Cost-Oriented Export Pricing
The export price like domestic price structure begins on the factory floor. Apart from manufacturing costs, there is a variety of costs peculiar to export. Special packing, labeling, commission to overseas agent, export credit insurance, duties on the export of the product, port charges, warehousing at port documentation, consular fees, pre-shipment inspection, etc., involve substantial costs. So, cost consideration becomes a prime factor in export pricing methods.
The costs are no doubt important but ‘competitive prices’ should also be considered before fixing the export price. Thus, pricing methods are oriented towards both cost and market considerations. The various methods of pricing the product in foreign markets are divided into cost oriented pricing, market oriented pricing and other methods like dumping and transfer pricing.
Methods of Cost-Oriented Export Pricing
The cost based price has two methods:
- full cost or total cost method; and
- variable cost or marginal cost method.
1. Full cost or total cost method
Full cost method is quite commonly followed in export pricing. Under this method, the export price is determined on the basis of the total cost incurred in manufacturing export products. The total cost is made up of direct cost and fixed costs.
1. Direct costs: Direct cost includes variable and other costs directly related to exports. So, these are studied under two heads, namely, variable costs and other costs directly related to exports.
- variable costs: Variable costs include expenditure on direct materials, direct labour, direct expenses and overheads which are directly variable with the production.
- Other costs directly related to exports: In addition to variable costs, there are some other variable costs which are peculiar to export. These include costs on special packing, labeling, commission to overseas agent, export credit insurance, bank charges, inland freight charges, inland insurance, port charges, duties on export of the product, expenditure on warehousing at port, documentation, consular fees, preshipment inspection, etc.
2. Fixed costs: Fixed costs are those costs which remain constant irrespective of changes in production at a particular level. In international marketing, fixed costs include overheads on production and administration, publicity and advertising, travel abroad, after sale service, etc. From the total costs, compensatory assistance, duty drawback, import replenishment benefits, expenditure on freight and insurance are deducted.
Advantages of full cost pricing
Full cost pricing offers the following advantages:
1. It covers all the costs
2. It is easy to add a target rate of margin to the costs.
3. It is rational and acceptable to all exporters.
4. This method is very simple to understand and operate.
Demerits of full cost pricing
Total cost method suffers from the following disadvantages:
1. It is very difficult to understand the behavior of costs. Sometimes, those costs which remain the same for some manufacturers tend to increase temporarily for others. In this context, the cost based price determined in the case of increased costs may be more than the market price.
2. The prices of the firms which are able to control the cost efficiently will be competitive. Those who are not able to control the cost will have to fix an enhanced price. This involves the risk of losing customers to competitors.
3. The total cost pricing ignored non-cost factors like elasticity and cross elasticity of demand and other market factors.
4. Cost based pricing would not provide a useful basis for determining penetration pricing.
5. Cost based pricing has an in-built rigidity to pricing decisions.
2. Variable cost or marginal cost pricing
Under marginal cost, price is determined on the basis of variable costs (or direct costs), ignoring fixed costs of production. Variable costs are those costs which vary in production to changes in volume of production. These include direct material, direct labour and direct expenses. Fixed expenses remain constant, irrespective of the volume of production up to certain level of activity. While determining the price of the export product, fixed cost is excluded from the calculation of the product’s cost.
Advantages of Variable cost or marginal cost pricing
Following are the important advantages of marginal cost pricing:
1. Marginal costing is realistic when idle capacity exists. In order to attain full capacity utilization, the export order may be executed at a price covering marginal cost and desired margin. Because the domestic sales will take care of fixed expenses which are common both to domestic sales and overseas sales.
2. Price based on marginal cost will be competitive.
3. Marginal cost pricing allows the manufacturer to penetrate market with lower price.
4. Marginal cost pricing contributes to the total sales turnover.
5. Export sales are additional sales. These are not burdened with overhead costs which are ordinarily met from the domestic trade.
Disadvantages of Variable cost or marginal cost pricing
1. Marginal cost pricing is suitable only where idle capacity exists.
2. Marginal cost pricing encourages cut throat competition.
3. Developing countries dump their products in foreign markets by selling at price below the market price.
4. When fixed overhead costs are substantial, marginal cost pricing will not be realistic as it does not cover fixed costs.
5. Once products are sold at a low price, it is difficult to increase the price later.
A word of caution is necessary while adopting marginal cost pricing. Marginal cost provides only a lower limit up to which a firm can reduce its price. The conditions in various markets may be different. In many cases, contribution of the price towards fixed expenses might be essential. Even if marginal cost pricing is unavoidable in certain cases, it cannot be so for a longer period. The long term objective should be to recover not only the direct cost but also to ensure some contribution towards fixed costs as well.