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transfer pricethe internal PRICE at which raw materials, components and final products are transacted between the divisions or subsidiaries of a vertically integrated or conglomerate firm.
The transfer price charged may be set by reference to the prices ruling in outside markets for inputs and products (arms-length pricing). Alternatively, the transfer price may be set at a lower or higher level than the going market price, according to some internal accounting convention (for example, cost of production plus standard profit mark-up) and the desired ‘profit split’ between the firm's activities. Such administered transfer prices would generally be designed to achieve the firm's overall profit goals, but in transfer pricing decisions there may often be an inherent conflict between the overall goals of the firm and the goals of its subunits. For example, if one COST CENTRE is allowed to transfer components at cost of production plus a specific mark-up, then it has little incentive to minimize its production costs. Again, where a PROFIT CENTRE does not have discretion over its buying or selling prices but must buy or sell some or all of its inputs or outputs to other subunits at transfer prices established by headquarters, then the profit performance of the subunit will not depend solely upon the efforts of local managers, making it difficult to evaluate the performance of subgroup managers and motivate them to improve efficiency.
Transfer pricing gives a firm added flexibility in pricing its products. It may deploy transfer pricing to gain a competitive advantage over rival suppliers (to PRICE SQUEEZE a non-integrated rival), in the case of a MULTINATIONAL ENTERPRISE, transfer pricing provides an opportunity to increase its profits by setting transfer prices across national frontiers in such a way that most of the firm's profits accrue in countries where company taxation rates are the lowest. In addition, inflated transfer prices for components or services may be used to remit surpluses back to the parent company from subsidiaries located in countries which limit the repatriation of profits through dividend controls or EXCHANGE CONTROLS. See INTERNALIZATION, TAX HAVEN, VERTICAL INTEGRATION, DIVERSIFICATION, SHADOW PRICE, MIXER COMPANY.
transfer pricethe internal PRICE at which FACTOR INPUTS and PRODUCTS are transacted between the branches or subsidiaries of an integrated firm (see TRANSACTION, VERTICAL INTEGRATION, DIVERSIFICATION). The transfer price may be set by reference to the prices ruling in outside markets for inputs and products (arm‘s-length pricing) or it may be administered (see ADMINISTERED PRICE) according to some internal accounting convention (for example, a FULL-COST PRICE).
Transfer pricing gives a firm added discretion in pricing its products, and the danger is that it could well be tempted to employ ‘manipulative’ transfer pricing to harm competitors (for example, PRICE-SQUEEZE a non-integrated rival firm) and, in the case of a MULTINATIONAL COMPANY, to boost its profits (for example, transfer price across national frontiers so that the greater part of the firm's profits are received in a low-taxation economy).