Chapter six
Pricing and terms of payment
International pricing strategy
verses domestic pricing strategy
International pricing strategies and domestic pricing
strategies differ in several aspects due to the complexities and unique factors
involved in the international market.
ü Here are some key points of differentiation:
1.
Currency Fluctuations
and Exchange Rates:
ü Pricing
globally is more challenging due to currency fluctuations and devaluations.
These fluctuations can impact the profitability of transactions and make it
difficult to determine stable pricing.
ü In contrast, domestic pricing is typically more predictable as it is based on the local currency
2. Tariffs and Trade Barriers:
ü International
pricing must consider price escalation through tariffs, import duties, and
other trade barriers. These additional costs need to be factored into the
pricing strategy.
ü In domestic pricing, such barriers are generally not a concern.
3. Credit Risks and Payment Methods:
ü International
pricing needs to account for difficult-to-assess credit risks and variations in
payment methods. Exporters may need to offer flexible payment terms and
consider the financial stability of foreign buyers.
ü In domestic pricing, credit risks and payment methods are typically more standardized and predictable.
4. Competition and Market Analysis:
ü Pricing
in the international market requires careful analysis of competitors,
distributors, and consumers.
ü The global market may have different pricing dynamics and competitive landscapes compared to the domestic market.
5. Additional Costs and Taxes:
ü International
pricing should consider additional costs borne by importers, such as tariffs,
customs fees, currency fluctuations, transaction costs, and value-added taxes
(VATs). These costs can significantly impact the final price paid by the
importer.
ü In domestic pricing, additional costs and taxes are usually more straightforward and localized.
6. Market Research and Market Demand:
ü Pricing
decisions in both international and domestic markets should consider market
research and market demand.
ü However,
international pricing requires a more comprehensive evaluation of variables
that may affect price ranges, including cultural preferences, local economic
conditions, and purchasing power parity.
Price standardization
Price standardization is a pricing strategy in international
markets where a fixed price is set for the product as it leaves the factory.
ü This
strategy involves establishing a consistent world price at the headquarters of
the firm, considering factors such as foreign exchange rates and variations in
local market conditions.
Price standardization can be suitable when the firm sells to
large customers with multinational operations.
§ In
such cases, the firm may face pressure from the customer to deliver the product
at the same price across all country subsidiaries within the customer's
multinational organization.
There are several advantages
associated with price standardization.
ü Firstly, it enables the rapid introduction of
new products in international markets.
§ Since the pricing is standardized, the firm can quickly launch new products without the need for extensive price adjustments in each market.
ü Secondly, price standardization helps present a
consistent price image across different markets. This consistency can
contribute to building a strong brand and reputation globally, as customers
perceive the product as having the same value regardless of the country, they
are in.
Price escalation
Price escalation refers to the disproportionate difference
in price between the exporting country and the importing country.
ü When
people travel abroad, they may encounter goods that are priced higher in other
countries compared to their home country.
Several factors contribute
to this higher price:
·
Cost of Exporting:
·
Taxes, Tariffs, and Administrative Costs:
·
Inflation:
·
Exchange Rate Fluctuations:
·
Middlemen and Transportation Costs:
Pricing methods
1.
Cost-Plus Pricing
(Mark-Up):
Cost-plus pricing involves setting the price of a product by
adding a desired profit margin to the total cost of producing one unit. The
formula for calculating the unit cost is:
Unit Cost = Selling Price
/ (1 + Desired Rate of Return on Cost)
Alternatively, when the
mark-up is based on the selling price, the formula is:
Selling Price = Unit Cost
/ (1 - Desired Rate of Return on Sales)
2.
Break-Even Analysis and
Target Profit Pricing (Marginal Analysis):
Marginal analysis considers both demand
and costs to determine the optimal price for maximizing profit.
·
It takes into account overhead costs and
aims to find the price that will generate the desired profit.
·
Break-even analysis involves using a
break-even chart to establish a target profit pricing system.
3. Market Entry Pricing:
I.
Market Skimming
Pricing: involves setting a
relatively high initial price for a new product, targeting customers who are
willing to pay a premium.
ü This
strategy aims to recover research and development costs quickly and provide
healthy profit margins.
ü It also offers flexibility to lower prices if necessary.
II.
Market Penetration
Pricing: involves setting a
relatively low initial price for a new product to attract a large number of
customers and gain a significant market share.
ü The goal is to generate substantial sales volume and discourage competitors from entering the market.
III. Dumping: refers
to the practice of selling products in a foreign market at significantly lower
prices than in the domestic market, which can harm local producers.
ü There
are various reasons for dumping, including getting rid of excess inventory,
gaining market access, and engaging in price discrimination.
ü
Forms of dumping
§ Predatory dumping involves
intentionally selling at a loss to gain market share,
§ unintentional dumping may
occur due to time lags between the dates of sales transaction, shipment, and
arrival and exchange rate fluctuations.
Export coaptation terms (INCOTERMS)
Incoterms
are standardized shorthand expressions that define the responsibilities of
buyers and sellers in terms of transport costs, transfer of risks, customs, and
insurance.
ü It
is essential for both parties to explicitly refer to the agreed Incoterm in
their contracts to avoid any misunderstandings or disputes.
ü The
Incoterms 2000 edition, developed by the International Chamber of Commerce
(ICC), consists of 13 different terms.
Some commonly used Incoterms are:
1. Ex-Works (EXW) or Ex-Named point of origin: The seller makes the goods available at a
specified location, such as their place of business or warehouse.
ü The buyer is responsible for all transportation, customs, and insurance costs from that point onward.
2. FAS – Named port of shipment: The
seller delivers the goods alongside the vessel or mode of transportation at the
specified port of shipment.
ü The seller covers the costs up to that point, but loading charges are not included.
3. FOB Named Point: FOB stands for "Free on Board." The price is applicable at a specific point, which could be the named inland carrier, inland point of departure, port of shipment, or inland point in the country of importation. Typically, the price includes local delivery and loading.
4. C&F – to named point of destination (CFR): C&F, or "Cost and Freight,"
usually designates the overseas port of import as the relevant point.
ü The price includes the cost of transportation to that point, while the buyer is responsible for insurance.
5. CIF – to named point of destination: CIF, or "Cost, Insurance, and
Freight," can be any location, but the recommended point is the
destination.
ü The CIF price covers the cost of goods, insurance, and transportation charges to the point of debarkation (destination).
6. FCA – Free Carrier: The
seller hands over the goods, cleared for export, to the first carrier named by
the buyer at the specified place.
ü This term is suitable for all modes of transport.
7. CPT – Carriage Paid To: Similar
to CFR, but applicable to general/containerized/multi-modal transport.
ü The
seller pays for carriage to the named destination point, and risk transfers
when the goods are handed over to the first carrier.
8. CIP – Carriage Paid To: Similar
to CIF, but applicable to general/containerized/multi-modal transport.
ü The seller pays for carriage and insurance to the named destination point, and risk transfers to the buyer upon handover to the first carrier.
9. DAF – Delivered At Frontier: The
seller makes the goods available, cleared for export, at the named place on the
frontier.
ü This term is suitable for rail/road transport.
10. DES – Delivered Ex ship: The seller delivers the goods to the buyer on board the ship at the port of destination, without being cleared for import.
11. DEQ – Delivered Ex quay: Similar to DES, but the goods must be unloaded into the quay at the port of destination.
12. DDU – Delivered Duty Unpaid: The
seller must deliver the goods to a named place in the buyer's country of
destination.
ü However, the buyer is responsible for customs clearance and payment of duties.
13. DDP – Delivered Duty Paid: The
maximum obligation for the seller.
ü The
seller pays for costs, charges, and official formalities up to the destination.
Method of payment
A. Cash-in-Advance: With
cash-in-advance terms, the exporter receives payment before the goods are
shipped or ownership is transferred to the buyer.
§ This
method minimizes credit risk for the exporter but can be unfavorable for the
buyer due to cash flow considerations.
§ Cash-in-advance
options include wire transfers and credit card payments.
B.
Export credit terms
(letter of credit)
Export credit terms are financial arrangements used in
international trade to facilitate payment between the buyer and
seller.
ü They
involve the use of letters of credit (L/C) issued by banks to provide assurance
of payment to the exporter (seller) and mitigate risk for both parties. Here
are some key types of export credit terms:
§ The
issuing bank is responsible for issuing the L/C, but it does so only for its
own customers, even if collateral is provided by someone else.
§ On
the other hand, the advising bank is the bank that informs the seller
(exporter) that an L/C has been issued. The issuing bank sends the L/C to the
advising bank, which is usually chosen based on its proximity to the
beneficiary (seller).
§ If
the advising bank is also a conforming bank, it performs the same services as
the advising bank but also becomes liable for payment.
Types of letters of credit
1. Revocable letter of credit: This
type of L/C can be modified or canceled by the issuing bank without prior
notice to the seller.
ü Since the bank’s commitment is not legally binding, the protection to the seller is minimal and is generally not preferred by exporters.
2. Irrevocable letter of credit: An
irrevocable L/C cannot be amended or canceled without the agreement of all
parties involved.
ü Once accepted by the seller, it provides a binding commitment from the issuing bank to honor the payment as long as the required documents are presented.
3. Confirmed letter of credit: A
confirmed L/C involves a second bank, known as the confirming bank, which adds
its guarantee of payment to the exporter.
ü This provides additional security to the seller, as they receive payment from both the issuing bank and the confirming bank.
4. Unconfirmed letter of credit: In
an unconfirmed L/C, the issuing bank's guarantee is not backed by a confirming
bank.
ü Payment
may be slower and the certainty of payment is reduced compared to a confirmed
L/C.
ü However, if the issuing bank is financially strong, it can still be acceptable to the seller.
5. Transferable letter of credit: A
transferable L/C allows the first beneficiary (agent or broker) to transfer all
or part of their rights to another party, such as the supplier of the goods.
ü This is useful when the agent's credit standing is weak or unknown and they need to involve another party in the transaction.
6. Untransferable letter of credit: An untransferable L/C is one where the seller cannot assign or transfer the credit to someone else. The credit remains solely with the original beneficiary.
7. Deferred/Usance letter of credit: A deferred or usance L/C requires payment
to be made after a specified duration, agreed upon by the buyer and seller.
ü The seller provides the goods and allows the buyer to pay at a later date, typically after selling the goods.
8. At Sight letter of credit: An at sight L/C requires the issuing bank to pay the required amount immediately upon presentation of the specified documents by the seller.
9. Revolving letter of credit: A
revolving L/C is used when the buyer and seller have an ongoing relationship
involving multiple shipments.
ü Instead of creating separate L/Cs for each shipment, a revolving L/C is established, which can be renewed or reinstated to cover multiple shipments over an extended period.
10. Red Clause letter of credit: A red clause L/C allows the buyer to advance cash to the seller before shipment. This is useful when the seller needs funds to purchase the goods or arrange for shipment.
11. Back-to-Back letter of credit: A
back-to-back L/C is used when the seller needs to purchase goods from another
supplier to fulfill the buyer's order.
ü The seller uses the first L/C received as collateral to request a second L/C in favor of the supplier, enabling the goods to be obtained and shipped.
C. Documentary Collections (D/C): Documentary
collections involve the exporter entrusting the collection of payment to their
bank.
§ The
bank sends the necessary documents to the importer's bank, which releases the
documents to the buyer upon payment.
§ There
are two types of D/Cs: document against payment (payment upon sight) and
document against acceptance (payment on a specified date).
§ D/Cs
offer limited recourse in case of non-payment but are generally less expensive
than LCs.
D. Open Account: In
an open account transaction, the goods are shipped and delivered to the buyer
before payment is due.
§ Payment
terms are typically 30, 60, or 90 days after delivery.
§ This
method offers advantages to the importer in terms of cash flow and cost but
presents higher risk for the exporter.
§ Open
account terms are more common in foreign markets, and exporters can mitigate
the risk of non-payment by using trade finance techniques or export credit
insurance.
E. Consignment: is
a variation of open account terms where payment is made to the exporter after
the goods are sold by the foreign distributor to the end customer.
§ The
exporter retains ownership of the goods until they are sold. Consignment
carries significant risk for the exporter, as payment is not guaranteed.
§ It
requires a trustworthy foreign distributor or logistics provider and
appropriate insurance coverage.
Transfer pricing
Transfer pricing refers to the pricing of goods and
services exchanged between different units or subsidiaries of the same multinational
company located in different countries.
ü It
involves determining the prices at which intra-company transactions take place.
There are several reasons why companies engage in
transfer pricing:
1. Lowering duty costs: By
setting minimal transfer prices, companies can reduce duty costs when shipping
goods into high tariff countries.
ü This helps minimize the duty base and the amount of duty paid.
2. Reducing income taxes: Companies
may overprice goods transferred to units in high-tax countries.
ü This
allows them to shift profits to low-tax countries, thereby reducing overall tax
liabilities.
ü Profit shifting can also be used to manipulate financial statements by inflating profits in countries where financial activities like borrowing are undertaken.
3. Facilitating dividend repatriation: In countries where government policies
restrict dividend repatriation, companies can use transfer pricing to
repatriate funds indirectly.
ü They
achieve this by inflating prices for products or components shipped to units in
the country, effectively transferring income out of the country.
Bartering and counter trading
Countertrade
is a form of international trade where goods or services are exchanged for
other goods or services, rather than using cash as a medium of exchange.
ü It is often used by countries with limited foreign exchange or credit facilities. There are several types of countertrades, including barter, counter purchase, and offset.
1. Barter: is
the simplest form of countertrade, where there is a direct exchange of goods or
services between two parties of equal value.
ü It involves the removal of money as a medium of exchange. For example, a bag of nuts could be exchanged for coffee beans or meat.
2. Counter purchase: In
a counter purchase arrangement, the exporter sells goods or services to an
importer and agrees to purchase other goods from the importer within a
specified period.
ü Unlike bartering, the exporter does not use the goods themselves but uses a trading firm to sell them. This ensures a reciprocal commitment between the parties involved.
3. Offset: An
offset arrangement typically involves the seller assisting in marketing
products manufactured by the buying country or allowing a portion of the
exported product's assembly to be carried out by manufacturers in the buying
country.
ü This
practice is often seen in industries such as aerospace, defense, and
infrastructure. It can also be referred to as industrial participation or
industrial cooperation.
ü Offset
arrangements are more common for larger and more expensive items.
Benefits of counter trade
§ Countertrade
provides a way for countries with limited access to cash or credit to engage in
international trade and acquire needed goods and resources.
§ It
allows countries to leverage their own resources and capabilities to obtain
essential products from other nations.