Dr. Chris D’Souza, CFO & COO (International), ICMA Australia
“The single most important decision in evaluating a business is pricing power… If you’ve got the power to raise prices without losing business to a competitor, you’ve got a very good business. And if you have to have a prayer session before raising the price by 10 percent, then you’ve got a terrible business. You can determine the strength of a business over time by the amount of agony they go through in raising prices.”– Warren Buffett.
The above quote from highlights both the importance and difficulties that businesses face in the pricing decision. Setting prices is not an easy task even in domestic markets, but pricing in international markets is even more complex. International markets are all different and decisions related to product, price, and distribution are unique to each country and will inevitably differ from the domestic market.
The pricing decision is based on a host of interrelated factors. Some of these are internal to the organisation such as costs, required rate of return, marketing and the marketing mix objectives etc. Others are external to the firm such as market competition, customers, demand and supply, environmental factors, government policy etc. All these factors need to be considered in formulating pricing strategy and in arriving at the optimum pricing decision.
The international pricing decision needs to take into consideration all of the above factors but in addition to those when the organisation crosses into international markets it encounters a variety of different cultures, legal systems, customs, geographical and climatic conditions, education, religions, wants, attitudes, values, purchasing powers, influences etc. We will look at how these factors affect pricing in the 7 C’s of International Pricing.
Why Do Firms Venture Overseas?
Firms embark on an international venture or adventure in pursuit of a wide range of objectives based on “pull” factors, as well as for “push” factors. International pull factors are those that lure a company towards the overseas market and are based on the attractiveness of a potential foreign market. International push factors are compulsions or occurrences within the internal or domestic environment of the company which force it to seek overseas markets.
A company lured by the pull factor proactively seeks foreign markets. On the other hand, companies pushed into venturing overseas are reacting to internal or domestic market compulsions. Formulation of international business strategy is highly complex in nature and companies consider a combination of multiple factors both push and pull in evaluating international expansion.
Following are some of the reasons why companies venture overseas:
- Large foreign markets – This is the reason why international companies consider India and China with over a billion people in each of them to be attractive destinations for their products and services – for the same reason that a global brand like amazon is ready to pour US$ one billion into India in 2020 just to recover their losses to date.
- Resource availability – These resources could be labour (cheap or talented) or availability of raw material or even suitable climatic conditions. For example, availability of cheap labour is the reason for developed countries like USA and Australia to manufacture in countries like China and Vietnam. Mineral resources attract investment in Australia. Apple cannot manufacture the iPhone in the USA and needs to manufacture it in Asia due to the non-availability of sufficient tiny screws in the US[i].
- First mover advantage and new market development – Often companies are willing to enter and develop new markets before their competitors to get a competitive first mover advantage.
- Export only products – Sometimes companies develop a product for international and export markets only – an example of this would be some of the garment manufacturers in Bangladesh who manufacture exclusively for exports.
- Attractive export promotion schemes – Governments have created Special Economic Zones (SEZ) like Jebel Ali in Dubai and SEEPZ in India for companies manufacturing only for export.
- Economies of scale – The domestic market may be too small and exporting may be a viable option to exploit economies of scale. For example, Australia has a relatively small population so though it ranks 8th in the world for per capita consumption of wine.[ii] However, Australia is the fifth largest exporter of wine in the world and exports approximately 60 per cent of its total production[iii].
- The nature of the business – The product requires firms to operate internationally or in foreign markets – e.g. international airlines and most online businesses.
- Diversification – Firms that look to reduce their dependence on a single market go for geographical diversification. Do not put all your eggs in one basket is a wise saying and many multinational companies like Coca-Cola have succeeded in offsetting low or negative growth in one market with high and positive growth in other markets.
- Optimising the product life cycle – When a product has reached its mature (and saturated) stage in the domestic market, while being at earlier stages of its life cycle in less developed markets, firms look overseas. For example, a Bloomberg report suggests that Apple seems to be following this strategy by selling its older iPhones in India.[iv]
Why Do Firms Resist Going Overseas?
Despite all the lure and attraction of the International markets some firms are still reluctant to go there due to the following reasons:
- Foreign markets are perceived to be more difficult as well as more expensive to enter.
- International business brings with is higher risk – actual as well as perceived.
- Foreign exchange risks involved in international business.
- Unfamiliar international environment – Different culture, language, geography, climate, education, religion, attitudes and values.
- Unfamiliar international laws and regulations.
- Product modifications required – due to acceptable quality levels or other reasons.
- Local labour laws and conditions.
Despite these inherent difficulties in entering international markets, in a globalised business environment, firms that resist even considering the overseas option are like the frog in the well who thinks that the outside world is only as big as the top of the well. If they actually ventured out of the well, they would have an entirely different view. Companies need to strategically consider the global market to realise their full potential.
INTERNATIONAL BUSINESS STRATEGIES
Companies today might venture overseas due to push factors or pull factors or some might resist going overseas. However, very few companies can survive without an international business strategy in today’s globalised business environment. It is important to emphasise that all companies face international competition, not only in export markets, but in domestic markets as well. Becoming internationally competitive is therefore not only an essential requirement for successful exporters, but also the best means of defence that local companies can use to counter foreign imports. So, it is imperative that all companies formulate a carefully considered International Business Strategy to survive in a globalized international market.
Exporting is normally the first option to be explored when firms decide to pursue international trade. This form of international trade has been happening for centuries – the most well-known international trade was established when the Han Dynasty in China officially opened trade with the West in 130 B.C. The Silk Road routes remained in use until 1453 A.D., when the Ottoman Empire boycotted trade with China. Export trade was carried out over a network of mostly land but also sea trading routes, the Silk Road stretched from China to Korea and Japan in the east, and connected China through Central Asia to India in the south and to Turkey and Italy in the west. The Silk Road system has existed for over 2,000 years, with specific routes changing over time[v].
Often it is companies that are successful in the domestic market that decide to venture overseas looking for expansion opportunities beyond the shores of their home countries. However just because a company is successful in the domestic market does not mean that it will be similarly successful in overseas markets.
Exporting provides economic benefits not just to the exporter but also to the exporting country. Consequently, many countries provide incentives and subsidies to promote export trade. Exporting companies benefit in different ways from the internationalisation of their products. The following are some of the benefits of exporting:
- Enhanced revenue and profit.
- Increased market share in global markets.
- Reduced risk from geographical diversification and seasonal demand risks.
- Economies of scale leading to lower production cost and increased profitability.
- Optimum capacity utilisation.
- Expansion of product life cycle.
- Gain knowledge and experience benefiting both local and international trade.
PRICING DECISIONS IN INTERNATIONAL MARKETING
“Pricing is actually a pretty simple and straight forward thing. Customers will not pay literally a penny more than the true value of the product.”– Ron Johnson, the former Chief Executive Officer of J. C. Penney [New York Time, 2013].
Customers in one overseas market are dissimilar to customers in other markets and so are many other market dimensions that are unique to each market. So, determining what the value of your product is to the foreign customer and consequently determining what the customer will pay in each market makes the international pricing decision much more complex.
The 7 C’s of International Pricing Strategy
Pricing strategy brand depends on three primary factors: your cost to offer the product to consumers, competitors’ products and pricing, and the perceived value that consumers place on your brand and product vis-a-vis the cost. These three factors can be referred to as the 3 C’s of Pricing Strategy[vi] and are relevant both domestically and internationally.:
1. Costs: Comprehensive understanding of all costs related to offering the product, including development, creative, production, distribution, storage, advertising, manpower, and so on. International transportation and related costs like freight, insurance & handling lead to increase in costs. And then there is TAX. There could be custom duty and turnover tax like the local GST or VAT which could result in an escalating price
2. Competitors:Comprehensive and up-to-date analysis of your competitors’ in the international marketplace – competing products, brand, and prices as well as where your brand is positioned relative to those competitors.
3. Customers: Customers overseas will have a different perception of the value of the product as compared to domestic markets due to many differential cultural and other factors. It should also be noted that customers today are able to instantly compare their prices with domestic prices on the internet.
Besides the primary factors (3 c’s) that determine international pricing there are a range of secondary factors which are unique to each international market. These make the pricing decision much more complex in international marketing. When a firm crosses its domestic borders and enters a foreign country it encounters many unique international dimensions. These factors affect the pricing decision and consequently in case of international pricing we have expanded the 3 C’s of pricing to 7 C’s of International Pricing by adding the following additional 4 C’s:
4. Cultural Differences: The international pricing decision requires a comprehensive understanding of the overseas markets culture as well as the wants and needs of its inhabitants, including their perceptions of the value of your brand and products and your competitors’ brands and products.
5. Channels of Distribution: Lengthening channels of distribution means that more people are going to be handling your product including importers and wholesalers which causes not just cost escalation but increases distribution complexities.
6. Currency Rates – The complexities of multiple currencies which are subject to exchange rate fluctuations plus conversion costs.
7. Control by Government: Governmental and bureaucratic controls and regulations can be onerous and complex, like in China and even some European countries. Some countries have price control over some products like pharmaceuticals, fuel and food.
INTERNATIONAL PRICING STRATEGIES – Ensuring that your ‘Price is Right?’
“Don’t sell yourself short. No one will value you. Set a fair price for you, your book, your services, whatever it is that you have to offer. Most of us set way too low a price. Put it a little higher than you would normally be inclined to do. The worst that can happen is someone will come along and steal it.” ― John Kremer, 1001 Ways to Market Your Books: For Authors and Publishers.
“If you’re not worried that you’re pricing it too cheap, you’re not pricing it cheap enough.” Roy H. Williams
When formulating international pricing strategies, firms are also faced with the question – is our price too high to compete or is it unnecessarily low at the cost of profitability? The answer to this already complex question is further complicated by dimensions of international business which are unique to each country. So, it makes sense to have a different pricing strategy for each country based on that market’s unique dimensions which will lead to optimum pricing for the product – not too high to compete and not too low to reduce profitability, but striking the right balance to set an optimum price. In order to arrive at the optimum price a firm is required to undertake a full strategic analysis of the competitor and consumer environment (e.g. SWOT, GAP, and BCG analyses, PLC states of products/services etc.).
The international pricing strategy for firms will differ based on the elasticity of demand for the product which is linked with its competitive advantage. For example, the international pricing policy for Sensodyne repair and protect which is a specialist dental product with a differential advantage will differ from your run of the mill toothpaste without any differentiation.
Based on the differentiation that the product offers and considering the 7 C’s of international pricing – namely Cost, Customer, Competitors, Culture, Channels, Currency & Controls – the firm can select one or more of the following international pricing strategies:
Skimming in the International Market
Skimming as we know is the setting of the highest possible initial price for a new product and then lowering it progressively over time. This strategy is best for short term profit maximisation and is only possible for differentiated products for which there is no credible competition in the short run. In the International market the success of this strategy depends on factors like the demand in the local market, customer preferences, purchasing power etc. Apple, which seems to have mastered the art of skimming the market by introducing a new iPhone model every year, adopts this policy across all international markets.
Sliding-Down the Demand Curve
Sliding down the demand curve like skimming starts with the highest possible initial price but then as technology and competition increases move quickly down the demand curve to optimise your profit while remaining competitive. In the international market Samsung seems to be adopting this strategy in respect of its range of phones. Like Apple it skims the top end of the market segment by pricing its latest products high (but lower than Apple) and as the technology improves or as other Android phones are produced with similar features, it quickly reduces its prices to grab customers at the lower end. Thus, it combines skimming with competitive pricing by sliding down the demand curve to attract buyers in successively lower price segments of the market.
Penetration Pricing in the International market
Penetration pricing is the opposite of skimming in that the initial price is set very low to get the largest international market share. Internationally penetration pricing can allow profitable companies to gain access to market share in foreign countries. However, the trade policies of the foreign government would need to be considered as they might deem the low-priced products to be dumping or anti-competitive and in breach of their local legislation. As opposed to Apple, most manufactures of Android phones have a strategy of penetrating the International market.
Pre-emptive and extinction pricing strategies
Preemptive and extinction strategies are similar to penetration pricing policies in that they set the price very low in order to fight competition. Pre-emptive international pricing strategy sets the price very low so that new entrants to the international market find it uneconomical to enter that market. The example of Nintendo Wii which was first to enter the gaming market, intentionally set a low price to capture the market as a pre-emptive strategy against Sony which was to launch its Playstation. Extinction international pricing strategy is a strategy of driving away existing competitors by setting a low price that makes the business of competitors unviable. This could lead to a price war and is a risky strategy – it could also lead to breaching of ‘anti-dumping or fair competition’ legislation in some countries.
Skimming the Market v Penetration Pricing Strategy
Should a firm go for Skimming or Market Penetration pricing? This decision depends on the answer to two important inter-related questions:
- Do you have a differentiated product?
- Is the demand for your product elastic or inelastic?
These questions are interrelated because differentiated products generally have inelastic demand as compared to undifferentiated products which have elastic demand. For example, the Apple iPhone has a relatively inelastic demand compared to cheaper undifferentiated phones which compete on price.
So, if like Apple a firm has a differentiated product it can go for skimming otherwise (like the cheaper smartphone brands) it can aim for market penetration to capture a share of the market.
Differential Pricing in International markets
As discussed above, customers in different international markets have differing value perceptions of a product as well as differing purchasing power. Besides this there could be other local factors discussed above which could affect the pricing of a product. A differential pricing strategy is a ‘horses for course’ approach allowing the firm to charge different prices across different international segments.
Differential pricing can be used by a multinational firm where it wants to pursue different pricing strategies in different markets. For example, a firm using differential pricing may pursue skimming in one geographical market and penetration pricing in another
Example of differential pricing in International market
Sensodyne – Repair & Protect toothpaste
Prices in different countries:
- Ireland – AU$9 – Manufactured in Ireland
- Australia – AU$10 – Manufactured in Ireland
- India – AU$4 – Manufactured in India
- Thailand – AU$6.60 – Manufactured in India
- Indonesia – AU$3.50 – Manufactured in China
As shown above Multinational Companies like GlaxoSmithKline which sell the same product (Sensodyne Repair & Protect) globally have a wide variation in pricing. Based on the above information it is evident that products manufactured in first world countries (Ireland) are sold in those countries at a price which is more than double the price for the same product manufactured and sold in developing countries.
The price differential can be explained by the following factors:
- Cost – Manufacturing is cheaper in China & India than Ireland.
- Transportation costs & Custom Duties – this accounts for part of the difference in the price of the same product in India & Thailand (the other being purchasing power discussed next).
- Purchasing power – Purchasing power of consumers in Ireland & Australia is higher than the purchasing power of customers in India & Indonesia with Thailand somewhere in between. A good way of gauging the purchasing power of consumers in different countries would be by using the grading given to countries by the Australian Taxation Office for the purpose of allowing International business travel costs[vii]. Ireland (Group 5) is in the highest cost bracket where the minimum per diem allowed is $245. Indonesia and India (Group 3) are in the similar bracket the comparable per diem is $165. Thailand is in between (Group 4) with a comparable per diem of $205.
- Competition and Substitute products – ‘Sensodyne Repair & Protect’ is a differentiated product and is priced accordingly at a higher price than competing products.
- Other factors like customer preferences and needs are considered while fixing prices in various markets. This finally comes down to adjusting your price to ensure that the consumer in that market perceives that the product is ‘worth the price’.
It should be noted that whereas such price variations are easily maintainable for FMCG products with a relatively low price it would be harder for highly priced items like iPhones as this would create a profitable grey market for traders as explained below.
Problem of Grey Markets caused by Differential Pricing in International Markets:
“If Americans could legally access prescription drugs outside the United States, then drug companies would be forced to re-evaluate their pricing strategy.” Chuck Grassley
Price differentials like those exemplified in the Sensodyne case above or non-availability of products in some markets may create a grey market which is an unofficial market not authorised by the manufacturer. Grey markets of course depend upon demand to make them viable. For example, if the Sensodyne toothpaste is in high demand in Australia it might be profitable for a trader in Indonesia to buy and export this toothpaste to Australia due to the price differential. Louis Vuitton Bags were sold for the equivalent of US$970 in Paris while at the same time priced at US$1129 in Japan and US$1260 in Hawaii.[viii] So it became profitable for traders to buy the bags in Paris and ship them to Japan.
Grey markets also exist due to non-availability of the product in some countries – like the example of infant milk formula from Australia which was systematically bought by Chinese students from the supermarkets to be sent to China where there is a shortage of good quality infant milk.
Foreign exchange fluctuations and the pricing decision
One of the risk factors in international business are volatile currency markets. Foreign exchange rates can fluctuate drastically, and this can impact the pricing decision. The firm has to make a strategic decision to either increase prices with an unfavourable change in exchange rate or to absorb the resultant loss. This decision will depend on the product the company is selling, the customers willingness to absorb the increase and its market positioning in comparison to its competitors. An example of how currency changes affects the international pricing decisions is from the Australian luxury car market in the pre-euro era. At one time the Australian Dollar depreciated against the DM / Pound Sterling / Japanese Yen and Italian Lira but appreciated against the Swedish Kroner. This put a downward pressure on the profitability of the German cars Mercedes, BMW & Audi, the Japanese Lexus, the Italian Alfa Romeo and the British Jaguar at the same time increasing the profit margins of the Swedish Volvo & Saab.
The cars affected by the unfavourable exchange rate all increased their prices to maintain profitability. The two Swedish car manufacturers had three pricing options:
- Keep prices the same as before and enjoy the increase in profits driven by the favourable exchange rate as well as the competitive benefit offered by a price lower than the competitors.
- Increase the prices to increase profitability even more.
- Decrease prices and try to get a larger market share while maintaining the same profit margin.
Volvo chose to keep the same price whereas the Saab reduced its price to pass the exchange rate benefit to its consumers. However, the price decrease backfired on Saab as it lost its prestige position as a luxury car. The question that needs to be asked is – if the other car manufacturers could raise the prices without a decrease in demand why did they need to wait for an adverse exchange rate to raise prices? Had they all priced their cars too low?
Prestige Pricing & Price as an indicator of quality in International Markets
“We knew how much these people were paying for cocaine—and the more coke cost, the more people wanted it. We applied the same marketing plan to our budding catering operation, along with a similar pricing structure, and business was suddenly very, very good.” – Anthony Bourdain
The experience of the Cocaine business (albeit illegal) which Anthony Bourdain draws upon to use as a pricing model for his successful catering business, indicates that many customers consider price as an indicator of quality. So, while fixing a pricing strategy at any level the firm should be careful as to not go low enough for customers to doubt the quality of their product.
For products like Rolex watches and Louis Vuitton bags that fall in the luxury goods market, the element of prestige pricing needs to be considered. In the example referred to above when Saab dropped its price in Australia to pass on the advantage of exchange rate gains to its customers, it inadvertently lost its reputation as a luxury car.
“Pricing is the moment of truth – all of marketing strategy comes to focus on the pricing decision.” – Raymond Corey
The international pricing decision is the moment of truth in a firms international marketing and business strategy. It is a complex and difficult decision that cannot be made in isolation but needs to take into consideration all related factors – International Customers, Costs, Competitors, Culture, Channels, Currency & Comparability – the 7 C’s of International Pricing discussed above. International pricing decision requires a thorough knowledge and understanding of its own products costs, which then allows it to identify the competitive advantage it has in the context of the overseas marketplace comprising of unique cultural and economic environment.
[i] Jack Nicas (2019) ‘Why a tiny screw caused big problems for Apple’ The New York Times, January 29
[ii] Wine Australia Market Bulletin Issue 151 ‘Australia – Wine market for Australian wines’ https://www.wineaustralia.com/news/market-bulletin/issue-151
[iii] Wine Australia Market Insights – Australian Wine exports
[iv] Saritha Rai (2017) ‘Apple is making old iPhones new again to win India’ – Bloomberg Businessweek 12 June https://www.bloomberg.com/news/articles/2017-06-12/in-india-apple-is-making-old-iphones-new-again
[v] Richard Kurin (2002) ‘The Silk Road, connecting people and cultures’ – Smithsonian https://festival.si.edu/2002/the-silk-road/the-silk-road-connecting-peoples-and-cultures/smithsonian
[vii] Australian Taxation Office – Taxation Determination TD 2019/11 https://www.ato.gov.au/law/view/pdf/pbr/td2019-011.pdf
[viii] Kathy Dowling (2015) ‘Is it cheaper to buy Louis Vuitton in Japan, Hawaii or Paris?’ March 9 https://www.cloversac.com/is-it-cheaper-to-buy-louis-vuitton-in-japan-hawaii-or-paris/