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CHAPTER TWELVE: Pricing Decisions

Overview
When Reebok, the world’s number two athletic shoe company, decided to enter India in
1995, it faced several basic marketing challenges. For one thing, Reebok was creating a
market from scratch. Upscale sports shoes were virtually unknown, and the most expensive
sneakers available at the time cost 1,000 rupees (about $23). Reebok officials also had to
select a market entry mode. There were two other issues as well: product and price. Should
Reebok create mass-market shoes specifically for India and priced at Rs 1,000, or offer the
same designs sold in other parts of the world and price them at Rs 2,500 ($58), the
equivalent of a month’s salary for a junior civil servant. As Reebok’s experience in India
illustrates, a basic issue in global marketing is establishing a pricing policy.

Objectives
• To show that pricing decisions are a critical element of the marketing mix that
must reflect costs, competitive factors, and customer perceptions regarding
value.

• To explain the pricing strategies of market skimming, market penetration,


market holding, and cost-plus pricing.

• To define Incoterms, terms of a sale such as ex-works, F.A.S., F.O.B., and


C.I.F.

• To show how costs lead to price escalation, the accumulation of costs that occurs
when transporting products abroad.

• To explain that expectations regarding currency fluctuations, inflation,


government controls, and the competitive situation must be factored into
pricing decisions.

• To show how global companies maintain competitive prices by shifting


production sources as business conditions change.

• To categorize a company’s pricing policies as ethnocentric, polycentric, or


geocentric.

• To consider pricing issues such gray market goods and parallel imports, dumping,
and transfer pricing.

• To explain how countertrade plays an important role in today’s global environment.


Barter, counterpurchase, offset, compensation trading, cooperation agreements,
and switch trading are countertrade options.

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Lecture/Outline P.P.
1

Two basic factors determine the boundaries for setting market prices. P.P.
2

Product cost establishes a price floor, or minimum price.

Prices for comparable substitute products create a price ceiling, or upper boundary.

Generally, international trade results in lower prices, which keep a country’s rate of
inflation in check.

Between the lower and upper boundary there is an optimum price, a function of the
demand for the product as determined by the willingness and ability of customers to
buy.

Discussion Question #1: What are the basic factors that affect price in any market?
What considerations enter into the pricing decision?

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Basic Pricing Concepts

In a true global market, the law of one price prevails: All customers could get the best
product available for the best price (e.g., a global market exists for crude oil).

Compact discs and other products are offered in national rather than global markets,
which reflect differences in costs, regulation, and rivalry (e.g., in Japan, beer price is
a function of the competition between Heineken, other imports, and five national
producers).

Companies must have pricing systems and policies that address price floors, price
ceilings, and optimum prices in each national market (e.g., companies in the euro
zone must adjust to new cross-border prices).

Within a corporation, there are interest groups and conflicting price objectives.

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Global Pricing Objectives and Strategies
P.P. 3

Marketing managers develop pricing objectives and strategies.

The overall goal may be an internal performance measure such as unit sales, market
share, or return on investment, but several pricing issues are unique to global
marketing.

A pricing strategy may vary from country to country—low-priced, mass-market


products in some countries are premium priced in others.

Pricing objectives depend on a product’s life cycle stage and the country-specific
competitive situation.

External considerations factor in, such as added costs for shipping across national
boundaries.

Global pricing can be integrated in the design process, an approach used by the
Japanese.

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• Market Skimming and Financial Objectives P.P.


4

When financial criteria such as profit and maintenance of margins are the objectives,
price is integral to the total positioning strategy.

Market skimming targets a segment willing to pay a premium price for a particular
brand or for a specialized product.

Companies that pursue differentiation strategies or position their products in the


premium segment use market skimming (e.g., Mercedes-Benz).

The skimming strategy is appropriate in the introductory phase of the product life
cycle. A high price limits demand to innovators and early adopters.

During the growth stage of the life cycle, competition increases and manufacturers
cut prices (e.g., Sony’s VCRs).

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• Penetration Pricing and Non-Financial Objectives
Price can be used as a competitive weapon to gain or maintain market position.

Penetration pricing sets price levels low enough to quickly build market share (e.g.,
Sony Walkman in 1979).

A company can change objectives as a product proceeds through its life cycle and as
competitive conditions change (e.g., Fuji used penetration pricing to gain market
share against Kodak).

A first-time exporter is unlikely to use penetration pricing because the product may
be sold at a loss, and companies cannot absorb such losses.

Many companies launch new products not innovative enough for patent protection,
but penetration pricing achieves market saturation before competitors copy the
product.

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• Calculating Prices: Cost-Plus Pricing and Price Escalation P.P. 5


Considerations for setting price:
• 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 discounts or allowances should be offered to international
customers?
• Should prices differ with market segment? P.P. 6
• 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 is based on an analysis of internal and external costs. P.P.


7

The full absorption cost method defines per-unit product cost as the sum of all past or
current direct and indirect manufacturing and overhead costs.

When goods cross national borders, there are costs and expenses such as
transportation, duties, and insurance.

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By adding the desired profit margin to the cost-plus figure, managers arrive at a final
selling price.

Rigid cost-plus pricing sets prices without regard to the considerations listed above.
They make no adjustments to reflect market conditions outside the home country.

The advantage of rigid cost-based pricing is its simplicity.

The disadvantage is that this approach ignores demand and competitive conditions in
target markets, setting prices too high or too low.

An alternative method, flexible cost-plus pricing, ensures that prices are competitive
in a particular market environment. Experienced exporters and global marketers use
this approach.

A rigid cost-plus approach can result in severe price escalation, with the result that
exports cost too much.

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

Discussion Question #2: Define the various types of pricing strategies and objectives
available to global marketers.

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• Terms of the Sales P.P. 8


The following activities take place when goods cross international boundaries:
• Obtain an export license if required
• Obtain a currency permit
• Pack goods for export
• Transport goods to the 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

Incoterms apply to all modes of transportation. P.P.


9

For ex-works, the seller places goods at the disposal of the buyer at the time
specified in the contract. The buyer takes delivery at the premises of the seller and
bears all risks and expenses.

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For delivered duty paid, the 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.

Several Incoterms apply to sea and inland waterway transportation:

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

• F.O.B. (free on board): seller’s responsibility does not end until the goods have
actually been placed aboard a ship.

• C.I.F. (cost, insurance, freight) named port of destination: risk of loss or


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

• C.F.R. (cost and freight): seller is not responsible at any point outside the
factory.

Price escalation occurs when these costs are added to the per-unit cost. P.P. 10

The net effect of this add-on accumulating process is a total retail price of $50,210,
or 166 percent of the ex-works price.

Experienced global marketers view price as a strategic variable that can achieve
marketing and business objectives.

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Environmental Influences on Pricing Decisions P.P. 11

Global marketers face environmental considerations when making pricing decisions:


currency fluctuations, inflation, government controls and subsidies, and competitive
behavior.

Some factors work in conjunction with others, such as inflation and government
controls.

• Currency fluctuations
Currency fluctuations create significant problems and opportunities.

A weakening of the home country currency swings exchange rates in a favorable


direction.

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When the home currency strengthens, it is unfavorable because revenues are reduced
when translated into the home country currency.

Today’s business environment is characterized by “roller coaster”-style swings in


currency values.

Currency fluctuations affect prices and other elements of the marketing mix
(See Table 12-4).

The first two strategies focus on competitive issues besides price, productivity, and
cost reduction efforts.

Companies in the strong-currency country can absorb the cost of maintaining


international market prices at previous levels.

A market holding strategy is a flexible approach to reduce prices in response to


unfavorable currency swings.

When the domestic currency is weak, strategies include marginal-cost pricing to


penetrate new markets; the selling price equals the variable (incremental) costs of
producing one additional unit.

This approach is applicable for a manufacturer with excess capacity in a weak-


currency country if the sales levels cover fixed costs.

A manufacturer in multiple markets avoids price escalation by shifting production to


another country (e.g., Honda shifted production from Japan to Ohio to avoid raising
prices when the yen strengthened in the mid-1990s).

A producer in a weak-currency country cuts export prices to increase market share or


maintains prices for healthier profit margins.

EU buyers will have price transparency; they can comparison shop because goods are
now priced in euros.

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• Inflationary environment
Inflation, a persistent upward change in price levels, is a worldwide phenomenon.

Inflation requires periodic price adjustments due to rising costs that must be covered
by increased selling prices.

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An essential requirement is the maintenance of profit margins; a company that
maintains its margins protects itself from inflation (e.g., in Peru in the 1980s, Procter
& Gamble had biweekly increases in detergent prices of 20 to 30 percent).

Low inflation presents different pricing challenges (e.g., 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, and cost-consciousness among buyers became


constraining factors.

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• Government controls, subsidies, and regulations


Governmental policies and regulations that affect pricing include dumping
legislation, resale price maintenance legislation, price ceilings, and reviews of price
levels.

If government action limits price adjustment, the maintenance of margins is


compromised.

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 (e.g., Procter & Gamble faced price controls in Venezuela in the late 1980s,
receiving only 50 percent of the price increases requested).

Government control can take the form of cash deposit requirements imposed on
importers. Such requirements encourage a company to minimize prices since lower
prices mean smaller deposits.

Government subsidies force a strategic use of sourcing to be price competitive (e.g., in


Europe, government subsidies to agriculture make it difficult for U.S. distributors to
compete on price).

Government regulations can affect prices in other ways (e.g., Germany’s move toward
deregulation improved market entry for insurance, telecommunications, and air travel
industries).

Change is coming to retailing; the Internet and globalization have forced the repeal of
archaic laws.

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• Competitive behavior
Pricing decisions are affected by competitive action.

If competitors do not adjust prices in response to rising costs, management is


constrained in adjusting prices.

If competitors are manufacturing or sourcing in a lower-cost country, it is necessary


to cut prices to stay competitive (e.g., In the U.S., Levi Strauss faces stiff price
competition from the Wrangler and Lee brands. Outside the U.S., Levi jeans
command premium prices).

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• Using Sourcing as a Strategic Pricing Tool
Manufacturers may be forced to switch to offshore sourcing to keep costs and prices
competitive.

The Far East and South America are low-cost sources of production (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 includes selecting new intermediaries, reassigning responsibilities, or


establishing direct marketing (e.g., in Japan, Toys ‘R’ Us bypasses layers of
distribution and uses warehouses).

Discussion Question #3: Identify some of the environmental constraints on global


pricing decisions.

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Global Pricing: Three Policy Alternatives P.P.


12

What pricing policy should a global company pursue? There are three pricing
alternatives.

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• Extension/Ethnocentric P.P. 13
An extension or ethnocentric pricing policy calls for the per-unit price of an item to
be the same worldwide.

The importer absorbs freight and import duties.

The advantage is simplicity. The disadvantage is that it fails to respond to each


national market and/or maximize profits (e.g., Mattel gave little consideration to
price levels by making Holiday Barbie overpriced in global markets).

Mercedes-Benz executives have recently moved beyond ethnocentric pricing.

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Adaptation/Polycentric
P.P. 14

Adaptation or polycentric pricing permits subsidiary managers or independent


distributors to establish the price they feel is most desirable in their circumstances.

There is no requirement that prices be coordinated.

This approach is sensitive to local market conditions, but creates potential for a gray
market—goods purchased in the low-price markets and sold in high-price markets.

Valuable knowledge and experience concerning pricing do not reach local pricing
decisions.

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• Invention/Geocentric P.P. 15
Geocentric pricing represents an intermediate course of action.

Geocentric pricing recognizes that several factors are relevant to pricing decisions:
local costs, income levels, competition, and the local marketing strategy.

Price is integrated with other elements of the marketing program (e.g., a “pull”
strategy with mass media advertising and intensive distribution needs an appropriate
price given advertising costs).

The geocentric approach also consciously and systematically seeks to ensure that
accumulated national pricing experience is leveraged and applied wherever relevant.

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Local costs plus a return on invested capital and personnel fix the price floor for the
long term.

In the short term, headquarters might set a market penetration objective and price at
less than the cost-plus return figure.

Another short-term objective might be an estimate of the market potential at a profit


with local sourcing and a certain scale of output.

For consumer products, local income levels are critical; a product priced above
manufacturing costs should be priced below prevailing levels in low-income markets.

Only the geocentric approach lends itself to global competitive strategy.

Prices support strategy objectives, not maximizing performance in a single country.

Discussion Question #7: What is the difference between ethnocentric, polycentric,


and global pricing strategies? Which one would you recommend to a company that
has global market aspirations?

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Gray Market Goods P.P.


16

Gray market goods are trademarked products that are exported from one country to
another where they are sold by unauthorized persons or organizations.

This practice, known as parallel importing, flourishes when a product is in short


supply, when producers use skimming strategies in certain markets, or when the
goods are subject to substantial markups (e.g., French champagne sold in the U.S at
prices that undercut importers’ prices).

In another scenario, a company manufactures a product in both the home country


market and a foreign market; products manufactured abroad are sold to gray
marketers, who bring the products into home-country market.

Buyers gain from lower prices and increased choice (e.g., in the United Kingdom,
total annual retail sales of gray market goods are estimated at $1.6 billion).

In the U.S., gray market goods are subject to the Tariff Act of 1930. Section 526
forbids importation of goods of foreign manufacture without the permission of the
trademark owner.

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The U.S. Customs Service, which implements the regulation, and the court system
have leeway in decisions regarding gray market goods.

In many instances, the court’s interpretation of the law differs from that of the
Customs Service.

One legal expert argues that the U.S. Congress should repeal Section 526 and require
gray market goods to bear labels explaining differences between them and goods from
authorized channels.

Other experts believe that improved market segmentation and product differentiation
would make gray market products less attractive.

The Internet is a powerful new tool that allows gray marketers to access pricing
information and reach customers.

Discussion Question #4: Why do price differences in world markets often lead to
gray marketing?

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Dumping
P.P. 17

Dumping is the sale of an imported product at a price lower than that normally
charged in a domestic market or country of origin.

The U.S. Congress has defined dumping as an unfair trade practice that results in
“injury, destruction, or prevention of the establishment of American industry.”

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

In Europe, the European Commission administers antidumping policy.

Dumping was a major issue in the Uruguay round of GATT negotiations, and a
significant change is the addition of a “standard of review.”

The agreement brought GATT standards into line with U.S. standards.

The last few years have seen an increased incidence of antidumping investigation and
penalties. Many U.S. dumping cases involve manufactured goods from Asia.

To prove dumping, both price discrimination and injury must be demonstrated.

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Price discrimination sets different prices when selling the same quantity of “like-
quality” goods to different buyers.

Companies concerned with violating antidumping legislation differentiate the product


so it does not represent “like-quality.”

Another approach is to make nonprice competitive adjustments in arrangements with


affiliates and distributors.
Discussion Question #5: What is dumping? Why was dumping such an important
issue during the Uruguay Round of GATT negotiations?

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Transfer Pricing P.P. 18

Transfer pricing refers to the 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.

Transfer pricing concerns intracorporate exchanges—transactions between buyers and


sellers that have the same corporate parent (e.g., Toyota subsidiaries sell to, and buy
from, each other).

Intracompany shipments by non-U.S. companies to U.S. units represent one-fourth of


U.S. merchandise shipments.

In determining transfer prices, companies consider taxes, duties and tariffs, country
profit transfer rules, conflicting objectives, and regulations.

Tax authorities take a keen interest in transfer pricing policies.

Transfer pricing will be a key issue in Europe after the Euro makes it easier to audit
transfer-pricing policies.

Three approaches to transfer pricing vary with the nature of the firm, products,
markets, and historical circumstances.

• Cost-based transfer pricing takes the same forms as the cost-based pricing,
including full cost and estimated future cost.

• Market-based transfer price is tied to the price required to be competitive in the


international market.

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Companies have outsourcing options, which apply pressure to control and cut
costs to compete with outside vendors.

• Negotiated transfer prices are set by the organizations themselves.

Discussion Question #6: What is a transfer price? Why is it an important issue for
companies with foreign affiliates? Why did transfer pricing in Europe take on increased
importance in 1999?

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• Tax regulations and transfer prices


There is an incentive to maximize income in countries with low tax rates and
minimize income in high-tax countries.

In response, governments maximize national tax revenues by examining company


returns and mandating reallocation of income and expenses.

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• Sales of tangible and intangible property


Section 482 of the U.S. Treasury regulations deals with controlled intracompany
transfers of raw materials and finished and intermediate goods, and intangibles such
as charges for the use of manufacturing technology.

The general rule that applies to sales of tangible property is known as the “arm’s-
length” formula, defined as the price that would have been charged in independent
transactions between unrelated parties under similar circumstances.

• Competitive pricing
If only the arm’s-length standard is applied, a company may not be able to respond to
the competitive factors that exist in every market, domestic and global.

Fortunately, the regulations provide an opening for the company that seeks to be
price- competitive or to aggressively price U.S.-sourced products globally.

Many interpret the regulations such that a company can reduce prices and increase
marketing expenditures through an affiliate to gain market share.

This is because market position represents an investment and an asset.

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The regulations are also interpreted to permit a company to lower its transfer price to
enter a new market or meet competition in an existing market.

Companies must have latitude in making price decisions to achieve success in


international markets.

Discussion Question #8: If you were responsible for marketing CAT scanners
worldwide (average price, $1,200,000) and your country of manufacture was
experiencing a strong and appreciating currency against almost all other currencies,
what options are available to you to maintain your competitive advantage in world
markets?

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• Importance of Section 482 regulations


The pricing rationale must conform with the intention of Section 482 regulations.

The IRS issued regulations in 1993 requiring participation of management and


marketing personnel in transfer pricing decisions, as opposed to the tax department
personnel.

Companies must demonstrate that pricing methods result from informed choice, not
oversight.

The government seeks to prevent tax avoidance and ensure fair distribution of income from
global companies.

The government does not always succeed in enforcing Section 482 (e.g., Merck won
a suit against the U.S. government on the grounds that the IRS’s allocation of 7
percent of the income from a wholly-owned subsidiary to the parent company was
“arbitrary, capricious, and unreasonable”).

Even companies that try to comply with regulations and document this effort may
find themselves in tax court.

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Joint ventures

Joint ventures present an incentive to set transfer prices at higher levels because a
company’s share of the earnings is less than 100 percent.

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Any profits in the joint venture must be shared.

The frequency of audits is an incentive to find an agreement acceptable to tax


authorities.

The criterion of “arm’s-length” prices is appropriate for the majority of joint


ventures.

To avoid potential conflict, companies with joint ventures should have pricing
agreements considering:

• The way in which transfer prices are adjusted in response to exchange-rate


changes.
• Expected reductions in manufacturing costs arising from improvements and
reflected in transfer prices.
• Shifts in sourcing from parents to alternative sources.
• The effects of competition on volume and margins.

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Open to Discussion: Is Competitiveness a Dangerous Obsession?

Stanford University economist Paul Krugman offers the following proposition: We can
only be competitive in the new global economy if we forge a new partnership between
government and business. Krugman’s complaint is that fundamental economic concepts
—especially comparative advantage—are being misinterpreted, misapplied, or ignored
altogether in the name of public policy.

First, Krugman says that America is not “part of a truly global economy” because most
U.S. produced goods and services are for domestic consumption. Next, he disputes the
idea that America “competes in the global marketplace” because Japan, the U.S., and
others do not compete in the manner of Coca-Cola and PepsiCo. Third, he opposes
linking higher U.S. productivity with international trade because improved productivity
in other nations does not make the U.S. less competitive. Finally, if strategic traders heed
the message of “rhetoric of competitiveness,” the results could have undesirable
consequences.

Q: What are the consequences of the “rhetoric of competitiveness”?

A: It could lead to wasteful government spending to enhance competitiveness,


protectionism and trade wars, or poor public policy decisions.

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Countertrade
P.P. 19

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

In a countertrade transaction, a sale results in product flowing in one direction to a buyer;


a separate stream of products and services, often flowing in the opposite direction, is also
created.

Countertrade generally involves a seller from the West and a buyer in a developing
country (e.g., former Soviet bloc countries rely on countertrade).

Countertrade flourishes when hard currency is scarce. Exchange controls prevent a


company from expatriating earnings, forcing it to spend money in country for export
products.

Several conditions affect countertrade such as the priority attached to the Western
import, the value of the transaction, and the availability of other suppliers.

If competitors deal on a countertrade basis, a company has little choice but to agree
or risk losing the sale altogether.

Developing economies gain access to Western expertise, technology, and the creation
of hard currency export markets.

The U.S. government opposes countertrade, which represents a bilateral trade


agreement that violates free trade as established by GATT.

Two categories of countertrade include barter and mixed forms of countertrade—


counterpurchase, offset, compensation trading, cooperation agreements, and switch
trading.
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• Barter
Barter is a direct exchange of goods or services between two parties.

No money is involved, but both partners approximate a price for products flowing in
each direction.

Companies sometimes seek outside help from barter specialists (e.g., in the Soviet
era, PepsiCo bartered soft-drink syrup concentrate for Stolichnaya vodka, exported to
the U.S. and marketed by M. Henri Wines).

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• Counterpurchase
This form of countertrade, also termed parallel trading or parallel barter, is paid for in cash.
(e.g., Rockwell International sold a printing press to Zimbabwe for $8 million and purchased
$8 million in ferrochrome and nickel, which it sold).

Generally, products offered by the foreign principal are not related to the Western
firm’s exports and cannot be used by the firm.

In most counterpurchase transactions, two contracts are signed; the supplier sells
products for cash and purchases unrelated products.

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• Offset
Offset is a reciprocal arrangement whereby the government in the importing country
recovers large sums of hard currency spent on expensive purchases, such as military
aircraft or telecommunications systems.

The government says, “If you want us to spend government money on your exports,
you must import products from our country.”

Offset arrangements may involve manufacturing, technology transfer, local


subcontracts, or local assembly (e.g., Lockheed Martin sold F-16 fighters to the
United Arab Emirates for $6.4 billion and invested $160 million in the petroleum-
related UAE Offsets Group).

Offset differs from counterpurchase, characterized by smaller deals in a short time frame.

Offset is not a contract but a memorandum of understanding with the value to be offset and
a time frame.

There is no penalty on the supplier for nonperformance.

Offsets have become controversial. To win sales in markets such as China, companies
face demands for offsets when transactions do not involve military items.

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• Compensation trading
Buyback involves two separate and parallel contracts.

In one, 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, the supplier company agrees to take payment in the form of the plant’s
output equal to its investment (minus interest) for up to 20 years.
The success of compensation trading rests on the willingness to be both a buyer and a
seller (e.g., Egypt used this approach to develop an aluminum plant with a Swiss
company).

Compensation differs from counterpurchase because the technology or capital is


related to the output produced.

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• Cooperation agreements
Each cooperation agreement represents an accommodation to the needs of trading
partners.

They include cooperation and simple barter (triangular deals); cooperation and
counterpurchase; and cooperation, counterpurchase, and credit by a bank.

Problems with these arrangements include finding two industrial-country firms with a
supply-demand fit and the flexibility to handle delays in payment or delivery.

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• Hybrid countertrade arrangements


Hybrid forms of countertrade are becoming prevalent (e.g., countries such as Brazil,
Mexico, and even Canada now make investment proposals contingent on
commitments to export).

Project accompaniment is a condition to the exchange of industrial goods by the West


for oil from the Middle East.

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• Switch trading
Also called triangular trade and swap, switch trading can be applied to barter or
countertrade.

A professional switch trader, switch trading house, or bank steps into a simple barter
or other countertrade arrangement when one party does not accept all the goods in a
transaction.

Switching provides a “secondary market” for goods and reduces the inflexibility
inherent in barter and countertrade.

Switch traders charge fees from 5 percent of market value for commodities to 30
percent for high-technology items.

Switch traders develop networks and are headquartered in Vienna, Amsterdam,


Hamburg, and London.

Advantages include: (1) economic efficiency in pricing and increased trade; (2)
discounted prices to open new markets; and (3) no responsibility for marketing goods
received in countertrade.

Disadvantages include: (1) disruptions when switch dealers discount; (2) products in
oversupply or difficult to sell; (3) assessment of the Western firm as uncommitted to
a long-term trade relationship; and (4) complex transactions.

Discussion Question #9: Compare and contrast the different forms of countertrade.

Notes________________________________________________________________
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Discussion Questions

1. What are the basic factors that affect price in any market? What considerations
enter into the pricing decision?

One factor is the price floor, which can be linked to product cost or some other
consideration. For example, in the fall of 1996, Florida tomato growers concerned
about cheap tomatoes from Mexico persuaded the U.S. government to impose a price
floor of 21 cents per pound on Mexican tomatoes.

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A second basic factor is the price ceiling, an upper limit created when comparable
products are available. As industries globalize, consumers should enjoy lower prices
unless national or regional protective barriers are erected to imports. The U.S. market
for entry-level luxury cars is crowded with imported nameplates, and price
competition in the entry-level category is fierce among Lexus, Infiniti, Mercedes-
Benz, and BMW. In the Mercosur countries, on the other hand, external tariffs on
motor vehicles are still as high as 70 percent. Thus, many consumers in Brazil,
Argentina, Uruguay, and Paraguay must buy locally produced vehicles at high prices.

Finally, between these two extremes there is an optimum price. Many Japanese
companies have struggled to find the optimum price in view of a strong and
fluctuating yen.
Some pricing considerations noted in Chapter 12 include:
• Whether or not a product’s quality is reflected in the price
• How to price to different segments
• Determining the latitude to adjust prices if costs change
• Enforcement of dumping laws

2. Define the various types of pricing strategies and objectives available to global marketers.

The three strategies discussed in the chapter are market skimming, penetration pricing, and
market holding or status quo pricing. Market skimming is appropriate in the introductory
phase of the product life cycle if there is little competition or few acceptable substitutes.
Skimming can be the quickest way for a company to recoup product development and
marketing costs. For example, Sony's PlayStation 2 (PS2) was launched at $299; in an
effort to further increase its customer base, Sony lowered PS2's price to $199 in May 2002.
The price of the original PlayStation, which at this point was $99, was dropped to $49.
Archcompetitor Microsoft matched the $100 price cut on its Xbox player.

With a penetration pricing strategy, a relatively low price is established in an effort to gain
market share. This strategy has historically been favored by Japanese companies that take
a longer-term view of profitability. RCA has clearly switched from skimming to
penetration as DSS enters the growth phase of the product life cycle.

Status quo pricing is particularly important in global marketing because currency


fluctuations can drive up product prices in export markets. To avoid a sales decline, a
company should be prepared to adjust prices. Another option is to try to cut fixed or
variable costs.

3. Identify some of the environmental constraints on global pricing decisions.

Currency fluctuations are an important consideration in global marketing. Inflation is


another factor in the economic environment that may force a company to make frequent
price changes. Government regulations can hinder or prohibit a company’s efforts to
adjust costs. Finally, the presence or absence of competitors directly affects a company’s
flexibility with prices. In the absence of competitive restraints, a company can charge
whatever the market will bear. In Switzerland, for example, there is little competition

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for imported Chevy S pickup trucks, so the price per vehicle is nearly double the typical
price paid in the U.S.

4. Why do price differences in world markets often lead to gray marketing?

Price differentials mean opportunities to engage in arbitrage. “Buy low, sell high” is the
operative phrase, and many entrepreneurs are quick to capitalize on the chance to make
some quick money. On the consumption side, many buyers jump at the chance to save
money. They are willing to ignore issues such as buying from “authorized dealers.”

5. What is dumping? Why was dumping such an important issue during the Uruguay
Round of GATT negotiations?

Dumping is the practice of selling goods in foreign markets at prices that are lower than the
cost of production or lower than the home-country price. During the GATT negotiations,
government representatives from some countries expressed concern that enforcement of
U.S. antidumping policies always favored the U.S. For its part, the U.S. negotiators were
concerned about the relative absence of due process in overseas dumping cases.

6. What is a transfer price? Why is it an important issue for companies with foreign affiliates?
Why did transfer pricing in Europe take on increased importance in 1999?

A transfer price is the price one unit of a company charges to another company unit for
goods and services. Transfer prices can be determined on the basis of the market, or by
negotiation between the company’s various units. Companies under the jurisdiction of
U.S. tax laws must comply with Section 482, the portion of the Internal Revenue Code
that deals with controlled intracorporate transfers.

7. What is the difference between ethnocentric, polycentric, and global pricing


strategies? Which one would you recommend to a company that has global market
aspirations?

An ethnocentric pricing policy calls for the price of a particular product to be the same in
every part of the world. When management uses this approach it foregoes opportunities
to set prices higher in countries where a lower price is required. A polycentric approach
relies on adaptation of country managers who attempt to be as responsive as possible to
local market conditions. One problem with the polycentric approach is that it creates
conditions in which gray marketing can flourish. A geocentric pricing approach balances
the desire for long-term returns on investment with shorter-term considerations such as
market share. The geocentric approach is most appropriate for a company with a global
strategy and global aspirations.

8. If you were responsible for marketing CAT scanners worldwide (average price,
$1,200,000) and your country of manufacture was experiencing a strong and
appreciating currency against almost all other currencies, what options are available to
you to maintain your competitive advantage in world markets?

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The real issue here is not just options for adjusting prices, but options that will allow the
marketer to maintain competitive advantage. One option is to shift manufacture to one
or more weak-currency countries. If that is not feasible, another medical-products
company could become license under license. Another option is to keep manufacturing
in the strong currency country, focusing on cost-cutting efficiencies and/or product
innovation and improvements that will differentiate the scanners. A lower cost, “no
frills” model can be developed for some markets.

9. Compare and contrast the different forms of countertrade.

Companies barter when buyers are unable to pay in cash, or when a country’s currency is
not freely convertible in foreign exchange markets. Barter is a category of countertrade
in which goods, but no money, is exchanged. Other forms of countertrade, including
countertrade, offset, and compensation trading, may also involve exchanging money or
credit.

Teaching Tools and Exercises

I. Assign the following article for outside reading and class discussion:

Mehafdi, Messaoud. “The Ethics of International Transfer Pricing.” Journal of Business


Ethics 28, no. 4 (December 2000) pp. 365-381.

II. You are contemplating a price change for an established product sold by your global
firm. Write a memo analyzing the factors you need to consider in your decision.

III. Internet exercise: Price Fixing. To find out about current price-fixing cases, type
“price fixing” into your favorite Internet search engine. Compare the information you
find there with some of the companies’ own Web pages. How do companies deal with
this type of scandal on their Web sites? Does this surprise you?

IV. Interview a local business about its pricing philosophy and/or strategy. Apply what
you hear to the strategies described in the chapter and assess the approach. What are the
similarities and differences?

Case 12-1 Pricing AIDS Drugs in Emerging Markets

1. Given the discount prices that Merck and the other global drug companies are making
available in Africa and other developing countries, are they charging too much for AIDS
drugs in the United States? Should they be required to disclose their cost structures?

The standard argument of the pharmaceutical companies is that the cost of research and
development is so high that high drug prices are needed to cover the costs. Without these
high prices, it would not be possible to develop new drugs to fight AIDS. The feeling is that
it is in the consumer’s best interest to keep drug prices high. However, most AIDS patients
in the United States cannot afford the high drug prices. They are forced to spend a
disproportionate amount of their disposable income for medication, which they need to stay

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alive. The drug companies should provide some type of sliding scale for AIDS drugs in the
United States to make them affordable to all AIDS patients.

The drug companies should be required to disclose their cost structures, which might, in
turn, improve their public image. If research and other costs are extremely high, the public
might find high prices more acceptable. The drug companies have not made their case that
their costs warrant their prices.

2. Do you think intellectual property laws in countries such as South Africa should be
changed to allow generic producers such as Cipla access to the market?

Yes. For humanitarian reasons, generic producers should such as Cipla should have
access to the market. It is a question of ethics; AIDS is increasing in Africa as adults,
children, and babies die every day. Merck, Glaxo, and others can compete on non-price
variables to maintain or increase market share. For example, if these companies hired
spokespersons in the villages to provide patient education, it would give these companies
the edge over Cipla in the short term.

3. What should Merck, Glaxo, and other pharmaceutical manufacturers do to improve


their image with the general public?

The pharmaceutical manufacturers need to change their public image as companies that
make money from deadly diseases to the image of patient advocates, deeply concerned
with saving the lives of AIDS patients. They need to participate and/or organize AIDS
education programs to assure that the drugs are used correctly in conjunction with a
proper diet. The companies should become visible participants in worldwide AIDS
marches, conferences, and fundraisers. The companies should stress policies of
social responsibility—a for-profit company using its tremendous resources to help AIDS
victims worldwide.

Case 12-2 LVMH and Luxury Goods Marketing

Leadoff question/activity: Ask students whether they own any fake luxury goods (e.g.,
knockoffs of Rolex, Gucci, etc.) Better still; ask them to bring in fakes plus genuine
luxury goods for comparison.

1. Bernard Arnault has built LVMH into a luxury goods empire by making numerous
acquisitions. What strategy is evident here?

Arnault wants luxury to appeal to to everyone, not just the global elite. The basic problem is
making luxury brands available to a broader market without alienating the core consumer of
luxury products. The proliferation of licensing deals threatens to dilute the exclusivity of the
brands. Designer sunglasses, hosiery, and other products are more affordable to the mass market,
but if “everybody” is wearing the brand, then how luxurious is it?

3. Summarize how LVMH executives adjust prices in response to changing economic


conditions.

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Executives raise wholesale prices in an effort to prevent discount retailers from purchasing
designer products for resale in mass market outlets. They also raise prices in countries that have
experienced currency devaluations. Finally, cutting back on advertising and other promotional
expenses helps maintain profitability. The timing of LVMH’s $2.5 billion investment in DPS—
just prior to the Asian currency crisis—was certainly unfortunate. It does, however, illustrate the
risks that are present in the global arena. However, as Japan’s economic picture improves,
tourism will undoubtedly pick up again. Meanwhile, Mr. Arnault should close stores that are not
profitable.

3. Do you think the high retail prices charged for luxury goods are worth paying?

As every student of marketing should know, value assessments are, ultimately, in the eye of the
beholder. The promise of higher quality or exclusivity may justify premium prices; many luxury
brands are aspirational in the sense that consumers buy them in an effort to attain their idealized
self image. In most cases, luxury products are characterized by superior craftsmanship. For
example, the stitching on the straps of a fake Prada purse is likely to fray in a very short time,
while the “genuine article” is built to last. Beyond that, however, luxury goods prices are based
on perceived exclusivity and differentiation of the brands.

4. How will luxury goods marketers be affected by the slowdown in tourism that followed the
terror attacks of September 11, 2001?

Before the terror attacks, consumer confidence in the United States was high and the economy
was on roll; many consumers wanted “the best,” which meant luxury brands. LVMH saw
operating profits drop of 20% in 2001; the company projects that operating profits would climb
more than 10% in 2002. However, many in the industry predict that the recovery will be slow.
Many Japanese consumers, a key segment of the luxury market, continue to stay home.

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