Interacting supply chain distortions: The pricing of internal transfers and external procurement. The Accounting Review 82

This paper examines the impact of distortions wrought by transfer pricing when a firm is engaged in both internal production and external procurement of inputs. In particular, we demonstrate that a firm can actually glean benefits from oft-discussed transfer pricing problems in dealing with an external supplier. Though transfer prices above marginal cost introduce inter-division coordination problems, they also introduce a lower willingness to pay to outside suppliers. Knowing that costly internal transfers will eat into demand, the supplier is more willing to set lower prices. As a result, the feature of transfer pricing policy that is often viewed as a curse can turn out to be a blessing in the face of an aggressive supplier