CHAPTER 17

GLOBAL PRICING

Chapter Outline

A. Transfer Pricing
1. Use of Transfer Prices to Achieve Corporate Objectives
2. Transfer Pricing Challenges
B. Pricing within Individual Markets
1. Corporate Objectives
2. Costs
3. Demand and Market Factors
4. Market Structure and Competition
5. Environmental Constraints
C. Dealing with Financial Crises
1. Causes of the Crises
2. Effects of the Crises
3. Consumer and Marketer Responses
D. Pricing Coordination
E. The Euro and Marketing Strategy
F. Countertrade
1. Why Countertrade?
G. Types of Countertrade
H. Preparing for Countertrade

Chapter Objectives

The chapter focuses on the problems faced by multinational corporations that have direct
inventories in multiple countries when it comes to pricing. The discussion is based on an
analysis of two issues: (1) how should goods and services flows be priced when they are within
the corporate family, as well as who may be interested in this and why, and (2) what
considerations make pricing the most difficult of the marketing mix elements to standardize.
Price controls are discussed as a special challenge to the international marketer. The issue of a
common currency in the EU is discussed extensively to highlight the challenges of complete
price transparency to the international marketing manager. The chapter also highlights the causes
and effects of financial crises across the world, and the different responses of consumers and
marketers faced with such crises.

International countertrade, i.e., trade which is linked to anything other than money, is increasing
in importance. The reasons are lack of hard currency, greater indebtedness, the desire for new
market expansions, and increased bilateralism. Companies confronted with countertrade
demands should not automatically shy away from such business transactions. However in their
preparations for such transactions, corporations need to be very clear on the inherent dangers of
countertrade. These dangers mainly consist of the fact that even though the two transactions are
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linked, two entirely separate business activities need to be carried out and planned
simultaneously.

Suggestions for Teaching

One way of making the discussion on transfer prices exciting for the class is to treat it, after
outlining the basics of it (using, for example, the information in Exhibit 17.1), as a ethical issue.
Students may be asked to suggest whether the discussion of transfer prices, (beyond the arm's
length principle) is proposing unethical (if not illegal) behavior? The issue of pricing
coordination can be brought up in the context of economic integration and tying in the parallel
importation phenomenon. A number of cases can be used: Aurora Lotion (IMEDE), or Minolta
Camera (ICCH). Similarly, the emerging issues of common currencies, especially the euro,
present a number of new teaching opportunities. In order to make the lecture interesting, students
can be asked to research the impact of the recent financial crisis faced by U.S. on the different
countries trading with it. Moreover, discussing the policies undertaken by the U.S. government to
counteract this crisis will help them to understand the methods of dealing with financial crisis at
the company level.

A good way of bringing the subject of countertrade closer to students is by beginning a

discussion around domestic barter. Many students will be able to contribute examples,
particularly since in younger years due to lack of money, many of them will have carried out
barter transactions with their peers. From that discussion one can then gradually introduce the
notion of inefficiency, which becomes very obvious when larger transaction volumes are
considered. It is important for students to understand that the matching of needs suddenly
becomes much more complex. This complexity means more marketing activities and therefore
more expenses. As a result, the cost of countertrade transactions is higher when compared to the
cost of transactions which do not include countertrade. At the same time, however, it is useful to
focus on the quite limited financial resources of many companies and countries and have students
develop the theme of whether or not some trade is better than no trade at all. Given the increased
trade dependency of many companies and nations, usually the option of some trade will be
preferred.

Key Terms

Arm’s-length price: A basis for intra-company transfer pricing: The price that unrelated parties
would have arrived at for the same transaction.
Arm’s-length standard: A principal basis for transfer pricing favored by governments to stop
companies from shifting their income to foreign subsidiaries in low- or no-tax jurisdictions.
Price elasticity of consumer demand: The degree of responsiveness of prices to market
demand; for example, a status-conscious market that insists on products with established
reputations will be inelastic, allowing for more pricing freedom than a price-conscious market.
Price controls: Government regulations on price levels in the form of maximum or minimum
prices for a product; governmental imposition of limits on price changes.
Countertrade: A sale that encompasses more than an exchange of goods, services, or

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ideas for money; transactions which have as a basic characteristic a linkage legal or otherwise,
between exports and imports of goods or services in addition to, or in place of, financial
settlements
Barter: Exchange of goods for other goods of equal value.
Counterpurchase: A parallel barter agreement in which the participating parties sign two
separate contracts that specify the goods and services to be exchanged.
Buyback: A form of countertrade arrangement under which one party agrees to supply
technology or equipment that enables the other party to produce goods with which the price of
the supplied products or technology is repaid.
Clearing Arrangements: A more refined form of barter aimed at reducing the effect of the
immediacy of the transaction; clearing accounts are established for deposit and withdrawal of
results of countertrade activities.
Switch-trading: Credits in a clearing account (established for countertrading) can be sold or
transferred to a third party.
Offset: A form of barter trade; industrial compensation mandated by governments when
purchasing defense-related goods and services in order to equalize the effect of the purchases on
the balance of payments.

Questions for Discussion

1. Comment on the pricing philosophy, "Sometimes price should be wrong by design."

This pricing philosophy is a rather theoretical approach to multinational pricing in which the
multinational marketer has no restrictions set on how prices are set in the various markets of
operation. What the statement implies is that the marketer could set an internal (transfer)
price higher in markets where restrictions exist on profit repatriation, and in general move
funds through transfer pricing from one market to another depending on the tax rates,
foreign exchange rates, governmental regulations, and other economic and social challenges
of the different markets. If this was possible the marketer would benefit tremendously of
course.

In some markets, competition may prevent the international marketer from pricing at will.
Prices may have to be adjusted to meet local competition with lower labor costs. This
practice may provide entry to the market and a reasonable profit to the affiliate. However, in
the long term, it may also become a subsidy to an inefficient business.

Reality, on the other hand is quite different. Different entities in all of the countries in
which the international marketer operates want their due. These entities include tax
authorities as well as customs authorities. The safest approach for the international marketer
is arm's length.

2. The standard worldwide base price is most likely looked on by management as full-cost
pricing, including an allowance for manufacturing overhead, general overhead, and selling
expenses. What factors are overlooked?

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part.
 Basing the standard worldwide base price on full-cost pricing is a conservative attitude, but
overlooks several factors. First, pricing based on incremental costs would allow for some
sales that would be lost if the company insisted on recovering the full unit cost. Markup
under this approach is based on total investment and does not consider changes in price of
cost components. By taking up the cost approach, the firm ignores the local market
conditions

By not taking the market approach, the firm ignores the price requirements necessary to
meet competition, regulations imposed by the host governments in the form of taxes and
import duties, expected cost increases and other eventualities. The cost approach also
overlooks corporate objectives on return, demand and market factors, market structure and
competition and environmental constraints.

Other disadvantages of full-cost pricing are that it is often based on distorted measurements
of appraisal of costs and involves a circular form of reasoning because prices influence cost
through their effect on sales volume.

3. In combating price controls, multinational corporations will deal with agency

administrators rather than policymakers. How can they convince administrators that price
relief is fair to the company and also in the best interest of the host country?

In an attempt to fight price controls, multinational corporations usually demonstrate that

their return on investment is unacceptably low, and that, without an acceptable profit
opportunity, they would be forced to stop production and future investments in the country.
For example, Cadbury Schweppes sold its plant in Kenya because price controls made its
operation unprofitable. The firm can make the following arguments:
1. The maximum price will become the standard industry minimum price and price setting
will ignore costs.
2. Wage-spiral advances in anticipation of controls.
3. Forestalling of noninflationary wage increases.
4. Difficulties in enforcement of the government regulations.
5. Decreases taxes collected by the government as profit accrued by companies fall.
6. Government resources may be needed to avoid bankruptcies of the affected firms.
7. Hostility of labor towards restrictions since they are accompanied by an income policy
or wage restriction.

Once price controls are invoked, management will have to devote much time to resolving
the many difficulties that controls present. Therefore, multinational corporations try to work
closely with governments, especially in the developing countries, to establish an economic
policy centered on a relatively free market without price controls.

4. Which elements of pricing can be standardized?

Corporate objectives, costs, customer behavior and market conditions, market structure, and
environmental constraints are some of the elements which affect the pricing strategy of any
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part.
 company. Since all these factors vary among the countries in which the multinational
corporation might have a presence, the pricing policy is under pressure to vary as well.
However, the price level can be standardized if:
1. The firm operates in a monopolistic or oligopolistic market.
2. The consumers are homogeneous, as is often the case for consumers who are the first to
try the product.
3. Corporate objectives are uniform across all markets.

In general, only relative price can be standardized which makes pricing an important
element in the positioning decision for the product.

5. Why might local price differences stay in place even with the euro?

A single currency like euro makes prices completely transparent for all buyers. If price
discrepancies exist across the countries, parallel importation can occur. Hence, international
marketers are usually advised to impose a standard euro price for a product across the
market. However, by doing so firms may suffer huge losses in sales and profit, as this single
price is usually closer to the lower priced country’s level. Operational, distributional, and
promotional costs vary across nations which makes it difficult for an international marketer
to charge a standard price.

The recommended approach is a pricing corridor that defines the maximum and minimum
prices that country organizations can charge. Such an approach allows price flexibility
which is a result of differences in price elasticities, competition, and positioning and at the
same time prevents parallel imports.

6. Discuss the advantages and drawbacks of countertrade.

Countertrade is a sales transaction that provides a legal link between exports and imports
apart from financial settlements. These transactions are mostly encountered when there is a
lack of currency, lack of value of currency, and lack of acceptability of money as a medium
of exchange. Countertrade reduces the risk of the transaction in view of currency
devaluations. The use of countertrade permits the covert reduction of prices and therefore
allows firms and governments to circumvent price and exchange controls. Another
advantage of countertrade is that it can provide entry into a new market. Countertrade also
can provide stability for long-term sales. In the case of buy-backs or compensation deals,
countertrade ensures that the transfer of technology is complete as the selling party is repaid
by the product of what it has sold and wants to ensure that the type of goods obtained in
exchange are of high quality.

Drawbacks are that one may not need the goods offered in exchange or be unable to use the
goods. A firm could waste valuable time trying to find a buyer for the goods received in
exchange for the original purchase. Another disadvantage is that the restrictions imposed on
countertrade by one party may cause the costs of the other party to rise thereby decreasing
the potential profit. Also, because a transaction is dependent on other transactions, it is very
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 difficult to determine the actual value of the transaction for accounting and taxation
purposes. Finally, countertrade is less efficient than trade for money, since it reduces the
options and flexibility of all participants.

Internet Exercises

1. The European Union promotes the benefits of the euro as a common currency for the 16
EU nations that have adopted it see (http://europa.eu/index_en.htm). What are possible
disadvantages of it?

There are three possible disadvantages of the European Union promoting the benefits of the
euro as a common currency. First, a country can no longer conduct monetary policy on its
own behalf. Second, a country may have to substantially limit the use of expansionary
fiscal policy under the Stability and Growth Pact. Thirdly, the exchange rate in the
European Union is no longer able to cushion asymmetric shocks.

2. Compare the services of the Global Offset and Countertrade Organization

(http://www.globaloffset.org/) and the Asia-Pacific Countertrade Association
(http://www.apca.net).

The American Countertrade Association mainly focuses on publishing articles and hosting
conferences whereas the Asia Pacific Countertrade Association has an added service of an
online bulletin, known as Trade Matching, which is an online deal matching that assists
members and nonmembers alike in finding matches for their trades. APCA is an independent
service provider, consultant, facilitator and trainer in countertrade, offset, and public-private
partnership projects.

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