What is price escalation in international marketing

Case Assignment : Mary Kay In India

Price Quotations

Administered Pricing

Cartels Government-Infl uenced Pricing

Getting Paid: Foreign Commercial Transactions

Letters of Credit Bills of Exchange Cash in Advance Open Accounts Forfaiting

CHAPTER LEARNING OBJECTIVES

What you should learn from Chapter 18:

LO1 Components of pricing as competitive tools in international marketing

LO2 How to control pricing in parallel import or gray markets

LO3 Price escalation and how to minimize its effect

LO4 Countertrading and its place in international marketing practices

LO5 The mechanics of price quotations

LO6 The mechanics of getting paid

CHAPTER OUTLINE

Global Perspective: The Price War

Pricing Policy

Pricing Objectives Parallel Imports

Approaches to International Pricing

Full-Cost versus Variable-Cost Pricing Skimming versus Penetration Pricing

Price Escalation

Costs of Exporting Taxes, Tariffs, and Administrative Costs Infl ation Defl ation Exchange Rate Fluctuations Varying Currency Values Middleman and Transportation Costs

Sample Effects of Price Escalation

Approaches to Reducing Price Escalation

Lowering Cost of Goods Lowering Tariffs Lowering Distribution Costs Using Foreign Trade Zones to Lessen Price Escalation Dumping

Leasing in International Markets

Countertrade as a Pricing Tool

Problems of Countertrading The Internet and Countertrading

Pricing for International Markets

18 Chapter

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Global Perspective THE PRICE WAR

PA RT F O U R

The battle between Procter & Gamble and Kimberly-Clark brought Pampers and Huggies, respectively, to places they have never been, forcing down diaper prices worldwide, and expanding the global market for disposable diapers. A battle in Brazil between the two giants gives an interesting glimpse of the global markets of tomorrow. Disposable diapers are still considered a luxury by the vast majority of Brazil’s 194 million people, whose average annual income is under $8,000. Before P&G and Kimberly arrived, rich and poor alike generally made do with cloth or nothing at all. The disposables that were avail- able were expensive, bulky, and leaky. When less than 5 percent of the Brazilian mass market used disposable diapers, P&G launched Pampers Uni, a no-frills, unisex diaper. Before Uni, it cost more to pay for disposable diapers than to pay for a maid to wash the cloth ones. The introduction of the relatively cheap, high-quality Uni fundamentally changed the economics of the diaper market for most middle-class Brazilians. The plan was to put such nonessentials as disposable diapers within the reach of millions of Brazilians for the fi rst time. At the same time, the Brazilian economy was on the upswing— infl ation had subsided, and overnight, the purchasing power of the poor increased by 20 percent. Low-priced products fl ew off the shelves. P&G had to truck in diapers from Argentina as it struggled to open new production lines. But the good days did not last. Kimberly-Clark entered the market and began importing Huggies from Argentina. With the help of a Unilever unit as its Brazilian distributor, Kimberly- Clark gained immediate distribution across the country and quickly made deep inroads into the market. Unilever agreed to work with Kimberly-Clark because its archrival in soap was P&G, and Kimberly-Clark’s archrival in diapers was P&G. The two companies previously had entered into a global alliance to look for win–win situations when it was in both their best interests to partner and help each other, from a competitive standpoint, against the dominant P&G. The Brazilian market was the perfect case for cooperation. With Unilever’s help, Kimberly-Clark “push girls” in- vaded markets to demonstrate the diaper’s absorption. Sales rose rapidly and began to exceed production. To increase market share, Kimberly-Clark formed an alliance with Kenko do Brazil, P&G’s largest home-grown rival, and cre- ated the “Monica” brand. “Monica’s Gang,” a comic strip similar to “Peanuts” in the United States, sells widely in Bra- zil. São Paulo malls were crowded with thousands of kids waiting to get an Easter photo taken with actors in Monica suits, an honor that required the purchase of three packs of

diapers. Monica diapers were a big hit, and Kimberly-Clark became number one in the Brazilian market. It was a tough blow to P&G. The company had devoted an entire page of its annual report to how Pampers Uni had tripled its market share in Brazil, helping P&G “retain the number one position in a market that has grown fi vefold.” Now it suddenly found itself on the defensive. First it cut prices, a step P&G loathes. “Price cutting is like violence: No one wins,” said the head of its Brazilian operation. Then it broadened its prod- uct range, rolling out an up-market diaper called Super-Seca, priced 25 percent higher than Pampers Uni. Later, in a fl ank- ing move, it also unveiled Confort-Seca, a bikini-style diaper originally developed for Thailand and priced 10 to 15 percent lower than the already-inexpensive Uni. Kimberly-Clark fi red back, matching the price cut and then introducing a cheaper version of Monica called Tippy Basic. Four weeks later, P&G cut prices another 10 percent on Super- Seca and Confort-Seca. Despite the price cuts, the two brands were still relatively expensive; then a wave of really cheap dia- pers arrived. Carrefour, a French retailer that is now Brazil’s biggest supermarket chain, sells crudely made Bye-Bye Pipi diapers from Mexico. Despite their inferior quality, the cheap imports pulled down diaper prices across the board. The real war started when lower prices became so attrac- tive that consumers who otherwise could not afford diapers came into the market. As prices continued to drop, the mar- ket grew; that attracted more producers, which were mostly small, local Brazilian companies that offered even lower- priced competitive diapers. One such company, Mili, saw its market share increase from 4.8 percent to 16.2 percent over a three-year period. What accounts for growth of these smaller companies? One analyst suggests that the multi- nationals are too sophisticated and, thus, too expensive for the Brazilian market: “Smaller companies are just supply- ing what consumers need at a price they can afford.” But it also can be said that as prices drop, products become more attractive to a larger segment of the total market.

Sources: Raju Narisetti and Jonathan Friedland, “Disposable Income: Diaper Wars of P&G and Kimberly-Clark Now Heat Up in Brazil,” The Wall Street Journal, June 4, 1997, p. A1; “Brazil: Procter & Gamble Increased Market Share,” SABI (South American Business Information), May 31, 2000; Jonathan Birchall, “New Tactics in the Battle for Babies’ Bottoms,” Financial Times , http://www.FT.com, August 24, 2006. For more information, see Kimberly-Clark’s Web site at http://www . kimberly-clark.com, and Procter & Gamble’s at http://www.pg.com; also see Matthew Bird and Rosabeth Moss Kanter, “Procter & Gamble Brazil (A): 2 ½ Turnarounds,” Harvard Business School Cases , January 1, 2008, for details about the fi rms’ decision-making approaches.

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http://www.FT.com
http://www.kimberly-clark.com
http://www.kimberly-clark.com
http://www.pg.com
522 Part 4 Developing Global Marketing Strategies

Setting and changing prices are key strategic marketing decisions. Prices both set values and communicate in international markets. 1 For example, Hong Kong Disneyland’s early attendance was lower than expected, in part driven by what some called an unaffordable opening-day price of $32 a ticket. 2 Setting the right price for a product or service can be the key to success or failure. Even when the international marketer produces the right product, promotes it correctly, and initiates the proper channel of distribution, the effort fails if the product is not properly priced. Although the quality of U.S. products is widely recognized in global markets, foreign buyers, like domestic buyers, balance quality and price in their purchase decisions. An offering’s price must refl ect the quality and value the consumer per- ceives in the product. Of all the tasks facing the international marketer, determining what price to charge is one of the most diffi cult. It is further complicated when the company sells its product to customers in multiple country’s markets.

As globalization continues, competition intensifi es among multinational and home- based companies. All are seeking a solid competitive position so they can prosper as mar- kets reach full potential. The competition for the diaper market among Kimberly-Clark, P&G, and the smaller companies illustrates how price becomes increasingly important as a competitive tool and how price competition changes the structure of a market. Whether ex- porting or managing overseas operations, the manager’s responsibility is to set and control the price of goods in multiple markets in which different sets of variables are to be found: different tariffs, costs, attitudes, competition, currency fl uctuations, and methods of price quotation.

This chapter focuses on the basic pricing policy questions that arise from the special cost, market, and competitive factors found in foreign markets. A discussion of price es- calation and its control and factors associated with price setting and leasing is followed by a discussion of the use of countertrade as a pricing tool and a review of the mechanics of international price quotation. We close the chapter with a brief discussion about the me- chanics of getting paid the prices charged—letters of credit and such.

LO1

Components of pricing as competitive tools in international marketing

1Lorraine Eden and Peter Rodriguez, “How Weak Are the Signals? International Price Indices and Multinational Enterprises,” Journal of International Business Studies 36, no. 1 (2004), pp. 61–74.

2Don Lee, “Disneyland’s Cost a Hurdle for Chinese,” Los Angeles Times , September 10, 2005, pp. C1, C3.

3Carl Arthur Solberg, Barbara Stottinger, and Attila Yaprak, “A Taxonomy of the Pricing Practices of Exporting Firms: Evidence from Austria, Norway, and the United States,” Journal of International Marketing 14 (2006), pp. 23–48.

4Andrew LaVallee, “Unilever to Test Mobile Coupons,” The Wall Street Journal , May 29, 2009, p. B8.

5S. Tamer Cavusgil, Kwog Chan, and Chun Zhang, “Strategic Orientations in Export Pricing: A Clustering Approach to Create Firm Taxonomies,” Journal of International Marketing 11, no. 1 (2003), p. 47; Christopher K. Hsee, Jean-Pierre Dube, and Yan Zhang, “The Prominence Effect in Shanghai Apartment Prices,” Journal of Marketing Research 45, no. 2 (2008), pp. 133–44.

Pricing Policy Active marketing in several countries compounds the number of pricing problems and variables relating to price policy. Unless a fi rm has a clearly thought-out, explicitly defi ned price policy, expediency rather than design establishes prices. The country in which busi- ness is being conducted, the type of product, variations in competitive conditions, and other strategic factors affect pricing activity. Price and terms of sale cannot be based on domestic criteria alone.

In general, price decisions are viewed two ways: pricing as an active instrument of accom- plishing marketing objectives, or pricing as a static element in a business decision. If prices are viewed as an active instrument, the company sets prices (rather than following market prices) 3 to achieve specifi c objectives, 4 whether targeted returns on profi t, targeted sales volumes, or some other specifi c goals. 5 The company that follows the second approach, pricing as a static element, probably exports only excess inventory, places a low priority on foreign business, and views its export sales as passive contributions to sales volume. When U.S. and Canadian international businesses were asked to rate, on a scale of 1 to 5, several factors important in price setting, total profi ts received an average rating of 4.70, followed by

Pricing Objectives

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Chapter 18 Pricing for International Markets 523

return on investment (4.41), market share (4.13), and total sales volume (4.06). Liquidity ranked the lowest (2.19).

The more control a company has over the fi nal selling price of a product, the better it is able to achieve its marketing goals. However, controlling end prices is not always possible. The broader the product line and the larger the number of countries involved, the more complex is the process of controlling prices to the end user.

In addition to having to meet price competition country by country and product by product, companies have to guard against competition with their own subsidiaries or branches. Because of the different prices possible in different country markets, a product sold in one country may be exported to another and undercut the prices charged in that country. For example, to meet economic conditions and local competition, an American pharmaceutical company might sell its drugs in a developing country at a low price and then discover that these discounted drugs are being exported to a third country, where, as parallel imports, they are in direct competition

Parallel Imports

LO2

How to control pricing in parallel import or gray markets

You could buy one (indeed, more than one) in Beijing even though they had not yet been shipped there by Apple or AT&T. The gray market for iPhones in China was bustling. Apparently 800,000 to 1 million iPhones, or about one-fourth of the total sold, were “unlocked”—that is, altered to be able to run on net- works other than those of Apple’s exclusive partners. This iPhone aftermarket did not take long to de- velop. By the time the device went on sale on June 29, 2007, software hackers and companies that specialize in unlocking cell phones had already begun searching for ways to make the iPhone work on unsanctioned net- works. Within weeks, online forums were buzzing with an answer that emanated from a tiny company based in Prague, Czech Republic. Pavel Zaboj is a 36-year-old former math student who, together with friends, developed an electronic device called Turbo SIM that was designed to turn cell phones into mobile payment systems. Turns out, Turbo SIM also could be used to trick the iPhone into thinking it was operating on AT&T’s network. By mid- August, Zaboj’s 10-person fi rm, Bladox, was fl ooded with orders, particularly from Canada and Mexico, where Apple addicts did not have to venture far to get an iPhone. Bladox was totally unprepared and could not fi ll all the orders that rolled in. “We just sat there, open- mouthed,” Zaboj says. Bladox has sold devices used to unlock phones in roughly 100 countries, including French Polynesia and Afghanistan, Brazil, Canada, the Dominican Republic, Indonesia, Israel, Nigeria, Peru, Poland, Russia, and the United Arab Emirates. The boom was fueled not just by the short supply of a hot product but also by scant evidence of inter- ference from Apple or its partners. Apple-authorized

partners—AT&T, O2, Orange, and Deutsche Telekom’s T-Mobile—lost hundreds of dollars in monthly fees per subscriber when they avoided a two-year contract in favor of unlocking. But the bulk of the unlocking seems to have been occurring in places where customers had no authorized carrier to choose from anyway. Apple took in hundreds of dollars per iPhone sale when customers activated service with one of its part- ners, but most analysts say the unlocking craze also helps spread Apple’s brand awareness. The gray market got another push forward from ex- change rates. With the dollar falling, consumers from Europe and elsewhere could get a better deal on an iPhone during a trip to the United States than from buy- ing it at home. Gray marketers saw the same opportu- nity and began recruiting a range of people to secure iPhones. Sometimes, it is as simple as asking friends and fam- ily members to reach their iPhone limit: fi ve phones at Apple and three at AT&T. One reseller admits he got a friend to print business cards and pose as a small busi- ness owner to dupe an Apple Store manager into let- ting him buy 100 iPhones for his “employees.” Chinese retailers also admitted to “getting people like airline stewardesses to bring the iPhones over for us.” Some iPhones on the gray market may have leaked from points closer to the source: the big Chinese facto- ries where they are assembled. Most recently Apple is selling iPhones through its new partner Unicom (Hong Kong) but is still facing stiff competition from other smart phones. Sources: Peter Burrows, “Inside the iPhone Gray Market,” BusinessWeek, February 12, 2008; John Markoff, “Friends and Smugglers Meet Demand for iPhones,” The New York Times, February 18, 2008, pp. A1, A8; “Lukewarm Reception,” Business China, January 4, 2010, p. 5.

CROSSING BORDERS 18.1 Inside the iPhone Gray Market

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524 Part 4 Developing Global Marketing Strategies

with the same product sold for higher prices by the same fi rm. This practice is lucrative when wide margins exist between prices for the same products in different countries. A variety of conditions can create a profi table opportunity for a parallel market.

Restrictions brought about by import quotas and high tariffs also can lead to parallel imports and make illegal imports attractive. India has a three-tier duty structure on computer parts rang- ing from 50 to 80 percent on imports. As a result, estimates indicate that as much as 35 percent of India’s domestic computer hardware sales are accounted for by the gray market.

The possibility of a parallel market occurs whenever price differences are greater than the cost of transportation between two markets. In Europe, because of different taxes and competitive price structures, prices for the same product vary between countries. When this situation occurs, it is not unusual for companies to fi nd themselves competing in one country with their own products imported from another European country at lower prices. Pharmaceutical companies face this problem in Italy, Greece, and Spain because of price caps imposed on prescription drugs in those countries. For example, the ulcer drug Losec sells for only $18 in Spain but goes for $39 in Germany. The heart drug Plavix costs $55 in France and sells for $79 in London. Presumably such price differentials would cease once all restrictions to trade were eliminated in the European Union, and in most cases, this is true. However, the European Union does not prevent countries from controlling drug prices as part of their national health plans.

The drug industry has tried to stop parallel trade in Europe but has been overruled by European authorities. Now the industry is trying a different approach, restricting supplies to meet only local demand according to formulas based on prior demand and anticipated growth. The idea is that a country should receive just enough of a drug for its citizens. Wholesalers that order more with the intention of shipping the drugs to higher-priced mar- kets will not have enough to do so. A number of major pharmaceutical companies have imposed similar restrictions. The companies say these measures are intended to streamline distribution, help prevent medicine shortages, and curtail excess inventory, whereas dis- tributors claim the strategy is aimed at thwarting cross-border drug trading. The fact is, “half of all demand in Britain of several products is being met by imports from low-priced countries” and companies are attempting to curtail parallel imports.

Gray market pharmaceuticals moved from Canada to the United States are estimated to represent about $427 million annually—not a large amount when compared to the $135 bil- lion U.S. drug market, but it can be substantial for specifi c drugs like Paxil, Zyban, and Viagra. Although importing prescription drugs from a foreign country, including Canada, is against U.S. law, a person can travel to Canada or Mexico to make purchases or buy over the Internet. Technically, buying over the Internet and having the drugs mailed to the United States is illegal. However, the government has taken a relatively lax view toward such purchases, provided the supply does not exceed 90 days.

Naturally, drug companies that have been hit the hardest want to put a stop to the traf- fi c. Glaxo SmithKline, the prescription drug maker, has asked all Canadian pharmacies and wholesalers to “self-certify” that they are not exporting its drugs outside Canada. The company also is warning U.S. customers about imported drugs in a new advertising cam- paign. 6 Those that fail to comply will have their Glaxo supplies cut off—“Glaxo products are approved by Health Canada for sale in Canada only.” Some feel that this move will not solve the problem even if Glaxo is able to stop Canadian sales because Americans will be able to fi nd less expensive drugs in other markets, like Australia and Ireland. The Internet trade will be hard to shut down as long as large price differentials persist among markets. Furthermore, U.S. legislators are passing laws that allow such drug imports. 7

Exclusive distribution , a practice often used by companies to maintain high retail mar- gins to encourage retailers to provide extra service to customers, to stock large assortments, or to maintain the exclusive-quality image of a product, can create a favorable condition for parallel importing. Perfume and designer brands such as Gucci and Cartier are especially

6Barrie McKenna, “New Shot Fired in Net Drug Battle,” Toronto Globe and Mail , June 2, 2005, p. B3.

7“Senate Passes Bill to Keep Drug Import Bans Out of Trade Deals,” FDA Week 11, no. 37 (September 16, 2005).

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Chapter 18 Pricing for International Markets 525

prone to gray markets. To maintain the image of quality and exclusivity, prices for such products traditionally include high profi t margins at each level of distribution; charac- teristically, there are differential prices among markets and limited quantities of product, and distribution is restricted to upscale retailers. Wholesale prices for exclusive brands of fragrances are often 25 percent more in the United States than wholesale prices in other countries. These are ideal conditions for a lucrative gray market for unauthorized dealers in other countries who buy more than they need at wholesale prices lower than U.S. whole- salers pay. They then sell the excess at a profi t to unauthorized U.S. retailers but at a price lower than the retailer would have to pay to an authorized U.S. distributor.

The high-priced designer sportswear industry is also vulnerable to such practices. Nike, Adidas, and Calvin Klein were incensed to fi nd their products being sold in one of Britain’s leading supermarket chains, Tesco. Nike’s Air Max Metallic trainers, which are priced at £120 ($196) in sports shops, could be purchased at Tesco for £50 ($80). Tesco had bought £8 million in Nike sportswear from overstocked wholesalers in the United States ( Exhibit 18.1 ). To prevent parallel markets from developing when such marketing and pric- ing strategies are used, companies must maintain strong control over distribution and prices.

Companies that are serious about restricting the gray market must establish and moni- tor controls that effectively police distribution channels. In some countries they may get help from the courts. A Taiwan court ruled that two companies that were buying Coca- Cola in the United States and shipping it to Taiwan were violating the trademark rights of both the Coca-Cola Company and its sole Taiwan licensee. The violators were prohibited from importing, displaying, or selling products bearing the Coca-Cola trademark. In other countries, the courts have not always come down on the side of the trademark owner. The reasoning is that once the trademarked item is sold, the owner’s rights to control the trade- marked item are lost. In a similar situation in Canada, the courts did not side with the Canadian exporter who was buying 50,000 cases of Coke a week and shipping them to Hong Kong and Japan. The exporter paid $4.25 a case, plus shipping of $1.00 a case, and sold them at $6.00, a nifty profi t of 75 cents a case. Coca-Cola sued, but the court ruled that the product was bought and sold legally.

Exhibit 18.1 How Gray Market Goods End Up in U.S. Stores

Manufacturer

Buyer X

Freight Forwarder

Fake Paperwork

U.S. Store U.S. Store U.S. Store

1. A major manufacturer agrees to sell its products, at a price competitive for an overseas market, to “Buyer X” who promises to sell the products overseas.

2. The manufacturer ships the goods to Buyer X.

3. Buyer X has a local freight forwarder at the port take possession of the goods.

4. Instead of shipping the goods to their supposed destination, the freight forwarder (at the behest of Buyer X) sends them to smaller distributors and discount outlets in the United States.

5. The freight forwarder sends a bogus bill of lading to the manufacturer, so the company believes the goods have been sold overseas.

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526 Part 4 Developing Global Marketing Strategies

Parallel imports can do long-term damage in the market for trademarked products. 8 Customers who unknowingly buy unauthorized imports have no assurance of the quality of the item they buy, of warranty support, or of authorized service or replacement parts. Purchasers of computers, for example, may not be able to get parts because authorized dealers have no obligation to service these computers. In the case of software, the buyer may be purchasing a counterfeit product and will not be authorized for technical support. Furthermore, when a product fails, the consumer blames the owner of the trademark, and the quality image of the product is sullied.

Approaches to International Pricing Whether the orientation is toward control over end prices or net prices, company policy relates to the net price received. Cost and market consider- ations are important; a company cannot sell goods below cost of production and remain in business, and it cannot sell goods at a price unacceptable in the marketplace. Firms un- familiar with overseas marketing and fi rms producing industrial goods orient their pricing solely on a cost basis. Firms that employ pricing as part of the strategic mix, however, are aware of such alternatives as market segmentation from country to country or market to market, competitive pricing in the marketplace, and other market-oriented pricing factors, 9 including cultural differences in perceptions of pricing. 10

Firms that orient their price thinking around cost must determine whether to use variable cost or full cost in pricing their goods. In variable-cost pricing , the fi rm is concerned only with the marginal or incremental cost of producing goods to be sold in overseas markets. Such fi rms regard foreign sales as bonus sales and assume that any return over their variable cost makes a contribution to net profi t. These fi rms may be able to price most competitively in foreign markets, but because they are selling products abroad at lower net prices than they are selling them in the domestic market, they may be subject to charges of dumping. In that case, they open themselves to antidumping tariffs or penalties that take away from their competitive advantage. Nevertheless, variable-cost (or marginal-cost ) pricing is a practical approach to pricing when a company has high fi xed costs and unused production capacity. Any