International 8 PRICING STRATEGIES CONTENTS 8.0 Aims and Objectives 8.1 Introduction 8.2 Price and Non-Price Factors 8.2.1 Price Factors 8.2.2 Non-Price Factors 8.3 Methods of Pricing 8.
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8 PRICING STRATEGIES
CONTENTS
8.0 Aims and Objectives 8.1 Introduction 8.2 Price and Non-Price Factors 8.2.1 Price Factors 8.2.2 Non-Price Factors 8.3 Methods of Pricing 8.3.1 Cost-Oriented Export Pricing Method 8.3.2 Competitive Pricing
8.3.3 Market Price 8.4 International Price Quotations 8.5 Base of Export Price Quotations 8.6 International Pricing Strategy 8.6.1 Factors Affecting Pricing 8.6.2 Price Strategies
8.7 Dumping 8.8 Price Distortion 8.9 Counter-Trade 8.9.1 Types of Counter-Trade 8.10 Let us Sum up
8.11 Lesson End Activity 8.12 Keywords
8.13 Questions for Discussion 8.14 Suggested Readings
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8.0 AIMS AND OBJECTIVES
After studying this lesson you will be able to:
Understand methods of pricing a product which is required to be exported in the
international market
Distinguish between export pricing and domestic pricing
Explain international pricing strategy from time to time by using sourcing as a
strategic tool in pricing a product
Discuss the difference between price distortions and counter trade
8.1 INTRODUCTION
Pricing is a very critical decision in international marketing management because it is a
major factor influencing a firm’s total revenue from exports and its profitability There is
no thumb rule or any scientific or mathematical/statistical formula that can be applied in
pricing a product correctly There is no doubt that as is the case in the domestic market,
the interaction of market forces like demand and supply affect the price at which the
product can be sold in the international market Besides, several other factors — economic,
social, political, marketing conditions and product attributes — influence decision-making
in international marketing
In any given marketing, three basic factors determine the limits of pricing decisions of a
firm These are product cost, the purchasing power of the consumers and demand and
supply force The cost of the product serves as the floor price below which an exporter
shall not agree, in most cases, to sell the product The purchasing power of the consumer
fixes the upper limit of the price, which the firm can charge In reality, the prices are
rarely fixed by these two factors in the market; they are fixed by the demand and supply
forces in the market at a given time The international marketers task is compounded by
the fact that not only does he have to consider the above three factors but he has also to
take account of other government prices like taxes, tariffs, dumping regulations, price
ceiling, foreign exchange regulation and rate of inflation in different foreign markets It
is, therefore, necessary to adopt differentiated pricing in different foreign markets
8.2 PRICE AND NON-PRICE FACTORS
In international market, prices are fixed taking into consideration a combination of various
conditions and factors which put pressure on the pricing of a product These factors may
be termed as price factors and non-price factors
8.2.1 Price Factors
Pricing is like a tripod, the three factors being costs, demand and competition It is no
more possible to say that one or the other of these factors determines price than it is to
assess that one leg (factor) rather than either of the other two supports a tripod The
significance of these factors in pricing is discussed below:
1 Role of Costs: It is a popular fallacy to believe that price depends upon cost The
price cannot be fixed below cost for long Cost determines the floor price below
which an exporter may not agree to sell the goods But this principle does not
always hold good An increase in cost may justify the increase in prices yet it may
not be possible to do so because of marketing conditions, i.e., demand and supply
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On the other hand, it may also be possible that any increase in demand may lead to increase in price without an increase in costs
The cost price relationship is important as it does not support the claim that costs determine price In some cases, the prevalent price may determine the costs that may be increased from time to time The manufacturer exporter cuts the costs according to the prices current in the market The product is tailored according to the needs of the target consumers and their capacity to pay for it It explains why declining costs often result in better quality at the same price and raising costs lead
to deterioration in quality Another factor that evidences that costs do not determine price is that costs of each producer differ substantially because of different internal and external factors but prices of their product are close to one another If cost is the determining factor, the price must also vary substantially
2 Demand: Demand is another leg of the tripod It is a factor that determines prices
in international markets As regards demand in international market, it is also affected
by a number of other factors which are different from those operating in the domestic market Customs and taste of foreign customers may vary widely What is required
is that the product must be adapted to the needs of foreign customers If the product
is adapted accordingly, higher price may be fixed for the product as compared to competitors Thus demand of a product depends upon how the product has been adapted by the suppliers
Elasticity of demand is another factor which affects pricing If the demand of the product is elastic, a reduction in price may increase the sales volume On the other hand, higher price may be fixed if the demand is inelastic and the supply is limited
3 Competition: Competition in the targeted foreign market is an important factor in
the international market The competition increases elasticity of demand Competition
in foreign market may be so severe that the exporters have no other option except
to follow the market leader Competition may be either brand type or functional type Brand type refers to competition among brands of a product or service which aims at satisfying the other needs As against this, functional competition refers to the type of competition where the manufacturer tries to differentiate the function
of the product from its competitors This he may do either by altering this packaging
or by adding attributes to the products Both types of competitions put pressure on the companies, pricing decisions
Sometimes, company determines a price of the product with a specific objective of discouraging competition from entering a given foreign market
8.2.2 Non-Price Factors
Whenever an exporter fixes the price for his goods the importer does not necessarily consider the price of the product alone There are many other non-price factors that are considered by the importer Which play an important role in creating demand in foreign countries The non-price factors are confidence, brand image, frequency of purchase, association of price and quality, comprehensive knowledge of the product, before and after sales service, continuity of supply, prompt deliveries, settlement of claims, supply of complete range of products and terms of credit
1 Confidence: Most of the importers of developed countries do not have much
confidence in the quality of products manufactured by developing countries irrespective of the fact that the quality of their product may by much better Indians and exporters of other developing countries have to ensure that their products are priced lower than other competitors For example, Indians have to sell their storage
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though the quality is comparable Sometimes Indian exporters in carpets sell their
goods at much lower price than even the break-even point because of hard
competition from other countries like Pakistan, Nepal, China and Turkey Fixing
lower prices is inevitable to make our products acceptable in foreign markets
2 Brand Image: If products are well differentiated and they have built up a brand
image in the mind of foreign customers, the manufacturer of such products may
charge higher prices for his products Brand names like Bata, Tata, GKW, Dunlop,
Lucas, Phillips, BPL, LG, Sony, Samsung, Maruti, etc., have already earned good
brand name and are able to sell their products at higher prices
3 Frequency of Purchase: Frequency of purchase in some cases decides the price.
If customers purchase the goods very often, as is the case with non-durable consumer
items, they very often think of the price Where the item is a durable consumer
good, products having snob value or gift items, price is not a major consideration
People are willing to pay a higher price if the particular product appeals to them
Thus, durable consumer items or gift items may be sold at a much higher price
4 Association of Price and Quality: There appears to be a close association between
the price and quality of the product It is most commonly understood that lowest
priced goods do not carry adequate value The higher priced goods carry a much
greater conviction about quality than the low priced goods particularly in periods of
inflationary price rise A reduction in price may lead to reduction in demand because
it has an adverse reaction on the consumers
5 Comprehensive Knowledge of the Product: In case of an industrial product, the
importer has good knowledge of the quality of brands available in the world market
Therefore, apart from the quality, he considers other factors like technical soundness
of the product, steady availability at reasonable price and comprehensive after sale
service offered by the manufacturer Price is not the indicator of the quality alone
but it is a composite of all other related factors
6 Before and After Sale Service: In case of valuable industrial and engineering
products, both before and after sale service count much more than lower price
Before sale service in the case of engineering goods, industrial goods and scientific
technical equipment cover (i) advising the importer about the relative suitability of
competing products, and (ii) demonstrating the use of his product After sale service
in the case of sale of engineering goods and durable consumer goods include
(i) rectification of genuine technical fault in the product, (ii) educating the user on
the proper use of the product and providing proper training for its use and
maintenance, (iii) free service during the warranty period, and (iv) ensuring supply
of spare parts and components after the warranty period
7 Continuity of Supply: Regular supply of original product and its ancillary products
assumes great importance in foreign trade If regular supply of the original and
ancillary products is not arranged/maintained, the country has all the chances to
lose in the international market Development of substitutes for a number of products
exported by developing countries is also due to the failure of these countries to
maintain regular supplies An uninterrupted supply of the products may assure
better price
8 Prompt Delivery: Prompt deliveries may attract foreign buyers to pay higher prices
for the products This is a point which most developing countries fail to understand
Delayed deliveries affected India’s exports to Sri Lanka, Myanmar, Arab and
European countries While foreign importers like deliveries within three months
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from the date of the order, Indian exporters invariably fail to deliver the goods even before six months Studies made in recent years about Generalised System of Preferences (GSP) reveal that the reliability of product quality and delivery appear
to be more important factors than the price Hence, developing countries must adhere to the time schedule In that case, the price factor will take care of itself automatically
9 Settlement of Claims: In foreign trade, the exporter and importer are not close to
each other In most cases they even do not know each other The importer, therefore, will not hesitate to pay a somewhat higher price if there is an arrangement between them for prompt acceptance and settlement of claims if it is found correct during the course of enquiry
10 Supply of Complete Range of Products: In certain cases the price of the product
depends upon the fact that the producer (exporter) is in a position to supply complete range of products and in large quantities required by the importer Here also, Indian exporters and exporters of other developing countries have failed to come up to the expectations of the developed countries Generally, in developing countries, the exporters could not supply the goods in huge quantities because of lack of resources The reason being the small-scale sector is encouraged more in developing countries hence they are unable to produce complete range of the product For example, cycle manufacturers in India do not produce a complete range of cycle components
11 Terms of Credit: In case of export of capital goods, i.e., machinery and equipment,
availability of finance and terms of credit are very often the determining factor In this respect, developed countries dominate They supply goods on credit while exporters from developing countries including India are not able to do so because
of their limited resources However, in India, the Export Import Bank (EXIM) offers such credit to importers and the Export Credit Guarantee Corporation (ECGC) also offers guarantee cover for the credit given to the importers
8.3 METHODS OF PRICING
The export price structure, like the domestic price structure, begins on the factory floor But there is no similarity in the cost included in the two structures The pricing of the product for domestic and export purposes is calculated in a different manner The export price structure is the basis of all exports price quotations, discounts and commissions There are various methods of calculating the price in the foreign market The methods may be grouped into two–cost oriented export-pricing method and market-oriented export pricing method
8.3.1 Cost-Oriented Export Pricing Method
The cost-oriented export pricing methods are based on costs incurred in the production
of goods Total cost includes fixed costs and variable costs Thus, export pricing may be based on full cost (fixed and variable) or only the variable cost A reasonable profit will
be added to the base cost to arrive at export pricing Thus, cost-oriented export pricing method may be (i) full cost method and (ii) variable cost or marginal cost method
Full Cost Method or Cost-plus Method
The most frequently used pricing method in export is cost-plus method This method is based on the full cost or total cost approach In arriving at the export price under this method, the total cost of production of the article (fixed or variable) is taken into account Over and above the fixed and variable cost incurred in the production of exportable
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as R&D expenses and other expenses necessary for the export of article such as
transportation cost, freight, custom duties, risk costs, etc., are included Then a reasonable
profit allowance is added to the cost and the value of all assistance received from any
authority is deducted The net result is the total export price for the commodity produced
Price per unit may be calculated by dividing the total price thus arrived by the number of
units manufactured The various elements of cost forming the part of the total cost are
direct cost, fixed cost and freight and insurance
The various elements of cost forming part of the total costs are (a) direct cost which
includes variable costs – direct labour, variable production overhead and variable
administrative overheads (b) other costs directly related to exports These include selling
costs – advertising, special packaging, commission to overseas agents, export credit
insurance, bank charges, inland freight, power charges, inland insurance, port charges,
export duties, warehousing, documentation and so on Total direct cost will, therefore, be
(a) + (b)
Fixed Cost or Common Cost: These include production overhead, administrative
overheads, publicity and advertisement, travel abroad and so on less compensatory
assistance, duty drawback and import replenishment benefits
Freight and Insurance: This includes cost of freight and marine insurance up to the
importer’s destination This is also known as cost insurance freight (cif)
Evaluation: The main advantage of this approach is that the exporter realises the full
cost in marketing the product in a foreign market Another advantage may be its simplicity
but it may also be its main weakness because if the reorder is for a small number of units
to be supplied, it will not be possible for the exporter to supply the product at the same
rate due to its high cost of production per unit on account of fixed cost
This approach suffers from a number of disadvantages apart from simplicity: (i) it
completely ignores demand and the competitive conditions in the foreign target markets
(ii) it is often based on distorted measurement of cost appraisal (iii) it is based on circular
reasoning
Marginal Cost Pricing
Another common method of pricing in international trade is to determine the price on the
variable cost or direct cost Fixed cost element in the total cost of production is totally
ignored and the firm is concerned only with marginal or incremental cost of producing
the goods which are sold in the foreign markets The fixed cost remains fixed up to a
level of output irrespective of volume of output On the other hand variable costs vary in
proportion to the volume of production Thus it is variable or direct or marginal costs that
set the price after a certain level of output is achieved, i.e., the output at break-even
point
Evaluation: The export sales are additional sales Hence these should not be burdened
with overhead costs which are ordinarily met from domestic trade This approach is
favoured for the firms from developing countries who are not well known in foreign
countries as compared to their competitors from developed countries Therefore, lower
prices based on variable costs may help them enter foreign markets easily Low price
may serve to widen and create markets In such countries price is still the decisive
factor and quality is comparatively less important
Marginal cost pricing is not free from limitations Developing countries may be charged
of dumping their product in foreign markets because they would be selling their product
below net prices and attract anti-dumping provisions, which take away their competitive
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advantage The use of this approach may give rise to cut throat competition among exporting firms from developing countries resulting in loss in valuable foreign exchange
to developing countries Marginal cost pricing is not advisable if the importer is regularly purchasing the product at low price and mass production technique must have been adopted so that the gap between the full and marginal cost may be refunded
8.3.2 Competitive Pricing
Costs are no doubt important but competitive prices should also be considered before fixing the export price Competitive prices mean the prices that are charged by the companies for the same product or for the substitute of the product in the target market Once this price level is established, the following three main steps can determine the based price:
A Relevant demand schedules (quantities to be bought) at various prices should be determined based on the planning period,
B Relevant cost (total and incremental) of production and marketing costs should be estimated to achieve the target sales volume as per the demand schedules prepared, and
C The prices that offer highest profit contribution, i.e., the sales revenues minus all fixed costs
The final determination of base price should be made after considering all other elements
of marketing mix within these elements The nature and length of channel of distribution
is the most important factor affecting the final cost of production Besides, product adaptation cost should also be considered in fixing the base price The following chart gives the nature of analysis for market-oriented export pricing
8.3.3 Market Price
Less – retail margin on selling price cost to the retailer Less – wholesalers mark up to his cost (cost of the wholesaler) Less – importer’s mark up to his cost (cost of the importer) Less – import duty (landed price)
Less – free on board (fob) or cost of freight and insurance (cif)
Having found out what the market can bear, the firm has to determine whether it can sell the product at that price profitably or not by working back from the market price as shown above This analysis gives an idea of the upper limit of what the firm can charge The cost analysis discussed earlier gives the lower limit of what a firm can charge The price of a product in the foreign market may then be fixed between these two limits As the firm gains experience, it would be able to set the price that gives the highest profitability However, in many cases, it happens that the market realisation is very low In such circumstances the exporter may compare his fob realisation (under market-oriented export pricing) with direct cost or full cost as calculated under cost-oriented export pricing He can then determine whether he can export goods or not Whatever be the price determined by the firm for its product it must consider the price and non-price factors before taking a final decision
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Check Your Progress 1
1 Define marginal cost pricing
2 Elaborate price factors
8.4 INTERNATIONAL PRICE QUOTATIONS
An “export offer” or “quotation” is the basis of any export transaction Whenever an
exporter writes a formal letter to an importer with an offer of his export goods, the
importer, if replies in affirmative, needs to have any one of the following methods for an
export quotation or order
Proforma Invoice: An exporter prepares this after he receives an order from an importer.
It is a standardised proforma, which is applicable throughout the world It is similar to a
document known as “Commercial Invoice” It indicates the price as well as other charges
as per terms of contract incurred in shipment This is an exact duplicate of the invoice,
which will be sent to the importer just before the export of goods A point to remember
here is that proforma invoice is required by the importer to obtain the import license or
allotment of foreign exchange It should, therefore, be very accurate It also contains the
terms of payment, i.e., LC/DP/DA, etc Besides this, it contains the mode of shipment
and the price based on fob/wef
Global Price List: The offer may be made in response to a public global tender floated
by a buyer Such offers should be comprehensive covering all the conditions of the
tender and listing out the price together with other charges such as freight, insurance,
etc., and should also include escalation clause
Price List: An offer may also be in the form of a printed price list where the goods have
a standard export price The other terms and conditions to which the prices are subjected
may be either included in the price list or stated specifically in the accompanied letter
Letter Indicating the Price: An offer can be given in the form of a letter indicating the
price, terms of payment and the delivery of goods Whatever may be the mode of offer,
it should be written in a simple and easily understandable style Care should be taken to
ensure that there is no scope for any different interpretation or for any misunderstanding
It should clearly state the price and other terms and conditions to which the price is
subjected
8.5 BASE OF EXPORT PRICE QUOTATIONS
INCOTERMS have given some uniform export terms for delivery which are used all
over the world They indicate:
(a) The charge and expense, which must be paid by the seller
(b) Place of delivery of goods
(c) The point of time where the goods and their transit risks are transferred
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The export price quotations can be made with reference to the above terms The common terms in use are:
1 Ex-works: Under the ex-works quotation, the exporter pays packaging costs and
the delivery takes place at the works or a warehouse of the exporter All other expenses thereafter and transit risks are borne by the importer Ex-works price quotations are rarely used in international transactions However, for products which are heavy and for which shipping freight and transport charges cannot be estimated
in advance, ex-works quotations are usually accepted
2 (FAS) Free Alongside Ship Price: Under FAS quotations, the exporter pays all
charges upto putting the goods alongside the ship, while putting them on the ship is
a buyer’s expense Where shipping companies accept goods “on stream” and where goods have to be moved on barges to the side of a vessel, the FAS quotation should include barge’s charges as well The goods and the transit risks are transferred when the ship is able to load
3 (FOB) Free on Board Price: This is one of the most common terms used in
export pricing FOB means that the exporter has the obligation to put the goods on board the ship The exporter pays port trust charges and other charges necessary for completing documentation and loading the goods on a ship Delivery of goods takes place as soon as the goods have been loaded on the ship and the goods and transit risks are transferred when the goods go on the ship’s rail For Indian exporters, FOB price is significant because all assistance provided by the Government of India to exporters is related to FOB price of a contract
4 (C&F) Cost & Freight Price: Under this price, all responsibilities and expenses
are to be incurred as in FOB pricing, the exporter has to pay the ocean freight
5 CIF (Cost Insurance and Freight) Price: Under this price, all the costs as in
C&F plus the insurance are paid by the exporter but included in the price In C&F and CIF, the delivery takes place when the Bill of Lading is handed over and the goods and transit risks are transferred when the goods go over the ship’s rail The importers in most of the cases insist on the C&F or CIF prices The exporters will have to prepare their price quotations on such lines The implications of such insistences are two-fold (i) the exporter will have to arrange for shipping space and (ii) he will have to bear all transit costs and risks till the goods are handed over at the port of destination Thus any change in the transportation cost subsequently will have to be borne by the exporter
6 Ex-Ship Price: It includes all the costs till the goods are reached at the importer’s
port in the price quotations The property in goods and all risks are transferred as soon as the goods are offloaded at the importer’s port
7 Franco Price: In its broadest sense, Franco price includes all costs up to the
godown or warehouse of the importer The exporter pays for the importer’s godowns
in that foreign country In other words all the expenses and all risks will be transferred when the delivery is made to the buyer at his godown or the warehouse Thus any
of these prices may be the base price as per the terms of contract between the importer and the exporter The price thus quoted will also decide the point where the risks and property in goods will be transferred
8.6 INTERNATIONAL PRICING STRATEGY
Pricing strategy is an important part of fixing the international price The price has to be competitive and based on the quality of a product Different pricing strategies are adopted
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in different foreign countries because of certain environmental factors like political,
economic, socio-cultural, legal and so on
8.6.1 Factors affecting Pricing
There are three main factors which affect the export price strategy to be adopted by the
exporter in the foreign markets, viz., the characteristics of the product and the nature of
its demand, the philosophy of its management and the market characteristics The pricing
strategy is a short-term tool to make fit the prices in the changing competitive situations
in the short run with its pricing policy decisions
Characteristics of the Product and the Nature of its Demand: It is a major factor in
fixing the price of the product at a particular time In other words, improvement in quality
of the product and product adaptation according to the changing competitive conditions
in the foreign market should be taken as a continuous process Elasticity of demand is
another factor which influences the price If the demand of a product is inelastic, price
reduction will not help to increase the revenue In such a case, higher prices may be
fixed taking in view the competitive position in the market If, on the other hand, the
product is highly elastic, the sales revenue can be appreciably increased by slightly reducing
the price Thus, pricing strategy, i.e., whether to fix higher price or lower price as compared
to the competitor’s prices very much depends upon the elasticity of demand and the
competitive position
Philosophy of the Management: The philosophy or the objective of the management in
exporting goods is another important factor of pricing strategy As we know, the main
objective of the management of the every concern is to maximise profits — this is an
adverse relationship between price and demand The management can earn more profit
at increased revenue by reducing the price if the demand is more elastic On the other
hand, if the objective of the management is to export a committed value of merchandise,
the price may be even lower than the marginal cost In cases where a new product is
introduced in a competitive market, the management may sell it even below cost In
order to bar new entrants in the market, discounts may be increased or prices may be
reduced Thus, the strategy of pricing would depend upon the philosophy of the
management
Market Characteristics: Market characteristics such as number of competitors and
degree of competition, supply position, quality of the product, substitutes available in the
market, etc., determine the pricing strategy of the firm These market characteristics
vary from country to country
8.6.2 Price Strategies
The export price quotations may not be the same for all markets Prices may differ from
market to market due to various reasons, viz., political influence, buying capacity, financial
and import facilities, total market turnover and other pricing and non-pricing factors, etc.,
in order to make the local price of the product competitive Profitability will also be
affected to a great extent and may be different in different markets However, there is
nothing wrong in making a higher margin in small export markets and lower ones in
others provided there is an overall profit in export business
Thus, different strategies may be used in different markets In some markets prices may
be higher, in some others the product may be sold at cost price or in many others, it may
be sold at less than the cost price Normally, the following pricing strategies are used in
the export market:
1 Market Penetration Strategy: Under this strategy, exporters offer a very low
introductory price to speed up their sales and, therefore, to widen their market