Geographic Pricing

Geographic Pricing

Geographical pricing is the practice of modifying a basic list price based on the location of the buyer to reflect shipping costs.

Geographical pricing is the practice of modifying a basic list price based on the geographical location of the buyer. It is intended to reflect the costs of shipping to different locations. There are several types of geographic pricing:

• FOB origin (Free on Board origin): The shipping cost from the factory or warehouse is paid by the purchaser. Ownership of the goods is transferred to the buyer as soon as it leaves the point of origin. It can be either the buyer or seller that arranges for the transportation.

FOB: FOB is used for sea freight. The purchaser is responsible for the shipping costs.

• Uniform delivery pricing (also called postage stamp pricing): The same price is charged to all.
• Zone pricing: Prices increase as shipping distances increase. This is sometimes done by drawing concentric circles on a map with the plant or warehouse at the center and each circle defining the boundary of a price zone. Instead of using circles, irregularly shaped price boundaries can be drawn that reflect geography, population density, transportation infrastructure, and shipping cost. (The term “zone pricing” can also refer to the practice of setting prices that reflect local competitive conditions (i.e., the market forces of supply and demand, rather than actual cost of transportation). Zone pricing, as practiced in the gasoline industry in the United States, is the pricing of gasoline based on a complex and secret weighting of factors, such as the number of competing stations, number of vehicles, average traffic flow, population density, and geographic characteristics. This can result in two branded gas stations only a few miles apart selling gasoline at a price differential of as much as $0.50 per gallon. Many business people and economists state that gasoline zone pricing merely reflects the costs of doing business in a complex and volatile marketplace. Critics contend that industry monopoly and the ability to control not only industry-owned “corporate” stations, but locally owned or franchise stations, make zone pricing into an excuse to raise gasoline prices virtually at will. Oil industry representatives contend that while they set wholesale and dealer tank wagon prices, individual dealers are free to see whatever prices they wish and that this practice in itself causes widespread price variations outside industry control. Zone pricing is also used to price fares in certain metro stations.
• Basing point pricing: Certain cities are designated as basing points. All goods shipped from a given basis point are charged the same amount.
• Freight-absorption pricing: The seller absorbs all or part of the cost of transportation. This amounts to a price discount and is used as a promotional tactic.

Transfer Pricing

Transfer pricing describes all aspects of intracompany pricing arrangements between business entities for goods and services.

Transfer pricing refers to the setting, analysis, documentation, and adjustment of charges of goods and services within a multi-divisional organization, particularly in regard to cross-border transactions. Transfer pricing describes all aspects of intra company pricing arrangements between related business entities, including transfers of intellectual property, transfers of tangible goods, services and loans, and other financing transactions.

For example, goods from the production division may be sold to the marketing division, or goods from a parent company may be sold to a foreign subsidiary, with the choice of the transfer price affecting the division of the total profit among the parts of the company. This has led to the rise of transfer pricing regulations as governments seek to stem the flow of taxation revenue overseas, making the issue one of great importance for multinational corporations.

Intra-company transactions across borders are growing rapidly and are becoming much more complex. Compliance with the differing requirements of multiple overlapping tax jurisdictions is a complicated and time-consuming task. At the same time, tax authorities from each country are imposing stricter penalties, new documentation requirements, increased information exchange and increased audit/inspection activity.

Division managers are provided incentives to maximize their own division’s profits. The firm must set the optimal transfer prices to maximize company profits, or each division will try to maximize their own profits leading to lower overall profits for the firm. Double marginalization is when both divisions mark up prices in excess of marginal cost and overall firm profits are not optimal.

One can use marginal price determination theory to analyze optimal transfer pricing, with optimal being defined as transfer pricing that maximizes overall firm profits in a non-realistic world with no taxes, no capital risk, no development risk, no externalities, or any other frictions which exist in the real world. From marginal price determination theory, the optimum level of output is that where marginal cost equals marginal revenue. That is to say, a firm should expand its output as long as the marginal revenue from additional sales is greater than their marginal costs. In the diagram that follows, this intersection is represented by point A, which will yield a price of P*, given the demand at point B.

Optimal Transfer Pricing Diagram: From marginal price determination theory, the optimum level of output is where marginal cost equals marginal revenue.

When a firm is selling some of its product to itself, and only to itself (i.e., there is no external market for that particular transfer good), then the picture gets more complicated, but the outcome remains the same. The demand curve remains the same. The optimum price and quantity remain the same. But marginal cost of production can be separated from the firm’s total marginal costs. Likewise, the marginal revenue associated with the production division can be separated from the marginal revenue for the total firm. This is referred to as the Net Marginal Revenue in production (NMR) and is calculated as the marginal revenue from the firm minus the marginal costs of distribution.

It can be shown algebraically that the intersection of the firm’s marginal cost curve and marginal revenue curve (point A) must occur at the same quantity as the intersection of the production division’s marginal cost curve with the net marginal revenue from production (point C).

Consumer Penalties

Penalties, in the form of fees and restricted user access, exist for consumers who violate terms in contracts.

Consumer Penalties

Penalties, in the form of fees and restricted user access, exist for consumers who violate terms in contracts. Terms of service are rules which one must agree to abide by in order to use a service.

Certain websites are noted for having carefully designed terms of service, particularly eBay and PayPal, which need to maintain a high level of community trust because of transactions involving money. Terms of service can cover a range of issues, including acceptable user behavior online, a company’s marketing policies, and copyright notices. Some organizations, such as Yahoo!, can change their terms of service without notice to the users.

Most organizations reserve the right to restrict a user’s access to the service if they violate the terms in the agreement. In serious cases, the user may have his or her account terminated. In extreme cases, the company may pursue legal action.

Mobile Phones: Mobile phone service providers often charge an early termination fee on their service, which is a form of consumer penalty.