Transfer Pricing and its Impact on Company Performance

This report examines the concept of transfer pricing, focusing on its application within multinational firms. It highlights the complexities that arise when different divisions within a company engage in inter-company transactions, especially when one division supplies goods or services to another. The report explores three primary transfer pricing methods: cost-based, market-based, and negotiation-based. It analyzes the pros and cons of each method from the perspectives of both the purchasing and selling divisions, considering factors such as pricing, cost control, and potential for profit maximization. References include academic research on transfer pricing by Cristea & Nguyen (2016) and Rugman & Eden (2017), providing a comprehensive overview of the subject matter.

Running head: TRANSFER PRICING 1
TRANSFER PRICING

TRANSFER PRICING 2
Transfer pricing can be characterized as the value which is associated with the goods.
Transfer prices are basically the values for the inter company products that are purchased
from independent divisions. When the company adds the extra facilities to the organization
the complexity arises due to the process of the transfer pricing. For example one unit is
selling the tyre and the other unit is making the rubber of it. If the company outsources the
rubber the company may get a high price than what it can get while purchasing the price
internally. On the other hand the company manufacturing the rubber can sell at high prices
outside rather than internally which will create a situation of loss. Hence the transfer pricing
becomes a complex concept and can create clashes (Cristea & Nguyen, 2016). Such options
are cost based transfer pricing, negotiation based transfer pricing and market based pricing.
Basis Purchasing Division Selling division
Cost based Pros: The product can be
acquired at lower price.
Cons: The company is not
aware about the actuals costs
of the divisions.
Pros: The division can quote
the price of its choice. The
division gets the discount.
Cons: It can be a loss at
times.
Market based Pros: The stable product will
be purchased
Cons: Market rate would be
higher (Rugman & Eden,
2017).
Pros: Downstream division
can have higher profits.
Cons: Cost will be saved by
the purchasing division.
Negotiation based Pros: Emulation of the free
market.
Cons: Which divisional is
better remains a question
Pros:
Cons: transfer price defeats
the motivation for using the
negotiated transfer price.

TRANSFER PRICING 3
References
Cristea, A. D., & Nguyen, D. X. (2016). Transfer pricing by multinational firms: New
evidence from foreign firm ownerships. American Economic Journal: Economic Policy, 8(3),
170-202.
Rugman, A. and Eden, L., 2017. Multinationals and transfer pricing. Routledge.