The reading level for this article is Expert
Proper pricing, complete and accurate quotations, and choice of terms of sale and payment are four critical elements in selling a product or service internationally. Of the four, pricing is the most problematic, even for the experienced exporter.
At what price should the firm sell its product in the foreign market?
Does the foreign price reflect the product’s quality?
Is the price competitive?
Should the firm pursue market penetration or market-skimming pricing objectives abroad?
What type of discount (trade, cash, quantity) and allowances (advertising, trade-off) should the firm offer its foreign customers?
Should prices differ with market segment?
What should the firm do about product line pricing?
What pricing options are available if the firm’s costs increase or decrease? Is the demand in the foreign market elastic or inelastic?
Are the prices going to be viewed by the foreign government as reasonable or exploitative?
Do the foreign country’s dumping laws pose a problem?
As in the domestic market, the price at which a product or service is sold directly determines a firm’s revenues. It is essential that a firm’s market research include an evaluation of all of the variables that may affect the price range for the product or service. If a firm’s price is too high, the product or service will not sell. If the price is too low, export activities may not be sufficiently profitable or may create a net loss.
The traditional components for determining proper pricing are costs, market demand, and competition. These categories are the same for domestic and foreign sales and must be evaluated in view of the firm’s objective in entering the foreign market. An analysis of each component from an export perspective may result in export prices that are different from domestic prices.
Foreign Market Objectives
An important aspect of a company’s pricing analysis involves determining market objectives. Is the company attempting to penetrate a new market? Looking for long-term market growth? Looking for an outlet for surplus production or outmoded products? For example, many firms view the foreign market as a secondary market and consequently have lower expectations regarding market share and sales volume. Pricing decisions are naturally affected by this view.
Firms also may have to tailor their marketing and pricing objectives for particular foreign markets. For example, marketing objectives for sales to a developing nation where per capita income may be one tenth of per capita income in the local market are necessarily different from the objectives for Europe or Japan.
The computation of the actual cost of producing a product and bringing it to market or providing a service is the core element in determining whether exporting is financially viable. Many new exporters calculate their export price by the cost-plus method alone. In the cost-plus method of calculation, the exporter starts with the domestic manufacturing cost and adds administration, research and development, overhead, freight forwarding, distributor margins, customs charges, and profit.
The net effect of this pricing approach may be that the export price escalates into an uncompetitive range. For a sample calculation see table 10-1 below. The table shows clearly that if an export product has the same ex-factory price as the domestic product, its final consumer price is considerably higher.
A more competitive method of pricing for market entry is what is termed marginal cost pricing. This method considers the direct, out-of-pocket expenses of producing and selling products for export as a floor beneath which prices cannot be set without incurring a loss. For example, export products may have to be modified for the export market to accommodate different sizes, electrical systems, or labels. Changes of this nature may increase costs. On the other hand, the export product may be a stripped-down version of the domestic product and therefore cost less. Or, if additional products can be produced without increasing fixed costs, the incremental cost of producing additional products for export should be lower than the earlier average production costs for the domestic market.
In addition to production costs, overhead, and research and development, other costs should be allocated to domestic and export products in proportion to the benefit derived from those expenditures. Additional costs often associated with export sales include
- market research and credit checks;
- business travel;
- international postage, cable, and telephone rates;
- translation costs;
- commissions, training charges, and other costs involving foreign representatives;
- consultants and freight forwarders; and
- product modification and special packaging.
After the actual cost of the export product has been calculated, the exporter should formulate an approximate consumer price for the foreign market.
As in the domestic market, demand in the foreign market is a key to setting prices. What will the market bear for a specific product or service?
For most consumer goods, per capita income is a good gauge of a market’s ability to pay. Per capita income for most of the industrialized nations is comparable to that of ours’. For the rest of the world, it is much lower. Some products may create such a strong demand – chic goods such as “Levis,” for example – that even low per capita income will not affect their selling price. However, in most lower per capita income markets, simplifying the product to reduce selling price may be an answer. The firm must also keep in mind that currency valuations alter the affordability of their goods. Thus, pricing should accommodate wild fluctuations in currency, if possible. The firm should also consider who the customers will be. For example, if the firm’s main customers in a developing country are expatriates or the upper class, a high price may work even though the average per capita income is low.
In the domestic market, few companies are free to set prices without carefully evaluating their competitors’ pricing policies. This point is also true in exporting, and it is further complicated by the need to evaluate the competition’s prices in each export market the exporter intends to enter.
Where a particular foreign market is being serviced by many competitors, the exporter may have little choice but to match the going price or even go below it to establish a market share. If the exporter’s product or service is new to a particular foreign market, it may actually be possible to set a higher price than is normally charged domestically.
- Determine the objective in the foreign market.
- Compute the actual cost of the export product.
- Compute the final consumer price.
- Evaluate market demand and competition.
- Consider modifying the product to reduce the export price.
Quotations and Pro Forma invoices
Many export transactions, particularly first-time export transactions, begin with the receipt of an inquiry from abroad, followed by a request for a quotation or a pro forma invoice.
A quotation describes the product, states a price for it, sets the time of shipment, and specifies the terms of sale and terms of payment. Since the foreign buyer may not be familiar with the product, the description of it in an overseas quotation usually must be more detailed than in a domestic quotation. The description should include the following 15 points:
- Buyer’s name and address.
- Buyer’s reference number and date of inquiry.
- Listing of requested products and brief description.
- Price of each item.
- Gross and net shipping weight (in metric units where appropriate).
- Total cubic volume and dimensions (in metric units where appropriate) packed for export.
- Trade discount, if applicable.
- Delivery point.
- Terms of sale.
- Terms of payment.
- Insurance and shipping costs.
- Validity period for quotation.
- Total charges to be paid by customer.
- Estimated shipping date to factory or port.
- Estimated date of shipment arrival.
Sellers are often requested to submit a pro forma invoice with or instead of a quotation. Pro forma invoices are not for payment purposes but are essentially quotations in an invoice format. In addition to the foregoing list of items, a pro forma invoice should include a statement certifying that the pro forma invoice is true and correct and a statement describing the country of origin of the goods. Also, the invoice should be conspicuously marked “pro forma invoice.” These invoices are only models that the buyer uses when applying for an import license or arranging for funds. In fact, it is good business practice to include a pro forma invoice with any international quotation, regardless of whether it has been requested. When final collection invoices are being prepared at the time of shipment, it is advisable to check with reliable source for special invoicing requirements that may prevail in the country of destination.
It is very important that price quotations state explicitly that they are subject to change without notice. If a specific price is agreed upon or guaranteed by the exporter, the precise period during which the offer remains valid should be specified.
Terms of Sale
In any sales agreement, it is important that a common understanding exist regarding the delivery terms. The terms in international business transactions often sound similar to those used in domestic business, but they frequently have very different meanings.
Confusion over terms of sale can result in a lost sale or a loss on a sale. For this reason, the exporter must know the terms before preparing a quotation or a pro forma invoice.
The following are a few of the more common terms used in international trade:
- CIF (cost, insurance, freight) to a named overseas port of import. Under this term, the seller quotes a price for the goods (including insurance), all transportation, and miscellaneous charges to the point of debarkation from the vessel. (Typically used for ocean shipments only.)
- CFR (cost and freight) to a named overseas port of import. Under this term, the seller quotes a price for the goods that includes the cost of transportation to the named point of debarkation. The cost of insurance is left to the buyer’s account. (Typically used for ocean shipments only.)
- CPT (carriage paid to) and CIP (carriage and insurance paid to) a named place of destination. Used in place of CFR and CIF, respectively, for shipment by modes other than water.
- EXW (ex works) at a named point of origin (e.g., ex factory, ex mill, ex warehouse). Under this term, the price quoted applies 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 or within the period fixed. All other charges are for the account of the buyer.
- FAS (free alongside ship) at a named domestic port of export. Under this term, the seller quotes a price for the goods that includes 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.
- FCA (free carrier) to a named place. This term replaces the former “FOB named inland port” to designate the seller’s responsibility for the cost of loading goods at the named shipping point. It may be used for multimodal transport, container stations, and any mode of transport, including air.
- FOB (free on board) at a named port of export. The seller quotes the buyer a price that covers all costs up to and including delivery of goods aboard an overseas vessel.
The exporter should quote CIF whenever possible, because it has meaning abroad. It shows the foreign buyer the cost of getting the product to a port in or near the desired country.
If assistance is needed in figuring the CIF price, an international freight forwarder can provide help to exporting firms. The exporter should furnish the freight forwarder with a description of the product to be exported and its weight and cubic measurement when packed; the freight forwarder can then compute the CIF price. There is usually no charge for this service.
A simple misunderstanding regarding delivery terms may prevent exporters from meeting contractual obligations or make them responsible for shipping costs they sought to avoid. It is important to understand and use delivery terms correctly.