The effect of transfer pricing strategies on optimal control policies for a tax-efficient supply chain

Many multinational companies now relocate their procurement departments to low-tax jurisdictions to benefit from low tax rates via transfer pricing. This study examines which transfer pricing strategy should be adopted: the cost-plus or the resale-price method. This study considers a two-echelon supply chain consisting of one overseas procurement center and one or several divisions that order components from the procurement center. Strategically, corporate management can choose between an operating structure with a buy-sell model or a “commissionaire” model for the procurement center. Corporate management should design a transfer pricing method to optimize the supply chain's total after-tax profits under each structure. We then examine the tax benefits the procurement center can bring and the coordination issues involved in each structure. We find that some of the optimal decisions exhibit interesting non-monotone behavior. For instance, the results do not conclusively determine which system is better. We derive and analyze the threshold values of the bargaining performance parameters that describe the main trade-offs involved in selecting an operating structure. To clarify the structure of the problem and illustrate our findings, the study also conducts numerical experiments.