17: Personal Selling and Sales Management

Global Perspective: INTERNATIONAL ASSIGNMENTS ARE GLAMOROUS, RIGHT?

“Glamorous” is probably not the adjective the following executives would use.

The problem as I see it with the company’s talk about international managers is that they were just paying lip service to it. When I applied for the posting to Malaysia they gave me all this stuff about the assignment being a really good career move and how I’d gain this valuable international experience and so on. And don’t get me wrong, we really enjoyed the posting. We loved the people and the culture and the lifestyle and when it came back to returning home, we weren’t really all that keen. . . . The problem was that while I had been away, the company had undergone a wholesale restructuring. . . . This meant that when I got back, my job had been effectively eliminated.

We have been in the United States for eleven months and I reckon it will be another six to twelve months before my wife and the kids are really settled here. I’m still learning new stuff every day at work and it has taken a long time to get used to American ways of doing things. . . . I mean if the company said, “Oh, we want you to move to South Africa in a year’s time,” I would really dig my heels in because it was initially very disruptive for my wife when she first came here.

And “glamorous” would not be on the tip of these expatriate spouses’ tongues either:

I found I haven’t adapted to Spanish hours. I find it a continual problem because the 2–5 p.m. siesta closure is really awkward. I always find myself where I have to remind myself that from 2–5 I have a blank period that I can’t do anything. . . . We started adjusting to the eating schedule. Whether we like it or not, we eat a lot later.

We’ve been really fortunate we haven’t had to use health care services here. . . . The thought of going to, needing to go to a doctor is scary because for me it would have to be someone English speaking or I wouldn’t, you know, feel comfortable.

Given these kinds of problems, is that international sales position being offered to you as attractive as it looks? Will it really help your career?

Sources: Nick Forster, “The Myth of the ‘International Manager,’” International Journal of Resource Management 11, no. 1 (February 2000), pp. 126–42; Mary C. Gilly, Lisa Peñaloza, and Kenneth M. Kambara, “The Role of Consumption in Expatriate Adjustment and Satisfaction,” working paper, Paul Merage School of Business, University of California, Irvine, 2008.

The salesperson is a company’s most direct tie to the customer; in the eyes of most customers, the salesperson is the company. As presenter of company offerings and gatherer of customer information, the sales representative is the final link in the culmination of a company’s marketing and sales efforts.

Growing global competition, coupled with the dynamic and complex nature of international business, increases both the need and the means for closer ties with both customers and suppliers. Particularly in relationship-based cultures such as China, relationship marketing, built on effective communications between the seller and buyer, focuses on building long-term alliances rather than treating each sale as a one-time event.1 Advances in information technology are allowing for increasingly higher levels of coordination across advertising, marketing research, and personal selling efforts, yielding new roles and functions in customer relationship management (CRM).2 Similarly, such advances are changing the nature of personal selling and sales management, leading some to forecast substantial reductions in field sales efforts.

In this ever-changing environment of international business, the tasks of designing, building, training, motivating, and compensating an international sales group generate unique problems at every stage of management and development. This chapter discusses the alternatives and problems of managing sales and marketing personnel in foreign countries. Indeed, these problems are among the most difficult facing international marketers. In one survey of CEOs and other top executives, the respondents identified “establishing sales and distribution networks” and “cultural differences” as major difficulties in international operations.

Designing the Sales Force

The first step in managing a sales force is its design. Based on analyses of current and potential customers, the selling environment, competition, and the firm’s resources and capabilities, decisions must be made regarding the numbers, characteristics, and assignments of sales personnel. All these design decisions are made more challenging by the wide variety of pertinent conditions and circumstances in international markets. Moreover, the globalization of markets and customers, as illustrated by the IBM–Ford story in Crossing Borders 17.1, makes the job of international sales manager quite interesting.

As described in previous chapters, distribution strategies will often vary from country to country. Some markets may require a direct sales force, whereas others may not. How customers are approached can differ as well. For example, banks are placing sales representatives in Russian appliance stores to sell credit, a new concept there. The hard sell that may work in some countries can be inappropriate in others. Automobiles have been sold door to door in Japan for years, and only recently have stocks been sold over the Internet in Europe. More than 100,000 of Singapore’s 6 million inhabitants are involved in home product sales and other forms of multilevel marketing. The size of accounts certainly makes a difference as well—notice in Crossing Borders 17.1 that an IBM sales representative works inside Ford. Selling high-technology products may allow for the greater use of American expatriates, whereas selling consulting services will tend to require more participation by native sales representatives. Selling in information-oriented cultures such as Germany may also allow for greater use of expatriates. However, relationship-oriented countries such as Japan will require the most complete local knowledge possessed only by natives. Writing about Japan, two international marketing experts agree: “Personal selling as a rule has to be localized for even the most global of corporations and industries.”3

CROSSING BORDERS 17.1: Sales Force Management and Global Customers

Did IBM really need a major overhaul to its sales compensation plan? For proof, just ask Kevin Tucker. Tucker, an IBM global account manager dedicated to Ford Motor Company, closed a $7 million sale with the automotive giant’s European operations. Ford wanted Tucker and his team of IBM representatives to install networking systems in its engineering facilities. The systems would run the applications that design the company’s automobiles.

Ford’s installation required help from an IBM sales executive in Germany, the project’s headquarters. So Tucker, whose office sits in Ford’s Dearborn, Michigan, headquarters, sent an e-mail requesting the executive’s assistance. And that’s when things turned ugly. Although the rep in Germany did not turn his back on the project, his initial reaction was less than enthusiastic. Ford wanted the systems installed throughout Europe, yet the compensation plan for IBM’s Germany-based reps rewarded only the systems that were installed in that country. With 80 percent of the work scheduled outside of Germany, the executive was left wondering: Where’s the payoff? Tucker and other IBM sales incentive managers wasted three weeks discussing ways to maximize the rep’s incentive. Energy that could have been focused on the customer was wasted on a pay plan. “Ford was world-centric, we were country-centric,” Tucker says. “The team in Germany was asking, ‘Kevin, how can you make us whole?’”

They were not the only salespeople asking that question at IBM. Tucker’s predicament represents just one of many problems that were rooted in IBM’s “$72 billion” sales incentive plan—a plan that had been obviously put on the back burner as the company giant tinkered with its vision.

Bob Wylie, manager of incentive strategies for IBM Canada, says, “There was the attitude that if it’s outside my territory and outside my measurements, I don’t get paid for it, and I don’t get involved. What’s in my pay plan defines what I do.” Not the best setup for a company that operates in 165 countries.

Apparently, IBM has solved many of these problems. Ford signed contracts for more than $300 million with IBM to create almost all of the car company’s software, including Internet and e-commerce applications in Europe and North America. Details about IBM’s global sales compensation program are provided later in this chapter. And IBM continues its impressive sales force coverage in burgeoning new markets like India, where it now employs more than 50,000 professionals who are generating almost $1 billion in revenues.

Sources: Michele Marchetti, “Gamble: IBM Replaced Its Outdated Compensation Plan with a Worldwide Framework. Is It Paying Off?” Sales & Marketing Management, July 1996, pp. 65–69; “Ford Motor and IBM,” The Wall Street Journal Europe, January 13, 1999, p. UK5A; “IBM Aims at $1-b India Revenue by Year-End,” Business Line (The Hindu), December 9, 2007.

Once decisions have been made about how many expatriates, local nationals, or third-country nationals a particular market requires, the more intricate aspects of design can be undertaken, such as territory allocation and customer call plans. Many of the most advanced operations research tools developed in the United States can be applied in foreign markets, with appropriate adaptation of inputs, of course. For example, one company has provided tools to help international firms create balanced territories and find optimal locations for sales offices in Canada, Mexico, and Australia.4 However, the use of such high-tech resource allocation tools requires intricate knowledge of not only geographical details but also appropriate call routines. Many things can differ across cultures—the length of sales cycles, the kinds of customer relationships, and the types of interactions with customers. Indeed, more than one study has identified substantial differences in the importance of referrals in the sales of industrial services in Japan vis-à-vis the United States.5 The implications are that in Japan, sales calls must be made not only on customers but also on the key people, such as bankers, in the all-important referral networks.

Recruiting Marketing and Sales Personnel

The number of marketing management personnel from the home country assigned to foreign countries varies according to the size of the operation, the availability of qualified locals, and other firm characteristics.6 Increasingly, the number of U.S. home-country nationals (expatriates) assigned to foreign posts is smaller as the pool of trained, experienced locals grows.

The largest personnel requirement abroad for most companies is the sales force, recruited from three sources: expatriates, local nationals, and third-country nationals. A company’s staffing pattern may include all three types in any single foreign operation, depending on qualifications, availability, and company needs. Sales and marketing executives can be recruited via the traditional media of advertising (including newspapers, magazines, job fairs, and the Internet), employment agencies or executive search firms,7 and the all-important personal referrals. The last source will be crucial in many foreign countries, particularly the relationship-oriented ones.

Expatriates

The number of companies relying on expatriate personnel is declining as the volume of world trade increases and as more companies use locals to fill marketing positions. However, when products are highly technical, or when selling requires an extensive background of information and applications, an expatriate sales force remains the best choice. The expatriate salesperson may have the advantages of greater technical training, better knowledge of the company and its product line, and proven dependability. Because they are not locals, expatriates sometimes add to the prestige of the product line in the eyes of foreign customers. And perhaps most important, expatriates usually are able to effectively communicate with and influence headquarters personnel.

The chief disadvantages of an expatriate sales force are the high cost, cultural and legal barriers, and the limited number of high-caliber personnel willing to live abroad for extended periods. Employees are reluctant to go abroad for many reasons: Some find it difficult to uproot families for a two- or three-year assignment, increasing numbers of dual-career couples often require finding suitable jobs for spouses, and many executives believe such assignments impede their subsequent promotions at home. Recall the comments of the executives in the Global Perspective. The loss of visibility at corporate headquarters plus the belief that “out of sight is out of mind” are major reasons for the reluctance to accept a foreign assignment. Companies with well-planned career development programs have the least difficulty. Indeed, the best international companies make it crystal clear that a ticket to top management is an overseas stint. Korn/Ferry International reports in a survey of 75 senior executives from around the world that “international experience” is the attribute identified as second most important for CEOs—experience in marketing and finance positions were first and third, respectively.8

Expatriates commit to foreign assignments for varying lengths of time, from a few weeks or months to a lifetime. Some expatriates have one-time assignments (which may last for years), after which they return to the parent company; others are essentially professional expatriates, working abroad in country after country. Still another expatriate assignment is a career-long assignment to a given country or region; this assignment is likely to lead to assimilation of the expatriate into the foreign culture to such an extent that the person may more closely resemble a local than an expatriate. Because expatriate marketing personnel are likely to cost substantially more than locals, a company must be certain of their effectiveness.

More and more American companies are taking advantage of American employees who are fluent in languages other than English. For example, many U.S. citizens speak Spanish as their first language. The large number of Puerto Ricans working for American multinationals in places like Mexico City is well documented. Recent immigrants and their sons and daughters who learn their parents’ languages and about their native cultures will continue to be invaluable assets for firms wishing to enter such markets. Certainly ethnic Chinese- and Vietnamese-Americans are serving as cultural bridges for commerce with those two nations. Indeed, throughout history patterns of commerce have always followed paths of immigration.

Virtual Expatriates

The Internet and other advances in communications technologies, along with the growing reluctance of executives to move abroad, are creating a new breed of expatriate, the virtual one. According to a PricewaterhouseCoopers survey of 270 organizations, there has been a substantial increase in shorter-term, commute, and virtual assignments in recent years. Virtual expatriates manage operations in other countries but do not move there.9 They stay in hotels, make long visits, and maintain their families at home. Some spend up to 75 percent of their working time traveling. None leave home without the ubiquitous laptop and cell phone.

Close contact with subordinates and customers is, of course, tougher for virtual expatriates. Moreover, the travel can be a killer—that is, foreign bugs are often more virulent and easier to catch on long international flights (indeed, one doctor calls airplanes “germ tubes”), crime against expatriates and travelers in foreign cities is a real hazard, traffic and short-hop flights in less developed countries are dangerous,10 and living in hotels is lonely. However, virtual expatriates’ families do not have to be uprooted, and executives can stay in closer touch with the home office. Finally, from the firm’s perspective, a virtual assignment may be the only option and often a good way to avoid the extra expenses of an actual executive move.

Local Nationals

A worker cleans an American Airlines plane detained at San Jose International Airport in California after a nonstop flight from Tokyo in which several passengers complained of symptoms similar to SARS, or severe acute respiratory syndrome. Officials found no threat after isolating passengers and crew for two hours. International travel can be a lot of work! (© David Paul Morris/Getty Images)

The historical preference for expatriate managers and salespeople from the home country is giving way to a preference for local nationals. At the sales level, the picture is clearly biased in favor of the locals because they transcend both cultural11 and legal barriers. More knowledgeable about a country’s business structure and systems12 than an expatriate would be, local salespeople are better able to lead a company through the maze of unfamiliar distribution systems and referral networks. Furthermore, pools of qualified foreign personnel available in some places cost less to maintain than a staff of expatriates.

In Europe and Asia, many locals have earned MBA degrees in the United States; thus a firm gets the cultural knowledge of the local meshed with an understanding of U.S. business management systems. Although expatriates’ salaries may be no more than those of their national counterparts, the total cost of keeping comparable groups of expatriates in a country can be considerably higher (often three times the expense) because of special cost-of-living benefits, moving expenses, taxes, and other costs associated with keeping an expatriate abroad. As can be seen in Exhibit 17.1, only one of the most expensive cities in the world is in the United States.

Exhibit 17.1: The World’s 20 Most Expensive Cities (in order)

The main disadvantage of hiring local nationals is the tendency of headquarters personnel to ignore their advice. Even though most foreign nationals are careful to keep relationships at the home office warm, their influence is often reduced by their limited English communication skills and lack of understanding of how home-office politics influence decision making. Another key disadvantage can be their lack of availability; one CEO of a consulting firm that specializes in recruiting managers in China reports that ten openings exist for every one qualified applicant. Moreover, whereas in the United States hiring experienced salespeople from competitors, suppliers, or vendors is common practice, the same approach in other countries may not work. In places like Japan, employees are much more loyal to their companies and therefore are difficult to lure away even for big money. College recruits can also be hard to hire in Japan because the smartest students are heavily recruited by the largest Japanese firms. Smaller firms and foreign firms are seen in Japan as much more risky employment opportunities.

Locals hit the road. Japanese salesmen save on expenses in this “capsule hotel” in Osaka. Meanwhile, the Avon Lady calls on a customer in rural Brazil. (left: © Roger Ressmeyer/Corbis; right: © John Maier, Jr./The Image Works)

One other consideration makes recruiting of local nationals as sales representatives more difficult in many foreign countries. We all know about Americans’ aversion to being a salesperson. Personal selling is often derided as a career and represented in a negative light in American media—Arthur Miller’s Death of a Salesman is of course the best example. Despite the bad press, however, personal selling is the most common job in the United States. Indeed, the United States has been described as “a nation of salesmen.”13 But as negatively as the selling profession is viewed in the United States, in many other countries, it is viewed in even worse ways. Particularly in the more relationship-oriented cultures such as France, Mexico, and Japan, sales representatives tend to be on the bottom rung of the social ladder. Thus recruiting the brightest people to fill sales positions in foreign operations can be very difficult indeed.

CROSSING BORDERS 17.2: Avon Calling—or Not?

In a gold-mining town near an Amazon tributary, Maria de Fatima Nascimento ambles among mud shacks hawking Honesty and Care Deeply, two beauty products by Avon. She is part of a several-thousand-member Avon army that travels via foot, kayak, river-boat, and small plane through the Amazon Basin. Latin America accounts for 35 percent of Avon’s total sales, with Brazil being the firm’s number two market after the United States; its success can be attributed to the company’s willingness to adapt to local conditions. Cash payments are not required; many Brazilian customers barter for products with fruit, eggs, flour, or wood.

Two dozen eggs buys a Bart Simpson roll-on deodorant, and miners pay from 1 to 4 grams of gold powder or nuggets for fragrances like Sweet Crystal Splash. “Ladies of the evening,” who regard the cosmetics as a cost of doing business, are some of Nascimento’s better customers. But then, so are miners. As one commented, “It’s worth 1½ grams of gold to smell nice.”

Despite the success of the Bart Simpson roll-on in some parts of the world, Avon is not rolling along in the old-fashioned way in others. In 1998 at least ten people were killed in China during antigovernment rioting in several cities. Many of the rioters were among the country’s 200,000 Avon ladies. The Chinese government had banned direct selling, complaining in a directive that such practices spawn “weird cults, triads, superstitious groups, and hooliganism.” Worse yet, the authorities criticized meetings of direct marketers that involved singing, chanting, and inspirational sermons. The People’s Daily once even complained that direct sales encouraged “excessive hugging”!

The latest and perhaps most serious threat to the 2.6 million Avon ladies working worldwide in 135 countries is the Internet. Many fret that Avon.com may replace “Ding dong, it’s Avon calling.” But, no matter what, Avon’s international sales keep rolling along.

Sources: “Avon Calling Near the Amazon,” U.S. News & World Report, October 25, 1994, pp. 16–17; Andrew Higgins, “Avon Calling? Not in China,” The Guardian, May 1, 1998, p. 18; Kate Quill, “Ding Dong, Gone . . . Farewell Avon Lady?” Times (London), February 7, 2000, p. 7; “Avon Invests in Perfumes and Cosmetics to Grow in Brazil,” Gazeta Mercantil, March 12, 2008.

Third-Country Nationals

The internationalization of business has created a pool of third-country nationals (TCNs), expatriates from their own countries working for a foreign company in a third country. The TCNs are a group whose nationality has little to do with where they work or for whom. An example would be a German working in Argentina for a U.S. company. Historically, few expatriates or TCNs spent the majority of their careers abroad, but now a truly “global executive” has begun to emerge. The recently appointed chairman of a division of a major Netherlands company is a Norwegian who gained that post after stints in the United States, where he was the U.S. subsidiary’s chairman, and in Brazil, where he held the position of general manager. At one time, Burroughs Corporation’s Italian subsidiary was run by a French national, the Swiss subsidiary by a Dane, the German subsidiary by an Englishperson, the French subsidiary by a Swiss, the Venezuelan subsidiary by an Argentinean, and the Danish subsidiary by a Dutch person.

American companies often seek TCNs from other English-speaking countries to avoid the double taxation costs of their American managers. Americans working in Spain, for example, must pay both Spanish and U.S. income taxes, and most American firms’ compensation packages for expatriates are adjusted accordingly. So, given the same pay and benefits, it is cheaper for an American firm to post a British executive in Spain than an American.

Overall, the development of TCN executives reflects not only a growing internationalization of business but also an acknowledgment that personal skills and motivations are not the exclusive property of one nation. These TCNs often are sought because they speak several languages and know an industry or foreign country well. More and more companies feel that talent should flow to opportunity, regardless of one’s home country.

Host-Country Restrictions

The host government’s attitudes toward foreign workers often complicate selecting expatriate U.S. nationals over locals. Concerns about foreign corporate domination, local unemployment, and other issues cause some countries to restrict the number of non-nationals allowed to work within the country. Most countries have specific rules limiting work permits for foreigners to positions that cannot be filled by a national. Furthermore, the law often limits such permits to periods just long enough to train a local for a specific position. Such restrictions mean that MNCs have fewer opportunities for sending home-country personnel to management positions abroad.

In earlier years, personnel gained foreign-country experience by being sent to lower management positions to gain the necessary training before eventually assuming top-level foreign assignments. Most countries, including the United States, control the number of foreigners allowed to work or train within their borders. Since September 11, 2001, U.S. immigration authorities have clamped down even harder on the issuance of all kinds of work visas.

Selecting Sales and Marketing Personnel

To select personnel for international marketing positions effectively, management must define precisely what is expected of its people. A formal job description can aid management in expressing long-range as well as current needs. In addition to descriptions for each marketing position, the criteria should include special requirements indigenous to various countries.

People operating in the home country need only the attributes of effective salespersons, whereas a transnational management position can require skills and attitudes that would challenge a diplomat. International personnel requirements and preferences vary considerably.14 However, some basic requisites leading to effective performance should be considered because effective executives and salespeople, regardless of what foreign country they are operating in, share certain personal characteristics, skills, and orientations.

Maturity is a prime requisite for expatriate and third-country personnel. Managers and sales personnel working abroad typically must work more independently than their domestic counterparts. The company must have confidence in their ability to make ethical15 decisions and commitments without constant recourse to the home office, or they cannot be individually effective.

International personnel require a kind of emotional stability not demanded in domestic sales positions.16 Regardless of location, these people are living in cultures dissimilar to their own; to some extent they are always under scrutiny and always aware that they are official representatives of the company abroad. They need sensitivity to behavioral variations in different countries, but they cannot be so hypersensitive that their behavior is adversely affected.

Managers or salespeople operating in foreign countries need considerable breadth of knowledge of many subjects both on and off the job. The ability to speak one or more other languages is always preferable.

The marketer who expects to be effective in the international marketplace needs to have a positive outlook on an international assignment. People who do not like what they are doing and where they are doing it stand little chance of success, particularly in a foreign country. Failures usually are the result of overselling the assignment, showing the bright side of the picture, and not warning about the bleak side.

An international salesperson must have a high level of flexibility, whether working in a foreign country or at home. Expatriates working in a foreign country must be particularly sensitive to the habits of the market; those working at home for a foreign company must adapt to the requirements and ways of the parent company.

Successful adaptation in international affairs is based on a combination of attitude and effort. A careful study of the customs of the market country should be initiated before the marketer arrives and should be continued as long as facets of the culture are not clear. One useful approach is to listen to the advice of national and foreign businesspeople operating in that country. Cultural empathy is clearly a part of the basic orientation, because anyone who is antagonistic or confused about the environment is unlikely to be effective.17

Finally, international sales and marketing personnel must be energetic and enjoy travel. Many international sales representatives spend about two-thirds of their nights in hotel rooms around the world. Going through the long lines of customs and immigration after a 15-hour flight requires a certain kind of stamina not commonly encountered. Some argue that frequent long flights can damage your health. Even the seductive lights of Paris nights fade after the fifth business trip there.

Most of these traits can be assessed during interviews and perhaps during role-playing exercises. Paper-and-pencil ability tests, biographical information, and reference checks are of secondary importance. Indeed, as previously mentioned, in many countries, referrals will be the best way to recruit managers and sales representatives, making reference checks during evaluation and selection processes irrelevant.

There is also evidence that some traits that make for successful sales representatives in the United States may not be important in other countries. One study compared sales representatives in the electronics industries in Japan and the United States. For the American representatives, pay and education were both found to be positively related to performance and job satisfaction. In Japan, they were not. That is, the Americans who cared more about money and were more educated tended to perform better and be more satisfied with their sales jobs. Conversely, the Japanese sales representatives tended to be more satisfied with their jobs when their values were consistent with those of their company.18 The few systematic studies in this genre suggest that selection criteria must be localized, and American management practices must be adapted to foreign markets.

International sales is hard work. A typical week for this Canadian executive looks like this: Leave Singapore with the flu. Arrive home in Toronto to discover that a frozen pipe has burst. Immediately board a plane for a two-day trip to Chicago. Back to Toronto. On to Detroit, battling jet lag and the flu. Back to Toronto, running through the Detroit airport “like O.J. in the Hertz commercial” and throwing his briefcase into a closing door. Take a brief break in flooded house before boarding another plane to China. Reports waking up in a plane and asking his seatmate where they were landing. Seventeen flights in two weeks left him a bit confused. (© David McIntyre/Stock Photo)

Selection mistakes are costly. When an expatriate assignment does not work out, hundreds of thousands of dollars are wasted in expenses and lost time. Getting the right person to handle the job is also important in the selection of locals to work for foreign companies within their home country. Most developing countries and many European countries have stringent laws protecting workers’ rights. These laws are specific as to penalties for the dismissal of employees. Perhaps Venezuela has the most stringent dismissal legislation: With more than three months of service in the same firm, a worker gets severance pay amounting to one month’s pay at severance notice plus 15 days’ pay for every month of service exceeding eight months plus an additional 15 days’ pay for each year employed. Furthermore, after an employee is dismissed, the law requires that person be replaced within 30 days at the same salary. Colombia and Brazil have similar laws that make employee dismissal a high-cost proposition.

Finally, new evidence indicates that a manager’s culture affects personnel decisions. In a new line of international sales management research, one study reports “that managers given an identical [personnel selection] problem do not make the same decisions nor do they value the criteria often used in recruitment and promotion decisions equally. For example, they found that Austrian and German managers are more likely to hire compatriots than Italian managers.”19 Thus we are just scratching the surface of a variety of issues in the area of international sales management research.

Training for International Marketing

The nature of a training program depends largely on both the home culture of the salesperson20 and the culture of the business system in the foreign market.21 Also important is whether expatriate or local personnel will be representing the firm. Training for expatriates focuses on the customs and the special foreign sales problems that will be encountered, whereas local personnel require greater emphasis on the company, its products, technical information, and selling methods. In training either type of personnel, the sales training activity is burdened with problems stemming from long-established behavior and attitudes. Local personnel, for instance, cling to habits continually reinforced by local culture. Nowhere is the problem greater than in China or Russia, where the legacy of the communist tradition lingers. The attitude that whether you work hard or not, you get the same rewards, has to be changed if training is going to stick. Expatriates are also captives of their own habits and patterns. Before any training can be effective, open-minded attitudes must be established.

Exhibit 17.2: Personal Selling Tips, from Brussels to Bangkok

Continual training may be more important in foreign markets than in domestic ones because of the lack of routine contact with the parent company and its marketing personnel. In addition, training of foreign employees must be tailored to the recipients’ ways of learning and communicating. For example, the Dilbert cartoon characters theme that worked so well in ethics training courses with a company’s American employees did not translate well in many of its foreign offices.

One aspect of training is frequently overlooked: Home-office personnel dealing with international marketing operations need training designed to make them responsive to the needs of the foreign operations. The best companies provide home-office personnel with cross-cultural training and send them abroad periodically to increase their awareness of the problems of the foreign operations.

The Internet now makes some kinds of sales training much more efficient. Users can study text onscreen and participate in interactive assessment tests. Sun Microsystems estimates that its use of the Internet can shorten training cycles by as much as 75 percent. And in some parts of the world where telecommunications facilities are more limited, CD-ROM approaches have proven quite successful. Lockheed Martin uses an interactive CD-ROM–based system to train its employees worldwide on the nuances of the Foreign Corrupt Practices Act and associated corporate policies and ethics.

Motivating Sales Personnel

Motivation is especially complicated because the firm is dealing with different cultures, different sources, and different philosophies.22 Marketing is a business function requiring high motivation regardless of the location of the practitioner. Marketing managers and sales managers typically work hard, travel extensively, and have day-to-day challenges. Selling is hard, competitive work wherever undertaken, and a constant flow of inspiration is needed to keep personnel functioning at an optimal level. National differences must always be considered in motivating the marketing force.23 In one study, sales representatives in comparable Japanese and American sales organizations were asked to allocate 100 points across an array of potential rewards from work.24 As shown in Exhibit 17.3, the results were surprisingly similar. The only real difference between the two groups was in social recognition, which, predictably, the Japanese rated as more important. However, the authors of the study concluded that though individual values for rewards may be similar, the social and competitive contexts still require different motivational systems.

Exhibit 17.3: Salespeople’s Distribution of 100 Points among Rewards in Terms of Their Importance

CROSSING BORDERS 17.3: How Important Are Those Meetings?

In Japan, they’re really important. A former American sales manager tells this story:

I worked as general manager of the Japanese subsidiary of an American medical equipment company. Our office was in downtown Tokyo, which made for a two-hour commute for most of our salesmen. Rather than have them come into the office before beginning sales calls every day, I instructed them to go to their appointments directly from home and to come to the office only for a weekly sales meeting. Although this was a common way for a U.S. sales force to operate, it was a disaster in Japan. Sales fell, as did morale. I quickly changed the policy and had everyone come to the office every day. Sales immediately climbed as the salesmen reinforced their group identity.

Now contrast that with how sales representatives are managed at Hewlett-Packard in the United States, as described by one of its sales executives: “We’re really looking at this issue of work/family balance. If someone wants to work at home, they can, and we’ll outfit their home offices at our expense, provided they have a good reason to want to work at home. If you want to drive productivity, getting people’s work lives and home lives in balance is key.”

Sam Palmisano, IBM’s new CEO, puts it even more strongly: “To win, our players have to be on the field. We can’t win the game in the locker room. . . . We want our people on the field in front of the customers, not in conference rooms talking to their managers or other staff organizations.” At IBM, a new corporate policy limits sales meeting to one per week.

Sources: Clyde V. Prestowitz, Trading Places—How We Are Giving Away Our Future to Japan and How to Reclaim It (New York: Basic Books, 1989); Geoffrey Brewer et al., “The Top (25 Best Sales Forces in the U.S.),” Sales & Marketing Management, November 1, 1996, p. 38; Erin Strout, “Blue Skies Ahead?” Sales & Marketing Management, March 1, 2003, pp. 24–26; http://www.ibm.com, 2008.

Because the cultural differences reviewed in this and previous chapters affect the motivational patterns of a sales force, a manager must be extremely sensitive to the personal behavior patterns of employees.25 Individual incentives that work effectively in the United States can fail completely in other cultures. For example, with Japan’s emphasis on paternalism and collectivism and its system of lifetime employment and seniority, motivation through individual incentives does not work well because Japanese employees seem to derive the greatest satisfaction from being comfortable members of a group. Thus an offer of an individual financial reward for outstanding individual effort could be turned down because an employee would prefer not to appear different from peers and possibly attract their resentment. Japanese bonus systems are therefore based on group effort, and individual commission systems are rare. Japanese sales representatives are motivated more by the social pressure of their peers than by the prospect of making more money based on individual effort. Likewise, compensation packages in eastern European countries typically involve a substantially greater emphasis on base pay than in the United States, and performance-based incentives have been found to be less effective. Although some point out that motivational practices are changing even in Japan, such patterns do not change very quickly or without substantial efforts.

Part of the corporate culture (some say peer pressure) that motivates Japanese sales representatives is the morning calisthenics. (© Tom Wagner/Corbis)

Communications are also important in maintaining high levels of motivation; foreign managers need to know that the home office is interested in their operations, and in turn, they want to know what is happening in the parent country. Everyone performs better when well informed. However, differences in languages, culture, and communication styles26 can make mutual understanding between managers and sales representatives more difficult.

Because promotion and the opportunity to improve status are important motivators, a company needs to make clear the opportunities for growth within the firm. In truly global firms, foreign nationals can aspire to the highest positions in the firm. Likewise, one of the greatest fears of expatriate managers, which can be easily allayed, is that they will be forgotten by the home office. Blending company sales objectives and the personal objectives of the salespeople and other employees is a task worthy of the most skilled manager. The U.S. manager must be constantly aware that many of the techniques used to motivate U.S. personnel and their responses to these techniques are based on the seven basic cultural premises discussed in Chapter 5. Therefore, each method used to motivate a foreigner should be examined for cultural compatibility.

Designing Compensation Systems

For Expatriates

Developing an equitable and functional compensation plan that combines balance, consistent motivation, and flexibility is extremely challenging in international operations. This challenge is especially acute when a company operates in a number of countries, when it has individuals who work in a number of countries, or when the sales force is composed of expatriate and local personnel.27 Fringe benefits play a major role in many countries. Those working in high-tax countries prefer liberal expense accounts and fringe benefits that are nontaxable instead of direct income subject to high taxes. Fringe-benefit costs are high in Europe, ranging from 35 to 60 percent of salary.

Pay can be a significant factor in making it difficult for a person to be repatriated. Often those returning home realize they have been making considerably more money with a lower cost of living in the overseas market; returning to the home country means a cut in pay and a cut in standard of living. In many countries expats can afford full-time domestic help due to the low wages abroad that they cannot afford back at home.

Conglomerate operations that include domestic and foreign personnel cause the greatest problems in compensation planning.28 Expatriates tend to compare their compensation with what they would have received at the home office during the same time, and local personnel and expatriate personnel are likely to compare notes on salary. Although any differences in the compensation level may be easily and logically explained, the group receiving the lower amount almost always feels aggrieved and mistreated.

Short-term assignments for expatriates further complicate the compensation issue, particularly when the short-term assignments extend into a longer time. In general, short-term assignments involve payments of overseas premiums (sometimes called separation allowances if the family does not go along), all excess expenses, and allowances for tax differentials. Longer assignments can include home-leave benefits or travel allowances for the spouse. International compensation programs also provide additional payments for hardship locations and special inducements to reluctant personnel to accept overseas employment and to remain in the position.

For a Global Sales Force

Compensation plans of American companies vary substantially around the globe, reflecting the economic and cultural differences29 in the diverse markets served. As reflected in Exhibit 17.4, some experts feel compensation plans in Japan and southern Europe are most different from the standard U.S. approach. Those same experts believe that generally compensation schemes around the world are becoming more similar to the U.S. system with its emphasis on commissions based on individual performance.30 However, the data in Exhibit 17.4 still reflect the locations of the larger differences.31

Exhibit 17.4: Global Similarity to U.S. Compensation Plans

Source: David G. Schick and David J. Cichelli, “Developing Incentive Compensation Strategies in a Global Sales Environment,” ACA Journal, Autumn 1996; updated based on interview with David J. Cichelli, Vice President of the Alexander Group, April 2008.

One company has gone to great lengths to homogenize its worldwide compensation scheme. Beginning in the late 1990s, IBM rolled out what is perhaps the most global approach to compensating a worldwide sales force.32 The main features of that plan, which applies to 140,000 sales executives in 165 countries, are presented in Exhibit 17.5. The plan was developed in response to “global” complaints from sales representatives that the old plan was confusing and did not provide for work done outside one’s territory (such as in the scenario presented in Crossing Borders 17.1) and that it therefore did not promote cross-border teamwork. IBM sales incentive managers from North America, Latin America, Asia Pacific, and Europe worked together with consultants on the design for some nine months. At first glance it may appear that IBM is making the cardinal error of trying to force a plan developed centrally onto sales offices literally spread around the world and across diverse cultures; however, the compensation plan still allows substantial latitude for local managers. Compensation managers in each country determine the frequency of incentive payouts and the split between base and incentive pay, while following a global scheme of performance measures. Thus the system allows for a high incentive component in countries like the United States and high base-salary components in countries like Japan.

Exhibit 17.5: A Compensation Blueprint: How IBM Pays 140,000 Sales Executives Worldwide

Source: Adapted from Michele Marchetti, “Gamble: IBM Replaces Its Outdated Compensation Plan with a World Wide Framework. Will It Pay Off?” Sales & Marketing Management, July 1996, pp. 65–69.

Perhaps the most valuable information gained during IBM’s process of revamping its sales compensation scheme was the following list of the “do’s and don’ts” of global compensation:33

1. Do involve representatives from key countries.

2. Do allow local managers to decide the mix between base and incentive pay.

3. Do use consistent performance measures (results paid for) and emphasis on each measure.

4. Do allow local countries flexibility in implementations.

5. Do use consistent communication and training themes worldwide.

6. Don’t design the plan centrally and dictate to local offices.

7. Don’t create a similar framework for jobs with different responsibilities.

8. Don’t require consistency on every performance measure within the incentive plan.

9. Don’t assume cultural differences can be managed through the incentive plan.

10. Don’t proceed without the support of senior sales executives worldwide.

Evaluating and Controlling Sales Representatives

Evaluation and control of sales representatives in the United States is a relatively simple task. In many sales jobs, emphasis is placed on individual performance, which can easily be measured by sales revenues generated (often compared with past performance, forecasts, or quotas). In short, a good sales representative produces big numbers. However, in many countries the evaluation problem is more complex, particularly in relationship-oriented cultures, where teamwork is favored over individual effort and closer supervision is expected, and may even be appreciated.34 Performance measures require closer observation and may include the opinions of customers, peers, and supervisors. Of course, managers of sales forces operating in relationship-oriented cultures may see measures of individual performance as relatively unimportant.

One study comparing American and Japanese sales representatives’ performance illustrates such differences.35 Supervisors’ ratings of the representatives on identical performance scales were used in both countries. The distribution of performance of the Japanese was statistically normal—a few high performers, a few low, but most in the middle. The American distribution was different—a few high, most in the middle, but almost no low performers. In the United States, poor performers either quit (because they are not making any money), or they are fired. In Japan the poor performers stay with the company and are seldom fired. Thus sales managers in Japan have a problem their American counterparts do not: how to motivate poor performers. Indeed, sales management textbooks in the United States usually include material on how to deal with “plateaued” salespeople but say little about poor performers because the latter are not a problem.

The primary control tool used by American sales managers is the incentive system. Because of the Internet and fax machines, more and more American sales representatives operate out of offices in their homes and see supervisors infrequently. Organizations have become quite flat and spans of control increasingly broad in recent years. However, in many other countries spans of control can be quite narrow by American standards—even in Australia and particularly in Japan. In the latter country, supervisors spend much more time with fewer subordinates. Corporate culture and frequent interactions with peers and supervisors are the means of motivation and control of sales representatives in relationship-oriented cultures like Japan.

Preparing U.S. Personnel for Foreign Assignments

Estimates of the annual cost of sending and supporting a manager and his or her family in a foreign assignment range from 150 to 400 percent of base salary. The costs in money (some estimates are in the $300,000 to $600,000 range) and morale increase substantially if the expatriate requests a return home before completing the normal tour of duty (a normal stay is two to four years). In addition, if repatriation into domestic operations is not successful and the employee leaves the company, an indeterminately high cost in low morale and loss of experienced personnel results. To reduce these problems, international personnel management has increased planning for expatriate personnel to move abroad, remain abroad, and then return to the home country.36 The planning process must begin prior to the selection of those who go abroad and extend to their specific assignments after returning home. Selection, training, compensation, and career development policies (including repatriation) should reflect the unique problems of managing the expatriate.

Besides the job-related criteria for a specific position,37 the typical candidate for an international assignment is married, has two school-aged children, is expected to stay overseas three years, and has the potential for promotion into higher management levels. These characteristics of the typical expatriate are the basis of most of the difficulties associated with getting the best qualified personnel to go overseas, keeping them there, and assimilating them on their return.

Overcoming Reluctance to Accept a Foreign Assignment

Concerns for career and family are the most frequently mentioned reasons for a manager to refuse a foreign assignment. The most important career-related reservation is the fear that a two- or three-year absence will adversely affect opportunities for advancement.38 This “out of sight, out of mind” fear (as exemplified in the opening Global Perspective) is closely linked to the problems of repatriation. Without evidence of advance planning to protect career development, better qualified and ambitious personnel may decline offers to go abroad. However, if candidates for expatriate assignments are picked thoughtfully, returned to the home office at the right moment, and rewarded for good performance with subsequent promotions at home, companies find recruiting of executives for international assignments eased.

Even though the career development question may be adequately answered with proper planning, concern for family may interfere with many accepting an assignment abroad. Initially, most potential candidates are worried about uprooting a family and settling into a strange environment. Questions about the education of the children (especially those with specific needs), isolation from family and friends, proper healthcare, and, in some countries, the potential for violence reflect the misgivings a family faces when relocating to a foreign country. Special compensation packages have been the typical way to deal with this problem. A hardship allowance, allowances to cover special educational requirements that frequently include private schools, housing allowances, and extended all-expense-paid vacations are part of compensation packages designed to overcome family-related problems with an overseas assignment. Ironically, the solution to one problem creates a later problem when that family returns to the United States and must give up those extra compensation benefits used to induce them to accept the position.

Reducing the Rate of Early Returns

Once the employee and family accept the assignment abroad, the next problem is keeping them there for the assigned time. The attrition rate of those selected for overseas positions can be very high, though some studies have suggested it is declining overall. One firm with a hospital management contract experienced an annualized failure rate of 20 percent—not high when compared with the construction contractor who started out in Saudi Arabia with 155 Americans and was down to 65 after only two months.

The most important reasons a growing number of companies are including an evaluation of an employee’s family among selection criteria are the high cost of sending an expatriate abroad and increasing evidence that unsuccessful family adjustment39 is the single most important reason for expatriate dissatisfaction and the resultant request for return home.40 In fact, a study of personnel directors of over 300 international firms found that the inability of the manager’s spouse to adjust to a different physical or cultural environment was the primary reason for an expatriate’s failure to function effectively in a foreign assignment. One researcher estimated that 75 percent of families sent to a foreign post experience adjustment problems with children or have marital discord. One executive suggests that there is so much pressure on the family that if there are any cracks in the marriage and you want to save it, think long and hard about taking a foreign assignment.

Dissatisfaction is caused by the stress and trauma of adjusting to new and often strange cultures. The employee has less trouble adjusting than family members; a company’s expatriate moves in a familiar environment even abroad and is often isolated from the cultural differences that create problems for the rest of the family. And about half of American expatriate employees receive cross-cultural training before the trip—much more often than their families do.41 Family members have far greater daily exposure to the new culture but are often not given assistance in adjusting. New consumption patterns must be learned, from grocery shopping to seeking healthcare services.42 Family members frequently cannot be employed, and in many cultures, female members of the family face severe social restrictions. In Saudi Arabia, for example, the woman’s role is strictly dictated. In one situation, a woman’s hemline offended a religious official who, in protest, sprayed black paint on her legs. In short, the greater problems of culture shock befall the family. Certainly any recruiting and selection procedure should include an evaluation of the family’s ability to adjust.43

American expatriates flock to stores like this one in Amsterdam. Inside you’ll find not only books in English, but also Kraft macaroni and cheese, Bisquick, and other hard-to-find-in-Europe staples of the American diet.

Families that have the potential and the personality traits that would enable them to adjust to a different environment may still become dissatisfied with living abroad if they are not properly prepared for the new assignment. More and more companies realize the need for cross-cultural training to prepare families for their new homes. One- or two-day briefings to two- or three-week intensive programs that include all members of the family are provided to assist assimilation into new cultures. Language training, films, discussions, and lectures on cultural differences, potential problems, and stress areas in adjusting to a new way of life are provided to minimize the frustration of the initial cultural shock. This cultural training helps a family anticipate problems and eases adjustment. Once the family is abroad, some companies even provide a local ombudsman (someone experienced in the country) to whom members can take their problems and get immediate assistance. Although the cost of preparing a family for an overseas assignment may appear high, it must be weighed against estimates that the measurable cost of prematurely returned families could cover cross-cultural training for 300 to 500 families. Companies that do not prepare employees and their families for culture shock have the highest incidence of premature return to the United States.

Successful Expatriate Repatriation

A Conference Board study reported that many firms have sophisticated plans for executives going overseas but few have comprehensive programs to deal with the return home. Many have noted that too often repatriated workers are a valuable resource neglected or wasted by inexperienced U.S. management.

Low morale and a growing amount of attrition among returning expatriates have many causes. Some complaints and problems are family related, whereas others are career related. The family-related problems generally pertain to financial and lifestyle readjustments. Some expatriates find that in spite of higher compensation programs, their net worths have not increased, and the inflation of intervening years makes it impossible to buy a home comparable to the one they sold on leaving. The hardship compensation programs used to induce the executive to go abroad also create readjustment problems on the return home. Such compensation benefits frequently permitted the family to live at a much higher level abroad than at home (employing yard boys, chauffeurs, domestic help, and so forth). Because most compensation benefits are withdrawn when employees return to the home country, their standard of living decreases, and they must readjust. Unfortunately, little can be done to ameliorate these kinds of problems, short of transferring the managers to other foreign locations. Current thinking suggests that the problem of dissatisfaction with compensation and benefits upon return can be lessened by reducing benefits when overseas. Rather than provide the family abroad with hardship payments, some companies are reducing payments and other benefits44 on the premise that the assignment abroad is an integral requirement for growth, development, and advancement within the firm.

Family dissatisfaction, which causes stress within the family on returning home, is not as severe a problem as career-related complaints. A returning expatriate’s dissatisfaction with the perceived future is usually the reason many resign their positions after returning to the United States. The problem is not unique to U.S. citizens; Japanese companies have similar difficulties with their personnel. The most frequently heard complaint involves the lack of a detailed plan for the expatriate’s career when returning home. New home-country assignments are frequently mundane and do not reflect the experience gained or the challenges met during foreign assignment. Some feel their time out of the mainstream of corporate affairs has made them technically obsolete and thus ineffective in competing immediately on return. Finally, there is some loss of status, requiring an ego adjustment when an executive returns home.

Companies with the least amount of returnee attrition differ from those with the highest attrition in one significant way: personal career planning for the expatriate.45 This planning begins with the decision to send the person abroad. The initial transfer abroad should be made in the context of a long-term company career plan. Under these circumstances, the individual knows not only the importance of the foreign assignment but also when to expect to return and at what level. Near the end of the foreign assignment, the process for repatriation begins. The critical aspect of the return home is to keep the executive completely informed regarding such matters as the proposed return time, new assignment and an indication of whether it is interim or permanent, new responsibilities, and future prospects. In short, returnees should know where they are going and what they will be doing next month and several years ahead.

A report on what MNCs are doing to improve the reentry process suggests five steps:

1. Commit to reassigning expatriates to meaningful positions.

2. Create a mentor program.46 Mentors are typically senior executives who monitor company activities, keep the expatriate informed on company activities, and act as liaison between the expatriate and various headquarters departments.

3. Offer a written job guarantee stating what the company is obligated to do for the expatriate on return.

4. Keep the expatriate in touch with headquarters through periodic briefings and headquarters visits.

5. Prepare the expatriate and family for repatriation once a return date is set.47

Some believe the importance of preparing the employee and family for culture shock upon return is on a par with preparation for going abroad.

Developing Cultural Awareness

Many businesses focus on the functional skills needed in international marketing, overlooking the importance of cultural intelligence.48 Just as the idea that “if a product sells well in Dallas, it will sell well in Hong Kong” is risky, so is the idea that “a manager who excels in Dallas will excel in Hong Kong.” Most expatriate failures are not caused by lack of management or technical skills but rather by lack of an understanding of cultural differences and their effect on management skills. As the world becomes more interdependent and as companies depend more on foreign earnings, there is a growing need for companies to develop cultural awareness among those posted abroad.

Just as we might remark that someone has learned good social skills (i.e., an ability to remain poised and be in control under all social situations), so too good cultural skills can be developed.49 These skills serve a similar function in varying cultural situations; they provide the individual with the ability to relate to a different culture even when the individual is unfamiliar with the details of that particular culture. Cultural skills can be learned just as social skills can be learned. People with cultural skills can:

• Communicate respect and convey verbally and nonverbally a positive regard and sincere interest in people and their culture.

• Tolerate ambiguity and cope with cultural differences and the frustration that frequently develops when things are different and circumstances change.

• Display empathy by understanding other people’s needs and differences from their point of view.

• Remain nonjudgmental about the behavior of others, particularly with reference to their own value standards.

• Recognize and control the SRC, that is, recognize their own culture and values as an influence on their perceptions, evaluations, and judgment in a situation.

• Laugh things off—a good sense of humor helps when frustration levels rise and things do not work as planned.

The Changing Profile of the Global Manager

Until recently the road to the top was well marked. Surveys of chief executives consistently reported that more than three-quarters had finance, manufacturing, or marketing backgrounds. As the post–World War II period of growing markets and domestic-only competition fades, however, so too does the narrow one-company, one-industry chief executive. In the new millennium, increasing international competition, the globalization of companies, technology, demographic shifts, and the speed of overall change will govern the choice of company leaders. It will be difficult for a single-discipline individual to reach the top in the future.50

The executive recently picked to head Procter & Gamble’s U.S. operations is a good example of the effect globalization is having on businesses and the importance of experience, whether in Japan, Europe, or elsewhere. The head of all P&G’s U.S. business was born in the Netherlands, received an MBA51 from Rotterdam’s Eramus University, then rose through P&G’s marketing ranks in Holland, the United States, and Austria. After proving his mettle in Japan, he moved to P&G’s Cincinnati, Ohio, headquarters to direct its push into East Asia, and then to his new position. Speculation suggests that if he succeeds in the United States, as he did in Japan, he will be a major contender for the top position at P&G.

Fewer companies today limit their search for senior-level executive talent to their home countries. Coca-Cola’s former CEO, who began his ascent to the top in his native Cuba, and the former IBM vice chairman, a Swiss national who rose through the ranks in Europe, are two prominent examples of individuals who rose to the top of firms outside their home countries.

Some companies, such as Colgate-Palmolive, believe that it is important to have international assignments early in a person’s career, and international training is an integral part of its entry-level development programs. Colgate recruits its future managers from the world’s best colleges and business schools. Acceptance is highly competitive, and successful applicants have a BA or MBA with proven leadership skills, fluency in at least one language besides English, and some experience living abroad. A typical recruit might be a U.S. citizen who has spent a year studying in another country or a national of another country who was educated in the United States.52

Trainees begin their careers in a two-year, entry-level, total-immersion program that consists of stints in various Colgate departments. A typical rotation includes time in the finance, manufacturing, and marketing departments and an in-depth exposure to the company’s marketing system. During that phase, trainees are rotated through the firm’s ad agency, marketing research, and product management departments and then work seven months as field salespeople. At least once during the two years, trainees accompany their mentors on business trips to a foreign subsidiary. The company’s goal is to develop in their trainees the skills they need to become effective marketing managers, domestically or globally.

On the completion of the program, trainees can expect a foreign posting, either immediately after graduation or soon after an assignment in the United States. The first positions are not in London or Paris, as many might hope, but in developing countries such as Brazil, the Philippines, or maybe Zambia. Because international sales are so important to Colgate (60 percent of its total revenues are generated abroad), a manager might not return to the United States after the first foreign assignment but rather move from one overseas post to another, developing into a career internationalist, which could open to a CEO position.

Companies whose foreign receipts make up a substantial portion of their earnings and that see themselves as global companies rather than as domestic companies doing business in foreign markets are the most active in making the foreign experience an integrated part of a successful corporate career. Indeed for many companies, a key threshold seems to be that when overseas revenues surpass domestic revenues, then the best people in the company want to work on international accounts. Such a global orientation then begins to permeate the entire organization—from personnel policies to marketing and business strategies. This shift was the case with Gillette, which in the 1990s made a significant recruitment and management-development decision when it decided to develop managers internally. Gillette’s international human resources department implemented its international-trainee program, designed to supply a steady stream of managerial talent from within its own ranks. Trainees are recruited from all over the world, and when their training is complete, they return to their home countries to become part of Gillette’s global management team.

CROSSING BORDERS 17.4: A Look into the Future: Tomorrow’s International Leaders? An Education for the 21st Century

A school supported by the European Union teaches Britons, French, Germans, Dutch, and others to be future Europeans. The European School in a suburb of Brussels has students from 12 nations who come to be educated for life and work, not as products of motherland or fatherland but as Europeans. The European Union runs 10 European Schools in western Europe, enrolling 17,000 students from kindergarten to twelfth grade. Graduates emerge superbly educated, usually trilingual, and very, very European.

The schools are a linguistic and cultural melange. Native speakers of 36 different languages are represented in one school alone. Each year students take fewer and fewer classes in their native tongue. Early on, usually in first grade, they begin a second language, known as the “working language,” which must be English, French, or German. A third language is introduced in the seventh year, and a fourth may be started in the ninth.

By the time students reach their eleventh year, they are taking history, geography, economics, advanced math, music, art, and gym in the working language. When the students are in groups talking, they are constantly switching languages to “whatever works.”

Besides language, students learn history, politics, literature, and music from the perspective of all the European countries—in short, European cultures. The curriculum is designed to teach the French, German, Briton, and those of other nationalities to be future Europeans.

This same approach is being taken at the MBA level as well. The well-respected European School of Management has campuses in several cities—Berlin, Paris, Oxford, and Madrid. Students spend part of their time at each of the campuses. American MBA programs are beginning to imitate such programs. The University of Chicago School of Business now has campuses in Barcelona, and Singapore. The Fuqua School at Duke offers a unique executive MBA program involving travel to several foreign countries and a substantial percentage of teaching delivered interactively over the Internet. This last program attracts students from all over the world who are willing to pay a six-figure tuition.

Sources: Glynn Mapes, “Polyglot Students Are Weaned Early Off Mother Tongue,” The Wall Street Journal, March 6, 1990, p. A1. Reprinted by permission of The Wall Street Journal, © 1990 Dow Jones & Company, Inc. All Rights Reserved Worldwide. See also Kevin Cape, “Tips on Choosing the Right One, International Schools,” International Herald Tribune, January 25, 2003, p. 7; http://www.fuqua.duke.edu/mba/exec-utive/global/, 2008.

Foreign-Language Skills

Opinions are mixed on the importance of a second language for a career in international business. There are those whose attitude about another language is summed up in the statement that “the language of international business is English.” Indeed, one journalist quipped, “Modern English is the Wal-Mart of languages: convenient, huge, hard to avoid, superficially friendly, and devouring all rivals in its eagerness to expand.”53 Others feel that even if you speak one or two languages, you may not be needed in a country whose language you speak. So, is language important or not?

Proponents of language skills argue that learning a language improves cultural understanding and business relationships.54 Others point out that to be taken seriously in the business community, the expatriate must be at least conversational in the host language. Particularly when it comes to selling in foreign countries, languages are important. Says a Dutch sales training expert, “People expect to buy from sales reps they can relate to, and who understand their language and culture. They’re often cold towards Americans trying to sell them products.”

Some recruiters want candidates who speak at least one foreign language, even if the language will not be needed in a particular job. Having learned a second language is a strong signal to the recruiter that the candidate is willing to get involved in someone else’s culture.

Although most companies offer short, intensive language-training courses for managers being sent abroad, many are making stronger efforts to recruit people who are bilingual or multilingual. According to the director of personnel at Coca-Cola, when his department searches its database for people to fill overseas posts, the first choice is often someone who speaks more than one language.

We the authors feel strongly that language skills are of great importance; if you want to be a major player in international business in the future, learn to speak other languages, or you might not make it—your competition will be those European students described in Crossing Borders 17.4. A joke that foreigners tell about language skills goes something like this: What do you call a person who speaks three or more languages? Multilingual. What do you call a person who speaks two languages? Bilingual. What do you call a person who speaks only one language? An American! Maybe the rest of the world knows something we don’t.

Summary

An effective international sales force constitutes one of the international marketer’s greatest concerns. The company’s sales force represents the major alternative method of organizing a company for foreign distribution and, as such, is on the front line of a marketing organization.

The role of marketers in both domestic and foreign markets is rapidly changing, along with the composition of international managerial and sales forces. Such forces have many unique requirements that are being filled by expatriates, locals, third-country nationals, or a combination of the three. In recent years, the pattern of development has been to place more emphasis on local personnel operating in their own lands. This emphasis, in turn, has highlighted the importance of adapting U.S. managerial techniques to local needs.

The development of an effective marketing organization calls for careful recruiting, selecting, training, motivating, and compensating of expatriate personnel and their families to ensure the maximization of a company’s return on its personnel expenditures. The most practical method of maintaining an efficient international sales and marketing force is careful, concerted planning at all stages of career development.

18: Pricing for International Market

Global Perspective: THE PRICE WAR

The battle between Procter & Gamble and Kimberly-Clark is bringing Pampers and Huggies, respectively, to places they have never been, forcing down diaper prices worldwide, and expanding the global market for disposable diapers. A battle in Brazil between the two giants gives an interesting glimpse of the global markets of tomorrow. Disposable diapers are still considered a luxury by the vast majority of Brazil’s 160 million people, whose average annual income is under $4,000. Before P&G and Kimberly arrived, rich and poor alike generally made do with cloth or nothing at all. The disposables that were available were expensive, bulky, and leaky.

When less than 5 percent of the Brazilian mass market used disposable diapers, P&G launched Pampers Uni, a no-frills, unisex diaper. Before Uni, it cost more to pay for disposable diapers than to pay for a maid to wash the cloth ones. The introduction of the relatively cheap, high-quality Uni fundamentally changed the economics of the diaper market for most middle-class Brazilians.

The plan was to put such nonessentials as disposable diapers within the reach of millions of Brazilians for the first time. At the same time, the Brazilian economy was on the upswing—inflation had subsided, and overnight, the purchasing power of the poor increased by 20 percent. Low-priced products flew off the shelves. P&G had to truck in diapers from Argentina as it struggled to open new production lines.

But the good days did not last. Kimberly-Clark entered the market and began importing Huggies from Argentina. With the help of a Unilever unit as its Brazilian distributor, Kimberly-Clark gained immediate distribution across the country and quickly made deep inroads into the market. Unilever agreed to work with Kimberly-Clark because its archrival in soap was P&G, and Kimberly-Clark’s archrival in diapers was P&G. The two companies previously had entered into a global alliance to look for win–win situations when it was in both their best interests to partner and help each other, from a competitive standpoint, against the dominant P&G. The Brazilian market was the perfect case for cooperation.

With Unilever’s help, Kimberly-Clark “push girls” invaded markets to demonstrate the diaper’s absorption. Sales rose rapidly and began to exceed production. To gain more product, Kimberly-Clark formed an alliance with Kenko do Brazil, P&G’s largest home-grown rival, and created the “Monica” brand. “Monica’s Gang,” a comic strip similar to “Peanuts” in the United States, sells four million copies monthly. São Paulo malls were crowded with thousands of kids waiting to get an Easter photo taken with actors in Monica suits, an honor that required the purchase of three packs of diapers. Monica diapers were a big hit, and Kimberly-Clark became number one in the Brazilian market.

It was a tough blow to P&G. The company had devoted an entire page of its annual report to how Pampers Uni had tripled its market share in Brazil, helping P&G “retain the number one position in a market that has grown fivefold.” Now it suddenly found itself on the defensive. First it cut prices, a step P&G loathes. “Price cutting is like violence: No one wins,” says the head of its Brazilian operation. Then it broadened its product range, rolling out an up-market diaper called Super-Seca, priced 25 percent higher than Pampers Uni. Later, in a flanking move, it also unveiled Confort-Seca, a bikini-style diaper originally developed for Thailand and priced 10 to 15 percent lower than the already-inexpensive Uni.

Kimberly-Clark fired back, matching the price cut and then introducing a cheaper version of Monica called Tippy Basic. Four weeks later, P&G cut prices another 10 percent on Super-Seca and Confort-Seca. Despite the price cuts, the two brands were still relatively expensive; then a wave of really cheap diapers arrived. Carrefour, a French retailer that is now Brazil’s biggest supermarket chain, sells crudely made Bye-Bye Pipi diapers from Mexico. Despite their inferior quality, the cheap imports pulled down diaper prices across the board.

The real war started when lower prices became so attractive that consumers who otherwise could not afford diapers came into the market. As prices continued to drop, the market grew; that attracted more producers, which were mostly small, local Brazilian companies that offered even lower priced competitive diapers. One such company, Mili, saw its market share increase from 4.8 percent to 16.2 percent over a three-year period. What accounts for growth of these smaller companies? One analyst suggests that the multinationals are too sophisticated and, thus, too expensive for the Brazilian market: “Smaller companies are just supplying what consumers need at a price they can afford.” But it also can be said that as prices drop, products become more attractive to a larger segment of the total market.

Sources: Raju Narisetti and Jonathan Friedland, “Disposable Income: Diaper Wars of P&G and Kimberly-Clark Now Heat Up in Brazil,” The Wall Street Journal, June 4, 1997, p. A1; “Brazil: Procter & Gamble Increased Market Share,” SABI (South American Business Information), May 31, 2000; Jonathan Birchall, “New Tactics in the Battle for Babies’ Bottoms,” Financial Times (http://www.FT.com), August 24, 2006. For more information, see Kimberly-Clark’s Web site at http://www.kimberly-clark.com and Procter & Gamble’s at http://www.pg.com.

Prices both evaluate and communicate in international markets.1 For example, initially Hong Kong Disneyland’s early attendance was lower than expected, in part driven by what some called an unaffordable opening-day price of $32 a ticket.2 Setting the right price for a product or service can be the key to success or failure. Even when the international marketer produces the right product, promotes it correctly, and initiates the proper channel of distribution, the effort fails if the product is not properly priced. Although the quality of U.S. products is widely recognized in global markets, foreign buyers, like domestic buyers, balance quality and price in their purchase decisions. An offering’s price must reflect the quality and value the consumer perceives in the product. Of all the tasks facing the international marketer, determining what price to charge is one of the most difficult. It is further complicated when the company sells its product to customers in multiple country’s markets.

As globalization continues, competition intensifies among multinational and home-based companies. All are seeking a solid competitive position so they can prosper as markets reach full potential. The competition for the diaper market among Kimberly-Clark, P&G, and the smaller companies illustrates how price becomes increasingly important as a competitive tool and how price competition changes the structure of a market. Whether exporting or managing overseas operations, the manager’s responsibility is to set and control the actual price of goods in multiple markets in which different sets of variables are to be found: different tariffs, costs, attitudes, competition, currency fluctuations, and methods of price quotation.

This chapter focuses on the basic pricing policy questions that arise from the special cost, market, and competitive factors found in foreign markets. A discussion of price escalation and its control and factors associated with price setting and leasing is followed by a discussion of the use of countertrade as a pricing tool and a review of the mechanics of international price quotation.

Pricing Policy

Active marketing in several countries compounds the number of pricing problems and variables relating to price policy. Unless a firm has a clearly thought-out, explicitly defined price policy, expediency rather than design establishes prices. The country in which business is being conducted, the type of product, variations in competitive conditions, and other strategic factors affect pricing activity. Price and terms of sale cannot be based on domestic criteria alone.

Pricing Objectives

In general, price decisions are viewed two ways: pricing as an active instrument of accomplishing marketing objectives, or pricing as a static element in a business decision. If prices are viewed as an active instrument, the company sets prices (rather than following market prices)3 to achieve a specific objectives, whether targeted returns on profit, targeted market shares, or some other specific goals.4 The company that follows the second approach, pricing as a static element, probably exports only excess inventory, places a low priority on foreign business, and views its export sales as passive contributions to sales volume. When U.S. and Canadian international businesses were asked to rate, on a scale of 1 to 5, several factors important in price setting, total profits received an average rating of 4.7, followed by return on investment (4.41), market share (4.13), and total sales volume (4.06). Liquidity ranked the lowest (2.19).

The more control a company has over the final selling price of a product, the better it is able to achieve its marketing goals. However, controlling end prices is not always possible. The broader the product line and the larger the number of countries involved, the more complex the process of controlling prices to the end user.5

CROSSING BORDERS 18.1: Inside the iPhone Gray Market

You could buy one (indeed, more than one) in Beijing even though they had not yet been shipped there by Apple or AT&T. The gray market for iPhones in China was bustling. Apparently 800,000 to 1 million iPhones, or about one-fourth of the total sold, were “unlocked”—that is, altered to be able to run on networks other than those of Apple’s exclusive partners.

This iPhone aftermarket did not take long to develop. By the time the device went on sale on June 29, 2007, software hackers and companies that specialize in unlocking cell phones had already begun searching for ways to make the iPhone work on unsanctioned networks. Within weeks, online forums were buzzing with an answer that emanated from a tiny company based in Prague, Czech Republic.

Pavel Zaboj is a 36-year-old former math student who, together with friends, developed an electronic device called Turbo SIM that was designed to turn cell phones into mobile payment systems. Turns out, Turbo SIM also could be used to trick the iPhone into thinking it was operating on AT&T’s network. By mid-August, Zaboj’s 10-person firm, Bladox, was flooded with orders, particularly from Canada and Mexico, where Apple addicts did not have to venture far to get an iPhone. Bladox was totally unprepared and could not fill all the orders that rolled in. “We just sat there, open-mouthed,” Zaboj says.

Bladox has sold devices used to unlock phones in roughly 100 countries, including French Polynesia and Afghanistan, Brazil, Canada, the Dominican Republic, Indonesia, Israel, Nigeria, Peru, Poland, Russia, and the United Arab Emirates.

The boom was fueled not just by the short supply of a hot product but also by scant evidence of interference from Apple or its partners. Apple-authorized partners—AT&T, O2, Orange, and Deutsche Telekom’s T-Mobile—lost hundreds of dollars in monthly fees when subscribers avoided a two-year contract in favor of unlocking. But the bulk of the unlocking seems to have been occurring in places where customers had no authorized carrier to choose from anyway.

Apple took in hundreds of dollars per iPhone sale when customers activated service with one of its partners, but most analysts say the unlocking craze also helps spread Apple’s brand awareness.

The gray market got another push forward from exchange rates. With the dollar falling, consumers from Europe and elsewhere could get a better deal on an iPhone during a trip to the United States than from buying it at home. Gray marketers saw the same opportunity and began recruiting a range of people to secure iPhones.

Sometimes, it is as simple as asking friends and family members to reach their iPhone limit: five phones at Apple and three at AT&T. One reseller admits he got a friend to print business cards and pose as a small business owner to dupe an Apple Store manager into letting him buy 100 iPhones for his “employees.” Chinese retailers also admitted to “getting people like airline stewardesses to bring the iPhones over for us.”

Some iPhones on the gray market may have leaked from points closer to the source: the big Chinese factories where they are assembled. One distributor says he believes his China-based source gets iPhones from factory workers.

Sources: Peter Burrows, “Inside the iPhone Gray Market,” BusinessWeek, February 12, 2008; John Markoff, “Friends and Smugglers Meet Demand for iPhones,” The New York Times, February 18, 2008, pp. A1, A8.

Parallel Imports

In addition to having to meet price competition country by country and product by product, companies have to guard against competition with their own subsidiaries or branches. Because of the different prices possible in different country markets, a product sold in one country may be exported to another and undercut the prices charged in that country. For example, to meet economic conditions and local competition, an American pharmaceutical company might sell its drugs in a developing country at a low price and then discover that these discounted drugs are being exported to a third country, where, as parallel imports, they are in direct competition with the same product sold for higher prices by the same firm. This practice is lucrative when wide margins exist between prices for the same products in different countries. A variety of conditions can create a profitable opportunity for a parallel market.

Restrictions brought about by import quotas and high tariffs also can lead to parallel imports and make illegal imports attractive. India has a three-tier duty structure on computer parts ranging from 50 to 80 percent on imports. As a result, estimates indicate that as much as 35 percent of India’s domestic computer hardware sales are accounted for by the gray market.

The possibility of a parallel market occurs whenever price differences are greater than the cost of transportation between two markets. In Europe, because of different taxes and competitive price structures, prices for the same product vary between countries. When this situation occurs, it is not unusual for companies to find themselves competing in one country with their own products imported from another European country at lower prices. Pharmaceutical companies face this problem in Italy, Greece, and Spain because of price caps imposed on prescription drugs in those countries. For example, the ulcer drug Losec sells for only $18 in Spain but goes for $39 in Germany. The heart drug Plavix costs $55 in France and sells for $79 in London. Presumably such price differentials would cease once all restrictions to trade were eliminated in the European Union, and in most cases, this is true. However, the European Union does not prevent countries from controlling drug prices as part of their national health plans.

The drug industry has tried to stop parallel trade in Europe but has been overruled by European authorities. This time the industry is trying a different approach, restricting supplies to meet only local demand according to formulas based on prior demand and anticipated growth. The idea is that a country should receive just enough of a drug for its citizens. Wholesalers that order more with the intention of shipping the drugs to higher-priced markets will not have enough to do so. A number of major pharmaceutical companies have imposed similar restrictions. The companies say these measures are intended to streamline distribution, help prevent medicine shortages, and curtail excess inventory, whereas distributors claim the strategy is aimed at thwarting cross-border drug trading. The fact is, “half of all demand in Britain of several products is being met by imports from low-priced countries” and companies are attempting to curtail parallel imports.

Gray market pharmaceuticals moved from Canada to the United States are estimated to represent about $427 million annually—not a large amount when compared to the $135 billion U.S. drug market, but it can be substantial for specific drugs like Paxil, Zyban, and Viagra. Although importing prescription drugs from a foreign country, including Canada, is against U.S. law, a person can travel to Canada or Mexico to make purchases or buy over the Internet. Technically, buying over the Internet and having the drugs mailed to the United States is illegal. However, the government has taken a relatively lax view toward such purchases, provided the supply does not exceed 90 days.

Naturally, drug companies that have been hit the hardest want to put a stop to the traffic. Glaxo SmithKline, the prescription drug maker, has asked all Canadian pharmacies and wholesalers to “self-certify” that they are not exporting its drugs outside Canada. The company also is warning U.S. customers about imported drugs in a new advertising campaign.6 Those that fail to comply will have their Glaxo supplies cut off—“Glaxo products are approved by Health Canada for sale in Canada only.” Some feel that this move will not solve the problem even if Glaxo is able to stop Canadian sales because Americans will be able to find less expensive drugs in other markets, like Australia and Ireland. The Internet trade will be hard to shut down as long as large price differentials persist among markets. Furthermore, U.S. legislators are passing laws that allow such drug imports.7

Exclusive distribution, a practice often used by companies to maintain high retail margins to encourage retailers to provide extra service to customers, to stock large assortments, or to maintain the exclusive-quality image of a product, can create a favorable condition for parallel importing. Perfume and designer brands such as Gucci and Cartier are especially prone to gray markets. To maintain the image of quality and exclusivity, prices for such products traditionally include high profit margins at each level of distribution; characteristically, there are differential prices among markets and limited quantities of product, and distribution is restricted to upscale retailers. Wholesale prices for exclusive brands of fragrances are often 25 percent more in the United States than wholesale prices in other countries. These are ideal conditions for a lucrative gray market for unauthorized dealers in other countries who buy more than they need at wholesale prices lower than U.S. wholesalers pay. They then sell the excess at a profit to unauthorized U.S. retailers but at a price lower than the retailer would have to pay to an authorized U.S. distributor.

The high-priced designer sportswear industry is also vulnerable to such practices. Nike, Adidas, and Calvin Klein were incensed to find their products being sold in one of Britain’s leading supermarket chains, Tesco. Nike’s Air Max Metallic trainers, which are priced at £120 ($196) in sports shops, could be purchased at Tesco for £50 ($80). Tesco had bought £8 million in Nike sportswear from overstocked wholesalers in the United States (Exhibit 18.1). To prevent parallel markets from developing when such marketing and pricing strategies are used, companies must maintain strong control over distribution and prices.

Exhibit 18.1: How Gray Market Goods End Up in U.S. Stores

Companies that are serious about restricting the gray market must establish and monitor controls that effectively police distribution channels. In some countries they may get help from the courts. A Taiwan court ruled that two companies that were buying Coca-Cola in the United States and shipping it to Taiwan were violating the trademark rights of both the Coca-Cola Company and its sole Taiwan licensee. The violators were prohibited from importing, displaying, or selling products bearing the Coca-Cola trademark. In other countries, the courts have not always come down on the side of the trademark owner. The reasoning is that once the trademarked item is sold, the owner’s rights to control the trademarked item are lost. In a similar situation in Canada, the courts did not side with the Canadian exporter who was buying 50,000 cases of Coke a week and shipping them to Hong Kong and Japan. The exporter paid $4.25 a case, plus shipping of $1.00 a case, and sold them at $6.00, a nifty profit of 75 cents a case. Coca-Cola sued, but the court ruled that the product was bought and sold legally.

When differences in prices between markets occur, the Internet makes it easy for individuals to participate in the gray market. Music CDs are especially vulnerable because of price differentials. Six foreign-owned record companies that maintain high prices through limited distribution dominate the Australian market and create a situation ripe for the gray market. There, CDs retail for an average of $24 but can be purchased for about 25 to 30 percent less from the many e-stores on the Internet. It is estimated that CDs purchased directly from the United States over the Internet have led to a 5 percent fall in Australian retail sales. In the United Kingdom, gray market CDs come from Italy, where they are about 50 percent cheaper and account for between 15 and 20 percent of sales in some releases. Sony believes that more than 100,000 copies of one of Celine Dion’s best-selling albums sold in the United Kingdom were from parallel imports. The Internet has truly become a global price equalizer.

Parallel imports can do long-term damage in the market for trademarked products.8 Customers who unknowingly buy unauthorized imports have no assurance of the quality of the item they buy, of warranty support, or of authorized service or replacement parts. Purchasers of computers, for example, may not be able to get parts because authorized dealers have no obligation to service these computers. In the case of software, the buyer may be purchasing a counterfeit product and will not be authorized for technical support. Furthermore, when a product fails, the consumer blames the owner of the trademark, and the quality image of the product is sullied.

Approaches to International Pricing

Whether the orientation is toward control over end prices or net prices, company policy relates to the net price received. Cost and market considerations are important; a company cannot sell goods below cost of production and remain in business, and it cannot sell goods at a price unacceptable in the marketplace. Firms unfamiliar with overseas marketing and firms producing industrial goods orient their pricing solely on a cost basis. Firms that employ pricing as part of the strategic mix, however, are aware of such alternatives as market segmentation from country to country or market to market, competitive pricing in the marketplace, and other market-oriented pricing factors,9 including cultural differences in perceptions of pricing.10

Full-Cost versus Variable-Cost Pricing

Firms that orient their price thinking around cost must determine whether to use variable cost or full cost in pricing their goods. In variable-cost pricing, the firm is concerned only with the marginal or incremental cost of producing goods to be sold in overseas markets. Such firms regard foreign sales as bonus sales and assume that any return over their variable cost makes a contribution to net profit. These firms may be able to price most competitively in foreign markets, but because they are selling products abroad at lower net prices than they are selling them in the domestic market, they may be subject to charges of dumping. In that case, they open themselves to antidumping tariffs or penalties that take away from their competitive advantage. Nevertheless, variable-cost (or marginal-cost) pricing is a practical approach to pricing when a company has high fixed costs and unused production capacity. Any contribution to fixed cost after variable costs are covered is profit to the company.

In contrast, companies following the full-cost pricing philosophy insist that no unit of a similar product is different from any other unit in terms of cost and that each unit must bear its full share of the total fixed and variable cost.11 This approach is suitable when a company has high variable costs relative to its fixed costs. In such cases, prices are often set on a cost-plus basis, that is, total costs plus a profit margin. Both variable-cost and full-cost policies are followed by international marketers.

CROSSING BORDERS 18.2: Don’t Squeeze the Charmin, Mr. Whipple—Or Change the Color

The British pay twice as much as the Germans and the French, and nearly two-and-a-half times as much as Americans, for a standard four-roll pack of toilet paper. Why? Is it price gouging, the impact of the euro, the relative value of the English pound, or just culture?

The answer is rather simple: British consumers insist on a softer, more luxurious texture than their less discriminating continental and American cousins. British toilet paper is four grams heavier per square meter because it contains more fiber than European tissues. Extensive consumer testing has established that British consumers are not willing to be fobbed off with anything less.

Another factor distinguishes the British preference for a special toilet paper roll. Go to any supermarket, and you will be confronted by an extraordinary choice of more than 50 colors, sizes, and brands. Honeysuckle, warm pink, summer peach, pearl white, meadow green, breeze blue, and magnolia are just some of the shades on offer. The reason for this variety apparently is that the British shopper insists that toilet paper match the color scheme of the bathroom. On the continent, consumers settle happily for white, with pink thrown in as a wild alternative.

Procter & Gamble captured 10 percent of the market in less than five months after offering a stronger Charmin, but it may have gone too far. There were complaints that the “wet strength” of Charmin was unsuitable for U.K. toilets. The U.K. sewage system could handle Charmin alone, but the issue was whether the system would get clogged if several rival tissues adopted the stronger tissue. Procter & Gamble agreed to halve the strength of its Charmin toilet tissue, but will the price come down? And most recently, the P&G product has also been rated worst on a forest-friendly scale by Greenpeace. Complying with this latest criticism will surely raise costs.

Sources: “Going Soft,” The Economist, March 4, 2000; “P&G Unblocks Sewage Row with Toilet Paper Revamp,” Reuters, May 10, 2000; Timothy Kenny, “Eurasia: Of Toilet Paper, Escalators and Hope,” The Wall Street Journal Europe, September 16, 2005, p. A9; “Skip it, Eco-Worrier,” The Times (London), December 1, 2007, p. 11.

Skimming versus Penetration Pricing

Firms must also decide when to follow a skimming or a penetration pricing policy. Traditionally, the decision of which policy to follow depends on the level of competition, the innovativeness of the product, market characteristics, and company characteristics.12

A company uses skimming when the objective is to reach a segment of the market that is relatively price insensitive and thus willing to pay a premium price for the value received. If limited supply exists, a company may follow a skimming approach to maximize revenue and to match demand to supply. When a company is the only seller of a new or innovative product, a skimming price may be used to maximize profits until competition forces a lower price. Skimming often is used in markets with only two income levels: the wealthy and the poor. Costs prohibit setting a price that will be attractive to the lower-income market, so the marketer charges a premium price and directs the product to the high-income, relatively price-insensitive segment. Apparently this was the policy of Johnson & Johnson’s pricing of diapers in Brazil before the arrival of P&G. Today such opportunities are fading away as the disparity in income levels is giving way to growing middle-income market segments. The existence of larger markets attracts competition and, as is often the case, the emergence of multiple product lines, thus leading to price competition.

A penetration pricing policy is used to stimulate market and sales growth by deliberately offering products at low prices.13 Penetration pricing most often is used to acquire and hold share of market as a competitive maneuver. However, in country markets experiencing rapid and sustained economic growth, and where large shares of the population are moving into middle-income classes, penetration pricing may be used to stimulate market growth even with minimum competition. Penetration pricing may be a more profitable strategy than skimming if it maximizes revenues as a base for fighting the competition that is sure to come.

Chinese wait to enter Beijing’s first Wal-Mart outlet. Thousands crowded the Sam’s Club store on the far western edge of Beijing as the world’s biggest retailer made its first foray into a major Chinese city. Wal-Mart has more than 20 stores elsewhere in China; the first opened in 1996. The low-price-for-good-quality strategy of Wal-Mart and other mass retailers such as Costco and Carrefour, the French supermarket chain, have resulted in lower retail prices in China, Japan, and other Asian countries they have entered. (AP Photo/Greg Baker)

Regardless of the formal pricing policies and strategies a company uses, the market sets the effective price for a product. Said another way, the price has to be set at a point at which the consumer will perceive value received, and the price must be within reach of the target market. As a consequence, many products are sold in very small units in some markets to bring the unit price within reach of the target market. Warner-Lambert’s launch of its five-unit pack of Bubbaloo bubble gum in Brazil failed—even though bubble gum represents over 72 percent of the overall gum sector—because it was priced above the target market. A relaunch of a single-unit “pillow” pack brought the price within range and enabled the brand to quickly gain a respectable level of sales.

As a country’s economy grows and the distribution of wealth becomes more equitable, multiple income levels develop, distinct market segments emerge, and multiple price levels and price/quality perceptions increase in importance. As an example, the market for electronic consumer goods in China changed in just a few years. Instead of a market for imported high-priced and high-quality electronic goods aimed at the new rich versus cheaper, poorer quality, Chinese-made goods for the rest of the market, a multitiered market reflecting the growth of personal income has emerged.

Sony of Japan, the leading foreign seller of high-priced consumer electronic goods, was upstaged in the Chinese market when Aiwa, a competitor, recognized the emergence of a new middle-tier market for good-quality, modestly priced electronic goods. As part of a global strategy focused on slim margins and high turnover, Aiwa of Korea began selling hi-fi systems at prices closer to Chinese brands than to Sony’s. Aiwa’s product quality was not far behind that of Sony and was better than top Chinese brands, and the product resembled Sony’s high-end systems. Aiwa’s recognition of a new market segment and its ability to tap into it resulted in a huge increase in overall demand for Aiwa products.

Pricing decisions that were appropriate when companies directed their marketing efforts toward single market segments will give way to more sophisticated practices. As incomes rise in many foreign markets, the pricing environment a company encounters will be similar to that in the United States. As countries prosper and incomes become more equitably distributed, multiple market segments develop. As these segments emerge, Wal-Mart, Carrefour, and other mass retailers enter the market to offer price-conscious customers good value at affordable prices. This scenario seems to repeat itself in country after country. Within these markets, an effective pricing strategy becomes crucial.

Price Escalation

People traveling abroad often are surprised to find goods that are relatively inexpensive in their home country priced outrageously high in other countries. Because of the natural tendency to assume that such prices are a result of profiteering, manufacturers often resolve to begin exporting to crack these new, profitable foreign markets only to find that, in most cases, the higher prices reflect the higher costs of exporting. A case in point is a pacemaker for heart patients that sells for $2,100 in the United States. Tariffs and the Japanese distribution system add substantially to the final price in Japan. Beginning with the import tariff, each time the pacemaker changes hands, an additional cost is incurred. The product passes first through the hands of an importer, then to the company with primary responsibility for sales and service, then to a secondary or even a tertiary local distributor, and finally to the hospital. Markups at each level result in the $2,100 pacemaker selling for over $4,000 in Japan. Inflation results in price escalation, one of the major pricing obstacles facing the MNC marketer. This escalation is true not only for technical products like the pacemaker but for such products as crude oil, soft drinks, and beer. Estimates indicate that if tariffs and trade barriers on these products were abolished, the consumer would enjoy savings of 6.57 trillion yen.

Costs of Exporting

Excess profits exist in some international markets, but generally the cause of the disproportionate difference in price between the exporting country and the importing country, here termed price escalation, is the added costs incurred as a result of exporting products from one country to another. Specifically, the term relates to situations in which ultimate prices are raised by shipping costs, insurance, packing, tariffs, longer channels of distribution, larger middlemen margins, special taxes, administrative costs, and exchange rate fluctuations. The majority of these costs arise as a direct result of moving goods across borders from one country to another and often combine to escalate the final price to a level considerably higher than in the domestic market.

Taxes, Tariffs, and Administrative Costs

“Nothing is surer than death and taxes” has a particularly familiar ring to the ears of the international trader, because taxes include tariffs, and tariffs are one of the most pervasive features of international trading. Taxes and tariffs affect the ultimate consumer price for a product; in most instances, the consumer bears the burden of both. Sometimes, however, consumers benefit when manufacturers selling goods in foreign countries reduce their net return to gain access to a foreign market. Absorbed or passed on, taxes and tariffs must be considered by the international businessperson.

A tariff, or duty, is a special form of taxation. Like other forms of taxes, a tariff may be levied for the purpose of protecting a market or for increasing government revenue. A tariff is a fee charged when goods are brought into a country from another country. Recall from Chapter 15 that the level of tariff is typically expressed as the rate of duty and may be levied as specific, ad valorem, or compound. A specific duty is a flat charge per physical unit imported, such as 15 cents per bushel of rye. Ad valorem duties are levied as a percentage of the value of the goods imported, such as 20 percent of the value of imported watches. Compound duties include both a specific and an ad valorem charge, such as $1 per camera plus 10 percent of its value. Tariffs and other forms of import taxes serve to discriminate against all foreign goods.

A Japanese wholesale store manager of a meat market in Tokyo arranges packs of beef imported from Australia. Earlier in the day, the government had announced Japan plans to raise its tariff on refrigerated beef imports to 50 percent from 38.5 percent, following a spike in imports. The price tag reads: “Premium beef, sirloin steak from Australia @ 258 yen [US$2.20] per 100 grams.” Tariffs are one of the main causes of price escalation for imported products. (AP Photo/Katsumi Kasahara)

Fees for import certificates or for other administrative processing can assume such levels that they are, in fact, import taxes. Many countries have purchase or excise taxes that apply to various categories of goods; value-added or turnover taxes, which apply as the product goes through a channel of distribution; and retail sales taxes. Such taxes increase the end price of goods but in general do not discriminate against foreign goods. Tariffs are the primary discriminatory tax that must be taken into account in reckoning with foreign competition.

In addition to taxes and tariffs, a variety of administrative costs are directly associated with exporting and importing a product. Export and import licenses, other documents, and the physical arrangements for getting the product from port of entry to the buyer’s location mean additional costs. Although such costs are relatively small, they add to the overall cost of exporting.

Inflation

In countries with rapid inflation or exchange variation, the selling price must be related to the cost of goods sold and the cost of replacing the items. Goods often are sold below their cost of replacement plus overhead, and sometimes are sold below replacement cost. In these instances, the company would be better off not to sell the products at all. When payment is likely to be delayed for several months or is worked out on a long-term contract, inflationary factors must be figured into the price. Inflation and lack of control over price were instrumental in an unsuccessful new-product launch in Brazil by the H. J. Heinz Company; after only two years, Heinz withdrew from the market. Misunderstandings with the local partner resulted in a new fruit-based drink being sold to retailers on consignment; that is, they did not pay until the product was sold. Faced with a rate of inflation of over 300 percent at the time, just a week’s delay in payment eroded profit margins substantially. Soaring inflation in many developing countries (Latin America in particular) makes widespread price controls a constant threat.

Shoppers look at stacks of discount clothing jutting out on a sidewalk to attract potential buyers at Tokyo’s Sugamo shopping district. With the stock market plunging to 16-year lows, talk of deflationary dangers, and a morass of confusion in its political leadership, Japan appeared to be headed toward a serious economic crisis. The central bank played down the possibility of deflation, saying that falling prices show the market is finally opening up to competition. (AP Photo/Katsumi Kasahara)

Because inflation and price controls imposed by a country are beyond the control of companies, they use a variety of techniques to inflate the selling price to compensate for inflation pressure and price controls. They may charge for extra services, inflate costs in transfer pricing, or break up products into components and price each component separately.

Inflation causes consumer prices to escalate, and consumers face ever-rising prices that eventually exclude many of them from the market. In contrast, deflation results in ever-decreasing prices, creating a positive result for consumers, but both put pressure to lower costs on everyone in the supply chain.

Deflation

The Japanese economy was in a deflationary spiral for a number of years. In a country better known for $10 melons and $100 steaks, McDonald’s now sells hamburgers for 52 cents, down from $1.09; a flat screen 32-inch color television is down from $4,000 to $2,400; and clothing stores compete to sell fleece jackets for $8, down from $25 two years earlier.14 Consumer prices have dropped to a point that they are similar to those Japanese once found only on overseas shopping trips. The high prices prevalent in Japan before deflation allowed substantial margins for everyone in the distribution chain. As prices continued to drop over several years, those less able to adjust costs to allow some margin with deflated prices fell by the wayside. Entirely new retail categories—100-yen discount shops, clothing chains selling low-cost imported products from China, and warehouse-style department stores—have become the norm. Sales at discount stores grew by 78 percent in the late 1990s. Discounting is the way to prosper in Japan, which again helps fuel deflation. While those in the distribution chain adjusted to a different competitive environment or gave up, Japanese consumers were reveling in their newfound spending power. Japanese tourists used to travel to the United States to buy things at much cheaper prices, but as one consumer commented, “Nowadays, I feel prices in Japan are going down and America is no longer cheaper.” Although she was accustomed to returning from trips to the United States carrying suitcases of bargains, she returned from her last two-week vacation with purchases that fit in one fanny pack.

In a deflationary market, it is essential for a company to keep prices low and raise brand value to win the trust of consumers. Whether experiencing deflation or inflation, an exporter has to place emphasis on controlling price escalation.

Exchange Rate Fluctuations

At one time, world trade contracts could be easily written because payment was specified in a relatively stable currency. The American dollar was the standard, and all transactions could be related to the dollar. Now that all major currencies are floating freely relative to one another, no one is quite sure of the future value of any currency.15 Increasingly, companies are insisting that transactions be written in terms of the vendor company’s national currency, and forward hedging is becoming more common. If exchange rates are not carefully considered in long-term contracts, companies find themselves unwittingly giving 15 to 20 percent discounts. The added cost incurred by exchange rate fluctuations on a day-today basis must be taken into account, especially where there is a significant time lapse between signing the order and delivery of the goods. Exchange rate differentials mount. Whereas Hewlett-Packard gained nearly half a million dollars additional profit through exchange rate fluctuations in one year, Nestlé lost a million dollars in six months. Other companies have lost or gained even larger amounts.16

During the mid-1990s, Mexico knocked three zeroes off the peso in response to a major devaluation. Venezuela did the same in 2008.19 In 2005 Turkey knocked six zeroes off its lira toward its potential alignment with the European Union. Both actions affected perceptions of key constituencies. Both bills are worth about 75¢.

Varying Currency Values

In addition to risks from exchange rate variations, other risks result from the changing values of a country’s currency relative to other currencies,17 such as consumers’ perceptions of value.18 Consider the situation in Germany for a purchaser of U.S. manufactured goods from mid-2001 to mid-2003. During this period, the value of the U.S. dollar relative to the euro went from a strong position (U.S.$1 to €1.8315) in mid-2001 to a weaker position in mid-2003 (U.S.$1 to €0.8499). A strong dollar produces price resistance because a larger quantity of local currency is needed to buy a U.S. dollar. Conversely, when the U.S. dollar is weak, demand for U.S. goods increases because fewer units of local currency are needed to buy a U.S. dollar. The weaker U.S. dollar, compared with most of the world’s stronger currencies, that existed in mid-2003 stimulated exports from the United States. Consequently, when the dollar strengthens, U.S. exports will soften.

When the value of the dollar is weak relative to the buyer’s currency (i.e., it takes fewer units of the foreign currency to buy a dollar), companies generally employ cost-plus pricing. To remain price competitive when the dollar is strong (i.e., when it takes more units of the foreign currency to buy a dollar), companies must find ways to offset the higher price caused by currency values. When the rupee in India depreciated significantly against the U.S. dollar, PC manufacturers faced a serious pricing problem. Because the manufacturers were dependent on imported components, their options were to absorb the increased cost or raise the price of PCs.

Currency exchange rate swings are considered by many global companies to be a major pricing problem. Because the benefits of a weaker dollar are generally transitory, firms need to take a proactive stance one way or the other. For a company with long-range plans calling for continued operation in foreign markets that wants to remain price competitive, price strategies need to reflect variations in currency values.

A woman looks at a poster offering a half-priced bacon and lettuce hamburger, reduced from U.S.$3.20 to $1.60 during a monthly discount at a McDonald’s restaurant in downtown Tokyo. McDonald’s Japan announced that it would reduce the price of hamburgers by 30 percent for a month to return to customers the profit the company made by the strong yen against U.S. dollars in importing the raw materials from abroad. McDonald’s move created goodwill among its customers at a time when it is forced to lower prices to “hike” sales in an economy that is suffering a major downturn. This move is a good example of how differences in the value of currencies can be positive for a company, as in this case, or negative when the value of the dollar is much stronger than the local currency. (AP Photo)

Innumerable cost variables can be identified depending on the market, the product, and the situation. The cost, for example, of reaching a market with relatively small potential may be high. High operating costs of small specialty stores like those in Mexico and Thailand lead to high retail prices. Intense competition in certain world markets raises the cost or lowers the margins available to world business. Even small things like payoffs to local officials can introduce unexpected costs to the unwary entrepreneur. Only experience in a given marketplace provides the basis for compensating for cost differences in different markets. With experience, a firm that prices on a cost basis operates in a realm of reasonably measurable factors.

Middleman and Transportation Costs

Channel length and marketing patterns vary widely, but in most countries, channels are longer and middleman margins higher than is customary in the United States. The diversity of channels used to reach markets and the lack of standardized middleman markups leave many producers unaware of the ultimate price of a product.

Besides channel diversity, the fully integrated marketer operating abroad faces various unanticipated costs because marketing and distribution channel infrastructures are under-developed in many countries. The marketer can also incur added expenses for warehousing and handling of small shipments and may have to bear increased financing costs when dealing with underfinanced middlemen.

Because no convenient source of data on middleman costs is available, the international marketer must rely on experience and marketing research to ascertain middleman costs. The Campbell Soup Company found its middleman and physical distribution costs in the United Kingdom to be 30 percent higher than in the United States. Extra costs were incurred because soup was purchased in small quantities—small English grocers typically purchase 24-can cases of assorted soups (each case being hand-packed for shipment). In the United States, typical purchase units are 48-can cases of one soup purchased by the dozens, hundreds, or carloads. The purchase habits in Europe forced the company into an extra wholesale level in its channel to facilitate handling small orders.

Exporting also incurs increased transportation costs when moving goods from one country to another. If the goods go over water, insurance, packing, and handling are additional costs not generally added to locally produced goods. Such costs add yet another burden because import tariffs in many countries are based on the landed cost, which includes transportation, insurance, and shipping charges. These costs add to the inflation of the final price. The next section details how a price in the home market may more than double in the foreign market.

Sample Effects of Price Escalation

Exhibit 18.2 illustrates some of the effects the factors discussed previously may have on the end price of a consumer item. Because costs and tariffs vary so widely from country to country, a hypothetical but realistic example is used. It assumes that a constant net price is received by the manufacturer, that all domestic transportation costs are absorbed by the various middleman and reflected in their margins, and that the foreign middlemen have the same margins as the domestic middlemen. In some instances, foreign middleman margins are lower, but it is equally probable that these margins could be greater. In fact, in many instances, middlemen use higher wholesale and retail margins for foreign goods than for similar domestic goods.

Exhibit 18.2: Sample Causes and Effects of Price Escalation

Notice that the retail prices in Exhibit 18.2 range widely, illustrating the difficulty of price control by manufacturers in overseas retail markets. No matter how much the manufacturer may wish to market a product in a foreign country for a price equivalent to US$10, there is little opportunity for such control. Even assuming the most optimistic conditions for Foreign Example 1, the producer would need to cut its net by more than one-third to absorb freight and tariff costs if the goods are to be priced the same in both foreign and domestic markets. Price escalation is everywhere: A man’s dress shirt that sells for $40 in the United States retails for $80 in Caracas. A $20 U.S. electric can opener is priced in Milan at $70; a $35 U.S.-made automatic toaster is priced at $80 in France.

Unless some of the costs that create price escalation can be reduced, the marketer is faced with a price that may confine sales to a limited segment of wealthy, price-insensitive customers. In many markets, buyers have less purchasing power than in the United States and can be easily priced out of the market. Furthermore, once price escalation is set in motion, it can spiral upward quickly. When the price to middlemen is high and turnover is low, they may insist on higher margins to defray their costs, which, of course, raises the price even higher. Unless price escalation can be reduced, marketers find that the only buyers left are the wealthier ones. If marketers are to compete successfully in the growth of markets around the world, cost containment must be among their highest priorities. If costs can be reduced anywhere along the chain, from manufacturer’s cost to retailer markups, price escalation will be reduced. A discussion of some of the approaches to reducing price escalation follows.

Approaches to Reducing Price Escalation

Three methods used to reduce costs and lower price escalation are lowering the cost of goods, lowering tariffs, and lowering distribution costs.

Lowering Cost of Goods

If the manufacturer’s price can be lowered, the effect is felt throughout the chain. One of the important reasons for manufacturing in a third country is an attempt to reduce manufacturing costs and thus price escalation. The impact can be profound if you consider that the hourly cost of skilled labor in a Mexican maquiladora is less than $3 an hour including benefits, compared with more than $10 in the United States.

In comparing the costs of manufacturing microwave ovens in the United States and in Korea, the General Electric Company found substantial differences. A typical microwave oven cost GE $218 to manufacture compared with $155 for Samsung, a Korean manufacturer. A breakdown of costs revealed that assembly labor cost GE $8 per oven and Samsung only 63 cents. Perhaps the most disturbing finding for GE was that Korean laborers delivered more for less cost: GE produced four units per person, whereas the Korean company produced nine.

Although Korea remains an important offshore manufacturing location, China is emerging as a global manufacturing powerhouse backed by an inexpensive labor force, rapidly improving production quality, new sources of capital, a more dynamic private sector, and a deliberately undervalued currency. China supplies a growing range of products to the global marketplace. Japan, the land of zero-defect quality control, is increasingly happy with the competence of Chinese workers. Star Manufacturing, a Japanese precision machine tool manufacturing company, moved 30 percent of its production to China because China’s cheap labor and cheap resources reduced its production costs by 20 percent.

Eliminating costly functional features or even lowering overall product quality is another method of minimizing price escalation. For U.S.-manufactured products, the quality and additional features required for the more developed home market may not be necessary in countries that have not attained the same level of development or consumer demand. In the price war between P&G and Kimberly-Clark in Brazil, the quality of the product was decreased to lower the price. Remember that the grandmother in the grocery store chose the poorest quality and lowest priced brand of diaper. Similarly, functional features on washing machines made for the United States, such as automatic bleach and soap dispensers, thermostats to provide four different levels of water temperature, controls to vary water volume, and bells to ring at appropriate times, may be unnecessary for many foreign markets. Eliminating them means lower manufacturing costs and thus a corresponding reduction in price escalation. Lowering manufacturing costs can often have a double benefit: The lower price to the buyer may also mean lower tariffs, because most tariffs are levied on an ad valorem basis.

Lowering Tariffs

When tariffs account for a large part of price escalation, as they often do, companies seek ways to lower the rate. Some products can be reclassified into a different, and lower, customs classification. An American company selling data communications equipment in Australia faced a 25 percent tariff, which affected the price competitiveness of its products. It persuaded the Australian government to change the classification for the type of products the company sells from “computer equipment” (25 percent tariff) to “telecommunication equipment” (3 percent tariff). Like many products, this company’s products could be legally classified under either category. One complaint against customs agents in Russia is the arbitrary way in which they often classify products. Russian customs, for instance, insists on classifying Johnson & Johnson’s 2-in-1 Shower Gel as a cosmetic with a 20 percent tariff rather than as a soap substitute, which the company considers it, at a 15 percent tariff.

How a product is classified is often a judgment call. The difference between an item being classified as jewelry or art means paying no tariff for art or a 26 percent tariff for jewelry. For example, a U.S. customs inspector could not decide whether to classify a $2.7 million Fabergé egg as art or jewelry. The difference was $0 tariff versus $700,000. An experienced freight forwarder/customs broker saved the day by persuading the customs agent that the Fabergé egg was a piece of art. Because the classification of products varies among countries, a thorough investigation of tariff schedules and classification criteria can result in a lower tariff.

CROSSING BORDERS 18.3: What Does It Mean To Be Human? 5.2 Percent, That’s What

“What does it mean to be human?” asked Judge Barzilay in her chambers at the U.S. Court of International Trade. At the heart of the problem were some 60 little plastic figures of Marvel Enterprises’ X-Men and other comic figures.

Marvel subsidiary Toy Biz Inc. sought to have its heroes from a range of comic characters declared nonhuman. At the time, tariffs were higher on dolls (12 percent) than toys (6.8 percent). According to the U.S. tariff code, human figures are dolls, whereas figures representing animals or “creatures,” such as monsters and robots, are deemed toys.

Thus began the great debate over the figures’ true being. Barbie is a doll. Pooh Bear’s a toy. That much is easy. But what about Wolverine, the muscular X-Man with the metal claws that jut out from his fists? Wolverine has known many forms in his more than 40 years as a Marvel character. But is he human? Or consider Kraven, a famed hunter, who once vanquished Spiderman, thanks in part to the strength he gained from drinking secret jungle elixirs.

Toy Biz argued that the figures “stand as potent witnesses for their status as nonhuman creatures.” How could they be humans if they possessed “tentacles, claws, wings or robotic limbs”? The U.S. Customs Service argued that each figure had a “distinctive individual personality.” Some were Russians, Japanese, black, white, women, even handicapped. Wolverine, the government insisted, was simply “a man with prosthetic hands.”

To weigh the question, Judge Barzilay sat down with a sheaf of opposing legal briefs and more than 60 action figures, including Wolverine, Storm, Rogue, Kraven, and Bonebreaker. Judge Barzilay described in her ruling how she subjected many of the figures to “comprehensive examinations.” At times, that included “the need to remove the clothes of the figure.” The X-Men, oddly, gave her the least trouble. They are mutants, she declared, who “use their extraordinary and unnatural powers on the side of good or evil.” Thus the X-Men are “something other than human.” Tougher for the judge were figures from the Fantastic Four and Spiderman series. After careful examination and thought, the judge found Kraven exhibited “highly exaggerated muscle tone in arms and legs.” He wore a “lion’s mane-like vest.” Both features helped relegate him to the netherworld of robots, monsters, and devils. Case closed.

Toy Biz Inc. was elated, but fans were incensed—no way are X-Men mere creatures. “Marvel’s superheroes are supposed to be as human as you or I. They live in New York. They have families and go to work. And now they’re no longer human?” The current author of Marvel’s Uncanny X-Men comic book series is also incredulous. He worked hard for a year, he says, to emphasize the X-Men’s humanity, to show “that they’re just another strand in the evolutionary chain.” But “Don’t fret, Marvel fans, a decision that the X-Men figures indeed do have ‘nonhuman’ characteristics further proves our characters have special, out-of-this world powers.”

Although this scenario may seem trivial, it highlights just how arbitrary tariff classification can be. It pays to argue your case if you believe a product can be classified at a lower rate. For every $100,000 of plastic figures Toy Biz imports, the reclassification saves it $5,200. Not a bad day’s work, considering the hundreds of thousands of dollars worth of figures the company imports annually—not to mention the undisclosed sum Toy Biz can recoup from years of overpaid tariffs.

Sources: Niel King Jr., “Is Wolverine Human? A Judge Answers No; Fans Howl in Protest,” The Wall Street Journal, January 20, 2003; Marie Beerens, “Marvel’s Two Movies Should Fuel Demand,” Investor’s Business Daily, February 19, 2008.

Besides having a product reclassified into a lower tariff category, it may be possible to modify a product to qualify for a lower tariff rate within a tariff classification. In the footwear industry, the difference between “foxing” and “foxlike” on athletic shoes makes a substantial difference in the tariff levied. To protect the domestic footwear industry from an onslaught of cheap sneakers from the Far East, the tariff schedules state that any canvas or vinyl shoe with a foxing band (a tape band attached at the sole and overlapping the shoe’s upper by more than one-quarter inch) be assessed at a higher duty rate. As a result, manufacturers design shoes so that the sole does not overlap the upper by more than one-quarter inch. If the overlap exceeds one-quarter inch, the shoe is classified as having a foxing band; less than one-quarter inch, a foxlike band. A shoe with a foxing band is taxed 48 percent and one with a fox-like band (one-quarter inch or less overlap) is taxed a mere 6 percent.

Hugh Jackman portraying Wolverine, an X-Men fictional character from Marvel Enterprises. A tariff classification issue arose when the company declared the imported toy characters as nonhuman toys and U.S. Customs said that they were human figure dolls—tariffs on dolls at that time were 12 percent versus 6.8 percent for toys. U.S. Customs alleged that the X-Men figures were human figures and thus should be classified as dolls, not figures featuring animals or creatures, which would mean that they could be classified as toys. Product classifications are critical when tariffs are determined. See Crossing Borders 18.3 for more details on this case. (© 20th Century Fox/Marvel Entertainment Group/The Kobal Collection)

There are often differential rates between fully assembled, ready-to-use products and those requiring some assembly, further processing, the addition of locally manufactured component parts, or other processing that adds value to the product and can be performed within the foreign country. For example, a ready-to-operate piece of machinery with a 20 percent tariff may be subject to only a 12 percent tariff when imported unassembled. An even lower tariff may apply when the product is assembled in the country and some local content is added.

Repackaging also may help to lower tariffs. Tequila entering the United States in containers of one gallon or less carries a duty of $2.27 per proof gallon; larger containers are assessed at only $1.25. If the cost of rebottling is less than $1.02 per proof gallon, and it probably would be, considerable savings could result. As will be discussed shortly, one of the more important activities in foreign trade zones is the assembly of imported goods, using local and frequently lower cost labor.

Lowering Distribution Costs

Shorter channels can help keep prices under control. Designing a channel that has fewer middlemen may lower distribution costs by reducing or eliminating middleman markups. Besides eliminating markups, fewer middlemen may mean lower overall taxes. Some countries levy a value-added tax on goods as they pass through channels. Goods are taxed each time they change hands. The tax may be cumulative or noncumulative. A cumulative value-added tax is based on total selling price and is assessed every time the goods change hands. Obviously, in countries where value-added tax is cumulative, tax alone provides a special incentive for developing short distribution channels. Where that is achieved, tax is paid only on the difference between the middleman’s cost and the selling price. While many manufacturers had to cut prices in wake of Japan’s deflation, Louis Vuitton, a maker of branded boutique goods, was able to increase prices instead. A solid brand name and direct distribution have permitted Vuitton’s price strategy. Vuitton’s leather monogrammed bags have become a Japanese buyer’s “daily necessity,” and Vuitton distributes directly and sets its own prices.

Using Foreign Trade Zones to Lessen Price Escalation

Some countries have established foreign or free trade zones (FTZs) or free ports to facilitate international trade.20 More than 300 of these facilities operate throughout the world, storing or processing imported goods. As free trade policies in Africa, Latin America, eastern Europe, and other developing regions expand, an equally rapid expansion has taken place in the creation and use of foreign trade zones. Recall from Chapter 15 that in a free port or FTZ, payment of import duties is postponed until the product leaves the FTZ area and enters the country. An FTZ is, in essence, a tax-free enclave and not considered part of the country as far as import regulations are concerned. When an item leaves an FTZ and is imported officially into the host country of the FTZ, all duties and regulations are imposed.

Utilizing FTZs can to some extent control price escalation resulting from the layers of taxes, duties, surcharges, freight charges, and so forth. Foreign trade zones permit many of these added charges to be avoided, reduced, or deferred so that the final price is more competitive. One of the more important benefits of the FTZ in controlling prices is the exemption from duties on labor and overhead costs incurred in the FTZ in assessing the value of goods.

By shipping unassembled goods to an FTZ in an importing country, a marketer can lower costs in a variety of ways:

• Tariffs may be lower because duties are typically assessed at a lower rate for unassembled versus assembled goods.

• If labor costs are lower in the importing country, substantial savings may be realized in the final product cost.

• Ocean transportation rates are affected by weight and volume; thus unassembled goods may qualify for lower freight rates.

• If local content, such as packaging or component parts, can be used in the final assembly, tariffs may be further reduced.

All in all, a foreign or free trade zone is an important method for controlling price escalation. Incidentally, all the advantages offered by an FTZ for an exporter are also advantages for an importer. U.S. importers use over 100 FTZs in the United States to help lower their costs of imported goods. See Exhibit 18.3 for illustrations of how FTZs are used.

Exhibit 18.3: How Are Foreign Trade Zones Used?

Dumping

A logical outgrowth of a market policy in international business is goods priced competitively at widely differing prices in various markets. Marginal (variable) cost pricing, as discussed previously, is a way prices can be reduced to stay within a competitive price range. The market and economic logic of such pricing policies can hardly be disputed, but the practices often are classified as dumping and are subject to severe penalties and fines. Various economists define dumping differently. One approach classifies international shipments as dumped if the products are sold below their cost of production. Another approach characterizes dumping as selling goods in a foreign market below the price of the same goods in the home market.21

World Trade Organization (WTO) rules allow for the imposition of a dumping duty when goods are sold at a price lower than the normal export price or less than the cost in the country of origin, increased by a reasonable amount for the cost of sales and profits, when this price is likely to be prejudicial to the economic activity of the importing country. A countervailing duty or minimum access volume (MAV), which restricts the amount a country will import, may be imposed on foreign goods benefiting from subsidies, whether in production, export, or transportation.

For countervailing duties to be invoked, it must be shown that prices are lower in the importing country than in the exporting country and that producers in the importing country are being directly harmed by the dumping. A report by the U.S. Department of Agriculture indicated that levels of dumping by the United States hover around 40 percent for wheat and between 25 and 30 percent for corn, and levels for soybeans have risen steadily over the past four years to nearly 30 percent. These percentages, for example, mean that wheat is selling up to 40 percent below the cost of production. For cotton, the level of dumping for 2001 rose to a remarkable 57 percent, and for rice, it has stabilized at around 20 percent. The study indicated that these commodities are being dumped onto international markets by the United States in violation of WTO rules. The report found that after many years of accepting agricultural dumping, a few countries have begun to respond by investigating whether some U.S. agricultural exports are dumped. Brazil is considering a case against U.S. cotton before the WTO. In 2001, Canada briefly imposed both counter-vailing and antidumping duties on U.S. corn imports; the United States did the same for Chinese apple juice concentrate.22

Dumping is rarely an issue when world markets are strong. In the 1980s and 1990s, dumping became a major issue for a large number of industries when excess production capacity relative to home-country demand caused many companies to price their goods on a marginal-cost basis. In a classic case of dumping, prices are maintained in the home-country market and reduced in foreign markets.

Today, tighter government enforcement of dumping legislation is causing international marketers to seek new routes around such legislation. Assembly in the importing country is a way companies attempt to lower prices and avoid dumping charges. However, these screwdriver plants, as they are often called, are subject to dumping charges if the price differentials reflect more than the cost savings that result from assembly in the importing country. Another subterfuge is to alter the product so that the technical description will fit a lower duty category. To circumvent a 16.9 percent countervailing duty imposed on Chinese gas-filled, nonrefillable pocket flint lighters, the manufacturer attached a useless valve to the lighters so that they fell under the “nondisposable” category, thus avoiding the duty. Countries see through many such subterfuges and impose taxes. For example, the European Union imposed a $27 to $58 dumping duty per unit on a Japanese firm that assembled and sold office machines in the European Union. The firm was charged with valuing imported parts for assembly below cost.

The U.S. market is currently more sensitive to dumping than in the recent past. In fact, the Uruguay Round of the GATT included a section on antidumping that grew out of U.S. insistence on stricter controls on dumping of foreign goods in the United States at prices below those charged at home. Changes in U.S. law have enhanced the authority of the Commerce Department to prevent circumvention of antidumping duties and countervailing duties that have been imposed on a country for dumping. The United States and European Union have been the most ardent users of antidumping duties. A question asked by many though: Are dumping charges just a cover for protectionism? Previously, when an order was issued to apply antidumping and countervailing duties on products, companies charged with the violation would get around the order by slightly altering the product or by doing minor assembly in the United States or a third country. This effort created the illusion of a different product not subject to the antidumping order. The new authority of the Department of Commerce closes many such loopholes.

Leasing in International Markets

An important selling technique to alleviate high prices and capital shortages for capital equipment is the leasing system. The concept of equipment leasing has become increasingly important as a means of selling capital equipment in overseas markets. In fact, an estimated $50 billion worth (original cost) of U.S.-made and foreign-made equipment is on lease in western Europe.

The system of leasing used by industrial exporters is similar to the typical lease contracts used in the United States. Terms of the leases usually run one to five years, with payments made monthly or annually; included in the rental fee are servicing, repairs, and spare parts. Just as contracts for domestic and overseas leasing arrangements are similar, so are the basic motivations and the shortcomings. For example:

• Leasing opens the door to a large segment of nominally financed foreign firms that can be sold on a lease option but might be unable to buy for cash.

• Leasing can ease the problems of selling new, experimental equipment, because less risk is involved for the users.

• Leasing helps guarantee better maintenance and service on overseas equipment.

• Equipment leased and in use helps sell other companies in that country.

• Lease revenue tends to be more stable over a period of time than direct sales would be.

The disadvantages or shortcomings take on an international flavor. Besides the inherent disadvantages of leasing, some problems are compounded by international relationships. In a country beset with inflation, lease contracts that include maintenance and supply parts (as most do) can lead to heavy losses toward the end of the contract period. Furthermore, countries where leasing is most attractive are those where spiraling inflation is most likely to occur. The added problems of currency devaluation, expropriation, or other political risks are operative longer than if the sale of the same equipment were made outright. In light of these perils, leasing incurs greater risk than does outright sale; however, there is a definite trend toward increased use of this method of selling internationally.

Countertrade as a Pricing Tool

Countertrade is a pricing tool that every international marketer must be ready to employ, and the willingness to accept a countertrade will often give the company a competitive advantage. The challenges of countertrade must be viewed from the same perspective as all other variations in international trade. Marketers must be aware of which markets will likely require countertrades, just as they must be aware of social customs and legal requirements. Assessing this factor along with all other market factors will enhance a marketer’s competitive position.

One of the earliest barter arrangements occurred between Russia and PepsiCo before the ruble was convertible and before most companies were trading with Russia. PepsiCo wanted to beat Coca-Cola into the Russian market. The only way possible was for PepsiCo to be willing to accept vodka (sold under the brand name Stolichnaya) from Russia and bottled wines (sold under the brand name of Premiat) from Romania to finance Pepsi bottling plants in those countries. From all indications, this arrangement was very profitable for Russia, Romania, and PepsiCo. Pepsi continues to use countertrade to expand its bottling plants. In a recent agreement between PepsiCo and Ukraine, Pepsi agreed to market $1 billion worth of Ukrainian-made commercial ships over an eight-year period. Some of the proceeds from the ship sales will be reinvested in the shipbuilding venture, and some will be used to buy soft-drink equipment and build five Pepsi bottling plants in Ukraine. PepsiCo dominates the cola market in Russia and all the former Soviet republics in part because of its exclusive countertrade agreement with Russia, which locked Coca-Cola out of the Russian cola market for more than 12 years. After the Soviet Union was dismembered, the Russian economy crashed, and most of the Russian payment system broke down into barter operations. Truckloads of aspirin were swapped by one company, then traded for poultry, which in turn was bartered for lumber, in turn to be exchanged for X-ray equipment from Kazakhstan—all to settle debts. Many of these transactions involved regional electricity companies that were owed money by virtually everyone.

Although cash may be the preferred method of payment, countertrades are an important part of trade with eastern Europe, the newly independent states, China,23 and, to a varying degree, some Latin American and African nations. Barter or countertrades still constitute between 20 and 40 percent of all transactions in the economies of the former Soviet bloc. Corporate debts to suppliers, payment and services, even taxes—all have a noncash component or are entirely bartered. Many of these countries constantly face a shortage of hard currencies with which to trade and thus resort to countertrades when possible. A recent purchase of 48 F-16 Falcons from Lockheed Martin was pegged at $3.5 billion. The financial package included soft loans and a massive offset program—purchases from Polish manufacturers that more than erased the costs of the deal in foreign exchange. With an economy once short of hard currency, Russia has offered a wide range of products in barter for commodities it needed. For example, Russian expertise in space technology was offered for Malaysian palm oil and rubber, and military equipment was exchanged for crude palm oil or rice from Indonesia.24 Today, an international company must include in its market-pricing toolkit some understanding of countertrading.

Types of Countertrade

Countertrade includes four distinct transactions: barter, compensation deals, counter-purchase, and buyback. Barter is the direct exchange of goods between two parties in a transaction. For example, the Malaysian government bought 20 diesel-electric locomotives from General Electric. Officials of the government said that GE would be paid with palm oil, to be supplied by a plantation company. The company will supply about 200,000 metric tons of palm oil over a period of 30 months. This agreement was GE’s first barter deal for palm oil and palm products, though its division GE Trading has several other countertrade agreements worldwide. No money changed hands, and no third parties were involved. Obviously, in a barter transaction, the seller must be able to dispose of the goods at a net price equal to the expected selling price in a regular, for-cash transaction. Furthermore, during the negotiation stage of a barter deal, the seller must know the market and the price for the items offered in trade. In the General Electric example, palm oil has an established price and a global market for palm oil and palm products. But not all bartered goods have an organized market, and products can range from hams to iron pellets, mineral water to furniture to olive oil—all somewhat more difficult to price and to find customers.

Barter may also be used to reduce a country’s foreign debt. To save foreign exchange reserves, the Philippine government offered some creditors canned tuna to repay part of a state $4-billion debt. If tuna is not enough, coconut oil and a seaweed extract, carrageenan, used as an additive in foods, toothpaste, cosmetics and ice cream, were offered. The seaweed and tuna exporters will be paid with pesos so no currency leaves the country.

Compensation deals involve payment in goods and in cash. A seller delivers lathes to a buyer in Venezuela and receives 70 percent of the payment in convertible currency and 30 percent in tanned hides and wool. In an actual deal, General Motors Corporation sold $12 million worth of locomotives and diesel engines to Yugoslavia and took cash and $4 million in Yugoslavian cutting tools as payment. McDonnell Douglas agreed to a compensation deal with Thailand for eight top-of-the-range F/A-18 strike aircraft. Thailand agreed to pay $578 million of the total cost in cash, and McDonnell Douglas agreed to accept $93 million in a mixed bag of goods including Thai rubber, ceramics, furniture, frozen chicken, and canned fruit. In a move to reduce its current account deficit, the Thai government requires that 20 to 50 percent of the value of large contracts be paid for in raw and processed agricultural goods.

An advantage of a compensation deal over barter is the immediate cash settlement of a portion of the bill; the remainder of the cash is generated after successful sale of the goods received. If the company has a use for the goods received, the process is relatively simple and uncomplicated. However, if the seller has to rely on a third party to find a buyer, the cost involved must be anticipated in the original compensation negotiation if the net proceeds to the seller are to equal the market price.

Counterpurchase, or offset trade, is probably the most frequently used type of countertrade. For this trade, the seller agrees to sell a product at a set price to a buyer and receives payment in cash. However, two contracts are negotiated. The first contract is contingent on a second contract that includes an agreement by the original seller to buy goods from the buyer for the total monetary amount involved in the first contract or for a set percentage of that amount. This arrangement provides the seller with more flexibility than the compensation deal because there is generally a time period—6 to 12 months or longer—for completion of the second contract. During the time that markets are sought for the goods in the second contract, the seller has received full payment for the original sale. Furthermore, the goods to be purchased in the second contract are generally of greater variety than those offered in a compensation deal. Even greater flexibility is offered when the second contract is nonspecific; that is, the books on sales and purchases need to be cleared only at certain intervals. The seller is obligated to generate enough purchases to keep the books balanced or clear between purchases and sales.

Offset trades are becoming more prevalent among economically weak countries. Several variations of a counterpurchase or offset have developed to make it more economical for the selling company. For example, the Lockheed Martin Corporation entered into an offset trade with the United Arab Emirates (UAE) in a $6.4 billion deal for 80 F-16 fighter planes called Desert Falcons. Lockheed agreed to make a $160 million cash investment in a gas pipeline running from Qatar to UAE industrial projects and then on to Pakistan. The UAE requires that some of the proceeds from weapon sales be reinvested in the UAE. Such offsets are a common feature of arms deals, in which sellers build facilities ranging from hotels to sugar mills at the request of the buyer.

A product buyback agreement is the fourth type of countertrade transaction. This type of agreement is made when the sale involves goods or services that produce other goods and services, such as a production plant, production equipment, or technology. The buy-back agreement usually involves one of two situations: The seller agrees to accept as partial payment a certain portion of the output, or the seller receives full price initially but agrees to buy back a certain portion of the output. One U.S. farm equipment manufacturer sold a tractor plant to Poland and was paid part in hard currency and the balance in Polish-built tractors. In another situation, General Motors built an auto manufacturing plant in Brazil and was paid under normal terms but agreed to the purchase of resulting output when the new facilities came online. Levi Strauss took Hungarian blue jeans, which it sells abroad, in exchange for setting up a jeans factory near Budapest.

An interesting buyback arrangement has been agreed on between the Rice Growers Association of California (RGAC) and the Philippine government. The RGAC will invest in Philippine farmlands and bring new technologies to enhance local rice production. In return, the RGAC will import rice and other food products in payment. A major drawback to product buyback agreements comes when the seller finds that the products bought back are in competition with its own similarly produced goods. Yet some have found that a product buyback agreement provides them with a supplemental source in areas of the world where there is demand but no available supply.

Problems of Countertrading

The crucial problem confronting a seller in a countertrade negotiation is determining the value of and potential demand for the goods offered. Frequently there is inadequate time to conduct a market analysis; in fact, it is not unusual to have sales negotiations almost completed before countertrade is introduced as a requirement in the transaction.

Although such problems are difficult to deal with, they can be minimized with proper preparation. In most cases where losses have occurred in countertrades, the seller has been unprepared to negotiate in anything other than cash. Some preliminary research should be done in anticipation of being confronted with a countertrade proposal. Countries with a history of countertrading are identified easily, and the products most likely to be offered in a countertrade often can be ascertained. For a company trading with developing countries, these facts and some background on handling countertrades should be a part of every pricing toolkit. Once goods are acquired, they can be passed along to institutions that assist companies in selling bartered goods.

Barter houses specialize in trading goods acquired through barter arrangements and are the primary outside source of aid for companies beset by the uncertainty of a countertrade. Although barter houses, most of which are found in Europe, can find a market for bartered goods, this effort requires time, which puts a financial strain on a company because capital is tied up longer than in normal transactions.

In the United States, there are companies that assist with bartered goods and their financing. Citibank has created a countertrade department to allow the bank to act as a consultant as well as to provide financing for countertrades. It is estimated that there are now about 500 barter exchange houses in the United States, many of which are accessible on the Internet. Some companies with a high volume of barter have their own in-house trading groups to manage countertrades. The 3M Company (Minnesota Mining and Manufacturing), for example, has a wholly owned division, 3M Global Trading (www.3m.com/globaltrading), which offers its services to smaller companies.

The Internet and Countertrading

The Internet may become the most important venue for countertrade activities. Finding markets for bartered merchandise and determining market price are two of the major problems with countertrades. Several barter houses have Internet auction sites, and a number of Internet exchanges are expanding to include global barter.

Some speculate that the Internet may become the vehicle for an immense online electronic barter economy, to complement and expand the offline barter exchanges that take place now. In short, some type of electronic trade dollar would replace national currencies in international trade transactions. This e-dollar would make international business considerably easier for many countries, because it would lessen the need to acquire sufficient U.S. or other hard currency to complete a sale or purchase.

TradeBanc, a market-making service, has introduced a computerized technology that will enable members of trade exchanges to trade directly, online, with members of other trade exchanges anywhere in the world, as long as their barter company is a TradeBanc affiliate (www.tradebanc.com). The medium of exchange could be the Universal Currency proposed by the International Reciprocal Trade Association (IRTA; www.irta.com), an association of trade exchanges with members including Russia, Iceland, Germany, Chile, Turkey, Australia, and the United States. The IRTA has proposed to establish and operate a Universal Currency Clearinghouse, which would enable trade exchange members to easily trade with one another using this special currency. When the system is in full swing, all goods and services from all the participating affiliates would be housed in a single database. The transactions would be cleared by the local exchanges, and settlement would be made using IRTA’s Universal Currency, which could be used to purchase anything from airline tickets to potatoes.25

Proactive Countertrade Strategy

Currently most companies have a reactive strategy; that is, they use countertrade when they believe it is the only way to make a sale. Even when these companies include countertrade as a permanent feature of their operations, they use it to react to a sales demand rather than using countertrade as an aggressive marketing tool for expansion. Some authorities suggest, however, that companies should have a defined countertrade strategy as part of their marketing strategy rather than be caught unprepared when confronted with a countertrade proposition

A proactive countertrade strategy is the most effective strategy for global companies that market to exchange-poor countries. Economic development plans in eastern European countries, the Commonwealth of Independent States (CIS), and much of Latin America will put unusual stress on their ability to generate sufficient capital to finance their growth. Furthermore, as countries encounter financial crises such as that in Latin America in 1996 and Asia in 1998, countertrade becomes especially important as a means of exchange. To be competitive, companies must be willing to include some countertraded goods in their market planning. Companies with a proactive strategy make a commitment to use countertrade aggressively as a marketing and pricing tool. They see countertrades as an opportunity to expand markets rather than as an inconvenient reaction to market demands.

In short, unsuccessful countertrades are generally the result of inadequate planning and preparation. One experienced countertrader suggests answering the following questions before entering into a countertrade agreement: (1) Is there a ready market for the goods bartered? (2) Is the quality of the goods offered consistent and acceptable? (3) Is an expert needed to handle the negotiations? (4) Is the contract price sufficient to cover the cost of barter and net the desired revenue?

Transfer Pricing Strategy

As companies increase the number of worldwide subsidiaries, joint ventures, company-owned distributing systems, and other marketing arrangements, the price charged to different affiliates becomes a preeminent question. Prices of goods transferred from a company’s operations or sales units in one country to its units elsewhere, known as intracompany pricing or transfer pricing, may be adjusted to enhance the ultimate profit of the company as a whole. The benefits are as follows:

• Lowering duty costs by shipping goods into high-tariff countries at minimal transfer prices so that the duty base and duty are low.

• Reducing income taxes in high-tax countries by overpricing goods transferred to units in such countries; profits are eliminated and shifted to low-tax countries. Such profit shifting may also be used for “dressing up” financial statements by increasing reported profits in countries where borrowing and other financing are undertaken.

• Facilitating dividend repatriation when dividend repatriation is curtailed by government policy. Invisible income may be taken out in the form of high prices for products or components shipped to units in that country.

Government authorities have not overlooked the tax and financial manipulation possibilities of transfer pricing.26 Transfer pricing can be used to hide subsidiary profits and to escape foreign-market taxes. Intracompany pricing is managed in such a way that profit is taken in the country with the lowest tax rate. For example, a foreign manufacturer makes a DVD player for $50 and sells it to its U.S. subsidiary for $150. The U.S. subsidiary sells it to a retailer for $200 but spends $50 on advertising and shipping so that it shows no profit and pays no U.S. taxes. Meanwhile, the parent company makes a $100 gross margin on each unit and pays at a lower tax rate in the home country. If the tax rate were lower in the country where the subsidiary resides, the profit would be taken in the foreign country and no profit taken in the home country.27

When customs and tax regimes are high, companies have a strong incentive to trim fiscal liabilities by adjusting the transaction value of goods and services between subsidiaries. Pricing low cuts exposure to import duties; declaring a higher value raises deductible costs and thereby lightens the corporate tax burden. The key is to strike the right balance that maximizes savings overall.

The overall objectives of the intracompany pricing system include maximizing profits for the corporation as a whole; facilitating parent-company control; and offering management at all levels, both in the product divisions and in the international divisions, as an adequate basis for maintaining, developing, and receiving credit for their own profitability. Transfer prices that are too low are unsatisfactory to the product divisions because their overall results look poor; prices that are too high make the international operations look bad and limit the effectiveness of foreign managers.

An intracompany pricing system should employ sound accounting techniques and be defensible to the tax authorities of the countries involved. All of these factors argue against a single uniform price or even a uniform pricing system for all international operations. Four arrangements for pricing goods for intracompany transfer are as follows:

1. Sales at the local manufacturing cost plus a standard markup.

2. Sales at the cost of the most efficient producer in the company plus a standard markup.

3. Sales at negotiated prices.

4. Arm’s-length sales using the same prices as quoted to independent customers.

Of the four, the arm’s-length transfer is most acceptable to tax authorities and most likely to be acceptable to foreign divisions, but the appropriate basis for intracompany transfers depends on the nature of the subsidiaries and market conditions.

Although the practices described in this section are not necessarily improper, they are being scrutinized more closely by both home and host countries concerned about the loss of potential tax revenues from foreign firms doing business in their countries as well as domestic firms underreporting foreign earnings. The U.S. government is paying particular attention to transfer pricing in tax audits, as are other countries. This development has led to what some have described as a “tax war” between the United States and Japan over transfer pricing by MNCs, with each country bringing charges against foreign MNCs for underpayment of taxes because of transfer pricing practices. For example, the United States claimed that Nissan U.S. had inflated the prices it paid to its parent for finished cars it was importing to lower U.S. taxes. As a result, the United States levied a hefty multimillion-dollar tax penalty against Nissan. Japan retaliated by hitting Coca-Cola with a $145 million tax deficiency charge.

Governments are seeking tax revenues from their domestic MNCs as well. Prior to PepsiCo’s decision to spin off its restaurant division into a separate company, the IRS charged PepsiCo $800 million after an audit of its foreign operations of Taco Bell, Pizza Hut, and KFC indicated an underreporting of profits of their foreign operations. Penalties can be as high as 40 percent of the amount underreported. The only certain way to avoid such penalties is to enter an advanced pricing agreement (APA) with the IRS. An APA is an agreement between the IRS and a taxpayer on transfer pricing methods that will be applied to some or all of a taxpayer’s transactions with affiliates. Such agreements generally apply for up to five years and offer better protection against penalties than other methods. Otherwise, once the IRS charges underreporting, the burden of proof that a transfer price was fair rests with the company.

Price Quotations

In quoting the price of goods for international sale, a contract may include specific elements affecting the price, such as credit, sales terms, and transportation. Parties to the transaction must be certain that the quotation settled on appropriately locates responsibility for the goods during transportation and spells out who pays transportation charges and from what point. Price quotations must also specify the currency to be used, credit terms, and the type of documentation required. Finally, the price quotation and contract should define quantity and quality. A quantity definition might be necessary because different countries use different units of measurement. In specifying a ton, for example, the contract should identify it as a metric or an English ton and as a long or short ton. Quality specifications can also be misunderstood if not completely spelled out. Furthermore, there should be complete agreement on quality standards to be used in evaluating the product. For example, “customary merchantable quality” may be clearly understood among U.S. customers but have a completely different interpretation in another country. The international trader must review all terms of the contract; failure to do so may have the effect of modifying prices even though such a change was not intended.

Administered Pricing

Administered pricing is an attempt to establish prices for an entire market. Such prices may be arranged through the cooperation of competitors; through national, state, or local governments; or by international agreement. The legality of administered pricing arrangements of various kinds differs from country to country and from time to time. A country may condone price fixing for foreign markets but condemn it for the domestic market, for instance.

In general, the end goal of all administered pricing activities is to reduce the impact of price competition or eliminate it. Price fixing by business is not viewed as an acceptable practice (at least in the domestic market), but when governments enter the field of price administration, they presume to do it for the general welfare to lessen the effects of “destructive” competition.

The point at which competition becomes destructive depends largely on the country in question. To the Japanese, excessive competition is any competition in the home market that disturbs the existing balance of trade or gives rise to market disruptions. Few countries apply more rigorous standards in judging competition as excessive than Japan, but no country favors or permits totally free competition. Economists, the traditional champions of pure competition, acknowledge that perfect competition is unlikely and agree that some form of workable competition must be developed.

The pervasiveness of price-fixing attempts in business is reflected by the diversity of the language of administered prices; pricing arrangements are known as agreements, arrangements, combines, conspiracies, cartels, communities of profit, profit pools, licensing, trade associations, price leadership, customary pricing, or informal interfirm agreements.28 The arrangements themselves vary from the completely informal, with no spoken or acknowledged agreement, to highly formalized and structured arrangements. Any type of price-fixing arrangement can be adapted to international business, but of all the forms mentioned, cartels are the most directly associated with international marketing.

Cartels

A cartel exists when various companies producing similar products or services work together to control markets for the types of goods and services they produce. The cartel association may use formal agreements to set prices, establish levels of production and sales for the participating companies, allocate market territories, and even redistribute profits. In some instances, the cartel organization itself takes over the entire selling function, sells the goods of all the producers, and distributes the profits.

The economic role of cartels is highly debatable, but their proponents argue that they eliminate cutthroat competition and rationalize business, permitting greater technical progress and lower prices to consumers. However, most experts doubt that the consumer benefits very often from cartels.

The Organization of Petroleum Exporting Countries (OPEC) is probably the best known international cartel. Its power in controlling the price of oil has resulted from the percentage of oil production it controls. In the early 1970s, when OPEC members provided the industrial world with 67 percent of its oil, OPEC was able to quadruple the price of oil. The sudden rise in price from $3 a barrel to $11 or more a barrel was a primary factor in throwing the world into a major recession. In 2000, OPEC members lowered production, and the oil price rose from $10 to over $30, creating a dramatic increase in U.S. gasoline prices. Non-OPEC oil-exporting countries benefit from the price increases, while net importers of foreign oil face economic repercussions.

One important aspect of cartels is their inability to maintain control for indefinite periods. Greed by cartel members and other problems generally weaken the control of the cartel. OPEC members tend to maintain a solid front until one decides to increase supply, and then others rapidly follow suit. In the short run, however, OPEC can affect global prices. Indeed, at this writing, world oil prices are above $100 a barrel, but most analysts attribute this increase more to burgeoning demand29 than OPEC’s ability to control supply.30

A lesser-known cartel, but one that has a direct impact on international trade, is the cartel that exists among the world’s shipping companies. Every two weeks about 20 shipping-line managers gather for their usual meeting to set rates on tens of billions of dollars of cargo. They do not refer to themselves as a cartel but rather operate under such innocuous names as “The Trans-Atlantic Conference Agreement” (www.tacaconf.com). Regardless of the name, they set the rates on about 70 percent of the cargo shipped between the United States and northern Europe. Shipping between the United States and Latin American ports and between the United States and Asian ports also is affected by shipping cartels. Not all shipping lines are members of cartels, but a large number are; thus they have a definite impact on shipping. Although legal, shipping cartels are coming under scrutiny by the U.S. Congress, and new regulations may soon be passed.

Another cartel is the diamond cartel controlled by De Beers. For more than a century, De Beers has smoothly manipulated the diamond market by keeping a tight control over world supply.31 The company mines about half the world’s diamonds and takes in another 25 percent through contracts with other mining companies. In an attempt to control the other 25 percent, De Beers runs an “outside buying office” where it spends millions buying up diamonds to protect prices. The company controls most of the world’s trade in rough gems and uses its market power to keep prices high.

Oil prices quadrupled in the mid-1970s because of OPEC’s control of supplies. The $100 per barrel oil you see in this picture has been caused by burgeoning demand in China and around the world in 2008. Pertamina is the Indonesian national oil company. (© DADANG TRI/Reuters/Landov)

The legality of cartels at present is not clearly defined. Domestic cartelization is illegal in the United States, and the European Union also has provisions for controlling cartels. The United States does permit firms to take cartel-like actions in foreign markets, though it does not allow foreign-market cartels if the results have an adverse impact on the U.S. economy. Archer Daniels Midland Company, the U.S. agribusiness giant, was fined $205 million for its role in fixing prices for two food additives, lysine and citric acid. German, Japanese, Swiss, and Korean firms were also involved in the cartel. The group agreed on prices to charge and then allocated the share of the world market each company would get—down to the tenth of a decimal point. At the end of the year, any company that sold more than its allotted share was required to purchase in the following year the excess from a co-conspirator that had not reached its volume allocation target.

The De Beers company is one of the world’s largest cartels, and for all practical purposes, it controls most of the world’s diamonds and thus is able to maintain artificially high prices for diamonds. One of the ways in which it maintains control is illustrated by a recent agreement with Russia’s diamond monopoly, in which De Beers will buy at least $550 million in rough gem diamonds from Russia, or about half of the country’s annual output. By controlling supply from Russia, the second largest producer of diamonds, the South African cartel can keep prices high. (© Susan Van Etten/Photo Edit, Inc.)

Although EU member countries have had a long history of tolerating price fixing, the European Union is beginning to crack down on cartels in the shipping, automobile, and cement industries, among others. The unified market and single currency have prompted this move. As countries open to free trade, powerful cartels that artificially raise prices and limit consumer choice are coming under closer scrutiny. However, the EU trustbusters are fighting tradition—since the trade guilds of the Middle Ages, cozy cooperation has been the norm. In each European country, companies banded together to control prices within the country and to keep competition out.

Government-Influenced Pricing

Companies doing business in foreign countries encounter a number of different types of government price setting. To control prices, governments may establish margins, set prices and floors or ceilings, restrict price changes, compete in the market, grant subsidies, and act as a purchasing monopsony or selling monopoly.32 The government may also influence prices by permitting, or even encouraging, businesses to collude in setting manipulative prices. As an aside, of course, some companies need no help in price fixing—which often is illegal.33

The Japanese government traditionally has encouraged a variety of government-influenced price-setting schemes, However, in a spirit of deregulation that is gradually moving through Japan, Japan’s Ministry of Health and Welfare will soon abolish regulation of business hours and price setting for such businesses as barbershops, beauty parlors, and laundries. Under the current practice, 17 sanitation-related businesses can establish such price-setting schemes, which are exempt from the Japanese Anti-Trust Law.

Governments of producing and consuming countries seem to play an ever-increasing role in the establishment of international prices for certain basic commodities. There is, for example, an international coffee agreement, an international cocoa agreement, and an international sugar agreement. And the world price of wheat has long been at least partially determined by negotiations between national governments.

Despite the pressures of business, government, and international price agreements, most marketers still have wide latitude in their pricing decisions for most products and markets.

Summary

Pricing is one of the most complicated decision areas encountered by international marketers. Rather than deal with one set of market conditions, one group of competitors, one set of cost factors, and one set of government regulations, international marketers must take all these factors into account, not only for each country in which they are operating but often for each market within a country. Market prices at the consumer level are much more difficult to control in international than in domestic marketing, but the international marketer must still approach the pricing task on a basis of established objectives and policy, leaving enough flexibility for tactical price movements. Controlling costs that lead to price escalation when exporting products from one country to another is one of the most challenging pricing tasks facing the exporter. Some of the flexibility in pricing is reduced by the growth of the Internet, which has a tendency to equalize price differentials between country markets.

The continuing growth of Third World markets coupled with their lack of investment capital has increased the importance of countertrades for most marketers, making countertrading an important tool to include in pricing policy. The Internet is evolving to include countertrades, which will help eliminate some of the problems associated with this practice.

Pricing in the international marketplace requires a combination of intimate knowledge of market costs and regulations, an awareness of possible countertrade deals, infinite patience for detail, and a shrewd sense of market strategy.