Competitor profiling

Another common technique is to create detailed profiles on each of your major competitors. These profiles give an in-depth description of the competitor's background, finances, products, markets, facilities, personnel, and strategies. This involves:

•Background
1.location of offices, plants, and online presences
2.history - key personalities, dates, events, and trends
3.ownership, corporate governance, and organizational structure

•Financials
1.P-E ratios, dividend policy, and profitability
2.various financial ratios, liquidity, and cash flow

•Products
1.products offered, depth and breadth of product line, and product portfolio balance
2.new products developed, new product success rate, and R&D strengths
3.patents and licenses
4.quality control conformance
5.reverse engineering

•Marketing
1.segments served, market shares, customer base, growth rate, and customer loyalty
2.promotional mix, promotional budgets, advertising themes, ad agency used, and sales force success rate
3.distribution channels used, exclusivity agreements, alliances, and geographical coverage
4.pricing, discounts, and allowances

•Facilities
1.plant capacity, capacity utilization rate, age of plant, plant efficiency, capital investment
2.location, shipping logistics, and product mix by plant

•Personnel
1.number of employees, key employees, and skill sets
2.strength of management, and management style
3.compensation, benefits, and employee morale
•Corporate and marketing strategies
1.objectives, mission statement, growth plans, acquisitions, and divestitures
2.marketing strategies

Media Scanning

Scanning competitor's ads can reveal much about what that competitor believes about marketing and their target market. Changes in a competitor's advertising message can reveal new product offerings, new production processes, a new branding strategy, a new positioning strategy, a new segmentation strategy, line extensions and contractions, problems with previous positions, insights from recent marketing or product research, a new strategic direction, a new source of sustainable competitive advantage, or value migrations within the industry. It might also indicate a new pricing strategy such as penetration, price discrimination, price skimming, product bundling, joint product pricing, discounts, or loss leaders. It may also indicate a new promotion strategy such as push, pull, balanced, short term sales generation, long term image creation, informational, comparative, affective, reminder, new creative objectives, new unique selling proposition, new creative concepts, appeals, tone, and themes, or a new advertising agency. It might also indicate a new distribution strategy, new distribution partners, more extensive distribution, more intensive distribution, a change in geographical focus, or exclusive distribution. Little of this intelligence is definitive : additional information is needed before conclusions should be drawn.

A competitor's media strategy reveals budget allocation, segmentation and targeting strategy, and selectivity and focus. From a tactical perspective, it can also be used to help a manager implement his own media plan. By knowing the competitor's media buy, media selection, frequency, reach, continuity, schedules, and flights, the manager can arrange his own media plan so that they do not coincide.

Other sources of corporate intelligence include trade shows, patent filings, mutual customers, annual reports, and trade associations.

Some firms hire competitor intelligence professionals to obtain this information
New Competitors
In addition to analyzing current competitors, it is necessary to estimate future competitive threats. The most common sources of new competitors are:
•Companies competing in a related product/market
•Companies using related technologies
•Companies already targeting your prime market segment but with unrelated products
•Companies from other geographical areas and with similar products
•New start-up companies organized by former employees and/or managers of existing companies
The entrance of new competitors is likely when:
•There are high profit margins in the industry
•There is unmet demand (insufficient supply) in the industry
•There are no major barriers to entry
•There is future growth potential
•Competitive rivalry is not intense
•Gaining a competitive advantage over existing firms is feasible

Joint product pricing
Pricing for joint products is a little more complex that pricing for a single product. To begin with there are two demand curves. The characteristics of each demand curve could be different. Demand for one product could be greater than for the other product. Consumers of one product could be more price elastic than the consumers of the other product (and therefore more sensitive to changes in the product's price).
To complicate things further, both products, because they are produced jointly, share a common marginal cost curve. There are complexities in the production function also. Their production could be linked in the sense that they are bi-products (referred to as compliments in production), or they could be linked in the sense that they can be produced by the same inputs (referred to as substitutes in production). Also, production of the joint product could be in fixed proportions or in variable proportions.
When setting prices in a situation as complex as this, microeconomic marginal analysis is helpful. In a simple case of a single product, price is set at that quantity demanded where marginal cost exactly equals marginal revenue. This is exactly what is done when joint products are produced in variable proportions. Each product is treated separately. In fact, it might even be possible to construct separate cost functions. In the diagram below, to determine optimal pricing for joint products produced in variable proportions, you find the intersection point of marginal revenue (product A) with the joint marginal cost curve. You then extend that quantity, up to the demand curve for product A, and that gives you the profit maximizing price for product A (point Pa in the diagram). You do the same for product B, yielding price point Pb1.


Pricing of Joint Products
If the products are produced in fixed proportions (example: cow hides and cow steaks), then one of the products will very likely be produced in quantities different than the profit maximizing amount considered separately. In fact the profit maximizing quantity and price of the second half of the joint product, will be different than the profit maximizing amount considered separately. In the diagram, product B is produced in greater amounts than the profit maximizing amount considered separately, and sold at a lower price (point Pb2) than the profit maximizing price considered separately (point Pb1). Although price is lower and output is higher, marginal cost is also higher. Yet this is a profit maximizing solution to this situation. Quantity supplied of product B is increased to the point that marginal revenue becomes zero (i.e.: the point where the marginal revenue curve intersects the horizontal axis).

Transfer Pricing
Transfer pricing refers to the pricing of contributions (assets, tangible and intangible, services, and funds) transferred within an organization. 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. Since the prices are set within an organisation (i.e. controlled), the typical market mechanisms that establish prices for such transactions between third parties may not apply. The choice of the transfer price will affect the allocation of the total profit among the parts of the company. This is a major concern for fiscal authorities who worry that multi-national entities may set transfer prices on cross-border transactions to reduce taxable profits in their jurisdiction. This has led to the rise of transfer pricing regulations and enforcement, making transfer pricing a major tax compliance issue for multi-national companies.

Economic theory
The discussion in this section explains an economic theory behind optimal transfer pricing with optimal defined as transfer pricing that maximizes overall firm profits in a world with no taxes. In practice a great many factors influence the transfer prices that are used by multinationals, including performance measurement, capabilities of accounting systems, import quotas, customs duties, VAT, taxes on profits, and (in many cases) simple lack of attention to the pricing.
From marginal price determination theory, we know that generally 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.
When a firm is selling some of its product to itself, and only to itself (ie.: 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 firms 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.


Transfer Pricing with No External Market
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).
If the production division is able to sell the transfer good in a competitive market (as well as internally), then again both must operate where their marginal costs equal their marginal revenue, for profit maximization. Because the external market is competitive, the firm is a price taker and must accept the transfer price determined by market forces (their marginal revenue from transfer and demand for transfer products becomes the transfer price). If the market price is relatively high (as in Ptr1 in the next diagram), then the firm will experience an internal surplus (excess internal supply) equal to the amount Qt1 minus Qf1. The actual marginal cost curve is defined by points A,C,D.
If the firm is able to sell its transfer goods in an imperfect market, then it need not be a price taker. There are two markets each with its own price (Pf and Pt in the next diagram). The aggregate market is constructed from the first two. That is, point C is a horizontal summation of points A and B (and likewise for all other points on the Net Marginal Revenue curve (NMRa)). The total optimum quantity (Q) is the sum of Qf plus Qt.

Transfer Pricing with a Competitive External Market

Practical application
Role of Administrative Regulations and Guidelines
Although there is sound economic theory behind the selection of a transfer pricing method, the fact remains that it can be advantageous to arbitrarily select prices such that, in terms of bookkeeping, most of the profit is made in a country with low taxes, e.g. tax havens, thus shifting the profits to reduce overall taxes paid by a multinational group. However, most countries enforce tax laws based on the arm's length principle as defined in the OECD (Organisation for Economic Co-operation and Development) Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, limiting how transfer prices can be set and ensuring that that country gets to tax its "fair" share. In the United States the pricing of transactions between related parties that are reported for tax purposes are governed by Section 482 of the Internal Revenue Code and the regulations there under.


Application of the Arm's Length Principle
Although there are discrepancies in the specifics of each country's laws concerning the application of the arm's length principle, the fact that they are primarily based in the OECD Guidelines means that, although such a strategy carries a greater taxation risk than solutions tailored to each country, global transfer pricing policies can be effectively used to determine an appropriate range representing the arm's length price for transactions carried out across a global enterprise.
However, different countries may accept different methods of calculating the transfer prices (i.e. Japan requires that the three "traditional" methods, outlined below, be systematically discounted before allowing the use of alternative methods, while the United States accepts the most appropriate method regardless), so care must be taken in such circumstances. In addition, some countries may have immature transfer pricing regimes or apply the arm's length principle in different ways—Brazil, for example, does not apply the arm's length principle despite the existence of transfer pricing legislation.
The following definitions are thus based on the OECD Guidelines.

Traditional Transaction Methods
The OECD Guidelines refer to the following methods as 'traditional transaction method':
Comparable Uncontrolled Price method (CUP);
Resale Price Method (RPM); and
Cost Plus Method (CP method or C+);
These are described below and are different from the transactional profit methods:
Profit split method; and
Transactional Net Margin Method (TNMM).
The OECD Guidelines prefer the use of the traditional transaction methods, whereby the other methods should be used as methods of last resort (for example when there is no data available or available data cannot be used reliably). However, the Guidelines stress there is no best-method rule: a taxpayer is only required to show that the method used delivers a reasonable (at arm's length) result and is not required to disprove the use of each other method than the method used. Regarding the 'reasonable outcome', the Guidelines note that transfer pricing is not an exact science

Comparable Uncontrolled Price method
The Comparable Uncontrolled Price (CUP) method compares the price at which a controlled transaction is conducted to the price at which a comparable uncontrolled transaction is conducted. Comparability between a controlled and uncontrolled transaction exists when there are no differences between these transactions or, if there are differences, when such differences do not have a material effect or for which reasonable adjustments can be made. Hence, an at arm's length transfer price can be determined through a comparison with the sales price between two unrelated corporations executing a (comparable) transaction. However, the fact that virtually any minor difference in the circumstances of trade (billing period, amount of trade, branding, etc.) may have a significant effect on the price makes it exceedingly difficult to find a transaction--much less transactions--that are sufficiently comparable.
Should they exist, such comparable transactions fall into two categories: external comparables and internal comparables. The former is a comparable uncontrolled transaction in the purest sense of the term--if Company A, in France, sells widgets to its subsidiary A(sub) in Turkey, then an external comparable transaction would be the sale of widgets from an unrelated French Company B to an unrelated Turkish Company C on comparable terms as the trade between Company A and its subsidiary A(sub). An internal comparable transaction, then, would be either the trade of widgets between Company A and an unrelated Company C, or the trade of widgets between an unrelated Company B and Company A's subsidiary, with the term "internal" referring to the fact that one of the parties involved in the tested transaction is also involved in the comparable uncontrolled transaction.

Cost Plus Method
The Cost Plus (CP) method, generally used for the trade of finished goods, is determined by adding an appropriate markup to the costs incurred by the selling party in manufacturing/purchasing the goods or services provided, with the appropriate markup being based on the profits of other companies comparable to the tested party. For example, the arm's length price for a transaction involving the sale of finished clothing to a related distributor would be determined by adding an appropriate markup to the cost of materials, labour, manufacturing, and so on. Cost-based method calculates transfer price on the cost of the goods or services available as per the cost accounting records of the company. The method is generally accepted by the tax customs authorities, since it provides some indication that the transfer price approximates the real cost of item. Cost-based approaches are, however, not as transparent as they appear. A company can easily manipulate its cost accounts to alter the magnitude of the transfer price. Companies that adopt the cost-based transfer pricing method have to choose between alternative approaches which are listed below :
Actual cost approach
Standard cost approach
Variable cost approach
Marginal cost approach

Apart from this, companies also have to decide on the treatment of fixed cost and research and development cost. These issues can prove problematic for the company that adopts a cost-based transfer pricing method. Cost-based method usually creates difficulties for the selling profit centre. As their incentives to be cost effective may fall, if they know that they can recover increased cost simply by raising the transfer price without an incentive. To produce efficiently the transfer price may erode the competitiveness of the final product in the market place.

Resale Price Method
The Resale Price (RP), while similar to the CP method, is found by working backwards from transactions taking place at the next stage in the supply chain, and is determined by subtracting an appropriate gross markup from the sale price to an unrelated third party, with the appropriate gross margin being determined by examining the conditions under which the goods or services are sold and comparing said transaction to other, third-party transactions. In our clothing example, then, the arm's length price would be determined by subtracting an appropriate gross margin from the price at which the distributor sold the products received from the manufacturer to third-party retailers--department stores, boutiques, etc.
In this example, both the CP and RP methods are being used to examine the same transaction--the one between the manufacturer and the distributor--meaning that the selection of one for use is ultimately dependent on the availability of data and comparable transactions. This flexibility is not available in other transactions, particularly those involving intangible goods (i.e. it is exceedingly difficult to determine the costs involved in developing technological know-how, and so the arm's length price for the payment of royalties from one company to another is best determined by working backwards from the profits gained based on the usage of the know-how--in other words, the RP method).

Transactional Profit Methods
The OECD Guidelines consider the following transactional profit methods: the Profit Split (PS) method and the Transactional Net Margin Method (TNMM). In principle, application of any other method which would deliver a reasonable at arm's length transfer price should not be disallowed.

Profit Split Method (PSM)
The PS method (and its derivatives, including the Comparative and Residual Profit Split methods) is applied when the businesses involved in the examined transaction are too integrated to allow for separate evaluation, and so the ultimate profit derived from the endeavor is split-based on the level of contribution--itself often determined by some measurable factor such as employee compensation, payment of administration expenses, etc.--of each of the participants in the project.
To present a highly simplified example, if Company A above sent three researchers to Company A(sub) to aid in the development of widgets tailored for the Turkish market while Company A(sub) allocated seven identically-compensated researchers to aid in the development, we would expect that Company A(sub) would pay Company A 30% of the royalty fee portion of the ultimate profits for the technical knowledge provided by Company A's researchers.

The residual profit split method initially focuses on the company in a controlled transaction which performs the most routine functions, for example toll-manufacturing or (limited risk) distributing services. Routine functions are functions which are low value-added compared to the overall profitability. Such company is generally referred to as 'least-complex entity'. The residual profit split method seeks to set the appropriate arm's length remuneration for such least-complex entity, whereby the remaining profit is allocated to the other company of the controlled transaction.
An example: Company A sells widgets through its subsidiary, a limited-risk distributor, in the Turkish market. Assume that an overall profit of 100 is made on the sale. The limited-risk distributor should receive an at arm's length return of 5. Then, the residual profit of 95 would be allocated to Company A, being the complex entity or entrepreneur. In case of an overall loss, the Turkish subsidiary should, in principle, continue to receive the arm's length return of 5.

Transactional Net Margin Method (TNMM)

TNMM, meanwhile, is a method that focuses on the arm's length operating profit (earnings after all operating expenses, including overhead, but before interest and taxes) earned by one of the entities (the tested party) in the transaction. It stipulates that relative operating profit (relative to sales, costs, or assets to allow comparisons between different companies or transactions) may be a more robust measure of an arm's length result when close comparables, as required for the traditional methods, are not available. For example, two distributors may sell different products that require different sales efforts per unit sold. This may lead to very different gross margins (and hence the resale price method may not be easily applicable). However, the operating margins would not be expected to be materially different since the margins reflects a competitive return only.
The margin is measured pre-interest since the level of interest expense is a function of how a company decides to finance its operations and unrelated to the transfer pricing.
Although not one of the traditional three methods, the TNMM and its counterpart under the U.S. transfer pricing regulations, the Comparable Profits Method or CPM is one of the most-widely used transfer pricing methods. See for example, the IRS' annual APA report which publishes details on the transfer pricing methods used in APAs.

Advance Pricing Agreement (APA)

An Advance Pricing Agreement/Arrangement (the specific terminology varies by country), or APA, is an agreement between the taxpayer and the competent taxation authorities that a future transaction will be conducted at the agreed-upon price, which is recognized as the arm's length price for the period designated. Although retroactive APAs can be used to reduce tax exposure in past years, APAs are primarily used to avoid the risk of future income assessment adjustments which, as in the case of GlaxoSmithKline, could lead to hefty payments in the future.

There are two types of APAs: unilateral and bilateral/multilateral APAs. A unilateral APA is, as its name suggests, an agreement between a corporation and the authority of the country where it is subject to taxation. Although simpler to implement than a bilateral/multilateral APA, a unilateral APA will not be recognized by a foreign tax authority, meaning that a U.S. company securing a unilateral APA for trade with its British subsidiary would still run the risk of being assessed should the foreign tax authorities not agree with the method of calculating the arm's length price, resulting in double taxation.

Bilateral/multilateral APAs, however, do provide such coverage, although their implementation requires a more lengthy application process, including consultation between and the agreement of all competent authorities involved.
Mutual agreement procedures
A mutual agreement procedure is an instrument used for relieving international tax grievances, including double taxation. Although the specifics vary based on the laws of each country, they are only carried out between authorities of countries or principalities with existing tax treaties--for example, it is impossible to relieve double taxation by holding mutual agreement procedures between the authorities of China and Taiwan.

Although most conventions require that each party to put forth all reasonable effort to resolve such disputes, they are generally not required to come to any sort of agreement. This means that although mutual agreement procedures can be an effective tool for the relief of taxation grievances, they are not fail-safes.
Some countries are beginning to insert into their tax treaties provisions for the mandatory arbitration of mutual agreement procedures that do not reach resolution after a period of time. Such arbitration provisions, for example Article 25 of the OECD model tax treaty as at 2008, are intended to ensure that double taxation disputes under tax treaties reach a final and relatively independent resolution within a fixed period of time.