1. The Inter-Divisional Trade Dilemma
In vertically integrated corporations, one division often manufactures a component part that serves as the raw material for a downstream division. A Transfer Price is the internal price charged by the selling division to the buying division for that component.
  [ Division A: Supplying Unit ] ======= ( Transfer Price? ) =======> [ Division B: Buying Unit ]

2. The Conflict of Divisional Performance Evaluation
The transfer price creates an internal tug-of-war because it directly impacts the performance metrics of both managers:
  • For the Selling Manager, the transfer price represents revenue. They want a high price to boost their division’s ROI and profits.
  • For the Buying Manager, the transfer price represents a cost. They want a low price to protect their profit margins.

3. The Core Goal of Transfer Pricing Policy
Senior executives must design transfer pricing rules that achieve three goals simultaneously:
  • Goal Congruence: Ensuring that when local managers choose what is best for their own division, they automatically choose what maximizes total corporate profit.
  • Divisional Autonomy: Maintaining decentralization by allowing managers to negotiate freely without constant headquarters intervention.
  • Performance Equity: Allowing corporate leadership to evaluate the skills of local management teams fairly.

 
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