 12 pesos and still ensure satisfactory profit margins, P&G uses target costing (P&G calls it “reverse engineering”). Rather than create an item and then assign a price to it—the traditional cost-plus approach—the company first estimates what consumers in emerging markets can afford to pay. From there, product attributes and manufacturing processes are adjusted to meet various pricing targets. For example, to hold down the cost of its Ace Natural detergent, which is used to hand-wash clothes in Mexico, P&G reduced the product’s enzyme content. The result: a product that costs a peso less than a single-use packet of regular Ace. In addition, the reformulated product is gentler on the skin.

Cost-Plus Pricing & Export Price Escalation

Total cost depends on:

Destination

Mode of transport

Tariffs

Various fees

Handling charges

Documentation costs

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

Export Price Escalation

Table 11-1 Price Escalation: A 20-feet Container of Agricultural Equipment Shipped from Des Moines to Yokohama

Item	Blank	Blank	Percentage of Ex-Works Price
Ex-works Des Moines		$45,000	100%
Inland and ocean freight from D S M to C Y Yokohama	$1,475.00	Blank	4.44%
Bunker adjustment fee	300.00	Blank	0.67%
Destination charges	240.00	Blank	0.53%
Freight forwarding fee	150.00	Blank	0.33%
A E S filing fee	25.00	Blank	0.06%
Total shipping charges	$2,715.00	$ 2,715.00	6.03%
Insurance (110% of C I F value)-$0.20 per $100		104.97	0.23%
Total C I F Yokohama value		$47,819.97	106.27%
V A T (3% of C I F value)		1,434.60	3.19%
Landed cost		49,254.57	109.45%
Distributor markup (10%)		4,925.46	10.95%
Dealer markup (25%)		12,313.64	27.36%
Total retail price		$66,493.67	147.76%

Pricing Factors for Goods That Cross Borders (1 of 2)

Does the price reflect the product’s quality?

Is the price competitive given local market conditions?

Should the firm pursue market penetration, market skimming, or some other pricing objective?

What type of discount (trade, cash, quantity) and allowance (advertising, trade-off) should the firm offer its international customers?

Should prices differ with market segment?

A list of eight basic considerations for those whose responsibility includes setting prices on goods that cross borders

Pricing Factors for Goods That Cross Borders (2 of 2)

What pricing options are available if the firm’s costs increase or decrease? Is demand in the international market elastic or inelastic?

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

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

Cost-Based Pricing

Cost-based pricing is based on an analysis of internal and external cost

Firms using Western cost accounting principles use the Full absorption cost method

Per-unit product costs are the sum of all past or current direct and indirect manufacturing and overhead costs

Must include additional costs & expense when goods cross national borders

However, when goods cross national borders, additional costs and expenses such as transportation, duties, and insurance are incurred. If the manufacturer is responsible for those costs, they, too, must be included (we discuss Incoterms in the next section). By adding the desired profit margin to the cost-plus figure, managers can arrive at a final selling price. It is important to note that in China and some other developing countries, many manufacturing enterprises are state run and state subsidized. This makes it difficult to calculate accurate cost figures and opens a country’s exporters to charges that they are selling products for less than the “true” cost of producing them. The recent controversy over Chinese-made solar panel exports is a case in point.

Cost-Plus Pricing

Rigid cost-plus pricing means that companies set prices without regard to the eight pricing considerations

Flexible cost-plus pricing ensures that prices are competitive in the contest of the particular market environment

Estimated future cost method may be used when component prices fluctuate widely.

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 be set either too high or too low.

An alternative method, flexible cost-plus pricing, is used to ensure that prices are competitive in the context of the particular market environment. Experienced exporters realize that the rigid cost-plus approach can result in severe price escalation, with the unintended result that exports are priced at levels above what customers are willing or able to pay. 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. For example, the automobile industry uses palladium in catalytic converters. Because the market price of heavy metals is volatile and varies with supply and demand, component manufacturers might use the estimated future cost method to ensure that the selling price they set will enable them to cover their costs.

Crossing International Borders

Obtain export license if required

Obtain currency permit

Pack goods for export

Transport goods to place of departure

Prepare a land bill of lading

Complete necessary customs export papers

Prepare customs or consular invoices

Arrange for ocean freight and preparation

Obtain marine insurance and certificate of the policy

Terms of the Sale

Incoterms

Ex-works - E-Term-Seller places goods at the disposal of the buyer at the time specified in the contract; buyer takes delivery at the premises of the seller and bears all risks and expenses from that point on.

Delivery duty paid - D-Term-Seller agrees to deliver the goods to the buyer at the place he or she names in the country of import with all costs, including duties, paid

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. In principle, ex-works affords the buyer maximum control over the cost of transporting the goods. Ex-works can be contrasted with several “D-Terms” (“post-main-carriage” or “arrival” terms). For example, under delivered duty paid (DDP), the seller has agreed to deliver the goods to the buyer at the place the buyer names in the country of import, with all costs, including duties, paid. Under this contract, the seller is also responsible for obtaining the import license if one is required.

Incoterms: F-Terms & C-Terms

F C A (free carrier) sale occurs when goods are delivered to the carrier

F A S (free alongside ship) named port of destination - seller places goods alongside the vessel or other mode of transport and pays all charges up to that point

F O B (free on board) - seller’s responsibility does not end until goods have actually been placed aboard ship

C I F (cost, insurance, freight) named port of destination - risk of loss or damage of goods is transferred to buyer once goods have passed the ship’s rail

C F R (cost and freight) - seller is not responsible at any point outside of factory

Currency Fluctuations

Complicate setting prices

Weak home-country currency make exchange rates favorable

Cut export prices to increase market share

Maintain price for higher profit

May create windfall revenue when translated into home-country currency

Strong home-country currency is unfavorable

Overseas revenues are reduced when translated into home-country currency

Flexible cost-plus pricing is used by companies to maintain market share

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. Overseas sales can result in windfall revenues when translated into the home-country currency.

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. As an example, suppose the U.S. dollar weakens relative to the Japanese yen. This is good news for American companies such as Boeing, Caterpillar, and GE, but bad news for Canon and Olympus (and Americans shopping for cameras). Indeed, according

to Teruhisa Tokunaka, chief financial officer of Sony, a 1-yen shift in the yen–dollar exchange rate can raise or lower the company’s annual operating profit by 8 billion yen (see Figure 11-1). These examples underscore the point that “roller-coaster” or “yo-yo”–style swings in currency values, which may move in a favorable direction for several quarters and then abruptly reverse, characterize today’s business environment.

Inflationary Environment

Defined as a persistent upward change in price levels

Can be caused by an increase in the money supply

Can be caused by currency devaluation

Essential requirement for pricing is the maintenance of operating margins

Inflation, or a persistent upward change in price levels, is a problem in many country markets. An increase in the money supply can cause inflation; as noted in the previous section, inflation is often reflected in the prices of imported goods in a country whose currency weakened. For example, following the Brexit vote in 2016, the British pound fell approximately 15 percent against the euro and other major currencies. That was a mixed blessing for producers of English sparkling wine. On the plus side, export prices for wines made in England were more attractive and boosted demand, while the price of Champagne imported from France to the United Kingdom increased. As for the downside, most English vintners buy winemaking equipment and supplies such as bottles from Europe, so they are paying higher prices.

Low Inflation Environment

Should make it possible to raise prices but consider the global competitive environment

U.S. inflation rate in the 1990s was low and strong demand had factories at capacity

However, mid-1990s Europe had high unemployment, Asia was in recession

By the end of the decade, globalization, the Internet, low-cost products from China, and cost-conscious consumers became other constraining factors

Low inflation presents pricing challenges of a different type. With inflation in the United States in the low single digits in the late 1990s and strong demand forcing factories to run at or near capacity, companies should have been able to raise prices. However, the domestic economic situation was not the only consideration in pricing decisions made in that era. In the mid-1990s, excess manufacturing capacity in many industries, high rates of unemployment in many European

countries, and the lingering recession in Asia made it difficult for companies to increase prices. As John Ballard, CEO of a California-based engineering firm, noted in 1994, “We thought about price increases. But our research of competitors and what the market would bear told us it was not worth pursuing.” By the end of the decade, globalization, the Internet, a flood of low-cost exports from China, and a new cost-consciousness among buyers were also significant price-constraining

factors.

Government Controls, Subsidies, and Regulations

The types of policies and regulations that affect pricing decisions are:

Dumping legislation

Resale price maintenance legislation

Price ceilings

General reviews of price levels

Foreign governments may:

require funds to be noninterest-bearing accounts for a long time

restrict profits taken out of the country and limit funds paid for imported material

Restrict price competition

When selective controls are imposed, foreign companies are more vulnerable to control than local ones, particularly if the outsiders lack the political influence over government decision that local managers have. For example, Procter & Gamble encountered strict price controls in Venezuela in the late 1980s. Despite increases in the cost of raw materials, P&G was only granted about 50 percent of the price increases it requested; Even then, months passed before permission to raise prices was forthcoming. As a result, by 1988, detergent prices in Venezuela were less than what they were in the United States.

Government control can also take other forms. As discussed in Chapter 8, companies are sometimes required to deposit funds in a noninterest-bearing escrow account for a specified period of time if they wish to import products. For example, Cintec International, an engineering firm that specializes in restoring historic structures, spent eight years seeking the necessary approval from Egyptian authorities to import special tools to repair a mosque. In addition, the country’s port authorities required a deposit of nearly $25,000 before allowing Cintec to import diamond-tipped drills and other special tools. Why would Cintec’s management accept such conditions? Cairo is the largest city in the Muslim world, and there are hundreds of centuries-old historic structures in need of repair.

The German government historically restricted pricing, especially in the services sector. The recent move towards deregulation has made it possible for foreign providers in telecommunications, air travel, and insurance to enter the market. In retail, changes are the repeal of two laws. One limited discounts to 3% of list price; the other prohibited free gifts, like sturdy shopping bags.

Competitive Behavior

If competitors do not adjust their prices in response to rising costs it is difficult to adjust your pricing to maintain operating margins

If competitors are manufacturing or sourcing in a lower-cost country, it may be necessary to cut prices to stay competitive

In the United States, Levi Strauss & Company is under price pressure from several directions. First, Levi’s faces stiff competition from the Wrangler and Lee brands marketed by VF Corporation. A pair of Wrangler jeans retails for about $20 at JC Penney’s and other department stores, compared with about $30 for a pair of Levi 501s. Second, Levi’s two primary retail customers, J.C. Penney and Sears, are aggressively marketing their own private label brands. Finally, designer jeans from Calvin Klein, Polo, and Diesel are enjoying renewed popularity. Exclusive fashion brands, like Lucky and Seven, retail for more than $100 per pair. Outside the United States, thanks to the heritage of the Levi brand and less competition, Levi jeans command premium prices—$80 or more for one pair of 501s.

To support the prestigious image, Levi’s are sold in boutiques. Not surprisingly, Levi’s non-U.S. sales represent about one-third of revenues but more than 50 percent of profits. In an attempt to apply its global experience and enhance the brand in the United States, Levi’s has opened a number of Original Levi’s Stores in select American cities. Despite such efforts, Levi’s rang up only $4.5 billion in sales in 2016 compared with $7.1 billion in 1996. A decade ago, officials announced plans to close six plants and move most of the company’s North American production offshore in an effort to cut costs.

Using Sourcing as a Strategic Pricing Tool

Marketers of domestically manufactured finished products may move to offshore sourcing of certain components to keep costs down and prices competitive

China is “the world’s workshop”

Rationalization may include recruiting new intermediaries, changing the role of old ones, or establishing direct marketing operations

Rationalize the distribution system-Toys ‘R’ Us bypasses layers of intermediaries in Japan to operate U.S. style warehouse stores

Rationalization may include selecting new intermediaries, assigning new responsibilities to old intermediaries or establishing direct marketing.

Global Pricing: Three Policy Alternatives

Extension or Ethnocentric

Adaptation or Polycentric

Geocentric

Extension Pricing (1 of 2)

Ethnocentric

Per-unit price of an item is the same no matter where in the world the buyer is located

Importer must absorb freight and import duties

Fails to respond to each national market

The extension approach has the advantage of extreme simplicity because no information on competitive or market conditions is required for implementation. The disadvantage of the ethnocentric approach is that it does not respond to the competitive and market conditions of each national market and, therefore, does not maximize the company’s profits in each national market or globally. When toymaker Mattel adapted U.S. products for overseas markets, for example, little consideration was given to price levels that resulted when U.S. prices were converted to local currency prices. As a result, Holiday Barbie and some other toys were overpriced in global markets.

Extension Pricing (2 of 2)

“We used to say that we know what the customer wants, and he will have to pay for it…. We didn’t realize the world had changed.

Dieter Zetsche, Chairman of Daimler A G

Mercedes got a wake-up call in 1993 when Lexus began offering “Mercedes quality” for $20,000 less.

Responded by boosting employee productivity, increased low-cost outside suppliers, added production facilities in the U.S. and Spain to move to competitive pricing, rolled out lower-priced E & S Class sedans.

Similarly, Mercedes executives moved beyond an ethnocentric approach to pricing. As Dieter Zetsche, chairman of Daimler AG, noted, “We used to say that we know what the customer wants, and he will have to pay for it . . . we didn’t realize the world had changed.” Mercedes got its wake-up call when Lexus began offering “Mercedes quality” for $20,000 less. After assuming the top position in 1993, Mercedes CEO Helmut Werner boosted employee productivity, increased the number of low-cost outside suppliers, and invested in production facilities in the United States and Spain in an effort to move toward more customer- and competition-oriented pricing. The company also rolled out new, lower-priced versions of its E Class and S Class sedans. Advertising Age immediately hailed management’s new attitude for transforming Mercedes from “a staid and smug purveyor into an aggressive, market-driven company that will go bumper-to-bumper with its luxury car rivals—even on price.”

Adaptation or Polycentric Pricing

Permits affiliate managers or independent distributors to establish price as they feel is most desirable in their circumstances

Sensitive to market conditions but creates potential for gray marketing

IKEA takes a polycentric approach to pricing: While it is company policy to have the lowest price on comparable products in every market, managers in each country set their own prices, which depend in part on local factors such as competition, wages, taxes, and advertising rates. Overall, IKEA’s prices are lowest in the United States, where the company competes with large retailers. Prices are higher in Italy where local competitors tend to be smaller, more upscale furniture stores than those in the U.S. market. Generally, prices are higher in countries where the IKEA brand is strongest. When IKEA opened its first stores in China, the young professional couples, the primary target market, thought prices were too high. The company quickly increased the amount of Chinese products in order to lower prices; today the average Chinese customer spends 300 yen, or about $36.

European industrial exporters found that companies using independent distributors were most likely to use polycentric pricing.

Arbitrage is also a potential problem with the polycentric approach; when disparities in prices between different country markets exceed the transportation and duty costs separating the markets, enterprising individuals can purchase goods in the lower-price country market and then transport them for sale in markets where higher prices prevail.

This is precisely what has happened in both the pharmaceutical and textbook publishing industries. Discounted drugs intended for AIDS patients in Africa have been smuggled into the European Union and sold at a huge profit. Similarly, Pearson (which publishes this text), McGraw-Hill, Thomson, and other publishers typically set lower prices in Europe and Asia than in the United States. The reason is that the publishers use polycentric pricing: They establish prices on a regional or country-by-country basis using per capita income and economic conditions as a guide.

Geocentric Pricing

Intermediate course of action

Recognizes that several factors are relevant to pricing decision

Local costs

Income levels

Competition

Local marketing strategy

For consumer products, local income levels are critical in the pricing decision. If the product is normally priced well above full manufacturing costs, the global marketer should consider accepting reduced margins and price below prevailing levels in low-income markets. The important point here is that in global marketing there is no such thing as a “normal” margin. Of the three methods described, the geocentric approach is best suited to global competitive strategy. A global competitor will take into account global markets and global competitors in establishing prices. Prices will support global strategy objectives rather than the objective of maximizing performance in a single country.

In the short term, however, headquarters might decide to set a market penetration objective and price at less than the cost-plus return figure by using export sourcing to establish a market. Another short-term objective might be to arrive at an estimate of the market potential at a price that would be profitable given local sourcing and a certain volume of production. Instead of immediately investing in local manufacture, a decision might be made to supply the target market initially from existing higher-cost external supply sources. If the market accepts the price and product, the company can then build a local manufacturing facility to further develop the identified market opportunity in a profitable way. If the market opportunity does not materialize, the company can experiment with the product at other prices because it is not committed to a fixed sales volume by existing local manufacturing facilities.

Gray Market Goods

Trademarked products are exported from one country to another where they are sold by unauthorized persons or organizations

Occurs when product is in short supply, when producers use skimming strategies in some markets, and when goods are subject to substantial markups

This practice, known as parallel importing, occurs when companies employ a polycentric, multinational pricing policy that calls for setting different prices in different country markets. Gray markets can flourish when a product is in short supply, when producers employ skimming strategies in certain markets, or when the goods are subject to substantial markups. For example, in the European pharmaceuticals market, prices vary widely. In the United Kingdom and the Netherlands, for example, parallel imports account for as much as 10 percent of the sales of some pharmaceutical brands. The Internet is emerging as a powerful new tool that allows would-be gray marketers to access pricing information and reach customers.

Sometimes, gray marketers bring a product produced in a single country—French Champagne, for example—into export markets in competition with authorized importers. The gray marketers sell at prices that undercut those set by the legitimate importers. In another type of gray marketing, a company manufactures a product in the home-country market as well as in foreign markets. In this case, products manufactured abroad by the company’s foreign affiliate for sales abroad are sometimes sold by a foreign distributor to gray marketers. The latter then bring the products into the producing company’s home-country market, where they compete with domestically produced goods.

As these examples show, the marketing opportunity that presents itself requires gray market goods to be priced lower than goods sold by authorized distributors or domestically produced goods. Clearly, buyers gain from lower prices and increased choice. In the United Kingdom alone, total annual retail sales of gray market goods are estimated to be in the billions of pounds Sterling.

Gray Market Issues

Dilution of exclusivity

Free riding

Damage to channel relationships

Undermining segmented pricing schemes

Reputation and legal liability

• Dilution of exclusivity. Authorized dealers are no longer the sole distributors. The product is often available from multiple sources and margins are threatened.

• Free riding. If the manufacturer ignores complaints from authorized channel members, those members may engage in free riding. That is, they may opt to take various actions to offset downward pressure on margins. These options include cutting back on presale service, customer education, and salesperson training.

• Damage to channel relationships. Competition from gray market products can lead to channel conflict as authorized distributors attempt to cut costs, complain to manufacturers, and file lawsuits against the gray marketers.

• Undermining segmented pricing schemes. As noted earlier, gray markets can emerge because of price differentials that result from multinational pricing policies. However, a variety of forces—including falling trade barriers, the information explosion on the Internet, and modern distribution capabilities—hamper a company’s ability to pursue local pricing strategies.

• Reputation and legal liability. Even though gray market goods carry the same trademarks as goods sold through authorized channels, they may differ in quality, ingredients, or some other way. Gray market products can compromise a manufacturer’s reputation and dilute brand equity, as when prescription drugs are sold past their expiration dates or electronics equipment is sold in markets where they are not approved for use or where manufacturers do not honor warranties.

Dumping

Sale of an imported product at a price lower than that normally charged in a domestic market or country of origin

Occurs when imports sold in the U.S. market are priced at either levels that represent less than the cost of production plus an 8% profit margin or at levels below those prevailing in the producing countries

U.S. law, the Byrd Amendment, provides for payment to companies harmed by dumping

To prove, both price discrimination and injury must be shown

Antidumping policy is administered in the U.S. by the U.S. Commerce Dept.; by the European Commission in Europe.

Companies concerned with running afoul of antidumping legislation have developed a number of approaches for avoiding the dumping laws. One approach is to differentiate the product sold from that in the home market so it does not represent “like quality.” An example of this is an auto accessory that one company packaged with a wrench and an instruction book, thereby changing the “accessory” to a “tool.”

Price Fixing

Representatives of two or more companies secretly set similar prices for their products

Illegal act because it is anticompetitive

Horizontal price fixing occurs when competitors within an industry that make and market the same product conspire to keep prices high

Vertical price fixing occurs when a manufacturer conspires with wholesalers/retailers to ensure certain retail prices are maintained

For example, in 2011 the European Commission determined that Procter & Gamble, Unilever, and Henkel had conspired to set prices for laundry detergent. The term horizontal applies in this instance because Procter & Gamble and its co-conspirators are all at the same supply chain “level” (i.e., they are manufacturers).

The European Commission recently fined Nintendo nearly $150 million after it was determined that the video game company had colluded with European distributors to fix prices. During the 1990s, prices of Nintendo video game consoles varied widely across Europe. They were much more expensive in Spain than in Britain and other countries; however, distributors in countries with lower retail prices agreed not to sell to retailers in countries with high prices.

Transfer Pricing

Pricing of goods, services, and intangible property bought and sold by operating units or divisions of a company doing business with an affiliate in another jurisdiction

Intra-corporate exchanges

Cost-based transfer pricing

Market-based transfer pricing

Negotiated transfer pricing

A market-based transfer price is derived from the price required to be competitive in the global marketplace. In other words, it represents an approximation of an arm’s-length transaction. Cost-based transfer pricing uses an internal cost as the starting point in determining price. Cost-based transfer pricing can take the same forms as the cost-based pricing methods discussed earlier in the chapter. The way costs are defined may have an impact on tariffs and duties of sales to affiliates and subsidiaries by global companies. A third alternative is to allow the organization’s affiliates to determine negotiated transfer prices among themselves. This method may be employed when market prices are subject to frequent changes.

Countertrade (1 of 2)

Countertrade occurs when payment is made in some form other than money

Options

Barter

Counterpurchase or parallel trading

Offset

Compensation trading or buyback

Switch trading

Countertrade usually involves a seller from the West and a buyer in a developing country. Flourishes when hard currency is scarce. Exchange controls may prohibit a company from repatriating earnings so the company spends in country to buy products that are exported. The most important reason for countertrade is that developing countries have found it difficult to obtain bank financing for exports.

Counterpurchase is distinguished from other forms in that each delivery in an exchange is paid for in cash. For example, Rockwell International sold a printing press to Zimbabwe for $8 million. The deal went through, however, only after Rockwell agreed to purchase $8 million in ferrochrome and nickel from Zimbabwe, which it subsequently sold on the world market.

Offset is a reciprocal arrangement whereby the government in the importing country seeks to recover large sums of hard currency spent on expensive purchases such as military aircraft or telecommunications systems. Lockheed Martin Corp. sold F-16 fighters to the United Arab Emirates for $6.4 billion and agreed to invest $160 million in the petroleum-related UAE Offsets Group.

Compensation trading: This form of countertrade, also called buyback, involves two separate and parallel contracts. In one contract, the supplier agrees to build a plant or provide plant equipment, patents or licenses, or technical, managerial, or distribution expertise for a hard currency down payment at the time of delivery. In the other contract, the supplier company agrees to take payment in the form of the plant’s output equal to its investment (minus interest) for a period of as many as 20 years. Used heavily in China.

Switch trading is a mechanism that can be applied to barter or countertrade. In this arrangement, a third party steps into a simple barter or other countertrade arrangement when one of the parties is not willing to accept all the goods received in a transaction.

Countertrade (2 of 2)

Barter

The direct exchange of goods or services between two parties

Counterpurchase

Parallel trading or barter

Cash is used for each good or service

Products offered by the foreign principal are not used by the Western firm

2 separate contracts

Western company sells the product

The counterpurchase form of countertrade, also termed parallel trading or parallel barter, is distinguished from other forms of countertrade in that each delivery in an exchange is paid for in cash. For example, Rockwell International sold a printing press to Zimbabwe for $8 million—but the deal went through only after Rockwell agreed to purchase $8 million in ferrochrome and nickel from Zimbabwe. It subsequently sold those ores on the world market. The Rockwell–Zimbabwe deal illustrates several aspects of counterpurchase. Generally, products offered by the foreign principal are not related to the Western firm’s exports and cannot be used directly by the firm. In most counterpurchase transactions, two separate contracts are signed. In one contract, the supplier agrees to sell products for a cash settlement (the original sales contract); in the other, the supplier agrees to purchase and market unrelated products from the buyer (a separate, parallel contract). The dollar value of the counterpurchase generally represents a set percentage—and sometimes the full value—of the products sold to the foreign principal. When the Western supplier sells these goods, the trading cycle is complete.

Countertrade: Offset

A government in the importing country recovers the cash spent on expensive goods like military aircraft or telecommunication systems

Not contractual

Longer time period than Offset

No penalty for nonperformance; requests from 20-50% if the value of the supplier’s product

Controversial

“‘Offset’ is a bad word, and it’s against G A T T and a whole bunch of other stuff, but it’s still a fact of life.”

Dean Thornton, former Boeing Executive

Offset arrangements may also involve cooperation in manufacturing, some form of technology transfer, placing subcontracts locally, or arranging local assembly or manufacturing equal to a certain percentage of the contract value. In one deal involving offsets, Lockheed Martin sold F-16 fighters to the United Arab Emirates for $6.4 billion. In return, Lockheed Martin agreed to invest $160 million in the petroleum-related UAE Offsets Group.

Offsets have become a controversial aspect of today’s trade environment. To win sales in important markets such as China, global companies can face demands for offsets even when transactions do not involve military procurement. For example, the Chinese government requires Boeing to spend 20 to 30 percent of the price of each aircraft on purchases of Chinese goods.

As former Boeing executive Dean Thornton once explained:

“Offset” is a bad word, and it’s against GATT and a whole bunch of other stuff, but it’s a fact of life. It used to be 20 years ago in places like Canada or the UK, it was totally explicit, down to the decimal point. “You will buy 20 percent offset of your value.” Or 21 percent or whatever. It still is that way in military stuff. [With sales of commercial aircraft], it’s not legal so it becomes less explicit.

Countertrade: Compensation Trading & Switch Trading

Compensation Trading (Buyback)

2 separate and parallel contracts

First contract, the supplier agrees to build a plant, supply machinery, patents or licenses, or technical, managerial, or distribution expertise for a hard-currency down payment at the time of delivery.

Second contract, the supplier agrees to take payment in the form of the plant’s real output equal to its investment minus interest for up to 20 years.

Switch Trading (Triangular Trade or Trade and Swap)

A 3rd party steps into a simple barter or other agreement when one of the parties does not want the goods in the transaction.

Essentially, the success of compensation trading rests on the willingness of each firm to be both a buyer and a seller. China has used compensation trading extensively. Egypt also used this approach to develop an aluminum plant. A Swiss company, Aluswiss, built the plant and also exports alumina (an oxide of aluminum found in bauxite and clay) to Egypt. Aluswiss takes back a percentage of the finished aluminum produced at the plant as partial payment for

building the plant. As this example shows, compensation differs from counterpurchase in that the technology or capital supplied in the former is related to the output produced. In counterpurchase, as noted earlier, the goods taken by the supplier typically cannot be used directly in its business activities.

Also called triangular trade and swap, switch trading is a mechanism that can be applied to barter or countertrade. In this arrangement, a third party steps into a simple barter or other countertrade arrangement when one of the parties is not willing to accept all the goods received in a transaction. The third party may be a professional switch trader, a switch trading house, or a bank. The switching mechanism provides a “secondary market” for countertraded or bartered

goods and reduces the inflexibility inherent in barter and countertrade. Fees charged by switch traders range from 5 percent of market value for commodities to 30 percent for high-technology items. Switch traders develop their own networks of firms and personal contacts and are generally headquartered in Vienna, Amsterdam, Hamburg, or London. If a party to the original transaction anticipates that the products received in a barter or countertrade deal will be sold eventually at a discount by the switch trader, the common practice is to price the original products higher, build in “special charges” for port storage or consulting, or require shipment by the national carrier.

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