Advantages of negotiated transfer pricing are: 1.
An organisation’s strategies The Balanced Scorecard, referred to as the BSC, is a framework to implement
and goals are supported by ‘realistic’ transfer prices. 2 Goal congruence of the
overall organisation is promoted, as managers of divisions agree prices in the
interest of the organisation as a whole. 3.Divisional autonomy is promoted as
divisional managers may be motivated to maximise profits.
The limitations of negotiated transfer pricing are: 1.The outcome of
negotiated transfer prices may not be optimal. For example, there may be
power imbalance between divisions and/or managers. 2.Conflict may exist
between divisions, as divisional managers may be pitted against one another
in terms of performance measurement, or managers may not understand
each other’s divisions. 3.The negotiation process may be time-consuming for
managers. (University of Sunderland, 2011)
The following are advantages to using the full cost plus pricing method:
 Simple. It is quite easy to derive a product price using this method,
since it is based on a simple formula. Given the use of a standard
formula, it can be derived at almost any level of an organization.
 Likely profit. As long as the budget assumptions used to derive the
price turn out to be correct, a company is very likely going to earn a
profit on sales if it uses this method to calculate prices.
 Justifiable. In cases where the supplier must persuade its customers
of the need for a price increase, the supplier can show that its prices
are based on costs, and that those costs have increased.
The following are disadvantages of using the full cost plus pricing method:
 Ignores competition. A company may set a product price based on
the full cost plus formula and then be surprised when it finds that
competitors are charging substantially different prices.
 Ignores price elasticity. The company may be pricing too high or too
low in comparison to what buyers are willing to pay. Thus, it either
ends up pricing too low and giving away potential profits, or pricing
too high and achieving minor revenues.
 Product cost overruns. Under this method, the engineering
department has no incentive to prudently design a product that has
the appropriate feature set and design characteristics for its target
market. Instead, the department simply designs what it wants and
launches the product.
 Budgeting basis. The pricing formula is based on budget estimates
of costs and sales volume, both of which may be incorrect.
 Too simplistic. The formula is designed to calculate the price of only
a single product. If there are multiple products, then you need to
adopt a cost allocation methodology to decide on which costs are to
be assigned to which product.
This method is widely used in practice. It is based on the product or services
costs determined by the organisation’s costing systems. This is in fact a major
problem with full cost transfer prices, in that these costing systems may
provide poor estimates of long-run marginal costs.
Full cost transfer does not promote an incentive for the supplying division to
transfer goods and services internally because they do not include a profit
markup. It may be useful when it is difficult to determine the actual amount
of a profit mark-up. On the other hand, a full cost approach does not provide
any incentive for divisional managers to keep costs down, since they can pass
the costs onto the buying divisions.
A transfer price based on full cost plus a mark-up is also possible. However,
such a price may lead to sub-optimal decisions because it leads the ‘buying’
division to regard the fixed costs and the mark-up of the selling division as
variable costs.
and manage strategy. It links a vision to strategic objectives, measures,
targets, and initiatives. It balances financial measures with performance
measures and objectives related to all other parts of the organisation. It is a
business performance management tool.
Questions often arise about the four Perspectives described in the
methodology. Why should we only look at Financial, Customer, Business
Process and Organisational Capacity? Why not include Health and Safety? The
answer is, of course, there is nothing stopping us. The four perspectives are
simply a framework. However, over decades of use it has become clear that
they work.
More importantly, there is a causal relationship between the perspectives.
Working from the bottom to the top: Changes in Organisational Capacity will
drive changes in Business Processes that will impact Customers and improve
Financial results. The causal relationship may not be guaranteed if a new
perspective is added. The result might be a useful scorecard, but it would not,
by definition, be a balanced scorecard.
In brief, the four scorecard perspectives are:
Financial: The high-level financial objectives and financial measures of the
organisation that help answer the question – How do we look to our
shareholders? Financial objectives are usually the easiest to define and
measure. However, creating a financial objective, for example, Improve Profit,
rarely provides a clue as to how to achieve the objective. by linking objectives
from the lower levels in the model, we begin to see exactly where to define
projects and make investments.
Customer: Objectives and measures that are directly related to the
organisation’s customers, focusing on customer satisfaction. To answer the
question: How do our customers see us? It is always important to take a step
outside and view your company or organisation from your customers view
point. You need to understand what they want from you, not necessarily,
what you can do for them.
Internal Processes: Objectives and measures that determine how well the
business is running and whether the products or services conform to what is
required by the customers, in other words, what should we be best at? Some
of the biggest cost items can be reduced by streamlining internal processes.
This is also the best area to focus on new and creative ideas.
Organisational Capacity: Objectives and measures concerning how well our
people perform, their skills, training, company culture, leadership and
knowledge base. This area also includes infrastructure and technology.
Organisational Capacity tends to be the area where most investment takes
place. It answers the question: How can we improve and create value?
The real value of the Perspective approach is that it provides a framework to
describe a business strategy. It focuses on objectives and measures that both
inform us about progress and allow us to influence activities to achieve the
strategy.