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Capacity Rights and Full-Cost Transfer Pricing

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Abstract

This paper examines the theoretical properties of full-cost transfer prices in multidivisional firms. In our model, divisional managers are responsible for the initial acquisition of productive capacity and the utilization of that capacity in subsequent periods, once operational uncertainty has been resolved. We examine alternative variants of full-cost transfer pricing with the property that the discounted sum of transfer payments is equal to the initial capacity acquisition cost and the present value of all subsequent variable costs of output supplied to a division. Our analysis identifies environments where particular variants of full-cost transfer pricing induce efficiency in both the initial investments and the subsequent output levels. Our findings highlight the need for a proper integration of intracompany pricing rules and divisional control rights over capacity assets. This paper was accepted by Suraj Srinivasan, accounting.

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... It is well known that the online direct channel is greatly appreciated for selling products from the manufacturer to consumers without the middleman being involved. Under the decentralized structure, we assume that the e-commerce division aims at maximizing all the revenue from the online channel using cost-based transfer pricing, which is the most prevalent method used in firms (Dutta & Reichelstein, 2021). According to Tang (1992), over half of the respondents with the cost-based method use full production cost as their internal transfer price. ...
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Traditionally, manufacturer encroachment is investigated under an integrated organizational structure where the online business decisions are made at the whole firm level. However, with the establishment of a specific e‐commerce division, the manufacturer has the flexibility to delegate the decision‐making of the online business to its e‐commerce division to maximize the online revenue under a decentralized structure. We study manufacturer encroachment in a supply chain, where a manufacturer sells through a bricks‐and‐mortar retailer and plans to deploy its e‐commerce division to launch the online direct‐to‐consumer business. Different from prior research, we endogenize the manufacturer's choice between the integrated and the decentralized structures in its encroachment pursuit. Our results suggest that the decentralized structure could enlarge the manufacturer's feasible range to encroach, but it would also intensify the competition between the e‐commerce division and the retailer. Therefore, choosing the decentralized structure does not necessarily yield a higher profit for the manufacturer because the loss in the retail channel may be hard to offset due to the intensified competition. Instead, choosing the integrated structure could lead to a win‐win‐win outcome for the manufacturer, retailer, and e‐commerce division when the direct selling cost is sufficiently low. Although the manufacturer may benefit from encroachment under both internal structures, it should not encroach when the direct selling cost is between low and moderate. Notably, the bright side of manufacturer encroachment's impact on the retailer still exists under the decentralized structure. We also study some alternative settings, including consumers’ offline hassle cost, market‐based transfer price, and quantity competition, to obtain additional insights. This article is protected by copyright. All rights reserved
... Fahimnia, Tang, Davarzani, & Sarkis, 2015 ), transfer pricing (cf. Dutta & Reichelstein, 2018 ), and regulation (cf. Nezlobin, Rajan, & Reichelstein, 2012 ). ...
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