Chapter 17 Outline

Pricing Strategy

International pricing strategy is an important component of the overall international marketing mix. In this section, we look at three aspects of international pricing strategy. First, we examine the case for pursuing price discrimination, charging different prices for the same product in different countries. Second, we look at what might be called strategic pricing. Third, we review some regulatory factors, such as government-mandated price controls and antidumping regulations, that limit a firm's ability to charge the prices it would prefer in a country.

Price Discrimination

Price discrimination exists whenever consumers in different countries are charged different prices for the same product. Price discrimination involves charging whatever the market will bear; in a competitive market, prices may have to be lower than in a market where the firm has a monopoly. Price discrimination can help a company maximize its profits. It makes economic sense to charge different prices in different countries.

Two conditions are necessary for profitable price discrimination. First, the firm must be able to keep its national markets separate. If it cannot do this, individuals or businesses may undercut its attempt at price discrimination by engaging in arbitrage. Arbitrage occurs when an individual or business capitalizes on a price differential for a firm's product between two countries by purchasing the product in the country where prices are lower and reselling it in the country where prices are higher. For example, many automobile firms have long practiced price discrimination in Europe. A Ford Escort once cost $2,000 more in Germany than it did in Belgium. This policy broke down when car dealers bought Escorts in Belgium and drove them to Germany, where they sold them at a profit for slightly less than Ford was selling Escorts in Germany. To protect the market share of its German auto dealers, Ford had to bring its German prices into line with those being charged in Belgium. Ford could not keep these markets separate.

However, Ford still practices price discrimination between Great Britain and Belgium. A Ford car can cost up to $3,000 more in Great Britain than in Belgium. In this Figure 17.2

Elastic and Inelastic Demand Curves

case, arbitrage has not been able to equalize the price, because right-hand-drive cars are sold in Great Britain and left-hand-drive cars in the rest of Europe. Because there is no market for left-hand-drive cars in Great Britain, Ford has been able to keep the markets separate.

The second necessary condition for profitable price discrimination is different price elasticities of demand in different countries. The price elasticity of demand is a measure of the responsiveness of demand for a product to changes in price. Demand is said to be elastic when a small change in price produces a large change in demand; it is said to be inelastic when a large change in price produces only a small change in demand. Figure 17.2 illustrates elastic and inelastic demand curves. Generally, for reasons that will be explained shortly, a firm can charge a higher price in a country where demand is inelastic.

The Determinants of Demand Elasticity

The elasticity of demand for a product in a given country is determined by a number of factors, of which income level and competitive conditions are the two most important. Price elasticity tends to be greater in countries with low income levels. Consumers with limited incomes tend to be very price conscious; they have less to spend, so they look much more closely at price. Thus, price elasticities for products such as television sets are greater in countries such as India, where a television set is still a luxury item, than in the United States, where it is considered a necessity.

In general, the more competitors there are, the greater consumers' bargaining power will be and the more likely consumers will be to buy from the firm that charges the lowest price. Thus, many competitors cause high elasticity of demand. In such circumstances, if a firm raises its prices above those of its competitors, consumers will switch to the competitors' products. The opposite is true when a firm faces few competitors. When competitors are limited, consumers' bargaining power is weaker and price is less important as a competitive weapon. Thus, a firm may charge a higher price for its product in a country where competition is limited than in a country where competition is intense.

Profit Maximizing under Price Discrimination

For those readers with some grasp of economic logic, we can offer a more formal presentation of the above argument. (Readers unfamiliar with basic economic terminology may want to skip this subsection.) Figure 17.3 shows the situation facing a firm that sells the same product in only two countries, Japan and the United States. The

Figure 17.3

Price Discrimination

Japanese market is very competitive, so the firm faces an elastic demand curve (D_J) and marginal revenue curve (MR_J). The US market is not competitive, so there the firm faces an inelastic demand curve (D_U) and marginal revenue curve (MR_U). Also shown in the figure are the firm's total demand curve (D_J+U), total marginal revenue curve (MR_J+U), and marginal cost curve (MC). The total demand curve is simply the summation of the demand facing the firm in Japan and the United States, as is the total marginal revenue curve.

To maximize profits, the firm must produce at the output where MR = MC. In Figure 17.3, this implies an output of 55 units. If the firm does not practice price discrimination, it will charge a price of $43.58 to sell an output of 55 units. Thus, without price discrimination, the firm's total revenues are

$43.58 * 55 = $2,396.90.

Look what happens when the firm decides to engage in price discrimination. It will still produce 55 units, since that is where MR = MC. However, the firm must now allocate this output between the two countries to take advantage of the difference in demand elasticity. Proper allocation of output between Japan and the United States can be determined graphically by drawing a line through their respective graphs at $20 to indicate that $20 is the marginal cost in each country (see Figure 17.3). To maximize profits, prices are now set in each country at that level where the marginal revenue for that country equals marginal costs. In Japan, this is a price of $40, and the firm sells 40 units. In the United States, the optimal price is $65, and it sells 15 units. Thus, reflecting the different competitive conditions, the price charged in the United States is over 50 percent more than the price charged in Japan. Look at what happens to total revenues. With price discrimination, the firm earns revenues of

$40 * 40 units = $1,600

in Japan and

$65 * 15 units = $975

in the United States. By engaging in price discrimination, the firm can earn total revenues of

$1,600 + $975 = $2,575,

which is $178.10 more than the $2,396.90 it earned before. Price discrimination pays!

Strategic Pricing

The concept of strategic pricing has three aspects, which we will refer to as predatory pricing, multipoint pricing, and experience curve pricing. Both predatory pricing and experience curve pricing may be in violation of antidumping regulations. After we review predatory and experience curve pricing, we will look at antidumping rules and other regulatory policies.

Predatory Pricing

Predatory pricing is the use of price as a competitive weapon to drive weaker competitors out of a national market. Once the competitors have left the market, the firm can raise prices and enjoy high profits. For such a pricing strategy to work, the firm must normally have a profitable position in another national market, which it can use to subsidize aggressive pricing in the market it is trying to monopolize. Many Japanese firms have been accused of pursuing this strategy. The argument runs similarly to this: Because the Japanese market is protected from foreign competition by high informal trade barriers, Japanese firms can charge high prices and earn high profits at home. They then use these profits to subsidize aggressive pricing overseas, with the goal of driving competitors out of those markets. Once this has occurred, so it is claimed, the Japanese firms then raise prices. Matsushita has been accused of using this strategy to enter the US TV market. As one of the major TV producers in Japan, Matsushita earned high profits at home. It then used these profits to subsidize the losses it made in the United States during its early years there, when it priced low to increase its market penetration. Ultimately, Matsushita became the world's largest manufacturer of TVs.¹⁷

Multipoint Pricing Strategy

Multi-point pricing becomes an issue when two or more international businesses compete against each other in two or more national markets. For example, multipoint pricing is an issue for Kodak and Fuji Photo because both companies compete against each other in different national markets for film products around the world. Multipoint pricing refers to the fact a firm's pricing strategy in one market may have an impact on its rivals' pricing strategy in another market. Aggressive pricing in one market may elicit a competitive response from a rival in another market. In the case of Kodak and Fuji, Fuji launched an aggressive competitive attack against Kodak in the American company's home market in January 1997, cutting prices on multiple-roll packs of 35mm film by as much as 50 percent.¹⁸ This price cutting resulted in a 28 percent increase in shipments of Fuji color film during the first six months of 1997, while Kodak's shipments dropped by 11 percent. This attack created a dilemma for Kodak; the company did not want to start price discounting in its largest and most profitable market. Kodak's response was to aggressively cut prices in Fuji's largest market, Japan. This strategic response recognized the interdependence between Kodak and Fuji and the fact that they compete against each other in many different nations. Fuji responded to Kodak's counterattack by pulling back from its aggressive stance in the United States.

The Kodak story illustrates an important aspect of multipoint pricing--aggressive pricing in one market may elicit a response from rivals in another market. The firm needs to consider how its global rivals will respond to changes in its pricing strategy before making those changes. A second aspect of multipoint pricing arises when two or more global companies focus on particular national markets and launch vigorous price wars in those markets in an attempt to gain market dominance. In the Brazil market for disposable diapers, two US companies, Kimberly-Clark Corp. and Procter & Gamble, entered a price war as each struggled to establish dominance in the market.¹⁹ As a result, the cost of disposable diapers fell from $1 per diaper in 1994 to 33 cents per diaper in 1997, while several other competitors, including indigenous Brazilian firms, were driven out of the market. Kimberly-Clark and Procter & Gamble are engaged in a global struggle for market share and dominance, and Brazil is one of their battlegrounds. Both companies can afford to engage in this behavior, even though it reduces their profits in Brazil, because they have profitable operations elsewhere in the world that can subsidize these losses.

Pricing decisions around the world need to be centrally monitored. It is tempting to delegate full responsibility for pricing decisions to the managers of various national subsidiaries, thereby reaping the benefits of decentralization (see Chapter 13 for a discussion). However, because pricing strategy in one part of the world can elicit a competitive response in another part, central management needs to at least monitor and approve pricing decisions in a given national market, and local managers need to recognize that their actions can affect competitive conditions in other countries.

Experience Curve Pricing

We first encountered the experience curve in Chapter 12. As a firm builds its accumulated production volume over time, unit costs fall due to "experience effects." Learning effects and economies of scale underlie the experience curve. Price comes into the picture because aggressive pricing (along with aggressive promotion and advertising) can build accumulated sales volume rapidly and thus move production down the experience curve. Firms further down the experience curve have a cost advantage vis-à-vis firms further up the curve.

Many firms pursuing an experience curve pricing strategy on an international scale price low worldwide in attempting to build global sales volume as rapidly as possible, even if this means taking large losses initially. Such a firm believes that several years in the future, when it has moved down the experience curve, it will be making substantial profits and have a cost advantage over its less-aggressive competitors.

Regulatory Influences on Prices

The ability to engage in either price discrimination or strategic pricing may be limited by national or international regulations. Most important, a firm's freedom to set its own prices is constrained by antidumping regulations and competition policy.

Antidumping Regulations

Both predatory pricing and experience curve pricing can run afoul of antidumping regulations. Dumping occurs whenever a firm sells a product for a price that is less than the cost of producing it. Most regulations, however, define dumping more vaguely. For example, a country is allowed to bring antidumping actions against an importer under Article 6 of GATT as long as two criteria are met: sales at "less than fair value" and "material injury to a domestic industry." The problem with this terminology is that it does not indicate what is a fair value. The ambiguity has led some to argue that selling abroad at prices below those in the country of origin, as opposed to below cost, is dumping.

Such logic led the Bush administration to place a 25 percent duty on imports of Japanese light trucks in 1988. The Japanese manufacturers protested that they were not selling below cost. Admitting that their prices were lower in the United States than in Japan, they argued that this simply reflected the intensely competitive nature of the US market (i.e., different price elasticities). In a similar example, the European Commission found Japanese exporters of dot-matrix printers to be violating dumping regulations. To correct what they saw as dumping, the EU placed a 47 percent import duty on imports of dot-matrix printers from Japan and required that the import duty be passed on to European consumers as a price increase.²⁰

Antidumping rules set a floor under export prices and limit firms' ability to pursue strategic pricing. The rather vague terminology used in most antidumping actions suggests that a firm's ability to engage in price discrimination also may be challenged under antidumping legislation.

Competition Policy

Most industrialized nations have regulations designed to promote competition and to restrict monopoly practices. These regulations can be used to limit the prices a firm can charge in a given country. For example, during the 1960s and 70s, the Swiss pharmaceutical manufacturer Hoffmann-LaRoche had a monopoly on the supply of Valium and Librium tranquilizers. The company was investigated in 1973 by the British Monopolies and Mergers Commission, which is responsible for promoting fair competition in Great Britain. The commission found that Hoffmann-LaRoche was overcharging for its tranquilizers and ordered the company to reduce its prices 35 to 40 percent. Hoffmann-LaRoche maintained unsuccessfully that it was merely engaging in price discrimination. Similar actions were later brought against Hoffmann-LaRoche by the German cartel office and by the Dutch and Danish governments.²¹