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Cost-based transfer pricing with the existence of a direct channel in an integrated supply chain

Jumpei Hamamura (Momoyama Gakuin University, Osaka, Japan)

Journal of Modelling in Management

ISSN: 1746-5664

Article publication date: 11 August 2021

Issue publication date: 29 November 2022

417

Abstract

Purpose

This study aims to analytically explore the economic role of transfer pricing in a vertically integrated supply chain with a direct channel, specifically when it uses cost-based transfer prices, as is frequently observed in management practices. We compare two representative transfer pricing methods: full-cost and variable-cost pricing. Although many firms open a direct channel, which affects the optimal decision on transfer prices, prior literature has not considered this case.

Design/methodology/approach

We demonstrate the results using a non-cooperative game theoretical approach.

Findings

The results show that full-cost pricing is more profitable than variable-cost pricing when the fixed cost allocation to the marketing division is low, contrary to the established position in prior studies, from which I select their benchmark case. Moreover, we obtain a counterintuitive result, whereby, the firm-wide profit of a vertically integrated supply chain increases with fixed cost allocation.

Originality/value

This study considers the direct channel and internal transfer pricing in a vertically integrated supply chain, while prior research only considers one or the other. This model suggests an optimal choice of cost-based transfer pricing in managerial decisions. In addition, the authors demonstrate the positive effect of increasing fixed cost allocation, which prior management studies do not show. The findings of this study have implications for managerial practice by providing insights into supply chain design and showing that firms should consider the competition between channels when making decisions about transfer pricing methods.

Keywords

Acknowledgements

The author is truly indebted to two anonymous referees for their invaluable comments and suggestions. I would like to thank Chia-Ling Lee, Takeyoshi Senoo and Kenji Yasukata, seminar participants at JAMA 2018 annual conference in Keio University and 2018 Taiwan Accounting Association Annual Conference and Asian Accounting Associations Conference in National Chengchi University (Title: Impact of direct channel on the choice of absorption versus direct costing using cost-based transfer price). This work was partially supported by JSPS KAKENHI Grant Numbers 18K12909 and 21K13409. The usual disclaimers apply.

Citation

Hamamura, J. (2022), "Cost-based transfer pricing with the existence of a direct channel in an integrated supply chain", Journal of Modelling in Management, Vol. 17 No. 4, pp. 1544-1565. https://doi.org/10.1108/JM2-08-2020-0218

Publisher

:

Emerald Publishing Limited

Copyright © 2021, Emerald Publishing Limited

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