Question

Evaluate transfer pricing, by particularly paying attention to what is it, and how it works in the case of large multi-national corporations. Evaluate the criticisms of transfer pricing and the benefits and reasons for adopting this approach. Illustrative real examples could be used to help develop your argument. Just need short bullet points- confused on how it works with large multi-nationals

Answer 1

Transfer Pricing is a process of determining the transfer price for the goods transferred within and between the enterprises under common control or ownership.

Transfer Price is the price which one department of the firm charges for a product supplied or service rendered to another sub-unit of the same firm.

The main objective of intra- company  transfer pricing in large scale multi- nationals are

1. Overall Company Profitablility:

2. Full Capacity utilization:

3.Optimum resources Utilisation:

Advantages of operating a transfer Pricing system in a Multinational entities are as follows:

1.Goal Congruence:

An Efficient transfer pricing system can motivate the divisional managers to make economic and rational decisions which improves divisional as well as companys profit as a whole.

2. Wholistic Decisions:

Transfer Pricing system can ensure wholistic decision making which are in the best interests of the divisions and the company as a whole . Dysfunctional decision - making is there by avoided.

3.Performance Evaluation:

Tranfer pricing can be set at a level such that divisional performance can be measured commercially and viably.

4.Balance Between Autonomy & Company Goals:

An effective Transfer pricing system can ensure balance between - 1. divisional autonomy ( to provide incentives and motivation ) and 2. Centralized authority ( to ensure unity in direction and overall company profitablility)

Critisim in Tranfer pricing :

In transfer pricing each division is treated as a profit centre which leads to the following disadvantages:

Conflict between divisions and company as a whole

: if the divisional manager are given absolute free hand in decision making on transfer pricing there is a possibility that divisional goals may be pursued ignoring the overall company interests. This may force the top management to interfere in decision- making. However, interference of top management and dictating a tranfer pricing on the division is usually the main basis of conflict between a division and the company as a whole.

Conflict between goals and objectives:

their is a conflict between 1. goal congruence vs performance evaluation 2.Goal congruence vs Divisional Autonomy 3.Performance Evaluation Vs Profitability

.Identity:

it becomes difficult to identify and define precisely suitable profit centre. Also it confuses divisions results with managers performance.

.Short term Focus:

Divisions may compete with each other and may take decisions to increase profit

Disharmony

It may adversely affect the cooperation between divisions and lead to lack of harmony in achieving organisation goals.

Examples :Coca - cola is mutli national conglomate operating based on transfer pricing for each of its individual divisioins across the world. Due to produciton marketing and sales divisions in coca cola are present across the world the compnay protects its revenue by entering transfer pricing agreements with each respective countries to reduce its tax liablity.