Cost Calculation and Global Pricing Strategy: a Real-world Case Study
Cost calculation and Global Pricing Strategy
With cost calculation and global pricing strategy dominant in today’s market, have you ever thought of a world without prices? Would a country and its economic system be able to run properly without prices or would it descend into chaos within no time at all?
Without a global pricing strategy, how do a country trade with other countries? A global pricing strategy definition is one where international firms should consider several factors that influence pricing decisions in international markets. The goal of which is to match the organization with its environment. If markets extend across borders, then national environments become significant in its development.
Russia’s Utopian Society
Think a world without prices is fantasy land? Think again. It’s already happened in Russia 100 years ago.
How could a country survive in a world where commercialism is the dominant factor in a country’s progress?
Quite simply reinvent the rules and create a Utopian society where money does not exist and any profit motives are eradicated.
A world where wages are unnecessary to stimulate production and effort. A world where value is determined “according to [individual] ability” (or unit labour models) and production is determined “according to [individual] needs.” Here, the pricing strategies in marketing were obliterated.
Seems strange to think now, but yes, the old Soviet Union tried and failed to build a world where prices did not exist. It failed, leading to the downfall of the Soviet Union.
The Soviet Union Gosplan
The predominant driver of a world without prices was ‘Gosplan.’ Gosplan is an abbreviation of Gosudarstvennyy Planovyy Komitet, English State Planning Committee. It was a recommendation committee where all economic plans for the Soviet Union were made and then submitted to the Communist Party for approval.
Gosplan removed the study of prices from economic monetary planning. In fact, prices were forbidden. This meant that under Gosplan there were no proper price mechanisms or monetary calculations to determine value or drive production.
The Soviet type of planning was made under the special conditions prevailing in the U.S.S.R. The aim of Gosplan was to drive industrialisation, especially for heavy industry. The overriding logic of industrialisation was that steel and machinery were more favourable to industrial growth than textiles and jam – partly due to its military potential.
This article will examine the Soviet material balance system and its shortcomings from a modern-day pricing perspective, including the contemporary observations of economists Ludwig von Mises and F.A. Hayek.
Planning in the early U.S.S.R.
The kind of economic planning practised in the Soviet Union and in most other communist countries until the 1990s developed during the 1920s and ’30s in the struggle to industrialise the U.S.S.R. The Bolsheviks, led by Vladimir Lenin, seized power in 1917 without any clear notion as to how an economy should be run. The teachings of Karl Marx provided no guidance or indication on how to handle an economy under Communist rule.
The original capacity of the Gosplan was to be an advisory council to the government, its functions limited to influencing the level and direction of state investments. But with the introduction of the First Five-Year Plan in the 1930s, it has taken over the overall planning of rapid industrialisation. Including a drastic reduction of the private sector.
During the Russian Revolution of October 1917 there was a lot of social and political unrest unsettling the economic system:
- economic breakdown,
- a refusal of cooperation from officials and managers,
- civil war,
- and uncontrollable inflation
The Bolsheviks seized all industry and trade; nationalised all economic property including land. They declared all private enterprise illegal and demanded that the farmers deliver all farm surpluses to state procurement organs. In turn, money lost all value.
All economic units, except the farmers, were subjected to orders from the government’s Supreme Council of National Economy (V.S.N.Kh.). The Soviet Union devised a system of central planning called material balance planning, which equalizes the total output of the economy with the total input, which would, theoretically, allow for the most equitable distribution of resources and eliminate waste.
Gosplan’s Monetary System & Value / Price calculations
In order to ensure the success of the plan, it was necessary to ensure that inputs from one part of the economy matched outputs from another part of the economy. Gosplan used a methodology called the system of ‘material balances’ which drew up a balance sheet in terms of units of material (i.e. money was not used as part of the accounting process).
The first step was to determine how much steel, cement, wool cloth, etc. would be available for the next year. Calculation was based on the following formula:
Production minus exports plus imports plus or minus changes in stocks.
The planning system was a simple one. Gosplan calculated the sum of the country’s resources and facilities, established priorities for their use, and handed down output targets and supply allocations to the various economic ministries. They then delegated it to every branch and enterprise in the entire economy.
Gosplan’s Price issues and limitation
To be sure, the system had its limitations, including the absence of meaningful price and cost information. More serious difficulties came from the attitudes and priorities built into the Stalinist planning system. The administrative system identified by economic romanticism, profound economic illiteracy, and incredible exaggeration of the real effect that the ‘administrative factor’ had on economic processes and on the motivations of the public.
Soviet critics like Ludwig Von Mises and F.A Hayek pointed out the rigidity of prices, which did not reflect supply-demand conditions. In the absence of monetary calculation, Mises argued it would still be possible to have a system of exchange for consumption goods. Comrades could still barter with each other. However, no such system existed for capital goods. Since the state holds all capital goods, exchanges between enterprises were essentially just a relocation of state property. This left Gosplan with no means to determine whether production was efficient or inefficient.
The planners claimed that it was not their job on the price mechanism but to ensure a balance between supply and demand. But due to the bureaucracy and vast complexities of their task made it impossible to monitor the distribution of the resources.
Monetary planning process
After Gosplan calculated the sum of the country’s resources and facilities, the second step was to find any mismatches between levels of outputs of one material used as an input with another part of the economy i.e. to identify differences between supply and demand within the economy.
After mismatches identified, plans for the first-year plan either be to cut production or put more effort into increasing supply.
Plans for the fifth-year of production, conversely, would be to mitigate mismatches by modifying long-term plans for increasing production capacity.
Using this method, any changes in the plan to remove mismatches between inputs and outputs would result in numerous changes to material balances. This meant that, without the aid of information technology, Gosplan could only deal with the economy in very general terms.
General economic policy, however, created ideological biases. These biases often resulted in unrealistic plans that were almost impossible to execute. Pressure to execute them resulted in widespread false data on all levels of reporting. Falsified plan ‘realisation feedback’ resulted in Gosplan preparing plans even more detached from reality.
Gosplan during the time of Glasnost and Perestroika
Under the leadership of Mikhail Gorbachev, reform programs radicalized in 1987-90 true change in the Soviet economic and monetary system. Instead of the Gosplan planners, business owners and managers did the negotiations with their customers or with wholesale-trade entities. The Soviet leadership authorised large enterprises to enter foreign markets with affordable pricing strategy.
This stemmed from the continued shortages and corruption which alarmed the Soviet leadership. Reforms slowly introduced but with great opposition from some Politburo members. But with chronic shortages, hoarding soon became rampant. Prices gradually reformed to reflect their true economic value. Deeper reforms threatened the hold of the Communist Party over the country. Many ran against the traditional Marxist views on the free market.
Within a relatively short time, the central government lost its authority over the economy due to Gorbachev’s more liberal policies. This, in turn, freed businesses to operate within an economy that as yet lacked the free play of free-market mechanisms with the four common pricing strategies. This comprises premium pricing, penetration pricing, economy pricing, and price skimming.
With the fall of the Soviet central government in late 1991, Russia eliminated the economic policy-making. The other newly independent republics of the former union were now more prone to a diversified economic structure in which central planning was almost non-existent.
- At first, Gosplan worked, but the huge bureaucracy required to implement the utopian plan. They discarded it. Instead, much of the countries vital resources redirected to build up the country’s military might during the Cold War. This, in turn, diverted needed materials away from the general public and led to wide-scale poverty and corruption.
- Corruption and hoarding led to the collapse of the country’s economy – and hide the true economic state of the country. Mikhail Gorbachev’s Glasnost helped radically reform economic health to some degree. From here it was possible to introduce the free market and prices back to Russia. With the free market, it was possible for Russian businesses to determine the real value of their products and services.
- With the collapse of the Soviet government, the free enterprise launched in Russia and capitalism allowed to thrive bringing prosperity to the former Soviet Union.
- ‘Gosplan’ is to guide the Soviet Union into a centralised government-controlled economy. The communist belief that everyone had a fair share of the resources of the country no matter who they were. They implemented their belief using a centralised data gathering system and unit labour model to predict the country’s economy.
- The pursuit of wealth was no longer the driving force for the people to work. But rather the shared goal was to contribute to the betterment of society and patriotism for the country.
- Gosplan forecasts what materials needed to produce goods. The control of supply and demand was the method of driving the Soviet Union’s economy. Their recommendations submitted to the Central Committee for approval and delegated to various economic departments.
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