Sophisticated Pricing Techniques

Discussion on Most US Firms Paid No Taxes Over 7-Year Span” by Carolyn Said (SF Gate, August 2008)

 Article Summary and Classroom Relevance

The article titled “Most U.S. Firms Paid No Taxes Over 7-Year Span”, discusses the growing concern over the number of U.S. companies that did not pay federal income taxes between 1998 and 2005 based on a study conducted by the General Accountability Office. About two-thirds of U.S., foreign companies avoided paying taxes to the government during the observed seven year span. While most of these nonpayers were small companies that in fact made no money, about one-fourth of the large corporations in the U.S., those companies making over $250 million in assets or $50 million in gross receipts, paid no income taxes according to the report. There are various legal ways for companies to avoid taxes, with the underlying rule remaining that if a company does not make money, then it cannot pay taxes. Many inventive measures can be taken to give the appearance of losses that graze the line of legality. The practice of abusive transfer pricing is one of these measures which is discussed in the report. Transfer prices are what subsidiaries of the same corporation charge each other for goods and services and so when this practice is abused, goods and services are charged at inflated high prices and money is moved around among the subsidiaries. As an example of this abuse, companies will incorporate in a foreign location free of taxes. The companies will then subtract any royalty fees as an expense from the U.S. company and the profit will be moved to the foreign parent company, free of taxes. Transfer pricing is a type of sophisticated pricing technique, which is to be discussed in class. It is the goal of the firm to find the optimal transfer price so as to maximize the profit of the overall company since profit maximization is the ultimate objective of the firm. Transfer pricing is common, with 91% of Fortune 150 companies applying this practice, though not necessarily abusive.

A Commentary On Ethics

One technique used by the firms was to essentially transfer all profits to offshore parent companies, where the money would remain tax-free. Specifically, the article uses the example of a company making $50 million in profits, then paying that money to a parent company in another country for rights to logo usage.

Clearly this technique is not completely ethical. Technically, firms can legally use this tax avoidance strategy. However, they do not have the ethical “right” to deprive the government of their taxes. The money was earned in the United States so the company has a duty to pay the taxes required of everyone. The fees paid intra-company should be the same rate expected in the market. Tax free havens should not be utilized in such an unethical manner.

Real World Application

Sophisticated pricing techniques exist in many forms in the real world, not just to creatively avoid taxation. Microsoft, in 2009, cut prices on many of its software packages, conducting a risky experiment in price elasticity. This price slashes were in response to a terrible downturn for the company, increasing competition, as well as problems with piracy, especially in developing countries.

A particularly interesting aspect of this pricing technique is discrimination based on country. In China, piracy rates for Microsoft Office were near 95%. Microsoft began offering the product for $29 in China, and sales boosted 800%. Meanwhile, in the US, where piracy is a problem, but on a lesser scale, the effective price for office was dropped to $100 down from $150. Thus same product is offered to two different groups of customers at two different prices.

 This pricing technique used by Microsoft discriminates customers based on country. Consumers in the US and China react differently to price changes, demonstrating different price elasticities. This shows that sophisticated pricing techniques come in a wide variety, including some to avoid taxation, and some in an attempt to increase sales based on differing price elasticities. 

Posted by Ricky, Maureen and Patrick (Section 2)

Resources:

Burrows, Peter. “Microsoft’s Aggressive New Pricing Strategy.” BusinessWeek. 16 July 2009. Web. 9 Apr. 2012. <http://www.businessweek.com/magazine/content/09_30/b4140051491507.htm>.

Said, Carolyn. “Most U.S. Firms Paid No Taxes Over 7-Year Span”. SFGate. 13 Aug 2008. 10 Apr 2012 <https://www.library.nd.edu/reserves/ereserves/item_retrieve.cgi?item_id=49172&course_id=2012S_FIN_30210_01&copyright_accept=I+Accept>.

 

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