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A guide to export pricing.

A Guide to Export Pricing

In the face of a massive trade deficit in the early and mid 1980s, American exporters bitterly complained that the strong dollar made their products too expensive to be competitive. Beginning in the summer of 1985, the dollar began to decline in value against most major currencies - and against many minor ones as well - and over the last several years, the dollar has remained weak. While our trade deficit is not as bad as it once was, it still remains unacceptably high. One of the major reasons for this is that American exporters stubbornly cling to uncompetitive pricing policies. The cost-plus pricing methods used by most exporters severely limits their foreign sales, and U.S. companies must be more flexible when it comes to accepting payment in foreign currencies or even in foreign goods.

American exporters have been slow to utilize pricing as a competitive tool. In the 1950s and 1960s, international companies, like their domestic counterparts, usually emphasized non-price competition such as product differentiation and advertising. At the time, this approach made considerable sense. The American economy was expanding rapidly, incomes were shooting up, and the demand for consumer and industrial goods remained strong. At home and abroad, American companies did not have to counter stiff competition from foreign producers. The high regard many foreigners had for American goods enabled American companies to position their products as premium brands and to charge accordingly. High production costs in the United States, especially for the labor component, hindered American exporters from competing on a price basis. The high cost of exporting compounded the problem further.

In recent decades, many American companies have devoted far more attention to pricing. These companies have been forced to reconsider their way of doing business because foreign manufacturers have been producing quality products and have been offering them for sale at very competitive prices. In industry after industry, American companies are no longer able to rely upon a technological advantage and claims to superior products. Furthermore, the worldwide recession that began in the late 1970s, with its high unemployment and escalating inflation, made consumers more susceptible to price appeals. Ironically, the very success of American companies abroad encouraged them to lower their prices. As their original up-scale markets became saturated, these companies sought to tap the mass market. Success depended in good part on product repositioning and a commensurate price reduction.

Many U.S. exporters have been willing to use price as a competitive tool, but have not known how to do so. For all the attention export pricing has begun to receive, it still remains much of an enigma. In setting prices, the exporter will encounter the same types of market forces as at home. The problem is that in each foreign market these forces may have a different impact and a different constellation of components. Customers' price sensitivity, for example, will vary according to time, product category, product stage, price range, country, and submarket. Unfortunately, however, the beginning exporter will have little notion of the demand curve products will face. Even seasoned exporters often have to operate on the basis of incomplete information.

Complicating matters further, a business customarily loses some of its control over intermediate and final prices when it exports its products. Exporting involves greater political, economic, and geographic distances than does domestic distribution. Moreover, the exporter's foreign channel members often have to share pricing decisions with the host government. Americans are not accustomed to extensive government involvement in pricing matters. In the United States, the federal government oversees product and promotional standards, but pays limited attention to price. In developing and in less-developed countries (LDCs), the situation is reversed. Here, companies may experience more product and promotional freedom than back home. On the other hand, these countries often set prices, or at least price ranges.

All prices, for both domestic and foreign sales, should reflect a company's corporate and marketing goals. Very possibly, however, these goals will vary from market to market. Furthermore, foreign marketing environments will differ from one another and from what the company is accustomed to at home. The company's willingness and capacity to take action will also not be the same in each market. The company may export to one market on an ad hoc basis, have a marketing subsidiary in a second, and be engaged in foreign production in a third. Company goals must be adjusted accordingly. Thus, in one export market a company might insist on a given markup on costs, whereas in another the company drops prices in pursuit of market share. A company need not, of course, pursue one goal to the exclusion of all others. Most companies establish a hierarchy of goals.

Whatever the marketing goals, the company will have to select an appropriate pricing orientation and methodology. International and domestic marketers use the same types of pricing methods - mainly cost-plus, demand-based, and competitive. Since most international marketers are operating in an ambiguous pricing environment, cost-plus approaches are the most popular. Costs have the advantage of apparently being easy to calculate, but in truth, cost-plus methods are probably more complex than most companies realize. The basic question is whether to use full or variable cost pricing. The latter method ignores fixed costs and includes only those costs directly attributable to the manufacture and sale of an item. Companies using full cost pricing properly exclude all those expenses having nothing to do with the export market - for example, all domestic advertising costs. Regardless of whether full or variable cost pricing is chosen, the company may have difficulty selecting and measuring all the variable costs associated with exporting. All too often the cost of obtaining information exceeds the benefit of having it.

In theory, an optimum price can be derived by plotting the intersection of the marginal revenue and margin cost curve. Methods for estimating demand and market potential are the same internationally as domestically. The complicating factor for international marketers is the unavailability of the relevant data. To estimate the demand curve, the company must determine the size of the target market, its purchasing power, the product's place and importance in the consumer's life style, competition, and barriers to entry. After the company establishes the range of prices acceptable to potential consumers, it works backward to figure out the plant price FOB (free on board). Essentially, the company subtracts from each of the possible final prices all intermediate charges added on between the factory and the end purchaser. If none of the resulting plant prices is acceptable, the company will either have to forsake the market or devise a new marketing strategy.

For example, the company might be able to design a simpler but less expensive product. In setting an export or foreign market price, a company will have to consider the competitive market situation. How many competing companies are there, and what is their relative size, cost structure, and financial well-being? How do these companies compete? In some countries and industries, pricing is used as an active competitive tool, whereas in others it is limited to a passive role in the marketing mix. Most of all, a company must determine what competitive advantage, if any, if possesses. Because a foreign company may well encounter different market structures in each country, setting appropriate prices becomes all the more problematic. At home, for example, the company may face oligopolistic competition. In one foreign market, powerful competition may be absent, whereas another may be dominated by an entrenched government-owned company, such as Renault in France. The company may also find that it is competing abroad against some of its domestic competitors, but the relative strength of the companies may be reversed-abroad, Ford outsells General Motors and Schick outsells Gillette.

Cost-plus pricing has its limitations. A company using full cost pricing may find that it has priced itself out of the market. The combination of a high plant price FOB together with the various export costs may result in a final price that end customers find unacceptable. Price escalation (the steep increase in price of an exported product), occurs for two reasons. First, there are costs not incurred at home or which are higher when goods are shipped abroad. It is said that exports float upon a sea of documentation. The cost of processing these documents, not to mention the fees involved, can be quite high. Then too, there are freight and insurance costs, extra packing, tariff, and port costs. Second, exporting typically involves a longer channel than does domestic distribution.

The challenge faced by the exporter is roughly analogous to that of domestic manufacturers who wishes to sell in a distant part of their home own country. Added freight and insurance costs may make the product uncompetitive. The exporter, however, must cope with a multitude of add-ons. The end result is that the product may cost much more abroad than at home. But the foreign buyer may have less purchasing power than domestic consumers. Furthermore, price escalation can unleash an unrelenting cycle. Because the product's price is high and turnover is low, distributors and retailers may insist on especially high margins to cover their costs. This, of course, raises the price of the export still higher. Price escalation may not be an issue if the company has targeted an elite segment. But what if the company wishes to mass market its products?

Variable cost pricing may be appropriate if the company has temporary overcapacity (perhaps domestic sales are slow) and is merely taking advantage of a transient opportunity abroad. If over the long run export sales represent a sizeable portion of total sales, then the company will likely have to price on a full-cost basis to remain profitable. This is especially true if new investments in capital equipment are needed to serve the foreign market.

Variable cost pricing and market-oriented pricing avoid the danger of price escalation. From a business perspective, it makes enormous sense to charge different groups of customers different prices for the same product. The domestic marketer employs differential pricing when it is feasible and profitable to do so. Within the United States, however, many types of price discrimination are prohibited by the Clayton Act and by the Robinson-Patman Act. But even when legal, market conditions are not always obliging. For price discrimination to be profitable, a company must be able to segment its market.

Furthermore, each of the resulting segments must have a different price elasticity, and the company must also take care that it does not cannibalize its own sales. Customers paying the lower price should not be able to resell the merchandise to those who are paying a higher price. Finally, the company must make sure that price differentiation does not cheapen the image of its products or lead to enmity on the part of those consumers who are charged a higher price.

From a market perspective, the international arena is conducive to the use of price discrimination. Target markets are often separated by national boundaries, with all the trade barriers that that entails. Each national grouping has its own particular income level and price sensitivity. And international travel notwithstanding, crossborder communication is limited.

In the export market, legal constraints often stand in the way of differential pricing. The exporter with too low a price risks being charged with dumping by a foreign government. The definition of dumping varies among countries, but the term usually is defined as either selling below cost or below the price charged in the exporter's home market. Some definitions incorporate both aspects. Many countries, especially industrials, have enacted anti-dumping laws. The penalty for dumping is usually a heavy fine or higher custom duties. Innocent or guilty, the accused company may be drawn into a prolonged legal battle.

Economists usually distinguish among three types of dumping: sporadic, predatory, and continuous. Sporadic dumping is the occasionally unloading of goods at reduced prices. The company may temporarily have had excess inventory and for whatever reason was unable to dispose of it at home. Depending on many factors, foreign producers and customers may or may not be hurt by this kind of dumping.

In continuous dumping, a company habitually sells abroad below the market value. The goal is not to destroy competition but rather to dispose of continuing surpluses at home. For example, American and European farmers sell grain on the international market at prices subsidized by their governments. Although individual foreign producers may be harmed, the foreign economy as a whole benefits; it can rely on cheap imports and direct its productive energies elsewhere.

It is predatory dumping that causes the most ire. Here, an exporter systematically lowers its prices to weaken host country competitors or to destroy them altogether. Frequently, it is home-country subsidies that make predatory dumping possible. Once the predator attains a commanding market position, it then proceeds to raise prices. Predatory pricing is difficult to prove. The company data needed to make such a case may not be accessible. Assessing the impact of a government subsidy on a firm's cost structure is at best an involved task.

During the 1960s and 1970s, when worldwide demand was strong in most industries, dumping was not a major international trade issue. American automobile, steel, and television manufacturers complained about their Japanese competitors. But these incidents were the exception. It was only in the 1980s that cries of dumping reached a fever pitch, and not just in the United States. In some industries, worldwide demand lagged, and individual competitors responded by slashing prices. In other industries, new entrants from developing countries such as South Korea, Brazil, and Taiwan swelled global supplies. Sometimes, exporters deliberately engaged in predatory practices. Frequently, however, the imposition of dumping penalties was a thinly veiled political attempt to protect uncompetitive domestic companies.

In setting prices, an exporting company faces a problem totally absent in purely domestic transactions. In what currency should the price be quoted? Three choices are possible: the seller's, the buyer's, or that of a third country. For a number of reasons, both parties to a transaction usually prefer that their own currency be used. Most important, a company that deals in a currency other than its own bears a foreign exchange risk. The seller risks receiving less money in its own currency than expected, and the buyer risks having to pay more money in its own currency. Sometimes, of course, the party that accepts the foreign exchange risk comes out ahead.

Most major trading currencies float, that is their exchange rate relative to other currencies is continually in flux. The value of a currency at any given time depends upon supply and demand conditions. A currency usually changes in value slowly.

The danger of foreign exchange loss is exacerbated by the extended credit terms typical in international trade. Suppose an American company contracts with a French company to sell a computer for 100,000 French francs. Payment is to be made in 90 days. On the day the contract is signed, $1 U.S. equals 5Ff on the foreign exchange market. Thus, if the Americans received their francs on day one they could exchange them for U.S. $20,000. But payment is to be made in 90 days. Suppose on day 90 6Ff equals $1. The French company still pays only 100,000Ff. For these francs, however, the American company will only be able to obtain $16,666 U.S. (100,000/6). Note, this transaction is not a zero sum game. That the American company lost does not mean that the French company won. Suppose on day 90 the exchange rate had been U.S. $1=Ff4?

Many currencies, especially those of developing nations, have exchange rates fixed by their governments, and their values do not fluctuate on a daily basis. There is, however, the very real possibility that a government may suddenly introduce a new exchange rate. In July 1986, for example, the government of the People's Republic of China announced a 14 percent devaluation. Hereafter, it would take 14 percent more yuan to buy an equivalent amount of dollars. For the Chinese, the devaluation served to make imports more expensive and their exports more price competitive.

There are many ways buyers and sellers can protect themselves against foreign exchange risk. Each method has its own combination of advantages and disadvantages. The cost of coverage against loss is commensurate with the level of risk involved.

The question of which currency to use complicates price negotiations. But it also offers buyers and sellers bargaining options that they would not have in a domestic setting. Usually, each side prefers to have its own currency used.

Sometimes, a party will give way on the currency issue to obtain something else - a particular price perhaps, or different credit terms.

Increasingly, prospective international buyers are proposing countertrade agreements. Countertrade is the name given to a commercial transaction in which goods or services are substituted in whole or in part for cash payments. There are many approaches, the simplest of which is straight barter in which two parties exchange goods or services of equivalent value. This type of arrangement lacks flexibility and therefore is not frequently used. More common is the counter-purchase, where each party contracts to buy the goods or services of the other in cash. Although the purchases are tied to one another, the actual exchange need not be simultaneous. Several years ago, the Soviet Union agreed to buy construction machinery from two Japanese companies, Komatsu and Mitsubishi. In return, the Japanese agreed to purchase Siberian timber. In a compensation deal, the seller agrees to accept partial payment, often 40 percent, in goods or services. Buyback agreements obligate the seller of capital goods to accept payment in terms of the output produced by that equipment. Buybacks are particularly favored by the Eastern Bloc and by the People's Republic of China.

Counter-trade arrangements of one kind or another account for perhaps 25 percent to 30 percent of global trade. The percentage is even higher for East-West commerce. In the years to come, countertrade will probably become an even more significant component of global trade. To date, However, most American companies have shied away from countertrade, insisting instead upon cash deals. Since Japanese and European companies have been more flexible, they have won many sales away from Americans.

International countertrade has been expanding panding for many reasons. Many countries simply do not have enough foreign exchange to pay for everything they would like to import. LDCs, and Eastern Block nations in particular, resort to bartering because they are unable to sell many of their products on the world market. These products may be of inferior quality, in global surplus, or the country may not have the requisite marketing skill or infrastructure to sell abroad.

Countertrade interferes with free trade because it forces a seller to take payment in goods or services rather than in cash. The seller often does not have the expertise to appraise the value of the merchandise being offered. Disposing of the goods may be a formidable challenge in itself. If the company has no experience selling the product, it may have to rely on the services of an intermediary.

The dollar is far weaker today than it was in 1985. Furthermore, few experts expect the dollar to regain any of its lost strength anytime soon. An opportunity exists for American companies to enter the export market or, if already there, to increase their sales. Too often, however, American companies have thwarted an otherwise competitive export strategy by adhering to a static pricing methodology. Cost-plus pricing simply does not provide the flexibility that most companies require in the international arena. American companies must also become more flexible when it comes to accepting currencies other than the dollar. Although countertrade has many drawbacks, American companies are well advised to consider these arrangements. Western European and Japanese companies have been far more willing to accept countertrade agreements and, as a result, have won numerous contracts that otherwise might have gone to American companies.

Michael Kublin is associate professor of international business and marketing at the University of New Haven.
COPYRIGHT 1990 Institute of Industrial Engineers, Inc. (IIE)
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Copyright 1990 Gale, Cengage Learning. All rights reserved.

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Author:Kublin, Michael
Publication:Industrial Management
Date:May 1, 1990
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