So much has been written about transfer pricing. Yet it remains a bone of contention in almost every organisation. Transfer pricing is not merely a rational challenge – it often raises the emotions of internal service users and providers who argue regarding scope, quality, price and value.

We have found that effective transfer pricing relies on some fairly simple best practices and critical success factors.

Many organisations recover costs as a regular ‘below-the-line’ deduction from operating division income statements. In our experience, charge out is almost always preferable. This results in internal value judgements and negotiation regarding delivery happening closer to time of use.

Internal prices / cost recovery plays a crucial role within an organisation: it ‘price signals’ to the buyer and the supplier of the service. Buyers make economic use decisions and suppliers make resource and capacity decisions. This fundamental function and consequence governs the optimal implementation of internal pricing / cost recovery.

We have typically seen that the realisation that internal pricing plays this role and the consequences of poor implementation are not well understood.

Results of poor transfer pricing implementation

Sub-optimal economic use decisions

Where costs / prices are higher than they should be, buyers pass this on as an inflated cost to their customers, experience margin squeeze, or utilise less of the service than they might have.
Strategically this can lead to incorrect decisions regarding the provision of services to the market and loss of market share.
Where costs / prices are lower than they should be, this can lead to overuse of a product or service and poor cost recovery from external customers.
Strategically this can result in the over promotion and sales of products and services that are achieving lower margins than thought, or that might even be making losses.

Sub-optimal investment and resourcing decisions

Incorrect pricing can lead to over- or under-investment in capacity and product or service quality. Further, the resourcing decisions will be incorrect should the price signal to the supplier be incorrect.

Political and emotional argument

Where buyers are unable to obtain assurance that an internal price is correct, there is typically resentment regarding the cost of the internal product and service and the sheltered position employees of the internal service provider occupy – in the buyer’s eyes free from commercial pressures.
Buyers and suppliers typically also argue regarding the quality of the service or product relative to the price paid.
Suppliers may react to criticism claiming their product or service is strategic in nature and refute its availability in the external markets.

Poor product / service quality

Poor price signals will result in lack of comparable product and service quality benchmarks. This can result in ‘gold-plating’ or poor-quality product and service provision.


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