Transfer Pricing

Many large vertically integrated (vertical integration refers to operation of a firm at more than one stage of production process) firms are decentralized and made semi­autonomous profit centre. One division of a firm sells its product to another division of the same firm. The Reliance Industries has vertically integrated manufacture chain from naphtha to textiles. Oil refining unit produces naphtha, which is used to produce polymers like polyethylene and polypropylene. At a later stage, polyester staple fibre and filament yarn is manufactured by using these polymers that are again used to produce fabric.

The price at which transfer takes place is called the transfer price. Pricing problem arises because if one unit provides intermediate good to the other, the revenue of the unit will depend on the price charged. A high price will increase profits of the unit at the earlier stage of production, whereas a low price will make later stage production more profitable. While an incorrect price can affect the total profit earned by the firm. 

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