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‡ A large number of exporters in initial stages


use cost-based pricing, which is hardly the
best way to determine price in international
markets
‡ However, the cost is often a key determinant
of the profitability of a firm in marketing the
product
‡ Firms located in different countries do have
significant variations in their cost of production
and marketing but the price in international
markets is determined by the market forces
‡ Therefore, the profitability among international
firms varies widely depending upon their
costing.
 
 

‡ The competition is much higher in


international markets compared to the
domestic markets
‡ The competitive intensity and its nature vary
widely in international markets
‡ In a large number of markets, the competition
is from international firms while the local firms
or local subsidies of multi-nationals compete
only in a few markets.
 
   
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‡ In international trade, a firm is often required


to make certain irregular payments that vary
widely among the countries
‡ Although such irregular payments are
unethical, they form an integral part of market
access that needs to be taken into account
while carrying out costing and market
feasibility analysis.
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‡ Purchasing power of customers varies widely


among the countries
‡ A firm operating in international markets
should take into consideration the buying
power of the consumers while making pricing
decisions
‡ McDonald¶s prices its products in international
markets depending upon the country¶s
purchasing power
‡ The hamburger prices vary from US$ 1.2 in
China to US$ 4.52 in Switzerland
‡ The theory of purchasing power parity states that
in the long run the exchange rate should move
towards rates that would equalize the prices of an
identical basket of goods and services in any two
countries
‡ The economist invented the Big Mac Index in
September 1986 as a light-hearted guide for cross-
country comparison of currencies based on
McDonald¶s Big Mac, which is produced locally
and simultaneously in almost 120 countries
‡ The purchasing power parity is calculated by
dividing the price of Big Mac in a country with the
price in US$.
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‡ Buyers from high-income countries are more


demanding and knowledgeable, and the
buying decision is primarily based on superior
performance attributes, whereas the buyers
from low-income countries have been
reported to make choices based on the price
of the products and services.
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‡ A firm operating in international markets has


to keep a constant vigil on fluctuations of
exchange rates while making pricing
decisions
‡ The currency of price quotation has to be
decided by watching its movements over a
period.
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‡ Costs are widely used by firms to determine


prices in international markets especially in
the initial stages
‡ Generally, new exporters determine export
prices on µex-works¶ price level and add a
certain percentage of profit and other
expenses depending upon the terms of
delivery
‡ However, such cost-based pricing methods
are not optimum because of the following
reasons
‡ The price quoted by the exporter on the
basis of cost calculations may be too
vis-à-vis competitors, thus allowing importers
to earn huge margins
‡ The price quoted by the exporters may be
too high, making their goods incompetitive
and resulting in outright rejection of the offer.
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‡ It is the most common pricing approach used


by exporters in the initial stages of their
internationalization
‡ It includes adding a mark-up on the total cost
to determine price
‡ The major benefits of the full cost pricing
approach are as follows:
‡ It is widely used by exporters in the
initial phases of international marketing
‡ It ensures fast recovery of investments
‡ It is useful for firms that are primarily
dependent on international markets and
register very low or negligible sales in
domestic markets
‡ It eases operation and implementation of
marketing strategies
However, the following bottlenecks are also
associated with the full cost pricing approach:
‡ It often overlooks the prevailing price
structure in international markets that may
either make the product uncompetitive or
prevent the firm from charging higher prices
‡ As competitors often use price-cutting
strategies to penetrate or gain share in
international markets, the full cost pricing
approach may result in making the product
price uncompetitive in international markets.
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‡ In view of the huge size of international


markets as compared to the domestic market,
export activities are regarded as outlets for
the disposal of surplus production that a firm
finds difficult to sell in the domestic market
‡ As the intensity of competition in international
markets is much higher than in the domestic
market, competitive pricing becomes a pre-
condition for success
‡ Therefore, a large number of firms adopt the
marginal cost pricing approach for pricing
decisions in international markets.
‡ Marginal cost is the cost of producing and
selling one more unit
‡ It sets the lower limit to which a firm can
reduce its price without affecting its overall
profitability
The major reasons for adopting pricing costing on
marginal cost are as follows:
‡ In cases where foreign markets are used to
dispose of surplus production, marginal cost
pricing provides an alternate market outlet
‡ Products from developing countries seldom
compete on the basis of brand image or
unique value; marginal cost pricing is used
as a tool to penetrate international markets
‡ Marginal cost pricing provides some
advantage that the firm would forego if it
does not export at the marginal-cost-based
price.
However, the major limitations of the marginal cost
pricing approach are as follows:
‡ In case the firm is selling most of its output in
international markets, it cannot use marginal
cost pricing as the fixed cost also has to be
recovered
‡ Pricing based on marginal cost may be
charged, as dumping in overseas markets is
liable to action and subject to investigations
‡ Such pricing tends to trigger a price war in
the overseas market and leads to price
under-cutting among suppliers
‡ Use of marginal cost pricing with little
information on prevailing market prices leads
to unrealistically low price quotations.
 
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‡ As developing countries are marginal


suppliers of goods in most markets, they
rarely have market shares large enough to
influence prices in international markets
‡ Thus, the exporters in developing countries
are generally price followers rather than price
setters
‡ Besides, the products offered by them are
seldom unique so as to enable them to dictate
prices
‡ In such market situations, pricing decisions by
price followers from developing countries
involve assessment involve assessment of
prevailing prices in international markets and
a top-down calculation as follows:
‡ Establish the current market price for
comparative and/or substitutive
products in the target market
‡ Establish all the elements of the market
price, such as VAT, margins for the
trade and the importer, import duties,
freight and insurance costs, etc.
‡ Make a top-down calculation,
deducting all the elements of the
expected market price of the product
(s) in order to arrive at the µex-works¶ ,
µex-factory¶ , or µex-warehouse¶ price
‡ Assess if this can be met
‡ If not, re-calculate the cost price by finding
ways to decrease costs in the factory or
organization or to decrease the marketing
budget, which also burdens export-market
price
‡ Estimate total sales over a three-year
period, add total planned expenses,
including those of the export department and
the travelling, and canvassing efforts
‡ Make a bottom-up calculation per product
item, dividing the supporting budgets over
the total number of items to be sold
‡ Set the final market price
‡ Test the price (through market research).
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‡ The concept of transfer pricing, which was
earlier limited to foreign multinational
companies, is becoming increasingly significant
for Indian companies as a result of their
increasing internationalization
‡ Indian firms enter international markets by way
of joint ventures, wholly-owned subsidiaries,
etc. Companies own distribution systems in
international markets, which makes transfer
pricing crucial for formulating an international
pricing strategy.
‡ The price of an international transaction
between related parties is called transfer price
(figure 1)
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The objectives of transfer pricing are as follows:
‡ Maximizing overall after-tax profits
‡ Reducing incident of customs duty payments
‡ Circumventing the quota restrictions (in value
terms) on imports
‡ Reducing exchange exposure, circumventing
exchange controls, and restricting profit
repatriation so that transfer firms¶ affiliates to
the parent can be maximized
‡ Transferring of funds in locations so as to suit
corporate working capital policies
‡ µWindow dressing¶ operations to improve the
apparent (i.e., reported) financial position of an
affiliate so as to enhance its credit ratings.
‡ The objective of transfer price apparently seems
simple allocation of profits among the subsidiaries
and the parent company, but the differences in the
taxation patterns in various markets makes it a
complex phenomenon
‡ Transfer prices come under the scrutiny of taxation
authorities when it is different from the arm¶s length
price to unrelated parties
Transfer pricing involves the following stake-holders:
‡ Parent company
‡ Foreign subsidiary or joint venture or any
other strategic alliance
‡ Strategic alliance partners
‡ Home country and overseas managers
‡ Home country governments
‡ Host country government
‡ International transactions based on intra-company
transfer pricing involves conflicting interests of
various stake-holders
‡ Therefore, in view of the diverse interests of
stake-holders, transfer-pricing decisions become a
formidable task
The factors influencing transfer pricing include:
‡ Market conditions in the foreign country
‡ Competition in the foreign country
‡ Reasonable profit for the foreign affiliate
‡ Home country income taxes
‡ Economic conditions in the foreign country
‡ Import restrictions
‡ Customs duties
‡ Price controls
‡ Taxation in the host country, e.g., withholding
taxes
‡ Exchange controls, e.g., repatriation of
profits.
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‡ 
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 + It is referred to
as arm¶s length pricing, wherein the sales
transactions occur between the two unrelated
(arm¶s length) parties
Arm¶s length pricing is preferred by taxation
authorities
Transfer pricing comes under the scrutiny of tax
authorities when it is different from the arm¶s length
price to unrelated firms.
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 + Pricing policies that deviate
from market-based arm¶s length pricing are known
as non-marketing based pricing.
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It refers to the intra-firm transactions that
take palace at the marketing cost.
‡ A number of transnational corporations have re-
invoicing centres at low tax countries (popularly
known as tax heavens), such as, Jamaica,
Cayman Islands, Bahamas, etc. to co-ordinate
transfer pricing around the world
‡ These re-invoicing centres are used to carry out
intra-corporate transactions between two affiliates
of the same parent company or between the
parent and the affiliate companies
‡ These re-invoicing centres take title of the goods
sold by the selling unit and re-sell it to the
receiving units
‡ The prices charged to the buyer and the prices
received by the seller are determined so as to
achieve the transfer pricing objectives
‡ In such cases, the actual shipments of goods take
place from the seller to the buyer while the two-
stages transfer is shown only in documentation
‡ The basic objective of such transfer pricing is to
siphon profits away from a high-tax parent
company or its affiliate to low-tax affiliates and
allocate funds to locations with strong currencies
and virtually no exchange controls.