Export Pricing Strategies arguably is the most overlooked aspect of global trade. The common train of thought an exporter goes through when sussing their pricing options is: (1) “How much my competitor is pricing its products?”, (2) “What is my overall costs?”, (3) “how much do I want to profit from this export?”. This is commonly called the cost-plus pricing model, which is the least efficient pricing strategy. The cost-plus pricing model is a reactive strategy that does not maximize the profit of an exporter.
There are many other strategies of export pricing, price is not only the factor consumers consider when purchasing a product or service. It is the perceived value that a product or service provides to the consumer that is sort after.
Hence, export pricing strategies do not only touch on the price itself, but also all aspects of the export business operation. In this article, we will look into an alternative pricing strategy that may be intuitive to exporters but is worth a mention.
Shortcomings of Cost Plus Pricing
We mentioned that cost-plus pricing, relatively speaking, is the easiest export pricing strategy. However, it is the framework to subpar financial performance.
Cost-plus pricing may be deceptively simple, but in reality, ascertaining the true cost of producing one unit of product or service can be tricky. This makes cost-plus pricing markedly difficult.
Among other things there are a few factors that may affect product cost. The most prominent factors that is not accounted for by the cost-plus pricing model is the impact of economies of scale.
Impact of Economies of Scale
Economies of scale, in simple terms, means the larger your scale of operation, the cheaper it us to produce one unit of product.
In all business aspects, there are fixed costs and variable costs. There is a maximum efficiency a business operation can achieve with a certain level of fixed cost. Fixed costs and sunk costs share the same meaning by our definition.
For example, an exporter may have invested in a production line capable of producing 100 MT of cocoa powder per month.
With that being said, a production line is operating below maximum capacity if the business can achieve a demand of only for 50MT of cocoa powder.
In this similar example, if the cost of operating that production line is roughly USD 2.00 per ton, assuming it is operating at 100% capacity. We can only deduce that the sunk cost is now USD 4.00 per ton since we are operating at 50% capacity.
LRAC = Long Run Average Cost
C = Cost
Q = Output Quantity
In theory, there is an efficient curve (as displayed above) showing that with every extra Quantity (Q) produced, the Long Run Average Cost (LRAC) will decrease.
This is the exact reason why using the cost-plus pricing strategy is insufficient, and should be complemented with other pricing strategy as well.
The question that should be asked is: –
“How does price change affect the revenue, taking into account the total opportunity cost of quantity sold sacrificed?”
Benefits of Cost-Plus Pricing Model
However, Cost Plus Pricing Model as a export pricing strategy is not without its benefits. The cost-plus pricing model can be a good initial filter to determine whether a product is worth exporting.
Taking into account the product competitor’s price. An exporter can roughly determine the profitability of selling a product abroad.
This is especially useful when selling products that are highly homogenous, and has no stark product differentiation. For example, Crude Palm Oil, Soybean Oil, Grains, Ferrous Metals, etc…
Considering all the sunk costs and variable costs such as ocean freight and inland transportation, an exporter can gauge whether it is a viable option to export to another country.
Take an export from Port Busan to Port Newark, the ocean freight of 1 x 20’GP container is roughly USD 3,500. Not including terminal handling charges, and other relevant port charges.
Assuming that the cargo is transported with the INCOTERM CNF, the exporter is responsible for the ocean freight transportation charges. The exporter can immediately know roughly whether the increase in ocean freight rate is justified, using the cost-plus pricing model.
The Better Export Pricing Strategy
Frankly speaking, export pricing strategies are no different than other pricing strategies. It is the perceived value that an importer obtains in exchange for the price of unit sold that is the key deciding factor.
The use of any export pricing strategy is never about the price per unit sold. Instead, we need to shift our focus on profitability. This is also why cost-plus pricing models are suboptimal as well.
Export Pricing Strategy Based on Perceived Value of Goods
The job of exporters, is to determine the monetary value of the buyer’s perceived value in a product. Note that different segments of buyers have different perceived value of a product’s salient features.
Hence, pricing strategies goes hand-in-hand with marketing strategies as well.
According to Thomas T. Nagle, in his book “The Strategy and Tactics of Pricing”, perceived values can be categorized as: –
- Monetary Value
- Psychological Value
- Reference Value
Monetary Value is an indication to the buyers of how much money is saved from purchasing your product. For example, purchasing a more advanced CNC machine will reduce labor forces, and that can be quantified in monetary value.
Psychological Value indicates can be quantified by the relative ease of doing business with you. To emphasize, you can price your exported products higher by providing exceptional service level, credit facilities, and product training to supplement the products sold. Psychological value also emphasizes the unquantifiable values that is subjective to the consumer.
Reference Value is the importer’s best alternative product price. Value can be created simply by producing products that have a higher reference value as compared to the product’s next best alternative.
Monetary Value + Psychological Value + Reference Value = Total Economic Value
The sum of Monetary Value, Psychological Value, and Reference Value will derive the total economic value. A product with a high economic value will be highly sorted after by buyers, even if the actual dollar price per unit sold is higher than its competitors.
For a brief recap: –
We opine that cost-plus pricing model is inefficient, because it is difficult to determine the actual cost per unit of product produced.
However, cost-plus pricing model is a good way to determine the profitability of exporting product with a given quantity, location, and delivery requirements.
Exporters should focus instead on pricing products based on perceived value of the products sold as an export pricing strategy
Perceived value equals monetary value, plus psychological value, plus reference value.
Once a product’s perceived value is accurately determined by an exporter, the total cost of exporting is a secondary issue, and is not the main concern for all exporters.
How to determine a Products Economical Value
Putting into practice what we have learned about monetary, psychological, and reference value, let us go through the steps in determining a product price.
Step 1: Identify the Reference Price and Value
Technology has made this step simpler to achieve. The first step in determining an exporter’s product price is to first establish a reference price and value.
In simple term, it is to answer the question of “What are others charging for the same product sold?”
With modern technology, you can purchase market data online, scour through online product platforms, or even perform your own investigation by requesting for a price from the competitor directly.
The challenge, however, is to collect the most accurate reference price information. This ensures that the price of competitors is comparable with your own.
Determining reference price comes easy if the product sold is highly commoditised. Crude Oil, Grains, Sugar, Chemical Compounds, Fertilizers are some examples of highly commoditised product. Therefore, the reference price is easier to establish.
In contrast, products that are highly differentiated, such as electronic devices, machineries, food and beverages poses some challenge when we are searching for reference price. Although difficult, it is not impossible.
Step 2: Identify Psychological Value of a Product
This requires a firm understanding of the products sold, as well as understanding the key market segment an exporter is targeting.
The primer of identifying psychological value of a product is to determine the key market segment the product is targeting.
Every bit of consumer’s demographic information can assist in segmenting the market. Demographics can be both consumer specific or company specific. For example, age, gender, income level, business size, company size, and company location.
Once you as the exporter had successfully segmented your target market. You then can investigate perceived value of a product either with product testing, questionnaires or product sampling.
Psychological value are key forces that holds value to the consumer, which does not have features that are quantitatively measurable. Things such as feel, service, and satisfaction are non-quantifiable features.
For example, you can be an exporter of low range headphones, your target segments are country distributors that retails consumer electronics.
After a series of sampling, questionnaires and surveys, you deduce that your primary market segment are retail distributors located in Thailand, where the retailer’s target consumers are of generation between the age of 18 to 24, willing to pay approximately USD 10.00 for a headphone.
Now that you learned your key market segment, you can proceed to determine the psychological value of salient features of your product. For instance, this market segment places high emphasis on headphones with high bass qualities.
Consumers value headphones with additional bass qualities with a value of USD 3.00 extra, as oppose to headphones with less significant bass quality.
Therefore, you can employ a pricing strategy that is relatively higher than your competitor’s product, as consumers place high psychological value on certain features of your product.
Step 3: Identify Monetary Value of your product
Whereas psychological values of a product are non-quantifiable, monetary values of your product are measurable.
In other words, identifying the monetary value of your product is a question of asking yourself “How much money your consumers saved by using your product?”
Essentially, there are two forms on monetary gains that your consumers can enjoy.
- Cost savings – The additional amount of money your consumers saved from using your product
- Profit gains – the additional amount of money your consumers earn from using your product.
Lets look into one case example, Factory A are in the business of producing vehicle parts, they have been using an old CNC machine and are seeking to replace it with a newer, more efficient CNC machine to produce more parts from blocks of aluminium.
Cost saving products can be product that reduces labour costs. For example, a state-of-the-art CNC machine, or a computer-controlled waterjet cutter will drastically reduce monthly labour costs as well as costs due to cutting errors.
Profit gains can be exemplified with an increased production efficiency. Apart from the reduced labour cost from using CNC machines, the machine also has an output of 50 parts per hour instead of the previous 20 parts. The additional 30 parts are quantifiable and signifies monetary value to the factory owner.
Step 4: Bringing it all together
You have determined the relative costs of your competitor with a high degree of accuracy; you have segmented the target market well enough to know who your product appeals to; You have identified monetary values and psychological values of the product you are selling overseas.
Now, we add it all up to derive a value per unit sold that you can price your product to market. This is, in our opinion, a better alternative export pricing strategy.
Other key issues to consider for any Export Pricing Strategy
Logistics and Customs Duty costs are location-dependant.
An important point to note that other variable costs such as ocean freight, air freight, terminal handling charges, and all other significant supply chain management costs have to be taken into account.
There isn’t a cookie cutter guide to estimating logistics, supply chain and customs duty cost for exporting your products overseas.
Supply chain management are mired by challenges such as: –
- Pilferage costs
- Insurance costs
- Freight costs
- Port utilization costs
- Environment control costs (i.e. temperature control reefers)
- Storage costs
to name a few.
Be well versed with INCOTERMs and Trade Financing Options
For further information about INCOTERM and Trade Financing. Do spend some time looking through some of the article we written below: –
Marketing and Pricing Strategies Go Hand-in-hand
There has to be a given rationale to a pricing strategy. Even more so, the value has to be communicated effectively to the consumers. That is why marketing campaigns are as important as the pricing strategy itself.
Amazon has reached such heights of success due to no small role of it’s marketing strategy. I’m sure everyone has, at some point in their lives, purchased something via the Amazon marketplace.
Although the marketing information are primarily user generated, you can see that in one page, sellers are able to convey messages about the product: –
- Question and Answers
- Packaged Deals
- User Review
- Product description
Why we use Amazon as an example is because, consumer behaviors are largely similar, the information that consumer needs are the same regardless of the product or service.