Global
Pricing Approaches
METHODS
OF PRICING
Like the domestic price structure,
the export price structure begins on the factory floor. However, there is no
similarity in the costs included in the two structures. The prices of the
products for domestic and export purposes are calculated in a somewhat
different manner. The export price structure is the basis of all export price
quotations, discounts and commissions. The various methods of pricing the
product in the foreign markets may be grouped into two categories - (A)
cost-oriented export pricing methods and (B) market-oriented export pricing
methods.
A.
Cost-oriented Export Pricing Methods
These are based on costs
incurred in the production of the articles. As total costs include fixed costs
and variable costs, export pricing may be based on full cost (fixed and
variable) or only on variable costs. A reasonable profit will be added to the
base cost to arrive at the export pricing. Thus cost-oriented export pricing
methods may be (1) Full cost method, and (2) Variable cost or marginal cost
method.
1.
Full cost method or cost-plus method
It is most frequently used
pricing method in exports. It is based on the full cost or total cost approach.
Under this method in arriving at the export pricing the total cost of
production of the article (fixed and variable) is taken into account. All
direct and indirect expenses incurred for the development of product such as
R&D expenses and other expenses necessary for the export of the articles
such as transportation cost, freight, customs duties, risk costs etc., are
included over and above the fixed and variable costs incurred in the production
of exportable articles. Now, a reasonable profit allowance is added to the
costs and the value of all assistance received from any authority is deducted. The
net result is the total export price for the commodities produced. By dividing
the total price, thus arrived, by the number of units, manufactured price per
unit may be calculated.
Elements
of Total Costs
1.
Direct Cost
(a)
Variable Costs:
Direct materials.
Direct labour.
Variable production overheads.
Variable administrative
overheads.
(b)
Other Costs Directly Related to Exports:
Selling costs-advertising
support to importers abroad.
Special packing, labelling,
etc.
Commission to overseas agent.
Export credit insurance.
Bank charges.
Inland freight.
Forward charges.
Inland insurance.
Port charges.
Export duties (if any).
Warehousing at port (if
required).
Documentation and incidentals.
Interest on funds involved or
cost of deferred credit.
Cost of after sale service,
including free parts supply, consular fees.
Pre shipment inspection and
loss on rejects.
Total direct cost (a + b)
2.
Fixed Costs or Common Costs
Production overheads.
Administration overheads.
Publicity and advertising
(general)
Travel abroad.
After sale service.
Freight / Free On-Board cost
(1 + 2)
Less.
Compensatory assistance, duty drawback and import replenishment benefits.
Advantages
In this approach the exporter realizes
the full cost (fixed and variable) in marketing the product in a foreign market.
This pricing method is justified if the cost of information about demand and administrative cost of applying a demand-based pricing policy exceed the profit
contribution obtained by applying these approaches.
Disadvantages
(i) Simplicity. If the
recorder is for smaller number of units to be supplied, it would not be
possible for the exporter to supply the product at the same rate due to its
high cost of production per unit on account of fixed costs.
(ii) Completely ignores the
demand and the competitive conditions in the foreign target markets.
(iii) Distorted Measurement of
cost appraisal. As discussed above this is implied in its simplicity.
(iv) Based on circular
reasoning. The price influences cost through their effect on sales.
2.
Marginal cost pricing.
In this method the price is
determined on the basis of variable cost or direct cost, while fixed cost
element in the total cost of production is totally ignored. The firm is
concerned here only with the marginal incremental cost of producing the goods
which are sold in foreign markets. Now, the fixed cost remains fixed up to a
certain level of output irrespective of the volume of output. On the other
hand, variable costs vary in proportion to the volume of production. Thus, the
variable or direct or marginal costs set the price after output at break-even
point (BEP).
This
method is based on the following assumptions:
(i) The export sales are bonus
sales and any return over the variable costs contributes to the net profit.
(ii) The firm has been
producing the goods for home consumption and the fixed costs have already been
met or in other words, break-even point has been achieved. Thus, if the manufacturers
are able to realize the direct costs, including those involved in export
operations specifically, they would not affect the profitability of their
firms. However, the profitability of firms should be assessed with reference to
marginal cost which should normally constitute the basis for export pricing.
Direct costs and other elements in calculating price will remain the same.
Advantages
(i)
No Overhead Costs. Export sales are additional
sales. Hence these should not be burdened with overhead costs which are
ordinarily met from the domestic trade.
(ii)
Firms from Developing countries. This approach is
advocated for firms from developing countries who are not well-known in foreign
markets as compared to their competitors from developed countries. Therefore,
lower prices based on variable costs may help them enter a market. Price may be
used as a technique for securing market acceptance for products newly
introduced into the market.
(iii)
Large Market. Since the buyers of products from
developing countries are usually in countries with low national income, it is
advisable for the firm to serve a large segment of the market at low prices.
Low prices may serve to widen and create markets. In such countries price is
still the decisive factor and quality is comparatively less important.
Disadvantages
of Marginal cost-pricing
(i)
Attracts anti-dumping process. Developing countries
might be charged of dumping their products in foreign markets because they
would be selling their products below net prices and attract anti-dumping
provisions which take away their competitive advantage.
(ii)
Cut-throat competition. The use of this approach may
give rise to cut-throat competition among exporting firms from developing
countries resulting in loss in valuable foreign exchange to the exporting
countries.
(iii) Marginal cost pricing is not advisable in the following cases:
(i) If the importers are
regularly purchasing the product at a low price, it will be difficult for
exporters to increase the price of the commodities later on. It may lose their
market. (ii) This policy is not useful or of limited use to industries which are
mainly dependent upon export markets and where overheads or fixed costs are
insignificant.
Circumstances
of Feasibility
(i)
Large domestic market. There must be a large
domestic market of the product so that the overheads may be charged from
products manufactured for domestic market.
(ii)
Mass production. Mass production techniques must have been
adopted so that the gap between the full and marginal costs may be reduced.
(iii)
Higher prices in home market. The home market has a
capacity to bear the higher prices.
(iv)
No overhead costs. Additional production for
exports is possible without increasing overhead costs and within permissible
production capacity.
It is generally advocated that
marginal cost should be the basis for export pricing. In advocating this
system, direct cost only should not be charged in every case. Based on marginal
cost only this method sets the lower limit up to which a firm can sell its
product without affecting its overall profitability. Thus, it does not follow
that one should invariably charge the variable cost. Contribution towards fixed
cost might be possible and all efforts should be made to take advantage of the
possibility that situation in different markets may be different. In cases
where only marginal cost is possible to realize, the long-term objective of the
firm should be to recover direct costs plus some contribution towards overhead
costs as well.
B.
Market-oriented Export Pricing
The above approaches are based
on cost considerations only. No doubt the costs are important but the
competitive prices should also be considered before fixing the export price.
Competitive prices are the prices that are charged by the competitors for the
same product or for the substitute of the product in the target market. After
this price level is established, the base price, or what the buyer can afford,
should be determined. It can be determined by the following three basic steps:
(i) Relevant demand schedules
(quantities to be bought) at various prices should be estimated over the
planning period.
(ii) Relevant costs (lotal and
incremental) of production and marketing costs should be estimated to achieve
the target sales volume as per demand schedules prepared.
(iii) The price that offers
the highest profit contribution, i.e., sales revenues minus all fixed and
variable costs, should be taken.
The final base price should be
fixed after considering all other elements of marketing mix within these
elements. The nature and length of channel of distribution is the most
important factor affecting the final cost of the product. Besides, product
adaptation costs should also be considered in fixing the base price.
The above three steps, though
appear very simple, are not so because various other factors should be looked
into. The most appropriate method to estimate the demand of the product is the judgmental
analysis of company and trade executives. Another way may be the extrapolation
of demand estimates for target markets from actual sales in identical markets
in terms of basic factors.
After finding out what the
market can bear, the firm has to determine whether it can sell the product at
that price profitably or not by working back from the market price as shown
above.
The above analysis gives an
idea of the upper limit of what the firm can charge. The cost analysis gives
the lower limit of what a firm can charge. The price of the product in the
foreign market may be fixed between these two limits. As the firm gathers
experience, it may set the price that gives, the highest profitability.
However, if the market realization is very low. The exporter may compare his f.o.b.
(Free / Freight on Board) realization (under market-oriented export pricing)
with the direct cost or full cost as calculated under cost-oriented export
pricing. He can determine whether he should export the goods or not. He can
decide to export the goods even at a loss if he thinks that the market
prospects are better in future and the loss is only a short-term phenomenon.
Whatever be the price determined
by the firm for its product, the price and non-price factors must be considered
before taking a final decision.
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