An Instructional Case by
Charles Bailey & Denton Collins

• Illustrates the issues associated with setting a firm’s transfer pricing policies.
• Given that there is a best decision for Goliath as a whole in each negotiation, the case is useful in illustrating how policy choice can lead to good or bad insourcing/outsourcing decisions.
• Overview:
• Students to assume the roles of top management and divisional management in negotiating transfer prices.
• The simulation requires first that the student playing the role of CEO select a transfer pricing policy from four possible mechanisms: market-based, cost-based, negotiated, and
“dual” pricing.
• Following the CEO’s policy decision, the divisional managers decide whether to deal internally or externally based on their respective negotiation.
• Classroom discussion examines the process and outcomes

1.
Assign “companies” (groups of 4 students) and pass out materials:
• 1 CEO, 3 divisional-manager roles
2.
CEO sets TP policy [subject to constraint that we must use all policies in the exercise]—then receives full package to see the decisions divisional managers face.
3.
Divisional managers negotiate for their needs according to instructions.
4.
Meanwhile, CEO considers what the divisional managers should do for the overall welfare of Goliath.
• CEO observes but does not interfere. Be prepared to discuss the merits of division managers’ actual decisions.

5.
Tabulate the results of negotiations.
6.
Give everyone full package, discuss results.
• Were the results in the best interest of of Goliath as a whole?
• Look at theoretical effects of the methods on managers’ decisions

In keeping with maximum autonomy, you [the CEO] allow
divisions to accept or reject any offer to buy or sell to another division. However, whenever an internal transaction does
occur, the price must follow guidelines that you set. Here are the options you are considering.
 Market-based: actual competitive prices that the buyer would have to pay outsiders, less 2% to adjust for the economies of dealing internally
(less sales effort, no bad debts, etc.).
 Cost-based: actual full manufacturing cost.
 Negotiated: whatever price the two parties can agree on.
 Dual:
 The selling division receives 120% of its full manufacturing costs.
 The buying division pays 98% × (the market price they would pay outsiders).

Transaction
1: Plastics → Metals
2: Electronics
→
Plastics
3: Metals
→
Electronics
Good for
Goliath?
Market-Based
Company
(Student team)
Results under Policy of:
Cost-Based
Company
(Student team)
Negotiated
Company
(Student team)
Dual-Pricing
Company
(Student team)

Should Top Management Want the Transactions?
(Are they good for Goliath?)
• Out-of-pocket costs:
• Inside:
• (5000 cases)(28+17+34)=$395,000
• Outside:
• (5000 cases)($115) =$575,000
• Yes!

Should Top Management Want the Transactions?
(Are they good for Goliath?)
Transaction 2:Electronics sells sensors to Plastics
• Inside:
• Out-of pocket costs: 2000 x $43 = 86,000
+ opportunity costs:2000 (80-43)=74,000
Total $160,000
(NOTE: =2000*$80)
• Outside:
• 2000 x $75 = $150,000
• No! Better off outside.

Should Top Management Want the Transactions?
(Are they good for Goliath?)
• Inside:
• 8000 x $49
• Outside:8000 x $40
=$392,000
=$320,000

Is optimal outcome in this case likely with...
•Market?
•Cost-based
•Negotiated?
*See Overview of Incentives and Predicted Outcomes