Category Archives: Sophisticated Pricing Techniques

Sophisticated Pricing Techniques

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

In Carolyn Said’s article “Most US firms paid no taxes over 7-year span” published in August 2008, Said reveals that about two-thirds of US companies and foreign firms doing business in the US paid no federal income taxes from 1998 to 2005. Although many of these companies were small or new companies who probably were not profitable, a surprising number of large companies did not pay any income taxes.  The US tax system has the second highest corporate tax rate of any developed country, but due to the complicated tax laws, there are many loopholes that companies can use to evade taxes. One of these methods is transfer pricing. Transfer pricing occurs when a parent company is incorporated offshore where there is no tax. The parent company will then charge its US subsidiary large amounts for the use of the corporate logo or trademark. The US subsidiary then reports no income or a loss on the year, due to the fact that they had huge expenses. Transfer pricing and other tax evasion techniques are responsible for a low effective tax rate in the US.

Transfer pricing can be seen as sophisticated pricing techniques on a larger scale. Just as the sophisticated pricing techniques we discuss in class are largely used to increase profits, transfer pricing is used to protect that profit and decrease the loss incurred by taxes. The goal of both is to increase profits. Of course transfer pricing as referred to in this article is a very large-scale tax evasion technique that exploits regular transfer pricing. Regular transfer pricing involves the cost of transferring a product between a company’s divisions.  This transfer pricing just changes the company’s divisions to the company’s subsidiary companies that are subject to different tax rates.

As the article states, most corporations and individuals find loopholes in taxes to minimize the amount they pay.  This saves corporations money and allows them to keep more of their profit. Similarly individuals file taxes and get the most deductions that they can so they can keep more of their income.  This practice is legal, unless a person or corporation takes it beyond the scope of the law, but is this practice ethical?  With so many firms and individuals taking deductions it would be more beneficial to lower the tax rate as a whole, as the article suggests, than allowing all of the tax breaks.  As the article states, the US has the 2nd highest corporation tax rate in the world, and is tied for 4th to last for amount of revenue raised through corporate taxes.  Through the practice of getting deductions firms gain more profit, giving them a competitive advantage.  Firms have the right to work toward a competitive advantage and doing transfer pricing is a way to achieve this goal. 

Another real world example of sophisticated pricing techniques is a 3rd degree price discrimination, where firms charge different groups of consumers different prices for the same good due to differences in elasticities of demand.  For example, in a city the more affluent area of the city is more willing to pay higher gas prices than the less affluent end of the city.  This is because consumers in the less affluent part of the city have a lower reservation price for gas, and therefore demand for gas is more elastic in that part of town.  The differences in elasticity in different parts of town allow for gas companies to charge more for gas in the parts of town that have a higher elasticity of demand.

Posted by Grace, Chrissie, and Jeff (Section 4)

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Questions for Classroom Discussion on SOPHISTICATED PRICING TECHNIQUES

Although this real-world application provides an example of an abuse of a pricing technique, it shows how the pricing technique works nonetheless. The application then invites thought on the ethics of various pricing techniques (abused or not), which may allow firms to increase profits at the expense of consumers. Consider the following:

  • Does the fact that effective non-uniform pricing (NOT single pricing) raises the monopolist’s profit at the expense of consumers make it an unethical practice?
  • Is it fair to charge consumers more for a product just because they value it more?  Does it matter why consumers value the good more?
  • Firms often gather information regarding tastes, preferences and willingness to pay from consumer searches on the internet and the use of things like the “Martin’s Card.” In fact, in late 2010, the FTC proposed a plan to let consumers choose whether they want their internet browsing monitored by online businesses and advertisers.  Is this a violation of consumer privacy?  Is it fair that firms can then use this information to charge consumers higher (or lower) prices?  

Time permitting, our classroom discussion will take place on Thursday, April 12.

Posted by Prof. C-S

Sophisticated Pricing Strategies Blog Post

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

About two-thirds of US companies and foreign firms in this country paid no income taxes from 1998 to 2005. Although many of these non-payers were new, small companies that actually didn’t make any money, a quarter of companies with more than $250 million in assets or $50 million in gross receipts paid no income taxes.

There are a few legal ways that companies can dodge taxes, including writing off losses from the previous year, tax exemptions from expenses, or even writing off liabilities from stock options. However, there are a few other, less palatable ways that companies can duck paying income tax, including “transfer price abuse.” This practice shifts money within corporate subsidiaries by inflating the fees associated with the goods as opposed to charging the going market rate. This is made even easier by having an off-shore parent company to blame, since off-shore profits are tax-free.

Transfer price abuse is relevant to our class, especially in relation to our recent lesson on transfer pricing, where “the price set by the transferring division becomes the cost of the receiving division.” It is important to find the optimal transfer price that ensures the company’s profit maximization and that the transferring division will continue to produce the product efficiently. Transfer price abuse inflates the cost, which may interfere with producing the product efficiently. However, it allows the company to exaggerate their costs and pay a lower amount of income tax.

This abuse of transfer pricing is unethical as it provides misleading information regarding the state of the firm that could potentially influence the decisions of investors. Firms have an obligation to its investors to be honest regarding the state and value of their firm and by abusing the use of transfer pricing they are going against this core value. The taxes that these firms are avoiding by engaging in transfer pricing are to be used to benefit the country as a whole. By abusing transfer prices they are eliminating a portion of funds that would be used for the masses, which does not reflect positively on the firm as a whole. It is understandable that firms are looking to avoid taxes; however, going to the extent of many of these firms by not paying any taxes for seven years is crossing the line and ought to be addressed and regulated.

A similar issue of transfer pricing can be seen in the current state of Nigeria. According to reports done by PriceWaterhouseCoopers, Nigeria has lost a large amount of tax money due to transfer pricing. Tax earnings, excluding the taxation on oil revenue, in Nigeria make up approximately two percent of GDP while in other countries this can be as much as thirty five percent. By monitoring transfer pricing and clearly stating rules and regulations which ought to be followed, Nigeria could increase their earnings from taxes by a great deal as they are losing close to a million naira (their national currency) (Eboh, 2012). This shows that this is not just an issue with large firms in the US but can be detrimental to nations around the world.

Posted by Mick, Charles and Rachel (Section 3)

Resources:

Eboh, Michael. “Nigeria losing trillions from non-regulation of Transfer Pricing – PWC.” April 6, 2012. Retrieved from: http://www.vanguardngr.com.

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>.

 

Sophisticated Pricing Techniques

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

Summary

The article “Most U.S. firms paid no taxes over 7-year span” by Carolyn Said, discusses how almost two thirds of U.S. companies did not pay income taxes to the government between 1998 and 2005. While it does admit that many of these companies were small and little to no profit, about a quarter of corporations that had over $250 million didn’t have to pay taxes either. The way that this avoidance of taxes is achieved is through what is called “transfer pricing abuse”. Transfer pricing is when, in your company, you increase the prices on goods and services being moved from one part of the company to another. Prices technically should be set using an arm’s length standard, meaning that prices should be set within a reasonable distance of the market rate. This can be viewed as a creative form of accounting and is not technically illegal. For example, a business unit in the U.S. with a foreign parent company can write off profits that they make because the parent company has “overcharged” them for odd goods and services such as using the corporate logo.

Discussion

A problem arises however when with the use of transfer pricing and its ethical complications. On one side of the argument, citizens would prefer for large multimillion dollar companies to support the domestic government by paying the appropriate amount of federal income taxes. It’s easy to take this stance when budgets and company performance aren’t at the forefront of importance. However, in a capitalistic, profit maximizing economy everyone wants to pay as little taxes as possible to reduce their costs. Companies, just like the average tax payer, have the right to earn as many tax benefits and write offs as they can find. Taxpaying citizens go out of their way to avoid paying higher than necessary taxes so why can’t a corporation do the same? Transfer pricing is not illegal so the companies have the right to take advantage of it. If companies abuse transfer pricing to an extreme extent, although it is still legal and they have that right, it begins to fall into a grey area of what is saving and what is going beyond ethical and appropriate acts.

Real-World Example

There are many other types of sophisticated pricing techniques. Not all are used to avoid paying income taxes such as transfer pricing. One example is bundling that media and communication corporations such as Comcast use to draw customers into purchasing multiple services from them. For example, Comcast charges $70 per month for cable and internet whereas the internet package by itself is $50 and the cable package is $30. This sophisticated pricing technique is an attempt by companies to attract customers with what they perceive as saving more by convincing them that they’re getting a much better deal than what they actually are.

Posted by Laurel, Patrick, Kyle and Case (Section 1)

Resources:

www.comcast.com/shop