What is Price Escalation? Reason, Approaches to Lessening

What is Price Escalation?

Price escalation refers to the added costs incurred as a result of exporting products from one country to another.

Or

The Cost of disproportionate difference in price between the exporting Country and the Importing Country is Price Escalation. (Cateora)

Introduction of Price Escalations

Often it’s been seen while we travel internationally that the goods which are inexpensive in the home country are very expensive in other country. Usually we think that the appreciated price is due to the export cost added to the product.

For example the I Phone, will cost 40% more in India than in the US. First the product passes through the hands of an importer, then to the company with the primary responsibility of sales and services, then to the territory local distributor and finally to the Local Retail Shops from where it reaches the end users.

At every level the profit margins are fixed plus the cost of export and transportation is added to it, hence there are great differences in the prices of the products internationally.

Every time the product changes hands in the international market the cost keeps adding up till it reaches the final consumer.

Price escalation can also refer to the sum of cost factors in the distribution channels which add up to a higher final cost for a product in a foreign market.

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Reason for Price Escalation

Costs of Exporting

It is the added cost incurred as a result of exporting products from one country to another. Internationally the final prices are raised by shipping costs, insurance, packing, tariffs, and longer channels of distribution, larger middlemen margins, special taxes, administrative costs, and exchange rate fluctuations.

Taxes, Tariffs, and Administrative Costs

Tariffs are special form of taxes levied on goods when they are exported.

exported. A tariff is a tax or duty imposed by one nation on the imported goods or services of another nation. These costs results in higher prices, which are generally passed on to the buyer of the product. Tariffs are generally imposed for one of four reasons:

• To protect newly established domestic industries from foreign competition.
  
  
• To protect aging and inefficient domestic industries from foreign competition.
  
  
• To protect domestic producers from “dumping” by foreign companies or governments. Dumping occurs when a foreign company charges a price in the domestic market which is below its own cost or under the cost for which it sells the item in its own domestic market.
  
  
• To raise revenue. Many developing nations use tariffs as a way of raising revenue. For example, a tariff on oil imposed by the government of a company that has no domestic oil reserves may be a way to raise a steady flow of revenue.

Tariffs are of two kinds:

1. Specific Tariff
2. Ad Valorem Tariff

• Specific Tariff: Taxes that are levied as a fixed charge for each unit of goods imported. Example: The US government levies a 51 cent specific tariff on every wristwatch imported into the US.
  
  
• Ad valorem tariff: This is levied as a fixed percentage of the value of the commodity imported. “Ad valorem” is Latin for “on value” or “in proportion to the value.”

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Approaches to Lessening Price Escalation

Price escalation is a major pricing problem for the international marketer. How can this problem be counteracted?

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, 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.

Price escalation raises two important questions that management needs to confront:

1. Will our foreign customers be willing to pay the inflated price for our product?
2. Will this price make our product less competitive?

There are various reason for price escalation:

1. Lowering costs of goods,
2. Lowering tariffs, and
3. Lowering distribution costs (Cateora, Gilly, and Graham, p.543,
   2013).
4. Rearrange the distribution channel.
5. Eliminate costly features (or make them optional).
6. Downsize the product.
7. Assemble or manufacture the product in foreign markets.
8. Using Foreign Trade Zone

Lowering the cost of goods

This may be done by shifting the manufacturing plant to a less expensive area. Example: Companies such as Samsung, reduce their manufacturing costs by producing their goods in Korea, to benefit from low waged human resources (Cateora, Gilly, and Graham, p.548, 2013).

On the other hand, reducing the quality of a product minimizes significantly cost of a good. Even though some firms would not opt to sacrifice their image by reducing the quality of a product, hence eliminating some feature and simplifying the product can be a smart option to reduce costs without jeopardizing the brand.

Lowering Tariff

Tariffs account for a large part of price escalation (Cater, Gilly, and Graham, p.549, 2013). A company may be paying an erroneous percentage on tariff, Therefore firms must ensure their products are being placed under the correct category.

Lowering Distribution costs

The firm must analyze the distributing procedures of and intent to reduce as much as possible all intermediaries; mostly considering that in most countries taxes are paid every time they change of dealer.

Low distribution cost can be achieved by eliminating or reducing middlemen. Designing a channel which has fewer middlemen may lower distribution cost will lead to eliminating middlemen mark up or rearrange the distribution channel.

Eliminate costly features

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 crossborder volume differences. To that end, manufacturers may decide to go for a local branding strategy.

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 European Union markets, numerous firms have decided to set up assembly operations in EU member states.

Using Foreign Trade Zone

• Imported goods stored or processed without imposing tariffs or duties until items leave FTZ areas and is imported into host country
  
  
• FTZ’s can lower costs through:
  • Lower duties imposed
  • Lower labor costs in importing country
  • Lower ocean transportation costs with unassembled goods (weight and volume are less)
  • Using local materials in final assembly