Price and Authority in Inter-Profit Center Transactions

Price and authority have traditionally been regarded as alternative social mechanisms for allocating resources. However, actual transactions-whether inter- or intrafirm-can be evaluated in terms of the extent to which they combine both of these mechanisms. An especially revealing example of this is the exchange of goods between two profit centers in the multi-profit center firm. Three of the most common arrangements, or transfer pricing polices, for effecting these transactions are examined here. Exchange autonomy transfers depend primarily on price, with no or minimal use of authority. Mandated full cost transfers involve a substantial exercise of authority relative to the use of price. Mandated market based transfers use both authority and price in important ways. For all three policies, the transaction costs of these internal transactions may exceed these costs on external transactions.