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Chapter 14 Global Pricing McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc. All rights reserved. Outline Pricing Basics Global Pricing Issues Countertrade Pricing Strategies to Control Gray Trade Global Pricing Strategies Takeaways. Basic Factors in Pricing Costs Experience Curve Competition Demand Pricing Basics The Role of Costs The standard pricing procedure for exporting consists of A cost-plus formula Price escalation: The added costs in exporting mean that export prices tend to escalate over the domestic prices. Experience Curve Pricing Use of cost-based pricing has increased due to the “experience curve” effect The experience curve shows how unit costs go down as successively more units of a product are produced Experience curve pricing has been adopted primarily by companies entering an existing market in the maturity stage, because of the need to be competitive. The Experience Curve Effect UNIT COST PROFIT MARGIN < 0 P** PROFIT MARGIN > 0 BREAKEVEN TIME ACCUMULATED PRODUCTION = q Pricing Basics Competition The premium price differential refers to the degree to which the firm might be granted a higher price by the market because of the particular strengths of its product. Because of competition, prices in foreign market are sometimes lower than at home, contrary to the price escalation effect. Demand The strength of demand tends to vary with the PLC stage, the growth stage typically showing strongest demand. Demand and supply: Whether or not price can be high in a strong demand market, is also determined by the supply from competitors. Competitive Value Pricing SETTING A PRICE PREMIUM ON THE BASIS OF DIRECT COMPARISONS WITH COMPETITION (Caterpillar example) $ 20,000 IS THE COMPETITOR’S PRICE $ 3,000 IS THE PREMIUM FOR SUPERIOR DURABILITY $ 2,000 IS THE PREMIUM FOR SUPERIOR RELIABILITY $ 2,000 IS THE PREMIUM FOR SUPERIOR SERVICE $ 1,000 IS THE PREMIUM FOR LONGER WARRANTY $28,000 IS THE TOTAL VALUE $ 4,000 DISCOUNT $24,000 FINAL PRICE Global Pricing: Added to the Pricing Basics… EXPORT PRICING MULTINATIONAL PRICING EXCHANGE RATES, HEDGING CURRENCY RISK, CREDIT RISK TRANSFER PRICE TARIFFS, PRICE ESCALATION COUNTERTRADE, SYSTEMS PRICING DUMPING PRICE COORDINATION, GRAY TRADE SKIMMING VS. PENETRATION PRICING POLYCENTRIC PRICING, GEOCENTRIC PRICING, ETHNOCENTRIC PRICING POSITIONING PRICE, PRICE/QUALITY FINAL PRICE Skimming vs Penetration Pricing Unit sales Profitability Penetration price Skimming price Time in local market Penetration price Skimming price Time in local market Re-positioning via a Price Reduction Before Re-positioning After Re-positioning Economy Economy Brand C Brand C Brand A (low price) Performance Brand B Brand A (high price) Performance Brand B This is the PREFERENCE VECTOR. This shows that the market wants high performance AND high economy (strong quality/price ratio) Financial Issues EXCHANGE RATES – firms must be wary of devaluations; exchange rate fluctuations affect the performance of local subsidiaries HEDGING – purchasing insurance against losses because of currency fluctuations, firms make use of “forward contracts” or “swaps” GOVERNMENT INTERVENTION – various nations introduce stabilizing measures into financial systems via selective price controls and price discrimination laws Transfer Pricing TRANSFER PRICE – the price paid for products shipped between units of the same organization when the shipment crosses national borders so that the correct duties & related fees can be paid Transfer prices should reflect the prices the subsidiary might encounter in the open market, also known as “arm’s length prices” Transfer prices are also used to shift resources within a firm to offset inflation in country subsidiaries, to support a subsidiary’s local competitive position, and in other cases for profit repatriation. This has resulted in accounting firms developing strict guideline for the transfer pricing process. Countertrade COUNTERTRADE – transactions in which all or part of the payment is made in kind rather than cash. Examples are as follows: Barter The direct exchange of goods/services between trading partners Compensation Deals Involve payment both in goods and in cash; the inclusion of some amount of cash makes the deal more attractive to the seller. Counterpurchases The most typical version of countertrade; two contracts are negotiated, one to sell the product (which constitutes the initial agreement) at an agreed cash price, and one to buy goods from the purchaser at an amount equal to the amount in the initial transaction. May take two forms; 1) seller agrees to accept some amount of output as full or partial payment, 2) seller agrees to buy back some output at a later date. Product Buy-backs Offset Deals The seller contracts to invest in local production or procurement to partially offset the sale price. Evaluating a Countertrade Offer For the seller evaluating a countertrade proposal, the following points must be considered: 1. Is this the only way the order can be secured? 2. Can the received goods be sold? 3. How can we maximize the cash portion? 4. Does the invoiced price incorporate extra transaction costs? 5. Are there import barriers to the received goods? 6. Could there be currency exchange problems if we repatriate the earnings from sales in a third country? Systems Pricing in Turnkey Sales Pricing of turnkey package Bundled? Unbundled Get supplier discounts? No firm-specific advantages System discounts? Price taker Package Price Profit sharing or penalty for nonperformance Competitors: standalone profit centers? Components where firm has FSA's Price maker Competitive entry? Make or buy? Component prices? No profit sharing or penalty for nonperformance Gray Trade Gray trade is the sales of genuine branded goods through unauthorized channels. Gray trade involves shipments from overseas plants that enter a market via entry points not easily controlled. Examples include shipments from the Asian manufacturers who produce for Western companies and whose products can be diverted to ports in one country before entering the market country. Gray trade is acute in trade areas where barriers have been recently dismantled & exchange rates fluctuate, creating big arbitrage opportunities and “consumer tourism”. Pricing Actions against Gray Trade • ECONOMIC CONTROLS – influencing price setting in local markets via changing shipping prices or by rationing the product • CENTRALIZATION – forming price-corridors, setting limits for local prices • FORMALIZATION – standardizing the process of planning and implementing pricing decisions • INFORMAL COORDINATION – via articulation of corporate values & culture, human resource exchanges Controlling Gray Trade: Coordinating Pricing Strategies Level of Marketing Standardization High High Economic controls Low Informal coordination Strength of Local Resources Low Centralization Formalization Ethnocentric Pricing ETHNOCENTRIC PRICING One global price, in one currency $ PROS: no gray trade CONS: no local adaptation Geocentric Pricing GEOCENTRIC PRICING Y DM $ One price in each region, common regional currency PROS: some coordination, little gray trade, some adaptation CONS: not locally adapted Polycentric Pricing DM DM P PY k $ k POLYCENTRIC PRICING $ Y Local prices, in local currency PROS: locally adapted CONS: not coordinated, more gray trade Takeaways Although centrally coordinated prices interfere with the local subsidiary’s ability to target its market, it is necessary and possible to coordinate pricing at least by regions or trading areas. Takeaways To discourage gray trade, which attempts to take advantage of currency exchange shifts & local price differentials, companies try to keep prices in different countries within a narrow band or “corridor”. Takeaways Transfer prices between a global firm’s plants in different countries can seldom be used to shift profits but should be used to motivate subsidiaries & measure performance, while remaining supportable to local tax authorities. Takeaways Countertrade, including barter, is a frequent pricing option in countries with a lack of hard currency, especially when global financial turmoil puts domestic currencies under pressure. Takeaways Global pricing still has to pay attention to basic issues such as competition, price-quality relationships, & stage of the product life cycle.