Chapter 14: Pricing Strategies and Tactics Flashcards
Price
The only element in the marketing mix that generates revenue
The alternative strategies for first-time pricing are:
- Skimming
- Market pricing
- Penetration pricing
Skimming
Achieve the highest possible contribution in a short time period
Market pricing
final customer price is determined based on competitive prices
- Then both production and marketing must be adjusted to the price
Penetration pricing
Offer products at a low price to generate volume sales and achieve high market share, which would compensate for a lower per-unit return.
Export pricing strategies
- Standard worldwide price
- Dual pricing
- Market differentiated pricing
The first two methods are cost-oriented methods that are relatively simple to establish and easy to understand. The third strategy is based on a demand orientation and thus may be more consistent with the marketing concept
Standard worldwide price
- May be the same price regardless of the buyer (if foreign product or foreign marketing costs are negligible)
- May be based on average unit costs of fixed, variable, and export-related costs
Dual pricing
Differentiates between domestic and export prices.
If a cost-based approach is decided upon, the marketer can choose between:
- Cost-plus method
- Direct (marginal) cost method
Cost-plus method
The true cost, fully allocating domestic and foreign costs to the product.
- Although this type of pricing ensures margins, the final price may be so high that the firm’s competitiveness is compromised.
Direct (marginal) cost method
Considers direct costs for producing and selling products for export as the floor beneath which prices cannot be set.
Market-differentiated pricing
Calls for pricing exports according to the dynamic conditions of the marketplace.
- The marginal cost strategy provides a basis, and price may change frequently due to changes in competition, exchange rate changes, or other environmental changes.
Export-related costs include:
- Cost of modifying the product for foreign markets
- Operational costs of export operation
- Cost incurred in entering the foreign markets
Operational costs of export operation
- personnel
- marketing research
- additional shipping and insurance
- communication costs
Costs incurred in entering the foreign markets
- tariff and taxes
- buyer’s credit risks
- political risks
- risks of dealing with foreign currencies
Price escalation
The export-related costs (combined effect of both clear-cut and hidden costs) result in export prices that far exceed domestic prices.
Price escalation can be overcome through:
- Reorganize the channel of distribution
- Adapt the product
- Use new or more economical tariff or tax classifications (In some cases, products may qualify for entry under different categories that have different tariffs)
- Assemble or produce overseas
These methods focus on cost-cutting
Exchange rates movements may harm or benefit the exporter or importer:
- If the price is quoted in the exporter’s currency, the exporter will get exactly the price it wants, but may lose some sales due to lack of customer orientation
- If the exporter needs the sale, the invoice may be in the importer’s currency, and the exchange risk will be burden of the exporter
Strategies used to manage exchange risks
- Forward exchange market
- Currency options market
- Currency futures market
Forward exchange market
The exporter gets a bank to agree to a rate at which it will buy the foreign currency the exporter will receive when the importer makes payment
What is the benefit of forward exchange market?
- A fixed rate allows the exporter to budget effectively without currency fluctuation
- The risk still remains if the exchange rate does not move as anticipated, and the exporter may be worse off than if it had not bought forward
Currency options market (an option)
- An option gives the holder the right to buy or sell foreign currency at a prespecified price on or up to a pre-specified date
- The greater flexibility in the options contract makes it more expensive
What is the difference between the currency options market and the forward market?
that a transaction in the currency options market gives the participant the right to buy or sell, whereas a transaction in the forward market entails a contractual obligation to buy or sell
Currency futures market
- Conceptually similar to forward market
- Minimum transaction sizes are smaller on the futures market
- Forward quotes apply to transactions of $1 million or more, whereas on the futures market transactions will typically be below $100,000.
Exporter strategies under varying currency conditions:
- When the exporter’s domestic currency is weak
- When the exporter’s domestic currency is strong
- Techniques to adjust pricing
When the exporter’s domestic currency is weak
- Stressing the price advantage to customers
- Expanding the scale and scope of the export operation
- Sourcing can be shifted to domestic markets
- The export price can be subjected to full costing
When the exporter’s domestic currency is strong
- Engaging in non-price competition
- Reducing the costs
- Sourcing overseas
- Buying needed services abroad
Techniques to adjust pricing
- Pass-through
- Absorption
Pass-through
customers have to have a high level of preference for the exporter’s product
Absorption
- Increase in the price is absorbed into the margin of the product
- The goal is long-term market-share maintenance in a highly competitive environment
Pricing within the individual market is determined by:
- Corporate objectives
- Costs
- Customer demand
- Market structure and competition
- Environmental constraints
Corporate objectives
- Financial objectives (e.g., return on investment) or market-related objectives (e.g., maintaining or increasing market share)
- Skimming (i.e., if product is an innovation) or penetration (i.e., to make the product more attractive to the buyers and the market less attractive to the competition)
- Price may be used to reflect the positioning decision
Costs
- Procurement, manufacturing, logistics, marketing costs, and overhead
- Used as a basis for price determination
Consumer demand
- Demand sets a price ceiling
- Global marketers must understand the price elasticity of consumer demand
- Many U.S. and European firms have regarded Asia as a place to sell premium products at premium prices
Market structure or competition
- Competition helps set the price within the parameters of cost and demand
- Company may choose to compete directly on price or elect for non-price measures (e.g., quality)
Environmental constraints
- Government may have price control policies
- Consumers want it
- To fight price controls, multinational corporations can demonstrate that they are getting an unacceptable return on investment
Transfer pricing (or intracorporate pricing)
Pricing of sales to members of the extended corporate family
- Can be based on costs or on market prices.
Three philosophies of transfer pricing have emerged over time:
- Cost-based price
- Market-based price
- Arm’s-length price
Cost-based price (direct cost or cost-plus)
it increases the profits of affiliates, and their profitability will eventually benefit the entire corporation.
Market-based price
discounted “dealer” price derived from end-market prices
- It takes local conditions into account
Arm’s-length price
Price that unrelated parties would have reached on the same transaction
- Favored by many constitutes (e.g., governments)
- Becomes difficult when sales to outside parties do not occur in a product category
Transfer pricing can reduce the…
effect of environmental influences in overseas markets
How can transfer pricing reduce the effect of environmental influences in overseas markets?
High transfer prices on goods shipped to a subsidiary and low ones on goods imported from it will result in minimizing the tax liability of a subsidiary operating in a country with a high income tax
Transfer pricing challenges
- Performance measurement
- Taxation
Performance measurement
- To judge a subsidiary’s profit performance as unsatisfactory when it was targeted to be a net source of funds can easily create morale problems
- Solutions: dual bookkeeping or compensation in budgets
Taxation
Sales and transfers of tangible properties and transfers of intangibles (e.g., patent rights and manufacturing know-how) are subject to close tax review and to determinations about the adequacy of compensation received.
In the marketing mix price is the only element that generates revenue, so what are the other elements?
Costs
What does price serve as?
as a means of communication with the buyer by providing a basis for judging the attractiveness of the offer.
What factors bring price down and what brings it up?
Competition will often force prices down, whereas
intracompany financial considerations have an opposite effect.
What do prices along with costs determine?
Prices, along with costs, will determine the long-term viability of the enterprise.
Why should price not be determined in isolation from the other marketing mix elements?
- It may be used effectively in positioning the product in the marketplace
- The feasibility range for price setting established by demand, competition, costs, and legal considerations may be narrow or wide in a given situation (e.g., the pricing of a commodity versus an innovation).
Just like pricing cannot be determined in isolation from the other marketing mix elements, pricing decisions cannot be made in isolation from…
other functions of the firm
Pricing challenges
- pricing for a new market entry
- changing price either as an attack strategy or in response to competitive changes
- multiple-product coordination in cases of related demand
These are technically the same as problems encountered in domestic markets.
How does skimming achieve its goal?
The product has to be unique, and some segments of the market must be willing to pay the high price. As more segments are targeted and more of the product is made available, the price is gradually lowered. The success depends on the ability and speed of reaction.
What does the market pricing approach require?
This approach requires the exporter to have a thorough knowledge of product costs as well as confidence that the product life cycle is long enough to warrant entry into the market. It is a reactive approach and may lead to problems if sales volumes never rise to sufficient levels to produce a satisfactory return.
How did penetration pricing help IKEA?
IKEA found that 70% reduction in average pricing roughly doubled the demand for its product.
What does penetration pricing typically require?
This approach typically requires mass markets, price-sensitive customers, and decreasing production and marketing costs as sales volumes increase. This approach can be used to discourage other marketers from entering the market.
Price changes are called for when…
- a new product is launched
- a change occurs in overall market conditions (such as a change in the value of the billing currency)
- there is a change in the internal situation, such as costs of production
With multiple-product pricing…
the various items in the line may be differentiated by pricing them appropriately to indicate an economy version, a standard version, and a top-of-the-line version.
- One of the products in the line may be priced to protect against competitors or to gain market share from existing competitors. The other items in the line are then expected to make up for the lost contribution of such a “fighting brand.”
What are factors to consider when setting export prices?
- the importance of price in customer decision making (in particular, the ability to pay)
- the strength of perceived price–quality relationships
- potential reactions to marketing-mix manipulation by marketers
- Customers’ demands
Objective of the firm for a particular target market
- profit maximization
- market share
- survival
- percentage return on investment
- various competitive policies such as copying competitors’ prices, following a particular competitor’s prices, or pricing so as to discourage competitors from entering the market.
Where and how decisions are made is also an important part of an exporter’s pricing policy
The degree to which the pricing decision should be localized is a function of competitive conditions and economic conditions, such as inflation
Stages in setting export prices
- Assessment of pricing environments
- Pricing policy selection
- Pricing strategy determination
- Setting of specific price
Assessment of pricing environments
- External
- Internal
External assessment of pricing environment
- Market-related factors
- Industry-related factors
Market-related factors
- Nature of demand/target audience characteristics
- Government regulations (e.g., duties)
- Exchange rate stability
Industry-related factors
- Competition intensity
- Nature of competition
Internal assessment of pricing environments
- Marketing mix
- Company characteristics
- Management attitudes
Marketing mix
- Product (e.g., old/new; standardized/differentiated)
- Distribution system (e.g., length)
- Promotion needs (e.g., sales efforts)
Company characteristics
- Extent of internationalization
- Countries exported to
Management attitudes
- Importance of exports
- Overall price position of firm
Pricing policy selection
- Objectives
- Competitive posture
- Decision control
- Flexibility
Pricing strategy determination
- Standard worldwide price
- Differentiation
* Cost-based
* Market-based
Why can an exporter face dumping charges through the direct (marginal) cost method?
Fixed costs for plants, R&D, and domestic overhead as well as domestic marketing costs are disregarded. An exporter can thus lower export prices to be competitive in markets that otherwise might have been beyond access. On certain occasions, especially if the exporter is large, this may open a company to dumping charges because determination of dumping may be based on average total costs, which are typically considerably higher.
Why does cost-plus pricing usually not lead to desired performance?
It typically leads to pricing too high in weak markets and too low in strong markets by not reflecting prevailing market conditions.
It is important that the cost of implementing a pricing-adaptation strategy does not outweigh…
the advantages of having a more adapted price.
What is VAT
Value-added tax
What is an example of value-added tax?
In the case of Geochron, the marketer of world time indicators, the multilayered distribution system with its excessive markups makes the price of a $1,300 clock exceed $3,800 in Japan.
Overcoming price escalation: Reorganize the channel of distribution
Shortening of channels. It may bring about other costs such as demands for better discounts.
Overcoming price escalation: Adapt the product
The product itself can be reformulated by including less expensive ingredients or unbundling costly features
Overcoming price escalation: Use new or more economical tariff or tax classifications
The marketer may have to engage in a lobbying effort to get changes made in existing systems, but the result may be considerable savings.
Overcoming price escalation: Assemble or produce overseas
In the longer term, the exporter may resort to overseas sourcing or eventually production. Through foreign sourcing, the exporter may accrue an additional benefit to lower cost: duty drawbacks. A firm may be refunded up to 99 percent of duties paid on imported goods when they are exported or incorporated in articles that are subsequently exported within five years of the importation.
Duty drawbacks
Through foreign sourcing, the exporter may accrue an additional benefit to lower cost
Incoterms
are the internationally accepted standard definitions for terms of sale set by the International Chamber of Commerce (ICC) since 1936.
The most common Incoterms used in international marketing:
- Ex-works (EXW)
- Free carrier (FCA)
- Carriage paid to (CPT) terms
- Carriage and insurance paid to (CIP)
- Delivered at terminal (DAT)
- Delivered at place (DAP)
- Delivered duty paid (DDP)
- Free alongside ship (FAS)
- Free on board (FOB)
- Cost and freight (CFR)
- Cost, insurance, and freight (CIF)
Ex-works (EXW)
apply only at the point of origin, and the seller agrees to place the goods at the disposal of the buyer at the specified place on the date stated or within a fixed period. All other charges are for the account of the buyer.
- Maximum obligation for the buyer
Free carrier (FCA)
replaced a variety of “FOB” terms for all modes of transportation except vessel. FCA (named inland
point) applies only at a designated inland shipping point. The seller is responsible for loading goods into the means of transportation; the buyer is responsible for all subsequent expenses.
Carriage paid to (CPT)
the seller’s risk and responsibility for the condition of cargo end when the goods are delivered to the first carrier. The seller must bear all transportation costs to the named destination on the buyer’s side
Carriage and insurance paid (CIP)
indicates that the seller’s risk and responsibility for the condition of the cargo end when the goods are delivered to the first carrier. The seller must bear all transportation costs to the named destination on the buyer’s side. The seller is responsible to provide insurance. The seller is obligated to provide minimum insurance only, so we recommend the buyer obtain additional insurance coverage.
Delivered at terminal (DAT)
indicates that the seller’s obligation ends when it has delivered the goods to the disposal of the buyer and they are unloaded from the arriving carrier at the named destination terminal, cleared for export but not cleared for import
Delivered at place (DAP)
means the seller’s obligation ends when it has delivered the goods to the disposal of the buyer at the named destination place and they are cleared for export but not cleared for import. The seller and buyer should agree which party will be responsible for unloading.
Delivered duty paid (DDP)
the seller delivers the goods with import duties paid, including inland transportation from import point to the buyer’s premises. The buyer is responsible to take delivery of the goods at the named place of destination.
- Puts maximum burden on the seller.
Free alongside ship (FAS)
at a named port of export means that the exporter quotes a price for the goods, including charges for delivery of the goods alongside a vessel at the port. The seller handles the cost of unloading and wharfage; loading, ocean transportation, and insurance are left to the buyer.
Free on board (FOB)
applies only to vessel shipments. The seller quotes a price covering all expenses up to and including delivery of goods on an overseas vessel provided by or for the buyer.
Cost and freight (CFR)
to a named overseas port of import, the seller quotes a price for the goods including the cost of transportation to the named port of debarkation. The cost of insurance and the choice of insurer are left to the buyer.
Cost, insurance, and freight (CIF)
to a named overseas port of import, the seller quotes a price including insurance, all transportation, and miscellaneous charges to the point of debarkation from the vessel. If other than waterway transport is used, the terms are CPT or CIP.
The benefits of taking charge of the transportation on either a CIF or DDP basis include the following:
1) exporters can offer foreign buyers an easy-to-understand “delivered cost” for the deal
2) by getting discounts on volume purchases for transportation services, exporters cut shipping costs and can offer lower overall prices to prospective buyers
3) control of product quality and service is extended to transport, enabling the exporter to ensure that goods arrive to the buyer in good condition
4) administrative procedures are cut for both the exporter and the buyer.
Terms of payment for the exporter:
1) the amount of payment and the need for protection
2) terms offered by competitors
3) practices in the industry
4) capacity for financing international transactions
5) relative strength of the parties involved
Cash in advance
The most favorable term to the exporter
Why is cash in advance the most favorable term to the exporter?
because it relieves the exporter of all risk and allows for immediate use of the money
When would cash in advance be used?
for smaller, first-time transactions or situations in which the exporter has reason to doubt the importer’s ability to pay. Also, when orders are for custom-made products because the risk to the exporter is beyond that of a normal transaction.
Letter of credit
is an instrument issued by a bank at the request of a buyer. The bank promises to pay a specified amount of money on presentation of documents stipulated in the letter of credit, usually the bill of lading, consular invoice, and a description of the goods. Letters of credit are one of the most frequently used methods of payment in international transactions.
Letters of credit can be classified along three dimensions:
- Irrevocable versus revocable
- Confirmed versus unconfirmed
- Revolving versus nonrevolving
Irrevocable versus revocable
An irrevocable letter of credit can neither be canceled nor modified without the consent of the beneficiary (exporter), thus guaranteeing payment. According to the new rules drawn by the ICC, all letters of credit are considered irrevocable unless otherwise stated.
Confirmed versus unconfirmed
In the case of a U.S. exporter, a U.S. bank might confirm the letter of credit and thus assume the risk, including the transaction (exchange) risk. The single best method of payment for the exporter in most cases is a confirmed, irrevocable letter of credit. Banks may also assume an advisory role.
Revolving versus nonrevolving
Most letters of credit are nonrevolving, that is, they are valid for the one transaction only. In case of established relationships, a revolving letter of credit may be issued
What is the major caveat regarding the letter of credit?
that the exporter has to comply with all the terms of the letter of credit.
For example, if the documents state that shipment is made in crates measuring 4 x 4 x 4 and the goods are shipped in crates measuring 4 x 3 x 4, the bank will not honor the letter of credit. If there are changes, the letter of credit can be amended to ensure payment.
What is TradeCard?
is an online service for B2B (business-to-business)
exchanges.
What created things like TradeCard?
With the increasing amount of e-commerce, things will have to change. Solutions include online issuance and status reporting on letters of credit, creating a worldwide network of electronic trade hubs, and offering a smart card that will allow participating companies to transact financial business online.
The letter of credit in regard to payments
The letter of credit is a promise to pay but not a means of payment. Actual payment is accomplished by means of a draft
Draft
is similar to a personal check. Like a check, it is an order by one party to pay another. Most drafts are documentary, which means that the buyer must obtain possession of various shipping documents before obtaining possession of the goods involved in the transaction.
Clean drafts
Orders to pay without any other documents
- mainly used by multinational corporations in their dealings with their own subsidiaries and in well-established business relationships
Documentary collection
the seller ships the goods, and the shipping documents and the draft demanding payment are presented to the importer through banks acting as the seller’s agent.
What is another name for draft?
Bill of exchange
Sight draft
documents against payment and is payable on presentation to the drawee, that is, the party to whom the draft is addressed.
Time draft
documents against acceptance and allows for a delay of 30, 60, 90, 120, or 180 days.
Banker’s acceptance
When a time draft is drawn on and accepted by a bank, it becomes a banker’s acceptance, which is sold in the short-term money market.
Trader’s acceptances
Time drafts drawn on and accepted by a business firm become trader’s acceptances, which are normally not marketable.
Date draft
A date draft requires payment on a specified date regardless of the date on which the goods and the draft are accepted by the buyer
How is a draft accepted?
A draft is presented to the drawee, who accepts it by writing or stamping a notice of acceptance on it.
Even if the draft is not sold in the secondary market, how may the exporter convert it into cash?
By discounting
What does it mean to discount a draft?
simply means that the draft is sold to a bank at a discount from face value. If the discounting is with
recourse, the exporter is liable for the payment to the bank if the importer defaults. If the discounting is without recourse, the exporter will not be liable even if the importer does not pay the bank.
Open account (open terms)
The normal manner of doing business in the domestic market.
The exporter selling on open account removes both real and psychological barriers to importing. However, no written evidence of the debt exists, and the exporter has to put full faith in the references contacted. Worst of all, there is no guarantee of payment.
Consignment selling
The most favorable term to the importer. Allows the importer to defer payment until the goods are actually sold. This approach places all the burden on the exporter.
Commercial risk
refers primarily to the insolvency of, or protracted payment default by, an overseas buyer
Commercial defaults
usually result from deterioration of conditions in the buyer’s market, fluctuations in demand, unanticipated competition, or technological changes.
How may exchange rates harm or benefit the parties?
If the price is quoted in the exporter’s currency,
the exporter will get exactly the price it wants but may lose some sales due to lack of customer orientation. If the exporter needs the sale, the invoice may be in the importer’s currency, and the exchange risk will be the burden of the exporter.
Exchange rates may be a result of…
an appreciating or depreciating currency or result from a revaluation or devaluation of a currency by a central bank.
Two types of approaches to protect against currency-related risk exist:
- Risk shifting
- Risk modifying
Risk shifting
such as foreign currency contractual hedging
Risk modifying
such as manipulating prices and other elements of a marketing strategy
Pricing-to-market
Destination-specific adjustment of markups in response to exchange-rate changes
Beyond price manipulation, other adjustment strategies exist
- Market refocus
- Streamlined operations
- Shift in production
Market refocus
If lower values of the target-market currencies make exporting more difficult by, for example, making collection times longer, marketers may start looking at other markets for growth.
Streamlined operations
The marketer may start using more aggressive methods of collection, insisting on letters of credit and insurance to guarantee payments.
Shift in production
Especially when currency shifts are seen as long-term, marketers will increase direct investment. With the high value of the yen, Japanese companies shifted production bases to lower-cost locations or closer to final customers. Panasonic, for example, moved a substantial share of its production to Southeast Asian countries. Remaining units in Japan will focus on research and development, design, software, and high-precision manufactured goods.
Sources of export financing
- Commercial banks
- Forfaiting and factoring
- Official trade finance
Sources of export financing: Commerical banks
Commercial banks around the world provide trade financing depending on their relationship with the exporter, the nature of the transaction, the country of the borrower, and the availability of export insurance.
Forfaiting
provides the exporter with cash at the time of the shipment. In a typical forfait deal, the importer pays the exporter with bills of exchange or promissory notes guaranteed by a leading bank in the importer’s country. The exporter can sell them to a third party (e.g., Citicorp) at a discount from their face value for immediate cash. The sale is without recourse to the exporter, and the buyer of the notes assumes all the risks.
Factoring houses
may purchase an exporter’s receivables for a discounted price (2 to 4 percent less than face value). Factors not only buy receivables but also provide the exporter with a complete financial package that combines credit protection, accounts-receivable bookkeeping, and collection services to take away many of the challenges that come with doing business overseas.
Sources of export financing: Official trade finance
can take the form of either a loan or a guarantee, including credit insurance.
Loan
the government provides funds to finance the sale and charges interest on those funds at a stated fixed rate
Guarantee
a private-sector lender provides the funds and sets the interest rate, with the government assuring that it will reimburse the lender if the loan is unpaid
Advantages of official trade finance
1) protection in the riskiest part of an exporter’s business (foreign sales receivables)
2) protection against political and commercial risks over which the exporter does not have control
3) encouragement to exporters to make competitive offers by extending terms of payment
4) broadening of potential markets by minimizing exporter risks
5) the possibility of leveraging exporter accounts receivable
6) through the government guarantee, the opportunity for commercial banks to remain active in the international finance arena
Ex-Im Bank
The purpose of the bank is “to aid in financing and facilitating exports.” The Ex-Im Bank supports short-, medium-, and long-term financing to creditworthy international customers (both in the private and public sectors) as well as working capital guarantees to U.S. exporters.
Leasing
Organizational customers frequently prefer to lease major equipment. Leasing companies become more than a source of capital, developing new value-added services that have taken them from asset financiers to asset managers, or forming relationships with others who can provide these services.
Inelastic demand
A status-conscious market that insists on products
with established reputations will be inelastic, allowing for far more pricing freedom than a market where price-consciousness drives demand.
Transfer prices: cost approach
uses an internally calculated cost with a percentage markup added.
Transfer prices: Market price approach
based on an established market selling price, and the products are usually sold at that price minus a discount to allow some margin of profit for the buying division.
Uncontrolled prices exist when:
1) sales are made by members of the multinational corporation to unrelated parties
2) purchases are made by members of the multinational corporation from unrelated parties
3) sales are made between two unrelated parties, neither of which is a member of the multinational corporation
The starting point for testing the appropriateness of transfer prices is a comparison with…
comparable uncontrolled transactions involving unrelated parties.
Resale method
This usually applies best to transfers to sales subsidiaries for ultimate distribution. The arm’s-length approximation is arrived at by subtracting the subsidiary’s profit from an uncontrolled selling price. The appropriateness of the amount is determined by comparison with a similar product being marketed by the multinational corporation
Functional analysis approach
The two methods focused on profits are based on this.
Functional analysis measures the profits of each of the related companies and compares them with the proportionate contribution to total income of the corporate group or comparable multinational marketers. It addresses the question of what profit would have been reported if the intercorporate transactions had involved unrelated parties. Understanding the functional interrelationships of the various parties (that is, which entity does what) is basic to determining each entity’s economic contribution vis-à-vis total income of the corporate group.
Types of countertrade
- Counterpurchase
- Buyback
- Clearing arrangements
- Switch-trading
- Offset
Countertrade
Countertrade conditions that support such business activities are a lack of money, lack of value of money, lack of acceptability of money as an exchange medium, or greater ease of transaction by using goods. However, the shrinking of established markets and the existence of a substantial product surplus are also conditions that foster countertrade.
Cost-plus approach
is most applicable for transfers of components or unfinished goods to overseas subsidiaries. The arm’s-length approximation is achieved by adding an appropriate markup for profit to the seller’s total cost of the product. The key is to apply such markups consistently over time and across markets.
Why countertrade?
- Many countries are deciding that countertrade transactions are more beneficial to them than transactions based on financial exchange alone. A primary reason is that world debt crises and exchange rate volatility have made ordinary trade financing very risky.
- The use of countertrade permits the covert reduction of prices and therefore allows firms and governments to circumvent price and exchange controls.
- Countertrade is also often viewed by firms and nations alike as an excellent mechanism to gain entry into new markets.
- Countertrade also can provide stability for long-term sales.
- Under certain conditions, countertrade can ensure the quality of an international transaction.
Traditional types of barter arrangements
Under the traditional types of barter arrangements, goods are exchanged directly for other goods of approximately equal value.
Counterpurchase (or parallel barter) agreement
The participating parties sign two separate contracts that specify the goods and services to be exchanged. Frequently, the exchange is not of precisely equal value; therefore, some amount of cash will be involved.
Buyback (or compensation) arrangement
One party agrees to supply technology or equipment that enables the other party to produce goods with which the price of the supplied products or technology is repaid.
Clearing arrangements
aimed at reducing the effect of the immediacy of the transaction. Here, clearing accounts are established in which firms can deposit and withdraw the results of their countertrade activities. These currencies merely represent purchasing power, however, and are not directly withdrawable in cash. As a result, each party can agree in a single contract to purchase goods or services of a specified value
Switch-trading
Additional flexibility can be given to the clearing account by permitting switch-trading, in which credits in the account can be sold or transferred to a third party.
Offset arrangement
The industrial compensation mandated by governments when purchasing defense-related
goods and services in order to offset or counterbalance the effect of this purchase on the balance of payments.
