Transfer pricing is a contentious matter in some procurement scenarios. A transfer price is the price paid for goods and services involved in intra-corporate transactions between a subsidiary and other branches of the corporate family. Transfer pricing is a complex subject. A very useful insight can be gained by accessing “Internal and External Factors on Firms’ Transfer Pricing Decisions: Insights from Organization Studies” Dan Li and Manuel Ferreira, Kelly School of Business, Indiana University.
From a procurement point of view, Li and Ferreira give an extract from a conversation between two senior people in Northwestern vs Pulp Mills. The Director of the South Korean Subsidiary says “I don’t understand why it would make sense to pay $450/ton for pulp [to buy internally] when I can get it for $330/ton from Chile.” The reply from the Vice President of Northwestern was, “I understand your motivation for wanting to source the pulp from Chile but it is important [to buy inside] for the corporation to act as an integrated team.”
In 1993 it was believed that intra firm trade accounted for about 40% of the trade between the EU and the USA.
Transfer pricing is usually calculated in one of two ways. The first is market-based and this will probably appeal more to procurement. The price is determined by the open market, giving visibility and a reduction in conflict between members of the same group. The second, and a more contentious manner for setting transfer pricing, is nonmarket-based methods. This is the happy hunting ground of the corporate accountants who are motivated by alluring the parent to lower its overall tax bill. It can also enable cash to flow from the subsidiary to other parts of the firm, rather than forbidden dividend payments. The transfer pricing can also allow a firm to evade host country restrictions on reparations of profits. Manipulation of corporate overhead charges, royalties, licensing fees, IT and administrative support are considerations in transfer pricing decisions.
Are your procurement-pricing decisions of a sound nature? Procurisk® is a professional tool to conduct a methodological review. Please see www.procurisk.com for further information or email Ray Gambell at [email protected] to find out more.
Read the full paper by Li and Ferreira here: http://goo.gl/P7E92d
