International Pricing Decisions

Drivers of Foreign Market Pricing

Exhibit 8.1 compares the number of hours of work that is needed to buy an iPhone X. As you can see, the range is enormous running from about 4 days in Zürich up to nearly 133.3 days hours in Lagos. A range of factors governs global pricing decisions. Some of the drivers are related to the 4 Cs: Company (costs and company goals), Customers (price sensitivity, segments, and consumer references) Competition (market structure and intensity), and Channels.

Aside from these, in many countries, multinationals’ pricing decisions are often influenced by government policies (price controls, taxes, and import duties). We now consider the main drivers that may affect global pricing.

Company Goals

When developing a pricing strategy for its global markets, the firm needs to decide what it wants to accomplish with its strategy. These goals might include maximizing current profits, penetrating the market, projecting a premium image, and so forth.

According to one study, the most important pric- ing objectives of companies doing business in the United States (including foreign-based firms) are (1) to achieve a satisfactory return on investment, (2) to maintain market share, and (3) to meet a specified profit goal (in that order).

Company objectives will vary from market to market, especially in multinationals with a large degree of local autonomy. Positioning strategies could differ across countries. Leonidas a Belgian brand of chocolates with a vast network of selling points in its home market. In Belgium, Leonidas is very mainstream and far cheaper than Godiva (for instance, a box of 1 kg costs €26.4 for Leonidas compared to €65 for Godiva on the brand’s Belgium online shopping sites).

However, in some of its overseas markets, Leonidas goes for a premium image with prices that reflect it. In Hong Kong, for example, a heart-shaped Valentine’s box of 9 pieces cost about €25 versus merely €8.95 in the Netherlands.

Company goals are likely to change over time. Initially, when a firm enters a country, it often sets a relatively low price (compared to other countries) to penetrate the market. Once the firm is well entrenched, it may shift its objectives and bring them in line with the goals pursued in other countries.

Company Costs

Company costs figure prominently in the pricing decision. It is important that management considers all relevant costs of manufacturing, marketing, and distributing the product. Company costs consist of two parts: variable costs, which change with sales volume, and fixed costs (e.g., overheads) that do not vary.

Export pricing policies differ depending on the way costs are treated. Three basic options exist for setting export prices: (1) rigid cost-plus pricing, (2) flexible cost-plus pricing, and (3) dynamic incremental pricing. With rigid cost-plus pricing, the export price is adding all costs accrued in selling the product to the international market and a gross margin.

The second option, flexible cost-plus pricing, closely resembles the first method but adjusts prices to market conditions in the host market (e.g., level of competition). The final method, variable cost-plus pricing, arrives at a price after removing domestic fixed costs.

Examples of exporting-related incremental costs include manufacturing costs, shipping expenses, insurance, and overseas promotional costs. In the export market, situations where the export list price is far below the domestic price could trigger accusations of dumping.

When demand is highly price-sensitive, the company needs to consider how it can reduce costs from a global perspective. Hindustan Lever, Unilever’s India subsidiary, spends a large amount of its R&D money on developing new technologies to lower production costs. companies operating in these countries typically try to source mainly from local suppliers.

McDonald’s in India spent six years to set up a local supply chain even before opening its first restaurant in the country. However, high-quality potatoes were unavailable in India. McDonald’s and its supplier partner, McCain Foods, worked closely with farmers in India to develop process-grade potato varieties.

Customer Demand

While costs set a floor, the consumers’ willingness to pay for your product set a ceiling to the price. Consumer demand is a function of buying power, tastes, habits, and substitutes. These demand conditions will vary from country to country. Buying power is a key consideration in pricing decisions.

Exhibit 8.1 compares the number of working days needed to be able to afford the latest version of the iPhone X in 2018 based on a study done by Swiss bank UBS. Clearly, there are huge variations with the metric ranging from 4.7 days in Zürich to 133 days in Cairo. Consumers in such countries are far more price-sensitive than in developed markets. Foreign companies targeting the masses in emerging markets such as China or India offer cheaper products with lower costs by changing the product formula, packaging, or size.

One risk here is brand dilution, where a premium brand loses its cachet when a large number of consumers start using it. Another danger is cannibalization. This occurs when high-income customers switch to the cheaper products in the firm’s product line.

To lure the Chinese middle classes, P&G changed the brand’s formulation and packaging to emphasize cavity prevention, a generic benefit. The whitening benefit was reserved for premium Crest products.

In Egypt, one of the moves that P&G undertook to revitalize the sales of Ariel, its high suds laundry detergent brand, was to downsize the package size from 200 to 150 g prices and target the upper-end of the foreign market. A third option is to have a portfolio of products that cater to different income tiers. In India, Uni- lever dominates many consumer goods categories by following this road.

One final option—which seldom works—is to sell older versions of the product at a lower price in markets with low buying power. The practice of differentiating the retail or wholesale price of the same product across markets is known as pricing-to-market (PTM). In the car industry, for instance, manufacturers price discriminate in the EU by making certain features (e.g., air conditioning) standard in some countries and optional in others. Such bundling decisions sustain cross-country price differences of up to 13%.

Cultural symbolism can also influence pricing decisions. In Chinese cultures, the number “8”has an auspicious meaning as the word for “eight” (bā) sounds similar to the Chinese word for “wealth” (fā). As a result, special price offers in Chinese cultures often end with at least one 8-digit.

Competition

Competition is another key factor in global pricing. Differences in the competitive situation across countries will usually lead to cross-border price dif- ferentials. First, the number of competitors typically differs from country to country. In some countries, the firm faces very few competitors (or even en- joys a monopoly position), whereas in others, the company has to combat numerous competing brands.

Also, the nature of competition will differ global versus local players, private firms versus state-owned companies. Even when local companies are not state-owned, they often are viewed as “national champions” and treated accordingly by their local governments. Such a status entails subsidies or other goodies (e.g., cheap loans) that enable them to undercut their competitors. In some markets, firms have to compete with a knock-off version of their own product.

The presence of counterfeit products could force the firm to lower its price in such markets. Microsoft, for instance, slashed the Chinese price of its MS Office software suite by more than 70% from Rmb699 to Rmb199 in 2008 to encourage consumers to purchase genuine software instead of pirated software. The piracy rate for personal computer software in China was estimated to be more than 80% in 2007.

Distribution Channels

Another driver behind global pricing is the distribution channel. The balance of power between manufacturers and their distributors is another factor behind pricing practices. Countries such as France and the United Kingdom are characterized by large retailers (e.g., Carrefour and Tesco) who are able to order in bulk and to bargain for huge discounts with manufacturers.

The power of large-scale retailers in Europe is vividly illustrated by the hurdles that several manufacturers faced in implementing every day- low-pricing (EDLP). With EDLP, the manufacturer offers consistently lower prices to the retailer (and the ultimate shopper) instead of promotional price discounts and trade promotions.

Several German supermarket chains delisted P&G brands such as Ariel, Vizir, and Lenor detergent products and Bess toilet tissue when P&G introduced EDLP in Germany in early 1996. Large cross-country price gaps open up arbitrage opportunities that lead to parallel imports (gray markets) from low-price countries to high-price ones. These parallel imports are commonly handled by unauthorized distributors at the expense of legitimate trade channels. To curtail parallel trade, firms can consider narrowing cross-border price disparities.

Government Policies

Even after the launch of the euro, car prices in the EU still vary enormously. One of the main reasons for these car price disparities is the sales tax (VAT) rate for new cars. These vary from as low as 17% in Luxembourg up to 25% in Denmark and Sweden. This taxation gap also has an impact on pre-tax car prices. In fact, most car makers in Europe subsidize the pretext prices in high tax countries by charging more in low-tax country.

Indeed, a European Commission report found that pre-tax prices were the lowest in Denmark, followed by Hungary. However, when taxes were included, cars in Denmark were the most expensive in Europe. Government policies can have a direct or indirect impact on pricing policies. Factors that have a direct impact include sales tax rates (e.g., value-added taxes), tariffs, and price control.

The Chinese government sets minimum prices in scores of industries. The goal is to stamp out price wars and protect the Chinese economy against deflation pressures. Firms that ignore the pricing rules are slapped with hefty fines. An increase in the sales tax rate will usually lower overall demand. However, in some cases, taxes may selectively affect imports. For instance, in the late 1980s, the U.S. government introduced a 10% luxury tax on the part of a car’s price that exceeds $30,000.

This luxury tax primarily affected the price of luxury import cars since few U.S.-made luxury cars sold for more than the $30,000 threshold. Tariffs obviously will inflate the retail price of imports. In 2018, when a trade war escalated between the United States and China, the Chinese government upped its tariffs on U.S. car imports from 15% to 40%.

Tesla at the time had to decide to what extent it should pass on the tariff increase to its Chinese customers. Given that China was one of Tesla’s key markets, the pricing decision was very critical. In the end, Tesla raised its prices by about 20%.

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Managing Price Escalation

Exporting involves more steps and substantially higher risks than simply selling goods in the home market. To cover the incremental costs (e.g., shipping, insurance, tariffs, and margins of various intermediaries), the final foreign retail price will often be much higher than the domestic retail price. This phenomenon is known as price escalation.

Exhibit 3 provides an example of price escalation for one of Harley-Davidson’s popular motorcycle models. Note that the huge price tag for Harleys sold in China is mainly due to the hefty 50% import duty. As a result, Harleys can be much more expensive than German luxury sedans manufactured in China.

Price escalation raises two questions that management needs to confront: (1) will our foreign customers be willing to pay the inflated price for our product (sticker shock)? and (2) will this price make our product less competitive? If the answer is negative, the exporter needs to decide how to cope with price escalation.

There are two broad approaches to deal with price escalation: (1) find ways to cut the export price and (2) position the product as a (super) premium brand. Several options exist to lower the export price:

Rearrange the distribution channel

Channels are often largely responsible for price escalation, either due to the length of the channel (number of layers between manufacturer and end-user) or because of exorbitant margins. In some circumstances, it is possible to shorten the channel.

Eliminate costly features (or make them optional)

Several exporters have addressed the price escalation issue by offering no-frills versions of their product. Rather than having to purchase the entire bundle, customers can buy the core product and then decide whether or not they want to pay extra for optional features.

Downsize the product

Another route to dampen sticker shock is downsizing the product by offering a smaller version of the product or a lesser count. This option is only desirable when consumers are not aware of cross-border volume differences. To that end, manufacturers may decide to go for a local branding strategy. If done badly, so-called shrinkflation—reducing the size of the product while keeping the price unchanged—can backfire.

In 2016, Mondelēz decided to redesign its iconic Toblerone brand by widening the gaps between the bar’s triangular chunks. With the move, it cut for instance 170 g bars to 150 g while keeping the price the same. On its Facebook page, the firm mentioned ingredient cost increases as the reason behind the change-over. The redesign caused a public outcry. Many fans were displeased and described the change as “dumb” or “ridiculous.” Two years later, Mondelēz reinstated the original shape.

Assemble or manufacture the product in foreign markets

A more extreme option is to assemble or even manufacture the entire product in foreign markets (not necessarily the export market). Closer proximity to the export market will lower transportation costs. To lessen import duties for goods sold within EU markets, numerous firms have decided to set up assembly operations in EU member states. Due to high tariffs for motorbikes imported in India, Harley-Davidson decided to set up an assembly facility for bikes to be sold in that market.

Adapt the product to escape tariffs or tax levies

Finally, a company could also modify its export product to bring it into a different tariff or tax bracket. When the United States levied a new 10% tax on over $30,000 luxury cars, Land Rover increased the maximum weight of Range Rover models sold in America to 6,019 pounds. As a result, the Range Rover was classified as a truck (not subject to the 10% luxury tax) rather than a luxury car. These measures represent different ways to counter price escalation.

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Pricing in Inflationary Environments

When McDonald’s opened its doors in January 1990, a Big Mac meal (including fries and a softdrink) in Moscow cost 6 rubbles. Three years later, the same meal cost 1,100 rubbles. Rampant inflation is a major obstacle to doing business. In such environments, price setting and stringent cost control become extremely crucial.

Companies can resort to several ways to safeguard themselves against inflation:

1. Modify components, ingredients, parts, and/or packaging materials. Some ingredients are subject to lower inflation rates than others. This might justify a change in the ingredient mix. Of course, before implementing such a move, the firm should consider all its consequences (e.g., consumer response and impact on shelf life of the product).
   
   
2. Source materials from low-cost suppliers. Supply management plays a central role in high-inflation environments. A first step is to screen suppliers and determine which ones would be most cost-efficient without cutting corners. If feasible, materials could be imported from low-inflation countries. Note, however, that high inflation rates are coupled with a weakening currency. This will push up the price of imports.
   
   
3. Shorten credit terms. In some cases, profits can be realized by juggling the terms of payment. For instance, a firm that is able to collect cash from its customers within 15 days, but has one month to pay its suppliers, can invest its money during the 15-day grace period. At the same time, they also try to shorten the time to collect from their clients.
   
   
4. Include escalator clauses in long-term contracts. Many business-to-business marketing situations involve long-term contracts (e.g., leasing arrangements). To hedge their position against inflation, the parties will include escalator clauses that will provide the necessary protection.
   
   
5. Quote prices in a stable currency. To handle high inflation, companies often quote prices in a stable currency such as the U.S. dollar or the euro.
   
   
6. Pursue rapid inventory turnovers. High inflation also mandates rapid inventory turnarounds. As a result, information technologies (e.g., scanning techniques and computerized inventory tracking) that facilitate rapid inventory turnovers or even just-in-time delivery will yield a competitive advantage.
   
   
7. Draw lessons from other countries. Operations in countries with a long history of inflation offer valuable lessons for ventures in other high-inflation countries. Cross-fertilization by drawing from experience in other high-inflation markets often helps. Some companies— McDonald’s and Otis Elevator International, for example—relied on expatriate managers from Latin America to cope with inflation in the former Soviet Union.
   
   Hyperinflation happens when price rises are extremely high, causing the local population to minimize their cash holdings. This is often coupled with a total collapse of the value of the local currency.
   
   A recent notable example is Venezuela where hyperinflation reached 1.3 million percent in the 12 months to November 2018 due to economic mismanagement. To fight hyperinflation, governments will often implement rationing measures and impose price controls.
   
   For instance, Brazil went through five price freezes over a six-year interval. Such temporary price caps could be selective, targeting certain products, but, in extreme circumstances, they will apply across the board to all consumer goods.

Companies faced with price controls can consider several action courses:

1. Adapt the product line. To reduce exposure to a government-imposed price freeze, companies diversify into product lines that are relatively free of price controls. Modifying the product line could imply loss of economies of scale, an increase in overheads, and adverse reactions from the company’s customer base.
   
   
2. Shift target segments or markets. A more drastic move is to shift the firm’s target segment. For instance, price controls often apply to consumer food products but not to animal-related products. So, a maker of corn-based consumer products might consider a shift from breakfast cereals to chicken-feed products. Alternatively, a firm might consider using its operations in the high-inflation country as an export base for countries that are not subject to price controls.
   
   
3. Launch new products or variants of existing products. If price controls are selective, a company can navigate around them by systematically launching new products or modifying existing ones. Faced with price controls in Zimbabwe, bakers added raisins to their dough and called it “raisin bread,” thereby, at least momentarily, escaping the price control for bread. Also here, the firm should consider the overall picture by answering questions such as: Will there be a demand for these products?
   
   
4. Negotiate with the government. In some cases, firms are able to negotiate for permission to adjust their prices. Lobbying can be done individually but is more likely to be successful on an industry-wide basis.
   
   
5. Predict incidence of price controls. Some countries have a history of price freeze programs.

A drastic action course is simply to leave the country. Scores of multinational firms such as Clorox and Kellogg left Venezuela, once one of the wealthiest countries in South America. Others like Unilever and Ford decided to stay but slashed their product portfolio to cope with high inflation and waning demand.

However, companies that hang on and learn to manage a high-inflation environment will be able carry over their expertise to other countries.

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Transfer Pricing

Determinants of Transfer Prices

Most large multinational corporations have a network of subsidiaries spread across the globe. Sales transactions between related entities of the same company can be quite substantial, involving trade of raw materials, components, finished goods, or services. Transfer prices are prices charged for such transactions.

Transfer pricing decisions in an international context need to balance off the interests of a broad range of stakeholders: (1) parent company, (2) local country managers, (3) host government(s), (4) domestic government, and (5) joint venture partner(s) when the transaction involves a partnership. Not surprisingly, reconciling the conflicting interests of these various parties can be a mind-boggling juggling act.

A number of studies have examined the key drivers behind transfer pricing decisions. One survey of U.S.-based multinationals found that transfer pricing policies were primarily Influenced by the following factors (in order of importance):

• Market conditions in the foreign country
• Competition in a foreign country
• Reasonable profit for foreign affiliate
• U.S. federal income taxes
• Economic conditions in the foreign country
• Import restrictions
• Customs duties
• Price controls
• Taxation in the foreign country
• Exchange controls

Other surveys have come up with different rankings. However, a recurring theme appears to be the importance of market conditions (especially, the competitive situation), taxation regimes, and various market imperfections (e.g., currency control, custom duties, and price freeze).

Generally speaking, MNCs should consider the following criteria when making transfer pricing decisions:

• Tax regimes: Ideally, firms would like to boost their profits in low-tax countries and dampen them in high-tax countries. To shift profits from high-tax to low-tax markets, companies would set transfer prices as high as possible for goods entering high-tax countries and vice versa for low-tax countries. Most governments impose rules on transfer pricing to ensure a fair division of profits between businesses under common control.
  
  
• Local market conditions: Another key influence is local market conditions. Examples of market-related factors include the market share of the affiliate, the growth rate of the market, and the nature of local competition (e.g., nonprice- versus price-based). To expand market share in a new market, multinationals may initially under-price intracompany shipments to a start-up subsidiary.
  
  
• Market imperfections: Market imperfections in the host country, such as price freezes and profit repatriation restrictions, hinder the multinational’s ability to move earnings out of the country. Under such circumstances, transfer prices can be used as a mechanism to get around these obstacles. In addition, high import duties might prompt a firm to lower transfer prices charged to subsidiaries located in that particular country.
  
  
• Joint venture partner: When the entity concerned is part of a joint venture, parent companies should also factor in the interests of the local joint venture partner. Numerous joint venture partnerships have hit the rocks partly because of disputes over transfer pricing decisions.
  
  
• Morale of local country managers: Finally, firms should also be concerned about the morale of their local country managers. Especially when performance evaluation is primarily based on local profits, transfer price manipulations might distress country managers whose subsidiaries- its profits are artificially deflated.

Setting Transfer Prices

There are two broad transfer pricing strategies: market-based transfer pricing and nonmarket-based pricing. The first perspective uses the market mechanism as a cue for setting transfer prices. Such prices are usually referred to as arm’s length prices. Basically, the company charges the price that any buyer outside the MNC would pay, as if the transaction had occurred between two unrelated companies (at “arm’s length”). Tax authorities typically prefer this method to other transfer pricing approaches.

Since an objective yardstick is used—the market price—transfer prices based on this approach are easy to justify to third parties (e.g., tax authorities). The major problem with arm’s length transfer pricing is that an appropriate benchmark is often lacking, due to the absence of competition. This is especially the case for intangible services. Many services are only available within the multinational.

A high-stakes dispute between the U.S. Internal Revenue Service (IRS) and GlaxoSmithKline PLC, the British pharmaceuticals company, vividly illustrates the issue of valuing intangibles. According to the IRS, Glaxo’s U.S. subsidiary overpaid its European parent for the royalties associated with scores of drugs, including its blockbuster Zantacdrug.

Glaxo allegedly had overvalued the drugs’ R&D costs in Britain and under-valued the value of marketing activities in the United States, thereby artificially cutting the U.S. subsidiary’s profits and tax liabilities.

Glaxo vehemently denied this charge. As you can see, the case centred on the issue of where value is created and where credit is due—on the marketing or on the R&D front. Nonmarket-based pricing covers various policies that deviate from market-based pricing, the most prominent ones being: cost-based pricing and negotiated pricing.

Cost-based pricing simply adds a mark-up to the cost of the goods. Issues here revolve around getting a consensus on a “fair” profit split and allocation of corporate overhead. Further, tax authorities often do not accept cost-based pricing procedures.

Another form of nonmarket-based pricing is negotiated transfer prices. Here conflicts between country affiliates are resolved through the negotiation of transfer prices. This process may lead to better cooperation among corporate divisions.

One study showed that compliance with financial reporting norms, fiscal and custom rules, and antidumping regulations prompt companies to use market-based transfer pricing. Government-imposed market constraints (e.g., import restrictions, price controls, and exchange controls) favor nonmarket-based transfer pricing methods.

Minimizing the Risk of Transfer Pricing Tax Audits

Cross-country tax rate differentials encourage many MNCs to set transfer prices that shift profits from high-tax to low-tax countries to minimize their overall tax burden. This practice is sometimes referred to as international tax arbitrage.

At the same time, MNCs need to comply with the tax codes of their home country and the host countries involved. Noncompliance may risk accusations of tax evasion and lead to tax audits EU, matters can get even more confusing when tax deals set up by local governments are over-ruled by the EU. In October 2015, EU regulators ordered Starbucks to pay back tens of millions of euros in unpaid taxes to the Netherlands.

According to the European Commission, Starbucks’s tax deal with the Dutch government enabled the firm to pay unusually high royalties for coffee roasting know-how to a sister company based in the United Kingdom and unjustified high prices for coffee beans sourced from a Swiss affiliate. The European Commission alleged that such a tax deal and a similar one that Luxembourg made with Fiat amounted to illegal state aid.

The issue that MNCs face can be stated as follows: How do we as a company draw the line between setting transfer prices that maximize corporate profits and compliance with tax regulations? To avoid walking on thin ice, experts suggest setting transfer prices that are as close as possible to the Basic Arm’s Length Standard (BALS). This criterion is now accepted by tax authorities worldwide as the international standard for assessing transfer prices. In practice, there are three methods to calculate a BALS price: comparable/ uncontrollable price, resale price, and cost-plus.

The first rule—comparable/uncontrollable—states that the parent company should compare the transfer price of its “controlled” subsidiary to the selling price charged by an independent seller to an independent buyer of similar goods or services. The problem is that such “comparable products” are often not around. The resale price method determines the BALS by subtract- ing the gross margin percentage used by comparable independent buyers from the final third-party sales price.

Finally, the cost-plus method fixes the BALS by adding the gross profit mark-up percentage earned by comparable companies performing similar functions to the production costs of the controlled manufacturer or seller.

Note that this rule is somewhat different from the cost method that we discussed earlier since, strictly speaking, the latter method does not rely on markups set by third parties. The OECD has drawn up guidelines on transfer pricing that cover complex taxation issues. The latest version of these rules is presented in Transfer Pricing Guidelines for Multinational Enterprises and for Tax Administrations.

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Price Coordination

When developing a global pricing strategy, one of the thorniest issues is how much coordination should exist between prices charged in different countries. This issue is especially critical for global (or regional) brands that are marketed with no or very few cross-border variations. Economics dictates that firms should price discriminate between markets such that overall profits are maximized.

So, if (marginal) costs were roughly equivalent, multinationals would charge relatively low prices in highly price-sensitive countries and high prices in insensitive markets. In most cases, markets cannot be perfectly separated. Huge cross-country price differentials will encourage gray markets where goods are shipped from low-price to high-price countries by unauthorized distributors. Thus, some coordination will usually be necessary.

In deciding how much coordination, several considerations matter:

Nature of customers

When information on prices travels fast across borders, it is fairly hard to sustain wide price gaps. Under such conditions, firms will need to make a convincing case to their customers to justify price disparities. With global customers (e.g., multinational clients in business-to-business transactions), price coordination definitely becomes a must.

General Motors applies “global enterprise pricing” for many of the components it purchases. Under this system, suppliers are asked to charge the same universal price worldwide. In Europe, Microsoft sets prices that differ by not more than 5% between countries due to pressure from bargain-hunting multinational customers.

However, pharmaceutical firms often adopt tiered or differential pricing in developing countries. To make drugs or vaccines affordable in these countries, companies such as GlaxoSmithKline or Gilead sell their products far below the prices they charge in more developed markets.

Amount of product differentiation

The amount of coordination also depends on how well differentiated the product is across borders. Obviously, the less (cross-border) product differentiation, the larger the need for some level of price coordination and vice versa. Stains in Southern Europe differ from stains in Scandinavia because of different food habits.

In addition, the spin speed of washing machines varies across Europe. In cold, wet countries (e.g., Great Britain), the average spin speed is 1,200 rpm—twice as fast as the 600 rpm speed of washers in Spain. Thus, product differentiation can pose a barrier for cross-border price comparison shopping.

Nature of channels

In a sense, distribution channels can be viewed as intermediate customers. So, the same logic as for end consumers applies here: price coordination becomes critical when price information is transparent and/or the firm deals with cross border distribution channels. Pricing discipline becomes mandatory when manufacturers have little control over their distributors.

Nature of competition

In many industries, firms compete with the same rivals in a given region, if not worldwide. Global competition demands a cohesive strategic approach for the entire marketing mix strategy, including pricing. From that angle, competition pushes companies toward centralized pricing policies.

On the other hand, price changes made by competitors in the local market often require a rapid response. Local subsidiaries often have much better information about the local market conditions to answer such questions than corporate or regional headquarters. Thus, the need for alertness and speedy response to competitive pricing moves encourages a decentralized approach toward pricing decisions.

Market integration

When markets integrate, barriers to the cross-border movement of goods come down. Given the freedom to move goods from one member state to another, the pan-European market offers little latitude for perfect price discrimination. Many of the transaction costs plagu- ing parallel imports that once existed have now disappeared.

In fact, the European Commission imposes heavy penalties against companies that try to limit gray market transactions. In May 2019, the Commission fined AB InBev, the world’s biggest brewer, €200 million for hindering cheaper imports of the Jupiler beer brand from the Netherlands into Belgium.

For instance, the firm had changed the labels of Jupiler beer products sold to Dutch channels by removing the French version, making it harder to re-sell these products in the French-speaking areas of Belgium. The firm had also restricted the volumes of Jupiler sold to Dutch wholesalers to prevent imports into Belgium.

After a three-year investigation, the Commission concluded that the brewer “deprived European consumers of one of the core benefits of the Single Market, namely the possibility to have more choice and get a better deal when shopping.”

Internal organization

The organization setup is another important influence. Highly decentralized companies pose a hurdle to price coordination efforts. In many companies, the pricing decision is left to the local subsidiaries.

Moves to take away some of the pricing authority from country affiliates will undoubtedly spark opposition and lead to bruised egos. Just as with other centralization decisions, it is important to fine-tune performance evaluation systems, as necessary.

Government regulation

Government regulation of prices puts pressure on firms to harmonize their prices. A good example is the pharmaceutical industry. In many countries, multinationals need to negotiate the price for new drugs with the local authorities. Governments in the EU increasingly use prices set in other EU member states as a cue for their negotiating position.

Global Pricing Contracts (GPCS)

Increasingly, purchasers demand global pricing contracts (GPCs) from their suppliers. There are several reasons behind the shift toward GPCs: centralised buying, information technology that provides improved price monitoring, standardization of products or services.

GPCs, however, can also benefit suppliers: global customers can become showcase accounts; a GPC can offer the opening toward nurturing a lasting customer relationship; small suppliers can use GPCs as a differentiation tool to get access to new accounts.

However, before engaging in a GPC with a purchaser, it is important to do your homework. To achieve successful GPC implementation, Narayan Das and his colleague provide the following guidelines:

1. Select customers who want more than just the lowest price.
   
   
2. Align the supplier’s organization with the customer’s. Ideally, the supplier’s account management organization should mirror the client’s procurement setup.
   
   
3. Hire global account managers who can handle diversity. Get team members who cannot just handle sales but also market intelligence gathering, problem spotting, and contract compliance monitoring.
   
   
4. Reward those global account managers and local sales representatives who make the relationship work.
   
   
5. Allow for some price flexibility.
   
   
6. Build information systems to monitor the key variables (e.g., cost variations and competitive situation)

Aligning Pan-regional Prices

In the late 1990s, Procter & Gamble was facing a severe parallel imports situation in Russia for its Always feminine protection brand. The price for Always was much higher than in the other Central European countries, especially Poland from which most parallel imports originated. To resolve the problem, P&G lowered the price for Always in Russia and increased it in Poland so that the cross-border price variation became no more than 10.

In some cases, firms set a uniform pricing formula that is applied by all affiliates. Elsewhere, coordination is limited to general rules that only indicate the desired pricing positioning (e.g., premium positioning and middle-of-the-road positioning). Simon and Kucher propose a three-step procedure to align prices in regional markets with arbitrage opportunities.

Of course, this method is not fool proof. Competitive reactions (e.g., price wars) need to be factored in. Further, government regulations may restrict pricing flexibility. Still, the procedure is a good start when pricing alignment becomes desirable.

Implementing Price Coordination

Global marketers can choose from four alternatives to promote price coordination within their organization, namely:

Economic measures

Corporate headquarters are able to influence pricing decisions at the local level via the transfer prices that are set for the goods that are sold to or purchased from the local affiliates. Another option is rationing, that is, headquarters sets upper limits on the number of units that can be shipped to each country.

To sustain price differences, luxury marketers like Louis Vuitton set purchase limits for customers shopping at their European boutiques. Louis Vuitton products bought in Europe or Hawaii are often resold in Japan by discount stores as “loss leaders.”

Centralization

In the extreme case, pricing decisions are made at corporate or regional headquarters level. Centralized price decision-making is fairly uncommon, given its numerous shortcomings. It sacrifices the flexibility that firms often need to respond rapidly to local competitive conditions.

Formalization

Far more common than the previous approach is formalization where headquarters spells out a set of pricing rules that the country managers should comply with (e.g., price at par with the price of the leading brand). Within these norms, country managers have a certain level of flexibility in determining their ultimate prices. One possibility is to set prices within specified boundaries; prices outside these bounds would need approval from the global or regional headquarters.

Informal coordination

Finally, firms can use various forms of informal price coordination. The emphasis here is on informing and persuasion rather than prescription and dictates. Examples of informal price coordination tactics include discussion groups, and “best-practice” gatherings.

Which one of these four approaches is most effective depends on the complexity of the environment in which the firm is doing business. When the environment is fairly stable and the various markets are highly similar, centralization is usually preferable over the other options. However, highly complex environments require a more flexible decentralized approach.