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EXPORT PRICING

A. K. Sengupta Former Dean IIFT

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Right Price

• An important determinant of business success.

• Right price does not always mean low price.

• Right price depends upon factors like nature of the market, costs, competition, buyers purchasing power, foreign exchange fluctuations etc.

Pricing Approaches

• Major pricing approaches are Cost - based pricing and Market - based pricing.

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Cost-based pricing

Cost based pricing, also known as cost plus pricing, is a common method of pricing. Under this method the price includes a certain percentage of profit margin on the sum total of the full cost of production + marketing costs. That is Price = [fixed cost ,incl overhead + variable costs + marketing costs] + specified percentage of the total cost.

Market-based pricing

When exporters are price followers rather than price setters.

Involves assessment of prevailing prices in International Markets and a top-down calculation is made.

This is very flexible policy in the sense that is allows the prices to be changed in accordance with the changes in the market conditions. The product may be priced high when demand conditions are very good and the price may be lowered when the market is sluggish if that helps in increasing sales.

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Following Competitors

• Many firms follow the dominant competitors, particularly the price leader, in setting the price. The price leader is the firm which initiates the price trends.

Negotiated Prices

• Deciding the price by negotiations between the seller and the buyer. This is popular with government and institutional purchases.

Customer Determined Price

• In a number of cases, the foreign buyer specifies the price at which he is prepared to buy the product. Whether a price quotation given by the buyer will be acceptable to seller or not will depend on factors like his cost structure, conditions of business, objectives etc.

Marginal Cost Pricing

• Under the marginal cost pricing, the relevant cost considered for pricing is the variable cost, the fixed cost is excluded from the calculation of the cost of the product.

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Pricing Decisions for firms in Developing Countries

•Inability to influence prices.

•Lower production and technology base – results in higher cost of production.

•Marginal suppliers – little bargaining power to negotiate.

•Major proportion of export is commodities (with marginal value addition) – hence limited scope for realizing optimal prices.

•Fiercely competitive market – margin is low

Hence essential to formulate appropriate pricing strategies

• An order which may appear to be unprofitable and, therefore, unacceptable because of adopting the full cost approach (ie. ,both fixed and variable costs) may appear to be profitable if marginal cost approach is adopted.

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Pricing Objectives

A firm’s pricing policy may be guided by any one or more of the following objectives:

(i) Market Penetration: Market penetration may be a very important objective, particularly for new exporters. A firm may attempt to penetrate the market with a low price.

(ii) Market Share: The price may be manipulated to increase the market share.

(iii) Market Skimming: This is often the case with innovative products. The product is introduced with a high initial price to skim the cream of the market. The price may be subsequently reduced to achieve greater market penetration.

(iv) Fighting Competition: Sometimes price is a tool to fight competition. A price reduction by the competitor may have to be countered by price cuts. Sometimes price cuts may be affected to discipline the competitor or to compel the competitor to reduce prices.

(v) Preventing New Entry: A firm may charge a low price even when there is scope for high price so that the industry does not look very attractive to new entrants.

 

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(vi) Shorten Pay-back Period: When the market is uncertain and risky because of factors like swift technological changes, short product life cycles, political reasons, threat of potential competition etc., recouping the investment as early as possible would be an important objective.

(vii) Early Cash Recovery: A firm with liquidity problem might give priority to generate a better cash flow. Hence, it would adopt a pricing that might help it to liquidate the stock and/or encourage prompt payment by the channel members or buyers.

(viii) Meeting Export Obligation: A company with specific export obligation may be compelled to adopt a pricing policy that enables it to discharge its export obligation. Sometimes it may even imply a price lower than the cost.

(ix) Disposal of Surplus: A company confronted with a surplus stock may resort to exporting to dispose of the surplus.

(x) Optimum Capacity Utilization: Exporting is sometimes resorted to enable the firm to achieve optimum capacity utilization so as to minimize the unit cost of production. In such a case, achieving the required quantity of exports could be the objective of export pricing.

(xi) Return on Investment: Achieving the target rate of return is the most important pricing objective in a number of cases.

(xii) Profit Maximization: In many cases, the primary pricing objective is maximization of profits.

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Pricing Strategy

Types of Cost in Export Marketing

Fixed Cost

• Production cost

Variable Cost

• Selling and delivery costs.

Production Costs

Fixed Cost

Fixed costs are costs which remain fixed up to a certain level of output (investment in land, building, rent, plant & machinery)

Even if there is no production, some people are paid salary, minimum fixed expenses like electricity cost etc.

Variable Costs

Variable costs are costs which vary with the variation in the level of output and include cost of factors like labor, material etc.

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Selling and Delivery Costs

• Include the cost of holding stocks, packaging, transport, documentation, pre shipment inspection, insurance and cost of advertising, personal selling etc.

• Commission and traveling & incidental expenses are variable costs.

Marginal cost Pricing

• Pricing on Marginal cost – direct costs are covered i.e. the variable costs.

Points in support of use of Marginal cost

• Export sales are additional sales – need not be burdened with overhead costs, recovered from domestic market.

• Products less known in foreign markets.

• Markets with low purchasing power.

• Competition is severe.

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How to recover the fixed cost

• Domestic market

• Extra loading

Feasibility

• Existence of large domestic market

Limitations

• Importers become used to low price

• Not applicable to industries mainly dependent on export market.

• Where overheads are insignificant.

Marginal cost sets the lower limit

• The idea is not that direct cost should be charged every time.

• Marginal cost provides the lower limit up to which a firm can reduce the prices without in any way affecting its overall profitability.

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Disadvantages

• Countries might be charged of dumping.

• Competition among exporters from developing countries lead to undercutting each other resulting in loss of foreign exchange.

• Very often low prices may be quoted in the absence of adequate information about prevailing prices in foreign market.

Elements for Export Price Quotation

The following chart gives the various elements of costs.

(a) For export price based on marginal cost. (b) For export price based on full cost:

1) Export Price Based on Marginal Cost

(a)  Direct costs

(b) Variable costs:

Direct material

Direct labour

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Variable production overhead (for example, special dies and jigs)Variable administration overheads (for example, salary of export clerk)(c) Other costs directly related to exports:• Selling cost – advertising support to importers abroad• Special packaging, labeling etc.• Commission to overseas agent• Export credit insurance• Bank charges• Inland freight• Forwarding charges• Inland insurance• Port charges• Export duties if any• Warehousing at port, if required• Documentation and incidental• Interest on funds involved/cost of deferred credit• Cost of after-sales including free part supply• Pre-shipment inspection and loss on rejects• After-sales service

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Total Direct Costs

Less: duty drawback

Direct Cost Net

=F.O.B. price at marginal cost

II. Freight (volume or weight whichever is higher)

III. Insurance

C.I.F. price (based on marginal cost)

1. Export Price Based on Full Cost

i) Direct cost as in (1)

ii) Fixed cost/ common cost

Production overheads

Administration overheads

Publicity and advertising (general)

F.O.B. price (based on full cost)

iii) Freight (volume or weight whichever is higher)

iv) Insurance

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C.i.f. price based on full cost

Part of the above cost sheet gives the lower limit of the export pricing. As would be clear from the cost sheet, all cost directly related to export are taken into account for fixing the lower limit. If some incentives are allowed on the export of the product concerned the lower limit would be further reduced by the amount of incentives.

In the case of export houses purchasing their supplies from supporting manufacturers, the cost price of supplies obtain would constitute the lower limit.

Market Oriented Export Pricing

The following chart gives the nature of analysis for market – oriented pricing

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Analysis for market oriented export pricing

Market price _________

Less retail margin on selling price __________

Cost to the retailer _______

Less whole sellers mark up on his cost ________

Cost of the wholesaler ______

Less importers mark up on his cost ________

Cost of the importer _______

Less import duty ________

C.I.f. price _____

Less freight and insurance charges _______

F.O.B. realization of the exporter ___________

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Consumer Price:

VAT*

Market price minus VAT:

1,160

160

1,000

+ 16%**

Margin retailer:

Price to retailer:

Margin wholesaler:

Price to wholesaler:

Margin to importer

250

750

90

660

33

=

+

+

25%**

12%**

5%*

Landed-cost price:

Import duties:

Other costs (storage, banking):

CIF (Port of destination):

627

110

17**

500

+ 20%**

Transportation costs:

Insurance costs:

FOB (port of shipment)

130**

6**

364

Transportation costs factory to port:

Export price ex-works (EXW):

Factory cost price:

Export profit (per unit):

34**

330

300**

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To-down Calculation for International Pricing (US $)

*Note that VAT is calculated as a percentage of the price without VAT. Trade margins are usually calculated as a percentage of the trade selling price. The trade margins for some sectors are calculated as a percentage of trade buying prices.

**Figures based on assumptions.

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