Pricing for International Markets

1. Pricing Policy (Pricing Objectives; Parallel Imports)

2. Approaches to International Pricing (Full-Cost versus Variable-Cost Pricing; Skimming versus Penetration Pricing)

3. Price Escalation (Costs of Exporting; Taxes, Tariffs, and Administrative Costs; Inflation; Deflation; Exchange Rate Fluctuations; Varying Currency Values; Middlemen and Transportation Costs)

4. Sample Effects of Price Escalation

5. Approaches of Lessening Price Escalation (Lowering Costs of Goods; Lowering Tariffs; Lowering Distribution Costs; Using Foreign Trade Zones to Lessen Price Escalation)

6. Leasing in International Markets

7. Countertrade as a Pricing Tool (Types of countertrade; Problems of Countertrading; the Internet and the Countertrade; Proactive Countertrade Strategy)

8. Transfer Pricing Strategy

9. Price Quotations

Administered Pricing (Cartels; Government Influenced Pricing)

Chapter Learning Objectives

What you should learn from Chapter 10:

Components of pricing as competitive tools in international marketing

The pricing pitfalls directly related to international marketing

How to control pricing in parallel imports or grey markets

Price escalation and how to minimize its effect

Countertrading and its place in international marketing practices

The mechanism of price quotations

Chapter 10

PRICING FOR INTERNATIONAL MARKETS

Setting the right price for a product 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 Canadian products is widely recognized in global markets, foreign buyers, like domestic buyers, balance quality and price in their purchase decisions. A products price must reflect the quality and value the consumer perceives in the product. Of all the tasks facing the international marketer, determining what price to charge is one of the most difficult. It is further complicated when the company sells its product to customers if different country markets.

As the globalization of world markets continues, competition intensifies among multinational and home-based companies. All are seeking a solid competitive position so they can prosper as markets reach full potential. The competition for the diaper market between 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 exporting or managing overseas operations, the managers responsibility is to set and control the actual price of goods in different markets in which different sets of variables are found: different tariffs, costs, attitudes, competition, currency fluctuations, 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 escalation 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.

1. PRICING POLICY

Active marketing in several countries compounds the number of pricing problems and variables relating to price policy. Unless a firm has a clearly thought-out, explicitly defined price policy, expediency rather than design establishes prices. The country in which business 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.

A. Pricing Objectives

In general, price decisions are viewed two ways: pricing as an active instrument of accomplishing marketing objectives, or pricing as a static element in a business decision. If prices are viewed as an active instrument, the company uses price to achieve a specific objective, whether a targeted return on profit, a targeted market share, or some other specific goal. 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 profits received an average rating of 4.7, followed by 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 final selling price of a product, the better it is able to achieve its marketing goals. However, it is not always possible to control end prices. The broader the product line and the larger the number of countries involved, the more complex the process of controlling prices to the end user.

B. Parallel Imports

Besides 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, a Canadian 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 with the same product sold for higher prices by the same firm.

Parallel imports develop when importers buy products from distributors in one country and sell them in another to distributors who are not part of the manufacturers regular distribution system. This practice is lucrative when wide margins exist between prices for the same products in different countries. A variety of conditions can create a profitable 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 ranking from 50 to 80 percent on imports. As a result, estimates are that as much as 35 percent on Indias domestic computer hardware sales are accounted for by the grey 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 occurs, it is not unusual for companies to find 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 prices caps imposed on prescription drugs in those countries. For example, the ulcer drug Losec sells for only $22 in Spain but goes for $49 in Germany. The heart drug Plavix costs $69 in France and sells for $99 in London. Presumably such price differentials were to cease when all restrictions to trade were eliminated in the European Union and in most cases this is true. However, the EC does not prevent countries from controlling drugs prices as part of their national health plans. A similar practice exists in Canada. Major automobile producers impose an added charge on new cars purchased from dealerships in the U.S. that are destined to buyers living in Canada. Collected at the Canadian-U.S. border, the charge is an attempt to dissuade buyers of one country from taking advantage of price deals that occur in the neighbouring country.

The drug industry tried to stop parallel trade in Europe but was overruled by European authorities. This time they are trying a different approach, restricting suppliers of their products 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 markets would not have enough to do so. A number of major pharmaceutical companies imposed similar restrictions. The companies say these measures are intended to streamline distribution, help prevent medicine shortage, and curtail excess inventory while distributors 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.

Grey market pharmaceutical sales from Canada to the United States are estimated to be about $600 million annually. That is not a large amount when compared with the $170 billion U.S. drug market, but it can be substantial for specific drugs like Paxil, Zyban, and Viagra. Although it is against U.S. law to import prescription drugs from a foreign country, including Canada, a person can travel to Canada or Mexico to make purchases or can 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. When the Canadian dollar is low relative to the U.S. dollar, and with government price caps on drugs, an American can often save 50 percent to 70 percent by ordering from the 70 or more Internet pharmacies operating across Canada.

Naturally, drug companies that are hit the hardest want to put a stop to the traffic. Glaxo SmithKline, the prescription drug maker, asked all Canadian pharmacies and wholesalers to self-certify that they are not exporting its drugs outside Canada. Those who fail to comply have their supplies Glaxo 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 since there are other markets, like Australia or Ireland, where Americans are able to find less expensive drugs. The Internet trade will be hard to shut down as long as there are large price differentials among markets.

Exclusive distribution, a practice often used by companies to maintain high retail margins in order 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 favourable condition for parallel importing. Perfume and designer brands such as Gucci and Cartier are especially prone to grey markets. To maintain the image of quality and exclusivity, prices for such products traditionally include high profit margins at each level of distribution; characteristically, 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 Canada than wholesale prices in other countries. There are ideal conditions for a lucrative grey market for unauthorized dealers in other countries who buy more than they need at wholesale prices lower than Canadian wholesalers pay. They then sell the excess at a profit to unauthorized retailers, but at a price lower than the retailer would have to pay to an authorized distributor.

The high-priced designer sportswear industry is also vulnerable to such practices. Nike, Adidas, and Calvin Klein were incensed to find their products being sold in one of Britains leading supermarket chains, Tesco. Nikes Air Max Metallic trainers, which are priced at 120 ($246) in sports shops, could be purchased at Tesco for 50 ($105). Tesco had bought 8 million in Nike sportswear from overstocked wholesalers. To prevent parallel markets from developing when such marketing and pricing strategies are used, companies must maintain strong control over distribution and prices (see Exhibit 1).

Exhibit 1 How Grey-Market Goods End Up in Canadian Store

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.

The manufacturer ships the goods to Buyer X.

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

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 Canada.

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

Companies that are serious about restricting the grey market must establish and monitor 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 Coca-Cola company and its sole Taiwan licensee. The violators were prohibited from importing, displaying, or selling 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 after the trademarked item is sold, the owners rights to control the trademarked 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 $5.25 a case plus shipping of $1.25 a case and sold them at $7.50, a nifty profit of 75 cents a case. Coca-Cola sued, but the court ruled that the product was bought and sold legally.

Where differences in prices between markets occur, the Internet makes it easy for individuals to participate in the grey market. Music CDs are especially vulnerable because of price differentials. Six foreign-owned record companies that maintain high prices through limited distribution dominate the Australian market and create a situation ripe for the grey market. CDs retail there for an average of $30 but can be purchased for about 25 to 30 percent less from the many e-stores on the Internet. It is estimated that CDs purchased directly from the United States over the Internet have led to a 5 percent fall in Australian retail sales. In the United Kingdom, grey market CDs come from Italy, where they are about 50 percent cheaper and account for between 15 and 20 percent of sales in some releases. Sony believes that over 100,000 copies of one o Celine Dions best-selling albums sold in the United Kingdom were from parallel imports. The Internet truly is a global price equalizer. 

Parallel imports can do long-term damage in the market for trademarked products. Customers who unknowingly buy unauthorized imports are not sure of the quality of the item they buy, of warranty support, or of authorized service or replacement parts. Purchasers of computer, 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 buying counterfeit product and will not be authorized for technical support. Further, when a product fails, the consumer blames the owner of the trademark, and the quality image of the product is sullied.

With global brands and the euro making price comparison easier and the Internet facilitating purchasing, it is increasingly more difficult to differentiate prices among European markets. Companies must either harmonize prices among member states or contend with parallel imports where there are profitable differences in selling prices. Brand harmonization and price harmonization must be addressed simultaneously.

2. APPROACHES TO INTERNATIONAL PRICING

Whether the orientation is toward control over end prices or over net prices, company policy relates to the net price received. Cost and market considerations are important; a company cannot sell goods below cost of production and remain in business, nor can it sell goods at a price unacceptable in the marketplace. Firms unfamiliar with overseas marketing and firms 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.

A. Full-Cost versus Variable-Cost pricing

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 firm is concerned only with the marginal or incremental cost of producing goods to be sold in overseas markets. Such firms regard foreign sales as bonus sales and assume that any return over their variable cost makes a contribution to net profit. These firms 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 fixed costs and unused production capacity. Any contribution to fixed cost after variable costs are covered is profit to the company.

On the other hand, companies following the full-cost pricing philosophy insist that no unit of a similar product is different from any other unit in terms of cost and that each unit must bear its full share of the total fixed and variable cost. This approach is suitable when a company has high variable costs relative to its fixed costs. In such cases, prices are often set on a cost-plus basis, that is, total costs plus a profit margin. Both variable-cost and full-cost policies are followed by international marketers.

B. Skimming versus Penetration Pricing

Firms must also decide when to follow a skimming or a penetration policy. Traditionally, the decision of which policy to follow depends on the level of competition, the innovativeness of the product, and market characteristics.

A company uses skimming when the objective is to reach a segment of the market that is relatively price insensitive and thus willing to pay a premium price for the value received. If limited supply exists, a company may follow a skimming approach in order to maximize revenue and to match demand to supply. When a company is the only seller of a new or innovative product, a skimming price may be used to maximize profits until competition forces a lower price. Skimming often is used in those markets where there are only two income levels; the wealthy and the poor. Costs prohibit setting a price that is attractive to the lower-income market, so the marketer charges a premium price and directs the product to the high-income, relatively price-insensitive segment. Apparently this was the policy of Johnson &Johnsons pricing of diapers in Brazil before the arrival of P&G. Today such opportunities are fading away as the disparity in income levels is giving way to growing middle-income market segments. The existence of larger markets attracts competition and, as is often the case, the emergence of multiple product lines, thus leading to price competition.

A penetration pricing policy is used to stimulate market growth and capture market share by deliberately offering products at low prices. Penetration pricing most often is used to acquire and hold share of market as a competitive maneuver. However, in country markets experiencing rapid and sustained economic growth, and where large shares of the population are moving into middle-income classes, penetration pricing may be used to stimulate market growth even with minimum competition. Penetration pricing may be a more profitable strategy than skimming if it maximizes revenues and builds market share as a base for the competition that is sure to come.

Regardless of the formal pricing policies and strategies a company uses, it must be remembered that the market sets the effective price for a product. Said another way, the price must be set at a point at which the consumer perceives value received, and the price must be within reach of the target market. As a consequence, many products are sold in very small units in some markets in order to bring the unit price within reach of the target market. Warner-Lamberts launch of its five-unit pack of Bubbaloo bubble gum in Brazil failed even though bubble gum represents over 72 percent of the overall gum sector because it was priced above the target market. A relaunch of a single-unit pillow pack brought the price within range and enabled the brand to quickly gain a respectable market share.

As a companys economy grows and there is a more equitable distribution of wealth, multiple income levels develop, distinct market segments emerge, and multiple price levels and price/quality perceptions increase in importance. As an example, the market for electronic consumer goods in China changed in just a few years. Instead of a market for imported high-priced and high-quality electronic goods aimed at the new rich, and cheaper, poorer-quality Chinese-made goods for the rest of the market, a multitiered market reflecting the growth of personal income emerged.

Quebecs General International, a major producer of woodworking equipment for industrial shops and consumer hobbyists, follows both penetration and skimming strategies. The company recently launched line of woodworking products aimed at the intermediate and beginner home woodworker. For this particular market segment, its pricing strategy is to set prices relatively low low with respect to other major manufacturers (e.g., Dewalt, Grizzly, Delta, and Ryobi) to gain loyalty and stimulate repeat business among woodworkers as their skills improve and demand higher quality equipment. It also practices a skimming strategy with its topof-the-line equipment, which is targeted to highly skilled craftsmen, with prices well-above industry norms.

Sony of Japan, the leading foreign seller of the high-priced consumer electronic goods, was upstaged in the Chinese market when Aiwa, a competitor, recognized the emergence of a new middle tier market for good-quality, modestly priced electronic goods. As part of a global strategy focused on slim margins and higher turnover, Aiwa of Korea began selling hi-fi systems at prices closer to Chinese brands than to Sonys. Aiwas product quality was not far behind that of Sony and was better than top Chinese brands, and the product resembled Sonys high-end systems. Aiwas recognition of a new market segment and its ability to tap into it resulted in a huge increase in overall demand for Aiwa products.

Similarly, Mattel was successful in selling its Barbie dolls to the upper-end market in much of the world for years. However, sales of new product extensions such as the Holiday Barbie that were highly successful in North America did not generate enough foreign sales to justify their marketing abroad. Simply adapting North American products for foreign markets resulted in overpriced merchandise in some market segments. The company estimates that the potential for Barbie in lower-priced market segments is $2 billion. To capture that market, along with brands extensions of a collector Barbie, Mattel will introduce lower-priced dolls in a line called global friends, which features a different doll for each major global city.

Pricing decisions that were appropriate when companies directed their marketing efforts toward single market segments will give way to more sophisticated practices. As incomes rise in many foreign markets, the pricing environment a company encounters will be similar to that in Canada. As countries prosper and incomes become more equitable distributed, multiple market segments develop. As these segments emerge, Wal-Mart, Carrefour, and other mass retailers enter the market to offer price-conscious customers good value at affordable prices. This scenario repeats itself in country after country. Within these markets an effective pricing strategy becomes crucial.

3. PRICE ESCALATION

People traveling abroad often are surprised to find goods that are relatively inexpensive in their home country priced outrageously high in other countries. Because of the natural tendency to assume that such prices are a result of profiteering, manufacturers often resolve to begin exporting to crack these new, profitable foreign markets only to find that, in most cases, the higher prices reflect the higher costs of exporting. A case in point is the pacemaker for heart patients that for $2,000 in Canada. Tariffs and the Japanese distribution system add substantially to the final price in Japan. Beginning with the import tariff, each time the pacemaker changes hands an additional cost is occurred. First, the product passes through the hands of an importer, then the company with primary responsibility for sales and service, then to a secondary or even a tertiary local distributor, and finally to the hospital. Markups at each level result in the $2,700 pacemaker selling for over $5,000 in Japan. Inflation results in price escalation, one of the major pricing obstacles facing the MNC marketer. This is true not only for technical products like the pacemaker, but also for such products as crude oil, soft drinks, and beer. Estimates are that if tariffs and trade barriers on these products were abolished, the consumer would enjoy savings of $6.57 trillion yen.

A. Costs of Exporting

Excess profits exist in some international markets, but generally the cause of the disproportionate difference in price between the exporting country and the importing country, here termed price escalation is the added costs incurred as a result of exporting products from one country to another. Specifically, the term relates to situations in which ultimate prices are raised by shipping costs, insurance, packing, tariffs, longer channels of distribution, larger middleman margins, special taxes, administrative costs, and exchange rate fluctuations. The majority of these costs arise as a direct result of moving goods across borders from one country to another and often to escalate the final price to a level considerably higher than in the domestic market.

B. Taxes, Tariffs, and Administrative Costs

A tariff, or duty is a special form of taxation. Like other forms of taxes, a tariff may be levied for the purpose of protecting a market or for increasing government revenue. A tariff is a fee charged when goods are bought into a country from another country. Recall that the level of tariff is typically expressed as the rate of duty and may be levied as specific, ad valorem, or compound. A specific duty is a flat charged per physical unit imported, such as 15 cents per bushel of rye. Ad valorem duties are levied as a percentage of the value of the goods imported, such as 20 percent of the value of imported watches. Compound duties include both a specific and an ad valorem charge, such as $1 per camera plus 10 percent of its value. Tariff and other forms of import taxes serve to discriminate against all foreign goods.

Fees for import certificates or for other administrative processing can assume such level that they are, in fact, import taxes. Many countries have purchase or excise taxes, which apply to various categories of goods; value-added or turnover taxes, which apply as the product goes through a channel of distribution; and retail sales taxes. Such taxes increase the end price of goods but, in general, do not discriminate against foreign goods. Tariffs are the primary discriminatory tax that must be taken into account in reckoning with foreign competition.

In addition to taxes and tariffs, there are a variety of administrative costs directly associated with exporting and importing a product. Export and import licences, other documents, and the physical arrangements for getting the product from port of entry to the buyers location mean additional costs. Although such costs are relatively small, they add to the overall cost of exporting.

C. Inflation

In countries with rapid inflation or exchange variations, the selling price must be related to the cost of goods sold and the cost of replacing the items. Goods are often sold below their cost of replacement plus overhead, and are sometimes sold below replacement cost. In these instances, the company would be better off not to sell the products at all. When payments is likely to be delayed for several months or is worked out on a long-term contract, inflationary factors must be figures onto the price. Inflation and lack of control over price were instrumental in the unsuccessful new-product launch in Brazil by the H.J. Heinz Company; after only two years they withdrew from the market. Misunderstandings with the local partner resulted in a new fruit-based drink being sold to retailers on consignment; that is did not pay until the product was sold. Faced with a rate of inflation of over 300 percent, just a weeks delay in payment eroded profit margins substantially. Soaring inflation in many developing countries (Latin America in particular) makes widespread price controls a constant threat.

Because inflation and price controls imposed by a country are beyond the control of companies, they use a variety of techniques to inflate the selling price to compensate for inflation pressure and price controls. They may charge for extra services, inflate costs in transfer pricing, or break up products into components and price each component separately.

Inflation causes consumer prices to escalate and the consumer is faced with rising prices that eventually exclude many consumers from the market. On the other hand, deflation results in decreasing prices creating a positive result for consumers, but both put pressure to lower costs on everyone in the supply chain. Canadian consumers are forced to spend more to buy less as inflation eats away their incomes. During the inflationary periods, however, the problem is not limited to Canadian consumers; Canadian exporters have to adjust prices in foreign markets based on host-country inflation rates. During the Asian crisis, for example, exporters had to adjust prices downward as inflation eliminated almost fifty percent of consumers purchasing power in Thailand, Hong Kong, and Korea. Without making price reductions, companies faced losing out in the future when markets strengthened. Maintaining higher prices during the crisis would have led to a dramatic fall in consumer loyalty.

D. Deflation

The Japanese economy has been in a deflationary spiral for a number of years. In a country better known for $10 melons and $100 steaks, McDonalds now sells hamburgers for 65 cents, down from $1.30, a flat screen 32-inch colour television is down from $5,000 to $3,000, and clothing stores compete to sell fleece jackets for $10, down from $32 two years earlier. Prices have dropped to a point that consumer prices are similar to those previously found only on overseas shopping trips. The high prices prevalent in Japan before deflation allowed substantial margins for everyone in the distribution chain. As prices continued to drop over several years, those less able to adjust costs to allow some margin with deflated prices, fell by the way side. Entirely new retail categories 100-yen discount shops, clothing chains selling low-cost imported products from China, and warehouse-style department stores are now the norm. Sales at discount stores grew by 78 percent from 1995 to 2000. Discounting is the way to prosper in Japan, which again helps fuel deflation. While those in the distribution chain adjusted to a different competitive environment or gave up, Japanese consumers were revelling in their newfound spending power. Japanese tourists used to travel to North America to buy things at much cheaper prices, but, as one consumer commented, Nowdays, I feel prices in Japan are going down and North America is no longer cheaper. When she used to bring back suitcases of bargains on trips to North America, on her last trip she returned from a two-week vacation and limited her purchases to one fanny pack.

In a deflationary market, it is essential for a company to keep prices low and raise brand value to win the trust of consumers. Whether deflation or inflation, an exporter must emphasize controlling price escalation.

E. Exchange Rate Fluctuations

At one time, world trade contracts could be easily written because payment was specified in a relatively stable currency. The U.S. dollar was the standard and all transactions could be related to the dollar. Now that all major currencies are floating freely relative to one another, no one is quite sure of the future value of any currency. Increasingly, companies are insisting that transactions be written in terms of the vendor companys national currency, and forward hedging is becoming more common. If exchange rates are not carefully considered in long-term contracts, companies find themselves unwittingly giving 15 to 20 percent discount. The added cost incurred by exchange rate fluctuation on a day-to-day basis must be considered, especially where there is a significant time lapse between signing the order and delivery of the goods. Exchange rate differentials mount up. Whereas Hewlett-Packard gained nearly half a million dollars additional profit through exchange rate fluctuations in one year, Nestl lost a million dollars in six months. Other companies lost or gained even larger amounts. In Canada, relative exchange rates between the Canadian and U.S. dollars have altered 35 percent since 2002. As a consequence, tourist excursions to Canada are not as attractive; several of the leading ski resorts have reported that U.S. visitors have declined considerably. In response, Albertas Banff-Lake Louise and Quebecs Mount Tremblant resorts have been offering aggressive promotions to entice U.S. travelers back.

F. Varying Currency Values

In addition to risks from exchange rate variations, other risks result from the changing values of a countrys currency relative to other currencies. Consider the situation in Germany for a purchase of U.S. manufactured goods from mid-2001 to mid-2003. During this period, the value of the U.S. dollar relative to the euro went from a strong position ($1 U.S. to 1.8315) in mid-2001 to a weaker position in mid-2003 ($1 U.S. to 0.8499). A strong dollar produces price resistance because it takes a larger quantity of local currency to buy a U.S. dollar. Conversely, when is weak, demand for U.S. goods increases because fewer units of local currency are needed to buy a U.S. dollar. The weaker U.S. dollar, compared with most of the worlds stronger currencies, that existed in mid-2003 stimulated exports from the United States. Consequently, when the dollar strengthens U.S. exports will soften.

When the value of the dollar is weak relative to the buyers currency (i.e., it takes fewer units of the foreign currency to buy a dollar), companies generally employ cost-plus pricing. To remain price comparative when the dollar is strong (i.e., when it takes more units of the foreign currency to buy a dollar), companies must find ways to offset the higher price caused by currency values. When the rupee in India depreciated significantly against U.S. dollar, PC manufacturers faced a serious pricing problem. Because the manufacturers depended on imported components, their option was to absorb the increased cost or raise the price of PCs. Exhibit 2 focuses on the different price strategies a company might use under a weak or strong domestic currency. Companies marketing in those countries with strong currencies have a choice between lowering prices even further and thereby expanding their market share, or maintaining prices and accumulating larger profits.

Currency exchange rate swings are considered by many global companies to be a major pricing problem. Because the benefits of a weaker dollar are generally transitory, firms need to take a proactive stance one way or the other. For a company with long-range plans calling for continued operation in foreign markets, yet wanting to remain price competitive, price strategies need to reflect variations in currency values. Interestingly, whenever currencies fluctuate dramatically over short time periods, regulatory authorities are pressed by public opinion to intervene in order to stabilize currency relationships. In Canada, with the Canadian dollars deep slide relative to the U.S. currency in 1999-2000, and its dramatic rebound in 2002-2003, more and more people are calling for the authorities to fix the exchange rate, or abandon the Canadian dollar altogether for a common North American currency union. Among the major adherents for a common currency union are the five chartered banks, and the leading Canadian multinational companies organizations that are likely to experience sharp changes in their financial asset positions as currency values fluctuate.

Exhibit 2 Export strategies Under Varying Currency Conditions

Innumerable cost variables can be identified depending on the market, the product, and the situation. The cost, for example, of reaching a market with relatively small potential may be high. High operating costs of small specialty stores like those in Mexico and Thailand lead to high retail prices. Intense competition in certain world markets raises the cost or lowers the margins available to world business. Even small things like payoffs to local officials can introduce unexpected costs to the unwary entrepreneur. Only experience in a given marketplace provides the basis for compensations for cost differences in different markets. With experience, a firm that prices on a cost basis operates in a realm of reasonably measurable factors.

G. Middlemen and Transportation Costs

Channel length and marketing patterns vary widely, but in most countries channels are longer and middleman margins higher than in customary in the United States. The diversity of channels used to reach markets and the lack of standardized middleman markups leave many producers unaware of the ultimate price of a product. Recent merger discussions between Coors and Molson dramatized the fact that transportation costs for the Rocky Mountain producer were huge! The majority of product Coors produces comes from a brewery nestled in the Rocky Mountains and it sent to every market in the U.S., Canada, and Puerto Rico. It is rumoured that after the merger, certain Coors products will be brewed in Canada and other locations throughout the world in order to rationalize brewing operations and transportations costs.

Besides channel diversity, the fully integrated marketer operating abroad faces various unanticipated costs because marketing and distribution channel infrastructures are underdeveloped in many countries. The marketer can also incur added expenses for warehousing and handling of small shipments and may need to bear increased financing costs when dealing with under-financed middleman.

Because no convenient source of data on middleman costs is available, the international marketer must rely on experience and marketing research to ascertain middleman costs. The Campbell Soup Company found its middleman and physical distribution costs in the United Kingdom to be 30 percent higher than in the United States. Extra costs were incurred because soup was purchased in small quantities small English grocers typically purchase 24-cans cases of assorted soups (each case being hand-packed for shipment). In the United States, typical purchase units are 48-can cases of one soup purchased by the dozens, hundreds, or carloads. The purchase habits in Europe forced the company into an extra wholesale level in its channel to facilitate handling small orders.

Exporting also incurs increased transportation costs when moving goods from one country to another. If the goods go over water, there are additional costs for insurance, packing, and handling not generally added to locally produced goods. Such costs add yet another burden because import tariffs in many countries are based on the landed cost, which includes transportation, insurance, and shipping charges. These costs add to the inflation of the final price. The next section details how a reasonable price in the home market may more than double in the foreign market.

SAMPLE EFFECTS OF PRICE ESCALATION

Exhibit 3 illustrates some of the effects the factors discussed previously may have on the end price of a consumer item. Because costs and tariffs vary so widely from country to country, a hypothetical but realistic example is used. It assumes that a constant net price is received by the manufacturer, that all domestic transportation costs are absorbed by the various middlemen and reflected in their margins, and that the foreign middleman have the same margins as the domestic middlemen. In some instances, foreign middlemen margins are lower, but it is equally probable that these margins could be greater. In fact, in many instances, middlemen use higher wholesale and retail margins for foreign goods than for similar domestic goods.

Exhibit 3 Sample Causes and Effects of price Escalation

Unless some of the costs that create price escalation can be reduced, the marketer is faced with a price that may confine sales to a limited segment of wealthy, price-insensitive customers. In many markets, buyers have less purchasing power than in Canada and can be easily priced out of the market. Further, when price escalation is set in motion, it can spiral upward quickly. When the price to middlemen is high and turnover is low, they may insist on higher margins to defray their costs, which, of course, raises the price even higher. Unless price escalation can be reduced marketers find that the only buyers left are the wealthier ones. If marketers are to compete successfully in the growth of markets around the world, cost containment must be among their highest priorities. If costs can be reduced anywhere along the chain from manufacturers cost retailer markups, price escalation will be reduced. A discussion of some of the approaches to lessening price escalation follows.

5. APPROACHES OF LESSENING PRICE ESCALATION

Three methods used to reduce costs and lower price escalation are lowering cost of goods, lowering tariffs, and lowering distribution costs.

A. Lowering Costs of Goods

If the manufacturers price can be lowered, the effect is felt throughout the chain. One of the important reasons for manufacturing in a third country is to attempt to reduce manufacturing costs and thus price escalation. The impact can be profound if you consider that the hourly cost of skilled labour in a Mexican maquiladora is less than $3.50 an hour including benefits, compared with more than $12 in Canada.

China is emerging as a global manufacturing powerhouse backed by an inexpensive labour force, rapidly improving production quality, new sources of capital, a more dynamic private sector, and a deliberately undervalued currency. China supplies a growing range of products to the global marketplace. In Japan, the land of zero-defect quality control, is increasingly happy with the competence of Chinese workers. Star Manufacturing, a Japanese precision machine tool manufacturing company, moved 30 percent of its production to China because Chinas cheap labour and cheap resources reduce production cost by 20 percent.

Eliminating costly functional features or even lowering overall product quality is another method of minimizing price escalation. For certain manufactured products, the quality and additional features required for the more developed home market may not be necessary in countries without the same level of development or consumer demand. In the price war between P&G and Kimberly-Clark in Brazil, the quality of the product was lowered in order to lower the price. Remember that the grandmother in the grocery store chose the poorest-quality and the lowest-priced brand of diaper. Similarly, functional features on washing machines made for Canada, such as automatic bleach and soup dispensers, thermostats to provide four different levels of water temperature, controls to vary water volume, and bells to ring at appropriate times, may be unnecessary for many foreign markets. Eliminating them means lower manufacturing costs and thus a corresponding reduction in price escalation. Lowering manufacturing costs and thus can often have a double benefit: The lower price to the buyer may also mean lower tariffs, since most tariffs are levied on an ad valorem basis.

B. Lowering Tariffs

When tariffs account for a large part of price escalation, as they often do, companies seek ways to lower the rate. Some products can be reclassified into a different, and lower, customs classification. A good customs broker will determine the lowest possible import duty for the products you are importing. In many cases, a product can be imported under a few different tariffs classifications. The customs broker will provide you with a power of attorney form for you to fill out and sign, authorizing that company to act as your representative.

How a product is classified is often a judgment call. The difference between an item being classified as jewelry or art means paying no tariff for art or a 26 percent tariff for jewelry. For example, a U.S. customs inspector could not decide whether to classify a $2.7 million Faberg egg as art or jewelry. The difference was zero tariff versus $700,000. An experienced freight forwarder /customs broker saved the day by persuading the customs agent that the Faberg egg was a piece of art. Because the classification of products varies among countries, a thorough investigation of tariff schedules and classification criteria can result in a lower tariff. Several recent cases dramatize the importance of product descriptions for controlling import costs. In a recent case involving Pfizer Canada Inc. and the Canada Revenue Agency (CRA), the issue arose as to whether Halls Centres cough drops should be classified as sugar confectionary (as determined by the CRA) or as a medicaments (as Pfizer claimed). Although initially arguing that the correct description for the product was sugar confectionary, the CRA nonetheless agreed with Pfizer that medicaments was the correct description, thus saving the company an almost 10 percent tariff duty. In another case, FHP/Atlantic of Toronto argued that its goods were cleaning devices, which the CRA agreed with. The difficulty, however, was whether to apply the tariff at the 4, 6 or 8-digit tariff level-tariff rates varied depending on the degree of precision associated with the products description. Finally, Suzuki Canada Inc. and Canadian Kawasaki Motors Inc. argued that ATVs should be classified as motorcycles and cycles fitted with an auxiliary motor rather than as other motor vehicles principally designed for the transport of persons as defined by CRA. The difference was not insignificant motor vehicles are subject to a 6.1 percent duty whereas motorcycles are duty free. After much haggling, the CRA acquiesced and agreed that ATVs could enter Canada classified as motorcycles.

Besides having a product reclassified into a lower tariff category, it may be possible to modify a product quality for a lower tariff rate without a tariff classification. In the footwear industry, the difference between foxing and foxlike on athletic shoes makes a substantial difference in the tariff levied. To protect the domestic footwear industry from an onslaught of cheap sneakers from the Far East, the tariff schedules state that any canvas or vinyl shoe with a foxing band (a tape band attached at the sole and overlapping the shoes upper by more than inch) be assessed at a higher duty rate. As a result, manufacturers design shoes so that the sole does not overlap the upper more than inch. If the overlap exceeds inch, the shoe is classified as having a foxing band; less than inch, a foxlike band. A shoe with a foxing band is taxed 48 percent and one with a foxlike band (1/4 inch or less overlap) is taxed a mere 6 percent.

There are often differential rates between fully assembled, ready-to use products and those requiring some assembly, further processing, the addition of locally manufactured component parts, or other processing that adds value to the product and can be performed within the foreign country. For example, a ready-to-operate piece of machinery with a 20 percent tariff may be subject to only a 12 percent tariff when imported unassembled. An even lower tariff may apply when the product is assembled in the country and some local content is added.

Repackaging also may help to lower tariffs. Tequila entering Canada in containers of 4.5 litres or less carries a duty of $2.77 per proof 4.5 litres; larger containers are assessed at only $1.60. If the cost of rebottling is less than $1.30 per proof 4.5 litres, and it probably would be, considerable savings could result. As will be discussed shortly, one of the more important activities in foreign trade zones is the assembly of imported goods, using local and frequently lower-cost labour.

C. Lowering Distribution Costs

Shorter channels can help keep prices under control. Designing a channel that has fewer middlemen may lower distribution costs by reducing or eliminating markup. Besides eliminating markups, fewer middlemen may mean lower overall taxes. Some countries levy a value-added tax on goods as they pass through channels. Goods are taxed each time they change hands. The tax may be cumulative or noncumulative. A cumulative value-added tax is based on total selling price and is assessed every time the goods change hands. Obviously, in countries where value-added tax is cumulative, tax alone provides a special incentive for developing short distribution channels. Where that is achieved, tax is paid only on the difference between the middlemens cost and the selling price. While many manufacturers had to cut prices in the wake of Japans deflation, Louis Vuitton, a maker of branded boutique goods, was able to increase prices instead. A solid brand name and direct distribution permitted Vuittons price strategy. Vuittons leather monogrammed bags are now Japanese buyers daily necessity and Vuitton distributes directly and fixes its own prices.

D. Using Foreign Trade Zones to Lessen price Escalation

Some countries have established foreign or free trade zones (FTZs) or free ports to facilitate international trade. There are more than 400 of these facilities in operation throughout the world where imported goods can be stored or processed. As free trade policies in Africa, Latin America, Eastern Europe, and other developing regions expand, there has been an equally rapid expansion in the creation and use of foreign trade zones. Recall that in a free port or FTZ, payment of import duties is postponed until the product leaves the FTZ area and enters the country. An FTZ is, in essence, a tax-free enclave and not considered part of the country as far as import regulations are concerned. When an item leaves an FTZ and is imported officially into the host country of the FTZ, all duties and regulations are imposed.

Utilizing FTZs can to some extent control price escalation resulting from the layers of taxes, duties, surcharges, freight charges, and so forth. Foreign trade zones permit many of these added charges to be avoided, reduced, or deferred so that the final price is more competitive. One of the more important benefits of the FTZ in controlling prices is the exemption from duties on labour and overhead costs incurred in the FTZ in assessing the value of goods.

By shipping unassembled goods to an FTZ in an importing country, a marketer can lower costs in a variety of ways:

Tariffs may be lower because duties are typically assessed at a lower rate for unassembled versus assembled goods.

If labour costs are lower in the importing country, substantial savings may be realized in the final product cost.

Ocean transportation rates are affected by weight and volume, thus, unassembled goods may qualify for lower freight rates.

If local content, such as packaging or components parts, can be used in the final assembly, there may be a further reduction on tariffs.

All in all, a foreign or free trade zone is an important method for controlling price escalation. Incidentally, all the advantages offered by an FTZ for an exporter are also advantages for an importer. Importers use FTZs to help lower their costs of imported goods. See Exhibit 4 for illustrations of how FTZs are used.

E. Dumping

A logical outgrowth of a market policy in international business is goods priced competitively at widely differing prices in various markets. Marginal (variable) cost pricing, as discussed earlier, is a way prices can be reduced to stay within a competitive price range. The market and economic logic of such pricing policies can hardly be disputed, but the practices often are classified as dumping and are subject to severe penalties and fines. Various economists define dumping differently. One approach classifies international shipments as dumped if the products are sold below their cost of production. The other approach characterizes dumping as selling goods in a foreign market below the price of the same goods in the home market.

World Trade Organization (WTO) rules allow for the imposition of a dumping duty when goods are sold at a price lower than the normal export price or less than the cost in the country of origin, increased by a reasonable amount for their cost of sales and profits when this is likely to be prejudicial to the economic activity of the importing country. A countervailing duty or minimum access volume (MAV) which restricts the amount a country will import, may be imposed on foreign goods benefiting from subsidies whether in production, export, or transportation.

Exhibit 4 How Are Foreign Trade Zones Used?

Foreign Trade Zones (FTZs) exist in many countries.

Companies use them to postpone the payment of tariffs on products while they are in the FTZ. Here are some examples of how FTZs are used.

A Japanese firm assembles motorcycles, jet skis, and three-wheel all-terrain vehicles for import as well as for export to Canada, Latin America, and Europe.

A U.S. manufacturer of window shades and miniblinds imports and stores fabric from Holland in an FTZ, thereby postponing a 17 percent tariff until the fabric leaves the FTZ.

A manufacturer of hair dryers stores its product in an FTZ, which it uses as its main distribution center for products manufactures in Asia.

A European-based medical supply company manufacturers kidney dialysis machines and sterile tubing using raw materials from Germany and U.S. labour. It then exports 30 percent of its products to Scandinavian countries.

A Canadian company assembles electronic teaching machines using cabinets from Italy; electronics from Taiwan, Korea, and Japan; and labour from the United States, for export to Colombia and Peru.

In all these examples, tariffs are postponed until the products leave the FTZ and enter foreign countries. Further, in most situations the tariff is at lower rate for component parts and raw materials versus the higher rate that would be charged if products were imported directly as finished goods.

For countervailing duties to be invoked, it must be shown that prices are lower in the importing country than in the exporting country and that producers in the importing country are being directly harmed by the dumping. A report by the U.S. Department of Agriculture indicated that levels of dumping by the United States hover around 40 percent for wheat, between 25 percent and 30 percent for corn and levels for soybeans have risen steadily over the past four years, to nearly 30 percent. These percentages, for example, mean that wheat is selling up to 40 percent below their cost of production. For cotton, the level of dumping for 2001 rose to a remarkable 57 percent, and for rice it has stabilized at around 20 percent. The study indicated that these commodities are being dumped onto international markets by the United States in violation of World Trade Organization (WTO) rules. The report found that after many years of accepting agricultural dumping, a few countries have begun to respond with investigation into whether some U.S. agricultural exports are dumped. Brazil is considering a case against U.S. cotton before the WTO. In 2001, Canada briefly imposed both countervailing and dumping duties on U.S. corn imports.

Dumping is rarely an issue when world markets are strong. In the 1980s and 1990s dumping became a major issue for a large number of industries when excess production capacity relative to home-country demand caused many companies to price their goods on a marginal-cost basis. In a classic case of dumping, prices are maintained in the home-country market and reduced in foreign markets.

Today, tighter government enforcement of dumping legislation is causing international marketers to seek new routes around such legislation. Assembly in the importing country is a way companies attempt to lower prices and avoid dumping charges. However, these screw-driver plants, as they are often called, are subject to dumping charges if the price differentials reflect more than the cost savings that result from assembly in the importing country.

Another subterfuge is to alter the product so that the technical description fits a lower duty category. To circumvent a 16.9 percent countervailing duty imposed on Chinese gas-filled, nonrefillable pocket flint lighters, the manufacturer attached a useless valve to the lighters so than they fell under the nondisposable category, thus avoiding the duty. Countries do see through many such subterfuges and impose taxes. For example, the EC imposed a $27 to $58 dumping duty per unit on a Japanese firm that assembled and sold electronic typewriters in the EC. The firm was charged with valuing imported parts for assembly below cost.

6. LEASING IN INTERNATIONAL MARKETS

An important selling technique to alleviate high prices and capital shortages for capital equipment is the leasing system. The concept of equipment leasing is increasingly important as a means of selling capital equipment in overseas markets. In fact, it is estimated that $50 billion worth (original cost) of equipment is on lease in Western Europe.

The system of leasing used by industrial exporters is similar to the typical lease contracts used in Canada. Terms of the leases usually run one to five years, with payments made monthly or annually; included in the rental fee are servicing, repairs, and spare parts. Just as contract for domestic and overseas arrangements are similar, so are the basic motivations and the shortcomings. For example:

Leasing opens the door to a large segment of nominally financed firms that can be sold on a lease option but might be unable to buy for cash.

Leasing can ease the problems of selling new, experimental equipment, because less risk is involved for the users.

Leasing helps guarantee better maintenance and service on overseas equipment.

Equipment leased and in use helps to sell other companies in that country.

Lease revenue tends to be more stable over a period of time than direct sales would be.

The disadvantages of shortcomings take on international flavour. Besides the inherent disadvantages of leasing, some problems are compound by international relationships. In a country beset with inflation, lease contracts that include maintenance and supply parts (as most do) can lead to heavy losses toward the end of the contract period. Further, countries where leasing is most attractive are those where spiraling inflation is most likely to occur. The added problems of currency devaluation, expropriation, or other political risks are operative longer than if the sale of the same equipment is made outright. In light of these perils, there is greater risk in leasing than in outright sale; however, there is definite trend toward increased use of this method of selling internationally.

COUNTERTRADE AS A PRICING TOOL

Countertrade is a pricing tool that every international marketer must be ready to use, and the willingness to accept a countertrade often gives the company a competitive advantage. The challenges of countertrade must be viewed from the same perspective as all other variations in international trade. Marketers must be aware of which markets require countertrades just as they must be aware of social customs and legal requirements. Assessing this factor along with all other market factors enhances a marketers competitive position.

One of the earliest barter arrangements occurred between Russia and PepsiCo before the ruble was convertible and before most companies were trading with Russia. PepsiCo wanted to beat Coca-Cola into the Russian market. The only way possible was for them to accept vodka (sold under the brand Stolichnaya) from Russia and bottled wines (sold under the name of Premiat) from Romania to finance Pepsi-Cola bottling plants in those countries. From all indications, this was a very profitable arrangement for Russia, Romania, and Pepsi-Cola. PepsiCo continues to use countertrade to expand its bottling plants. In a recent agreement between PepsiCo and Ukraine, Pepsi agreed to market $1 billion worth of Ukrainian-made commercial ships over an eight-year period. Some of the proceeds from the ship sales will be reinvested in the shipbuilding venture, and some will be used to buy soft-drink equipment and build five Pepsi bottling plants in Ukraine. PepsiCo dominates the cola market in Russia and all the former republics of the USSR, in part because of its exclusive countertrade agreement with Russia that locked Coca-Cola out of the Russia cola market for more than 12 years. After the USSR was dismembered, the Russian economy crashed and most of the Russian payment system broke down into barter operations. Truck loads of aspirin were swapped by one company which was then traded for poultry, which in turn was bartered for lumber, in turn to be exchanged for X-ray equipment from Kazakhstan all to settle debts. Many of these transactions involved regional electricity companies that were owned money by virtually everyone.

Although cash may be the preferred method of payment, countertrades are an important part of trade with Eastern Europe, the Newly Independent States, China, and, to a varying degree, some Latin American and African nations. Barter or countertrades constitute between 20 and 40 percent of all transactions in the economies of the former Soviet bloc. Corporate debts to suppliers, payment and services, even taxes all have a noncash component or are entirely bartered. Many of these countries constantly face a shortage of hard currencies with which to trade and thus resort to countertrades when possible. A recent purchase of 48 F-16 Falcons from Lockheed Martin was pegged at $3.5 billion. The financial package included soft loans and a massive offset program purchases from Polish manufacturers that more than erased the costs of the deal in foreign exchange. With an economy short of hard currency, Russia is offering a wide range of products in barter for commodities they need. For example, their expertise in space technology is offered for Malaysian palm oil and rubber, and military equipment, in exchange for crude palm oil from Indonesia. Exhibit 5 illustrates the many reasons countries demand countertrades. Today an international company must include in its market-pricing tool kit some understanding of countertrading.

A. Types of countertrade

Countertrade includes four distinct transactions: barter, compensation deals, counter-purchase, and buy-back. Barter is the direct exchange of goods between two parties in a transaction. For example, the Malaysian government bought 20 diesel-electric locomotives from General Electric. Officials of the government said that GE will be paid with palm oil to be supplied by a plantation company. The company will supply about 200,000 metric tons of palm oil over a period of 30 months. This was GEs first barter deal for palm oil and palm products, although its division GE Trading has several other countertrade agreements worldwide. No money changed hands, nor were any third parties involved. Obviously, in a barter transaction, the seller must be able to dispose of the goods at a net price equal to the expected selling price in a regular, for-cash transaction. Further, during the negotiation stage of a barter deal, the seller must know the market and the price for the items offered in trade. In the General Electrical example, palm oil has an established price and a global market for palm oil and palm products. But not all bartered goods have an organized market and products can range from hams to iron pellets, mineral water, furniture, or olive all somewhat more difficult to price and to find customers.

Barter may also be used to reduce a countrys foreign debt. To save exchange reserves, the Philippine government offered some creditors canned tuna to repay part of a state-owned $4-billion. If tuna was not enough, coconut oil and a seaweed extract, carrageen, used as an additive in foods, toothpaste, cosmetics, and ice cream were offered. The seaweed and tuna exporters will be paid with pesos so no currency leaves the country.

Exhibit 5 Why Purchasers Impose Countertrade?

To preserve hard currency. Countries with nonconvertible currencies look to countertrade as a way of guaranteeing that hard currency expenditures (for foreign imports) are offset by hard currency (generated by the foreign party's obligations to purchase domestic goods).

To improve balance of trade. Nations whose exports have not kept pace with imports increasingly rely on countertrade as a means to balance bilateral trade ledgers.

To gain access to new markets. As a nonmarket or developing country increases its production of exportable goods, it often lacks a sophisticated marketing channel to sell the goods to the West for hard currency. By imposing countertrade demands, foreign trade organizations utilize the marketing organizations and expertise of Western companies to market their goods for them.

To upgrade manufacturing capabilities. By entering compensation arrangements under which foreign 8usuallz Western) firms provide plant and equipment and buy back resultant products, the trade organizations of less-developed countries can enlist Western technical cooperation in upgrading industrial facilities.

To maintain prices to export goods. Countertrade can be used as a means to dispose of goods at prices that market would not bear under cash-for-goods terms. Although the Western seller absorbs the added cost by inflating the price of the original sale, the nominal price of counterpurchased goods is maintained, and the seller need not concede what the value of the goods would be in the world supply-and-demand market. Conversely, if the world price for a commodity is artificially high, such as the price of crude oil, a country can barter its oil for Western goods (e.g., weapons) so that the real price the Western partner pays is below the world price.

To force reinvestment of proceeds from weapons deals. Many Arab countries require that a portion of proceeds from weapons purchases be reinvested in facilities designated by the buyer everything from pipelines to hotels and sugar mills.

Compensation deals involve payment in goods and in cash. A seller delivers lathes to a buyer in Venezuela and receives 70 percent of the payment in convertible currency and 30 percent in tanned hides and wool. In an actual deal, General Motors Corporation sold $12 million worth of locomotives and diesel engines to Yugoslavia and took cash and $4million in Yugoslavia cutting tools as payment. McDonnell Douglas agreed to a compensation deal with Thailand for eight top-of-the-range F/A-18 strike aircraft. Thailand agreed to pay $578 million of the total cost in cash, and McDonnell Douglas agreed to accept $93 million in a mixed bag of goods including Thai rubber, ceramics, furniture, frozen chicken, and canned fruit. In a move to reduce its current account deficit, the Thai government requires that 20 to 50 percent of the value of large contracts be paid for in raw and processed agricultural goods.

An advantage of a compensation deal over barter is the immediate cash settlement of a portion of the bill; the remainder of the cash is generated after successful sale of the goods received. If the company has a use for the goods received, the process is relatively simple and uncomplicated. On the other hand, if the seller has to rely on a third to find a buyer, the cost involved must be anticipated in the original compensation negotiation if the net proceeds to the seller are the equal the market price.

Counterpurchase, or offset trade, is probably the most frequently used type pf countertrade. For this trade, the seller agrees to sell a product at a set price to a buyer and receives payment in cash. However, two contracts are negotiated. The first contract is contingent on a second contract that is an agreement by the original seller to buy goods from the buyer for the total monetary amount involved in the first contract or for a set percentage of that amount. This arrangement provides the seller with more flexibility than the compensation deal because there is generally a time period 6 to 12 months or longer for completion of the second contract. During the time that markets are sought for the goods in the second contract, the seller has received full payment for the original sale. Further, the goods to be purchased in the second contract are generally of greater variety than those offered in a compensation deal. Even greater flexibility is offered when the second is nonspecific; that is the books on sales and purchases need to be clearly only at certain intervals. The seller is obliged to generate enough purchases to keep the books balanced or clear between purchases and sales.

Offset trades are becoming more prevalent among economically weak countries. Several variations of counterpurchase or offset have developed to make it more economical for the selling company. For example, the Lockheed Martin Corporation entered into an offset trade with the United Arab Emirates (UAE) in a $6.4 billion deal for 80 F-16 fighter plans called Desert Falcons. Lockheed agreed to make a $160 million cash investment in a gas pipeline running from Qatar to UAE industrial projects and then on to Pakistan. The UAE requires that some of the proceeds from weapon sales be reinvested in the UAE. Such offsets are a common feature of arms deals, in which sellers build facilities ranging from hotels to sugar mills at the request of the buyer.

McDonnell Douglas actively engages in all types of countertrades. A $100 million sale of DC-9s to Yugoslavia required McDonnell Douglas to sell or buy $25 million in Yugoslavia goods. Some of its commitment to Yugoslavia was settled by buying Yugoslavia equipment for its own use, but it also sold items such as hams, iron castings, rubber bumper guards, and transmission towers to others. McDonnell Douglas held showing for department store buyers to sell glassware and leather goods to fulfill its counterpurchase agreement. Twice a year, company officials meet to claim credits for sales and clear the books in fulfillment of the companys counterpurchase agreements.

Product buy-back agreement is the fourth type of countertrade transaction. This type of agreement is made when the sale involves goods or services that produce other goods and services, that is, production plant, production equipment, or technology. The buy-back agreement usually involves one of two situations. The seller agrees to accept as partial payment a certain portion of the output, or the seller receives full price initially but agrees to buy back a certain portion of the output. One North American farm equipment manufacturer sold a tractor plant to Poland and was paid part in hard currency and the balance in Polish-built tractors. In another situation, General Motors built an auto manufacturing plant in Brazil and was paid under normal terms but agreed to the purchase of resulting output when the new facilities came online. Levi Strauss took Hungarian blue jeans, which it sells abroad, in exchange for setting up a jeans factory near Budapest.

An interesting buy-back arrangement was agreed on between the Rice Growers Association of California (RGAC) and the Philippine government. The RGAC will invest in Philippine farmlands and bring new technologies to enhance local rice production. In return, the RGAC will import rice and other food products in payment. A major drawback to product buy-back agreements comes when the seller finds that the products bought back are in competition with its own similarly produced goods. On the other hand, some find that a product buy-back agreement provides them with a supplemental source in areas of the world where there is demand but where they have no available supply.

B. Problems of Countertrading

The crucial problem confronting a seller in a countertrade negotiation is determining the value of the potential demand for the goods offered. Frequently there is inadequate time to conduct a market analysis; in fact, it is not unusual to have sales negotiations almost completed before countertrade is introduced as a requirement in transaction.

Although such problems are difficult to deal with, they can be minimized with proper preparation. In most cases where losses occurred in countertrades, the seller was unprepared to negotiate in anything other than cash. Some preliminary research should be done in anticipation of being confronted with a countertrade proposal. Countries with a history of countertrading are identified easily, and the products most likely to be offered in a countertrade often can be ascertained. For a company trading with developing countries, these facts and some background on handling countertrades should be a part of every pricing tool kit. Once goods are acquired, they can be passed along to institutions that assist companies in selling bartered goods.

Barter houses specialize in trading goods acquired through barter arrangements and are the primary outside source of aid for companies beset by the uncertainty of a countertrade. Although barter houses, most of which are found in Europe, can find a market for bartered goods, it requires time, which puts a financial strain on a company because capital is tied up longer than in normal transactions.

In Canada, there are companies that assist with bartered goods and their financing. Snap Promotions, a Toronto promotional products distributor, administers almost ten percent of its business through barter networks. In 2003, the Barter Network, also based in Toronto, with over 1,400 members, facilitated trades worth $53 million. Members pay The Barter Network a $295 membership fee, plus a 5 percent commission on each transaction they complete (as buyer or seller). The network administrator aggregates the goods and services of companies that would like to do more business in kind and, in exchange for those items, issues credits that a member company can use to buy other items in the pool. In theory, barter networks can help companies of all sizes shed excess inventory. Although many barter network are robust, reputable marketplaces with brand-name members, more than a few less savoury organizations exist. In the U.S., Citibank has created a countertrade department to allow the bank to act as a consultant as well as to provide financing for countertrades. It is estimated that there are now about 500 barter exchange houses in the United States, many of which are accessible on the Internet. Some companies with a high volume of barter have their own in-house trading groups to manage countertrades. The 3M Company (Minnesota Mining and Manufacturing), for example, has a wholly owned division, 3M Global Trading (www.3m.com/globaltrading), which offers its services to smaller companies.

C. The Internet and the Countertrade

The Internet may become the most important venue for countertrade activities. Finding markets for bartered merchandise and determining market price are two of the major problems with countertrades. Several barter houses have Internet auction sites, and a number of Internet exchanges are expanding to include global barter.

Some speculate that the Internet may become the vehicle for an immense online electronic barter economy, to complement and expand the offline barter exchanges that take place now. In short, some type of electronic trade dollar would replace national currencies in international trade transactions. This would make international business considerably easier for many countries because it would lessen the need to acquire sufficient U.S. currency or other hard currency to complete a sale or purchase.

TradeBanc, a market-making service, introduced a computerized technology that enables members of trade exchanges to trade directly, online, with members of other trade exchanges anywhere in the world, as long as their barter company is a TradeBanc affiliate (www.tradebanc.com/home.taf). The medium of exchange could be the Universal Currency proposed by the international Reciprocal Trade Association (IRTA), (www.irta.com) an association of trade exchange with members including Russia, Iceland, Germany, Chile, Turkey, Australia, and the United States. The IRTA proposed to establish and operate a Universal Currency Clearinghouse, which would enable trade exchange members to easily trade with one another by using this special currency. When the system is in full swing all goods and services from all participating affiliates would be housed in a single database. The transactions would be cleared by the local exchanges, and settlement would be made using IRTAs Universal Currency, which could be used to purchase anything from airline tickets to potatoes.

D. Proactive Countertrade Strategy

Currently most companies have a reactive strategy; that is, they use countertrade when they believe it is the only way to make a sale. Even when these companies include countertrade as a permanent feature of their operations, they use it to react to a sales demand rather than using countertrade as an aggressive marketing tool for expansion. Some authorities suggest, however, that companies should have a defined countertrade strategy as part of their marketing strategy rather than be caught unprepared when confronted with a countertrade proposition.

A proactive countertrade strategy is the most effective strategy for global companies that market to exchange-poor countries. Economic development plans in eastern European countries, the Commonwealth of Independent States (CIS), and much of Latin America will put unusual stress on their ability to generate sufficient capital to finance their growth. Further, as countries encounter financial crisis such as in Latin America in 1996 and Asia in 1998, countertrade becomes especially important as a means of exchange. To be competitive, companies must be willing to include some countertraded goods in their market planning. Companies with a proactive strategy make a commitment to use countertrade aggressively as a marketing and pricing tool. They see countertrades as an opportunity to expand markets rather as an inconvenient reaction to market demands.

Successful countertrade transactions require that the marketer accurately establish the market value of the goods being offered and dispose of the bartered goods once they are received. Most unsuccessful countertrades result from not properly resolving one or both of these factors.

In short, unsuccessful countertrades are generally the result of inadequate planning and preparation. One experienced countertrade suggests answering the following questions before entering into a countertrade agreement: (1) Is there a ready market for the goods bartered? (2) Is the quality of the goods offered consistent and acceptable? (3) Is an expert needed to handle the negotiations? (4) Is the contract price sufficient to cover the cost of barter and net the desired revenue?

Capital-poor countries striving to industrialize account for much of the future demand for goods. Indonesia, for instance, requires, any foreign purchase exceeding $500 million to have a portion in a countertrade. Companies not prepared to seek this business with a proactive countertrade strategy will miss important market opportunities. A recent study explored the attitudes of Canadian executives toward countertrade with Asia-Pacific countries. Countertrade is important because many emerging markets in the region face pressures to keep country risk ratios satisfactory, and seek non-debt-creating trade and financing options like countertrade. Canadian executives, however, display a lack on interest in countertrade as a competitive strategy in the region, with the authors citing difficulties valuing commodities and the added problem of liquidating them once valued.

8. TRANSFER PRICING STRATEGY

As companies increase the number of worldwide subsidiaries, joint ventures, company-owned distributing systems, and other marketing arrangements, the price charged to different affiliates becomes a preeminent question. Prices of goods transferred from a companys operations or sales units in one country to its units elsewhere, known as intracompany pricing or transfer pricing, may be adjusted to enhance the ultimate profit of the company as a whole. The benefits are as follows:

Lowering duty costs by shipping goods into high-tariff countries at minimal transfer prices so that duty base and duty are low.

Reducing income taxes in high-tax countries by overpricing goods transferred to units in such countries; profits are eliminated and shifted to low-tax countries. Such profit shifting may also be used for dressing up financial statement by increasing reported profits in countries where borrowing and other financing are undertaken.

Facilitating divided repatriation when divided repatriation is curtailed by government policy. Invisible income may be taken out in the form of high prices for products or components shipped to units in that country.

Government authorities have not overlooked the tax and financial manipulation possibilities of transfer pricing. Transfer pricing can be used to hide subsidiary and to escape foreign-market taxes. Intracompany pricing is managed in such a way that profit is taken in the company with the lowest tax rate. For example, a foreign manufacturer makes a VCR for $50 and sells it to its subsidiary for $150. The subsidiary sells it to a retailer for $200, but spends $50 on advertising and shipping so that it shows no profit and pays no taxes. Meanwhile, the parent company makes a $100 gross margin on each unit and pays at a lower tax rate in the home country. If the tax rate were lower in the country where the subsidiary resides, the profit would be taken in the foreign country and no profit taken in the home country.

When customs and tax regimes are high, there is a strong incentive to trim fiscal liabilities by adjusting the transaction value of goods and services between subsidiaries. Pricing low cuts exposure to import duties; declaring a higher value raises deductible costs and thereby lightens the corporate tax burden. The key is to strike the right balance that maximizes savings overall.

The overall objectives of the intracompany pricing system include maximizing profits for the corporation as a whole; facilitating parent-company control; and offering management at all levels, both in the product divisions and in the international divisions, an adequate basis for maintaining, developing, and receiving credit for their own profitability. Transfer prices that are too low are unsatisfactory to the product divisions because their overall results look poor; prices that are too high make the international operations look bad and limit the effectiveness of foreign managers.

An intracompany pricing system should use sound accounting techniques and be defensible to the tax authorities of the countries involved. All of these factors argue against a single uniform price or even a uniform pricing system for all international operations. Four arguments for pricing goods for intracompany transfer are as follows:

Sales at the local manufacturing cost plus a standard markup.

Sales at the cost of the most efficient producer in the company plus a standard markup.

Sales at negotiated prices.

Arms-length sales using the same prices as quoted to independent customers.

Of the four, the arms-length transfer is most acceptable to tax authorities and most likely to be acceptable to foreign divisions, but the appropriate basis for intracompany transfers depends on the nature of the subsidiaries and market conditions.

Although the practices described in this section are not necessarily improper, they are being scrutinized more closely by both home and host countries concerned about the loss of potential tax revenues from foreign firms doing business in their countries as well as domestic firms underreporting foreign earnings. Canadas approach to transfer pricing issues is consistent with that of the Organization for Economic Cooperation and Development (OECD), particularly its 1995 Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (OECD Guidelines). International tax auditors from the Canada Revenue Agency (CRA) are increasing scrutiny on intercompany financing transactions. Because of the increased surveillance, there is an urgent need for Canadian MNCs in properly select and apply the most appropriate transfer methods to determine arms-length pricing. The CRA does not have a separate transfer pricing group. Instead, international tax field officers conduct transfer pricing auditors.

Underreporting profits is a serious offence in Canada, and heavy fines are imposed for those who break the rules. The only certain way to avoid substantial penalties is to enter into an Advanced Pricing Agreement (APA) with the CRA. An APA is an agreement between the CRA and a taxpayer on transfer pricing methods that will be applied to some or all of a taxpayers transactions with affiliates. Such agreements generally apply for up to five years and offer better protection against penalties than other methods. Otherwise, once the CRA charges underreporting, the burden of proof that a transfer price was fair rests with the company.

9. PRICE QUOTATIONS

In quoting the price of goods for international sale, a contract may include specific elements affecting the price, such as credit, sales terms, and transportation. Parties to the transaction must be certain that the quotation settled on appropriately locates responsibilities fro the goods during transportation and spells out who pays transportation charges and from what point. Price quotations must also specify the currency to be used, credit terms, and the type of documentation required. Finally, the price quotation and contract should define quantity and quality. A quantity definition might be necessary because different countries use different units of measurement. In specifying a ton, for example, the contract should identify it as metric or an English ton, and as a long or short ton. Quality specifications can also be misunderstood if not completely spelled out. Furthermore, there should be complete agreement on quality standards to be used in evaluating the product. For example, customary merchantable quality, may be clearly understood among Canadian customers but have a completely different interpretation in another country. The international trader must review all terms of the contract; failure to do so may have the effect of modifying prices even though such a change was not intended.

ADMINISTERED PRICING

Administrated pricing is an attempt to establish prices for an entire market. Such prices may be arranged through the cooperation of competitors, through national, state, or local government, or by international agreement. The legality of administered pricing arrangements of various kinds differs from country to country and from time to time. A country may condone price fixing for foreign markets but condemn it for the domestic market, for instance.

In general, the end goal of all administered pricing activities is to reduce the impact of price competition or eliminate it. Pricing fixing by business is not viewed as an acceptable practice (at least in the domestic market), but when governments enter the field of price administration, they presume to do it for the general welfare to lessen the effects of destructive competition.

The point at which competition becomes destructive depends largely on the country in question. To the Japanese, excessive competition is any competition in the home market that disturbs the existing balance of trade or gives rise to market disruptions. Few countries apply more rigorous standards in judging competition as excessive than Japan, but no country favours or permits totally free competition. Economists, the traditional champions of pure competition, acknowledge that perfect competition is unlikely and agree that some form of workable competition must be developed.

The pervasiveness of price-fixing attempts in business is reflected by the diversity of the language of administered prices; pricing arrangements are known as agreements, arrangement, combines, conspiracies, cartels, communities of profit, profit pools, licensing, trade association, price leadership, customary pricing, or informal interfirm agreements. The arrangements themselves vary from the completely informal, with no spoken or acknowledged agreement, to highly formalized and structured arrangements. Any type of price-fixing arrangement can be adapted to international business, but of all the forms mentioned, cartels are the most directly associated with international marketing.

A. Cartels

A cartel exists when various companies producing similar products or services work together to control markets for the types of goods and services they produce. The cartel association may use formal agreements to set prices, establish levels of production and sales for the participating companies, allocate market territories, and even redistribute profits. In some instances, the cartel organization itself takes over the entire selling function, sells the goods of all the producers, and distributes the profits.

The economic role of cartels is highly debatable, but their proponents argue that they eliminate cutthroat competition and rationalize business, permitting greater technical progress and lower prices to consumers. However, in the view of most experts, it is doubtful that the consumer benefits very often from cartels.

The Organization of Petroleum Exporting Countries (OPEC) is probably the best-known international cartel. Its power in controlling the price of oil resulted from the percentage of oil production is controlled. In the early 1970s, when OPEC members provided the industrial world with 67 percent of its oil, OPEC was able to quadruple the price of oil. The sudden rise in price from $10 or $12 a barrel to $50 or more a barrel was a primary factor in throwing the world into a major recession. In 200, OPEC members lowered production, and oil prices rose from $10 to $30, creating a dramatic increase in gasoline prices. Non-OPEC oil-exporting countries benefit from the price increases while net importers of foreign oil face economic repercussions.

One important aspect of cartels is their inability to maintain control for indefinite periods. Greed by cartel members and other problems generally weaken the control of the cartel. OPEC members tend to maintain a solid front until one decides to increase supply, and then others rapidly follow suit. In the short run, however, OPEC can affect global prices.

A lesser-known cartel, but one that directly impact international trade, is the shipping cartel that exists among the worlds shipping companies. Every two weeks about 20 shipping-line managers gather for their usual meeting to set rates on tens of billion of dollars of cargo. They do not refer to themselves as a cartel but rather operate under such innocuous names as The Trans-Atlantic Conference Agreement, (ww.tacaconf.com). Regardless of the name, they set the rates on about 70 percent of the cargo shipped between North America and Northern Europe. Shipping between Canada and Asian ports and between Canada and European ports also is affected by shipping cartels. Not all shipping lines are members of cartels, but a large number are; thus they have a definite impact on shipping. Although legal, shipping cartels are coming under scrutiny by numerous legislative bodies, and new regulations may soon be passed.

Another cartel is the diamond cartel controlled by DeBeers. For more than a century, DeBeers smoothly manipulated the diamond market by keeping a tight control over world supply. The company mines about half the worlds diamonds and takes in another 25 percent through contracts with other mining companies. In an attempt to control the other 25 percent, DeBeers runs an outside buying office where it spends million buying up diamonds to protect prices. The company controls most of the worlds trade in rough gems and uses its market power to keep prices high.

The legality of cartels at present is not clearly defined. Domestic cartelization is illegal in North America, and the European Union also provisions for controlling cartels. Canada does permit firms to take cartel-like actions in foreign markets, although it does not allow foreign-market cartels if the results have an adverse impact on the Canadian economy. Archer Daniels Midland Company, the agribusiness giant, was fined $205 million for its role in fixing prices for two food additives, lysine and citric acid. German, Japanese, Swiss, and Korean firms were also involved in the cartel. The group agreed on prices to charge and then allocated the share of the world market each company would get down to the tenth of a decimal point. At the end of the year, any company that sold more than its allotted share was required to purchase in the following year the excess from a co-conspirator that had not reached its volume allocation target. The CEO of Toronto-based UCAR International was fined $70,000 for his involvement in fixing prices of graphite electrodes, which are used in making steel. Previous to the decision, UCAR International, German Corporation, Aktiengesekkschaft, and Tokai Carbon Company, from Japan were fined a total of almost $30 million. The ruling, which took place in 2003, is a signal to Canadian executives that they are personally accountable if caught engaging in price-fixing. The Competition Bureau has made it known they will be very aggressive in pursuing people who support or engage in cartel-like behaviour, particularly if such behaviour harms Canadians. In the UCAR case, the Bureau estimated that Canadian prices for graphite electrodes almost doubled due to collusion among the firms.

Although the EU member countries have a long history of tolerating price fixing, the European Commission is beginning to crack down in the shipping, automobile, and cement industries, among others. The unified and the single currency have prompted the move. As countries open free trade, powerful cartels that artificially raise prices and limit consumer choice are coming under closer scrutiny. However, the EU trust-busters are fighting tradition since the trade guilds of the Middle Ages, cozy cooperation has been the norm. In each European country, companies banded together to control prices within the country and to keep competition out.

B. Government Influenced Pricing

Companies doing business in foreign countries encounter a number of different types of government price setting. To control prices, governments may establish margins, set prices and floor or ceiling, restrict prices changes, compete in the market, grant subsidies, and act as a purchasing monopsony or selling monopoly. The governments may also influence prices by permitting, or even encouraging, businesses to collude in setting manipulative prices.

The Japanese government has traditionally encouraged a variety of government-influenced price-setting schemes. However, in a spirit of deregulation that is gradually moving through Japan, Japans Ministry of Health and Welfare will soon abolish regulation of business hours and price setting for such business as barbershops, beauty parlors, and laundries. Under the current practice, 17 sanitation-related businesses can establish such price-setting schemes, which are exempt from the Japanese Anti-Trust Law.

Governments of producing and consuming countries play an ever-increasing role in the establishment of international prices for certain basic commodities. There is, for example, an international coffee agreement, an international cocoa agreement, and an international sugar agreement. And the world price of wheat has long been at least partially determined by negotiations between national governments.

Despite the pressure of business, government, and international price agreements, most marketers still have wide latitude in their pricing decisions for most products and markets.

Summary

Pricing is one of the most complicated decision areas encountered by international marketers. Rather than deal with one set of market condition, one group of competitors, one set of cost factors, and one set of government regulations, international marketers must take all these factors into account, not only for each country in which they are operating, but often for each market within a country. Market prices at the consumer level are much more difficult to control in international than in domestic marketing, but the international marketer must still approach the pricing task on a basis of established objectives and policy, leaving enough flexibility for tactical price movements. Controlling costs that led to price escalation when exporting products from one country to another is one of the most challenging pricing tasks facing the exporter. Some of the flexibility in pricing is reduced by the growth of the Internet, which has a tendency to equalize price differentials between country markets.

The continuing growth of Third World markets coupled with their lack of investment capital has increased the importance of countertrades for most marketers, making Countertrading an important tool to include in pricing policy. The Internet is evolving to include countertrades, which will help eliminate some of the problems associated with this practice.

Pricing in the international marketplace requires a combination of intimate knowledge of market costs and regulations, an awareness of possible countertrade deals, infinite patience for detail, and a shrewd of market strategy.