Question

What are the benefits of market based transfer pricing?

Answer 1

When the intermidiate products produced by upstream division had ready market and that market is competative, organisations are interested in using market based transfer pricing. Thus it implies that if there is no ready market or Intermidiate products ( which is a general phenomenon) its quite imposible with defining the market based selling pricing and setting it as transfer price. Similarly in the absence of competition, price is not truely market based.

Advantages

(1) Shareholder value creation : The divisional manager is indifferent between finding an internal customer ( downstream division) or an external division as long as the price he receives does not effect his aim of divisional profit maximization. This object inturn maximizes the shareholder value creation at its optimum level.

(2) Stops transfer of Inefficiency : The upstream division, even if working in cost disadvantage with cost exceeding the market price cannot push that inefficiency to downstream division due to use of market based prices as transfer price.

(3) Internal Savings : Several savings in the form of transportation, packing for market handling, special packing for attraction and commisons allowable at various levels of distribution channel are all possible savings associated with internal transfer which can be shared by both departments if market based transfer pricing is applied.

(4) External savings : Savings in the form of loss due to uncollected debts and bad delivers can be avoided through internal transfer which ultimately adds to goal congruence of shareholder

(5) Reduces conflits : Market based transfer pricing always helps in easy understanding of price and its comparision with market. So managers of both the department have dealings happening with just a hand shake rather than need for using paper work in determining the price.