The Transfer Pricing Problem with Non-Linearities

TL;DR

This paper extends Tomkins' pragmatic-analytical transfer pricing model to handle non-linear revenue curves, especially quadratic functions, enabling more accurate and flexible transfer pricing strategies.

Contribution

It develops a method to determine transfer price schedules for non-linear revenue functions, broadening the applicability of existing transfer pricing models.

Findings

Transfer price schedules are derived for quadratic revenue functions.

The method can be applied to any non-linear net average revenue curve.

The approach improves transfer pricing accuracy in complex revenue scenarios.

Abstract

A number of approaches to solving the well-known transfer pricing problem are known. However, few models satisfactorily resolve the core problem of allowing both the source and receiving divisions to earn a profit on transfers during a period in such a way that sub-optimal output levels are avoided. In 1969, Samuel proposed to use a transfer price schedule instead of just a single transfer price. An essential improvement of Samuels' model was given by Tomkins (1990) in his pragmatic-analytical transfer pricing approach, which is a combination of a single cost-plus transfer price and the pragmatic process of negotiation. This fundamental approach was developed under the assumption that the net average revenue curve for the final product is linear. In this paper, Tomkins' pragmatic-analytical model is further developed for non-linear net average revenue curves. In particular, typical quadratic functions are considered and corresponding transfer price schedules are determined. A similar technique can be used for the transfer pricing problem with any net average revenue curve.