2. Market-based transfer pricing method

Market-based transfer pricing is when competitive external market prices for specific products or services are used as a transfer price.  This method helps eliminate issues or concerns with other pricing methods (cost based or negotiated price) because the external market price is considered to be an objective representation of the price for goods or services. Market-based pricing allows the selling division to capture profits it would have had if the division sold the products to external customers. At the same time, the buying division will incur costs that would be same if there was no internal source of these products or services.

Market-based transfer pricing is a good choice when company divisions (affiliates) are autonomous and there is a competitive market for the goods or services.

Market-Based Transfer Pricing Example

Refer to the example with numbers described earlier in this tutorial. Based on analysis performed by the finance department and approved by top management of the company, Division D3 will buy the widget from Division D1 at a price of $150 (e.g., the market price of the widget). Note that Division D1’s cost is $100 per widget so Division D1 will accrue a profit of $50 per widget on these intercompany sales.

Considerations for Market-Based Transfer Pricing

• There may not be a competitive market for requested goods or services.

• Internal transfer pricing does not require marketing or selling expenses. There is also availability of volume discounts if a division buys from external vendors. The market based approach should consider these factors when determining appropriate adjustments to the market price for intercompany sales.

• Market prices may decrease during economic recessions or competitive wars. This will result in lower than normal transfer prices, and in the long run the decision to use a market price for intercompany sales may not be optimal.

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