RMIT UNIVERSITY SCHOOL OF ACCOUNTING AND LAW DOMESTIC TRANSFER PRICING IN SERVICES: A VALUE CHAIN FRAMEWORK Submitted in fulfillment of the requirements for the degree of Doctor of Philosophy by Bϋlend Terzioglu August 2006 1 PDF created with pdfFactory trial version www.com ABSTRACT The question of the management of the transfer process and transfer pricing is an important one for managers and academics alike (Colbert and Spicer, 1995). Yet, in general, our current knowledge on several aspects of transfer pricing process is limited. One question which arises in relation to transfer pricing in service organizations is whether there is an association between the transfer price and the internal customer’s perception of value emanating from the transaction. An inappropriate transfer pricing system can give rise to a number of adverse effects which can include among other things, maldistribution of economic resources, negative motivation for reducing costs (Lesser, 1987), lack of goal congruence and inequitable performance evaluation (Cravens and Shearon, 1997).
The gap in the literature on transfer pricing in the service sector applies equally in the Australian setting. This is despite the significant and increasing contribution of the service sector to both GDP and employment. The objective of this research is to explore the domestic transfer pricing practices of service organisations in Australia with the emphasis placed on examining whether, in internal transactions, the domestic transfer price had any influence on the value perceived by the internal buyer. Because the extant transfer pricing theories cannot explain the value perceived by the internal customer in internal exchange of goods and services, an exploratory research methodology is adopted and no assumptions are made about the relationship.
2 PDF created with pdfFactory trial version www.com Data were gathered from survey responses from eighty service organisations and thirteen face-to-face interviews. Survey data were sought at two levels. Questions of a strategic nature were directed to corporate management while questions pertinent to transfer pricing and value were sought from the divisional management who are actually involved in such transfers. Exploratory factor analysis was used to analyze the data.
The findings indicate that cost-based transfer pricing was the most preferred method, and in internal transactions, and responsiveness of the internal supplier was the key factor for internal buyers. The research found that service organisations are external customer oriented and internal customer issues are secondary. The research results also demonstrate that no significant association exists between transfer pricing and internal customer perceived value. The current research contributes to the transfer pricing literature by providing insights to locus of transfer pricing decisions, transfer pricing methods employed by service organizations in Australia, objectives of transfer pricing systems, conflicts arising during from the transfer pricing process and the role of transfer prices on the value perceived by internal customers.
As a research topic, this study is pioneering as it integrates for the first time, the constructs of transfer price and value in internal transactions. Another unique feature of this research is that it was carried out in another important but under-researched context of service organisations. 3 PDF created with pdfFactory trial version www.com TABLE OF CONTENTS Para Topic Page Abstract 2 List of Tables 4 List of Figures 11 Appendices 14 Acknowledgements 15 Declaration 16 CHAPTER 1: INTRODUCTION 18 1.1 Overview of the research topic 19 1.2 Two types of customers 22 1.1 External customer value and internal customer value 26 1.4 Value chain model and competitive advantage 29 1.8 Summary 36 CHAPTER 2: LITERATURE REVIEW 37 2.1 Current pricing practices and issues 37 2.3 Services and pricing of services 40 2.4 Costing of services 43 2.5 Bases for service pricing 46 2.6 Transfer pricing 47 4 PDF created with pdfFactory trial version www.com Para Topic Page 2.1 Transfer pricing methods used for international transfers 50 2.2 Transfer pricing methods used for domestic transfers 51 2.3 Strategy and transfer pricing 52 2.5 Transfer pricing and out-sourcing decisions 53 2.6 Transfer pricing studies conducted in Australia 56 2.7 An evaluation of methodologies employed in previous 58 studies 2.8 Transfer pricing in service industries 60 2.2 External markets and internal markets 64 2.1 External customers and internal customers 68 2.2 Arguments about the internal customer concept 69 2.3 Association between satisfaction of internal customers 69 and external customers 2.1 Value from the internal customer’s perspective 73 2.2 Dimensions of value 75 2.3 Expression of value 77 2.4 Measuring perceived value 81 2.5 Significance of the customer perceived value 87 2.6 Customer perceived value and service quality 89 5 PDF created with pdfFactory trial version www.com Para Topic Page 2.7 Customer perceived value and customer satisfaction 89 2.4 Value chain analysis and competitive advantage 90 2.1 Value chain analysis 90 2.1 Resource-based view (RBV) 94 2.2 Sources of competitive advantage 95 2.3 Customer perceived value and competitive advantage 96 2.4 Competitive advantage for service industries 97 2.6 Summary 98 CHAPTER 3: THEORETICAL FRAMEWORKS AND 103 RESEARCH PHILOSOPHY AND METHODOLOGY 3.1 Shortcomings of extant theories 107 3.2 Administration of the interviews 121 3.3 Reliability of transcription 124 3.4 Interviewer error and bias 124 3.1 Rationale for using the written questionnaires 126 3.2 Weaknesses of the questionnaires 126 3.4 Content of questionnaires 128 3.5 Administration of the questionnaires 130 6 PDF created with pdfFactory trial version www.com Para Topic Page CHAPTER 4: DATA ANALYSIS 132 4.2 Pre-analysis data checks 136 4.1 Accuracy of data entry 136 4. Missing data analysis 137 4.3 Non-response bias 137 4.3 Profile of respondents 137 4.4 Size of respondents in terms of number of people they 138 employed 4.5 Size of respondents in terms of annual sales volume 139 4.7 Breakdown of respondents by responsibility centres 140 4.8 Parties to internal transactions 140 4.10 Location of headquarters 141 4.11 Nature of services exchanged 142 4.12 External market for internally provided services 143 4.13 Evaluation of divisions 144 4.14 Who sets transfer prices 144 4.15 The role of the chief financial officer in setting transfer 145 prices 4.16 Review of transfer prices 146 4.17 Circumstances that prompt a change in transfer price 146 4.18 Objectives of transfer pricing system 147 4.19 How firms determine if transfer pricing objectives have 150 been achieved? 7 PDF created with pdfFactory trial version www.com Para Topic Page 4.20 Transfer pricing methods used 151 4.21 Rationale for multiple transfer prices 162 4.22 Transfer pricing conflict 163 4.23 Nature of conflicts 166 4.24 Resolution of conflicts 169 4.25 Use of activity-based costing (ABC) 171 4.26 Allocation of overheads 174 4.28 Freedom to out-source internally provided services 177 4.29 Reasons for out-sourcing 180 4.30 Extent of intra-corporate trade 181 4.32 Importance of the internal customer perceived value 184 4.33 Internal value creation and setting transfer price 187 4.34 Customer value and competitive advantage 189 4.35 Association between satisfaction of internal and 190 external customers 4.36 Value chain analysis 192 4.37 Sources of competitive advantage 199 4.38 Sustainability of competitive advantage 202 4.40 Controlling operating costs 206 4.41 Monitoring operations to keep costs under control 207 4.44 Emphasis in marketing communications 208 4.45 Development of new service products 209 8 PDF created with pdfFactory trial version www.46 Change in the product line 211 4.48 Offering superior service products than competition 212 4.49 Service level agreements (SLA) 213 4.4 Reversal of selected entries 220 4.5 Appropriateness of factor analysis 220 4.1 Test of normality 220 4.1 Kaiser-Meyer-Olkin test 221 4.2 Anti-Image correlation matrix analysis 222 4.3 Test of sphericity 222 4.4 Presence of substantial correlations 223 4.7 Test of linearity 224 4.10 Type of factor analysis 229 4.11 Method of factor extraction 230 9 PDF created with pdfFactory trial version www.com Para Topic Page 4.15 Unrotated component matrix 235 4.16 Rotated component matrix and discussion of findings 236 CHAPTER 5: CONCLUSIONS 242 5.1 Discussion of findings 242 5.2 Contributions of this research 245 5.3 Limitations of the research 245 5.4 Implications for further research 246 References 247 10 PDF created with pdfFactory trial version www.com LIST OF TABLES Table 2.1 Pricing decisions 43 Table 2.2 Breakdown of empirical studies carried out since 1956 48 Table 2.3 Objectives of transfer pricing for international transfers 50 Table 2.4 Transfer pricing bases for international transfers 51 Table 2.5 Prior studies on transfer pricing in service industries 61 Table 2.6 Previous research on applicability of SERVQUAL for 84 measuring service quality Table 2.7 Dimensions of PERVAL 87 Table 2.8 A comparison of SERVQUAL and SERVPERF 88 Table 3.1 Positions of the interviewees 104 Table 3.2 Manager’s Analytical Plane (MAP) 104 Table 3.2 Organisation Theory Model 106 Table 3.3 Transfer Pricing Framework 123 Table 3.4 Positions of the interviewees 133 Table 4.1 Profile of the sample and response rate 135 Table 4.2 Comparative sample sizes on domestic transfer pricing 136 surveys Table 4.3 Profile of interviewed organisations 138 Table 4.4 Respondents by industry 138 Table 4.5 Number of employees 139 Table 4.6 Annual sales volume of respondents 139 Table 4.7 Organisational structure 140 Table 4.8 Responsibility centres 140 Table 4.9 Nature of internal exchange 141 Table 4.10 Internal trading partner 141 Table 4.11 Subsidiary status 141 Table 4.12 Location of headquarters 142 Table 4.13 Nature of services exchanged 143 Table 4.14 Complexity of services 143 11 PDF created with pdfFactory trial version www.15 External market for services 143 Table 4.16 Basis of evaluation of divisions 144 Table 4.17 Who sets transfer prices 144 Table 4.18 Role of chief financial officer (CFO) in setting prices 145 Table 4.19 Frequency of transfer price reviews 146 Table 4.20 What prompts transfer price change 147 Table 4.21 Transfer pricing objectives – ranking by importance 148 Table 4.22 Transfer pricing objectives-descriptive statistics 148 Table 4.23 Comparison of transfer pricing objectives reported under 149 selected studies Table 4.24 Procedures to determine achievement of transfer pricing 151 objectives Table 4.25 Mostly used transfer pricing bases – current study 152 Table 4.26 Transfer pricing methods used 153 Table 4.27 Transfer pricing systems employed between responsibility 157 centres Table 4.28 Single versus multiple transfer price 162 Table 4.29 Rationale for using multiple transfer pricing bases 163 Table 4.30 Frequency of transfer pricing conflicts 164 Table 4.31 Satisfaction with the current transfer pricing system 165 Table 4.32 Nature of conflicts 167 Table 4.33 Conflict resolution methods 170 Table 4.34 Adoption of Activity-Based Costing (ABC) 172 Table 4.35 Allocation of overheads 174 Table 4.36 Control of overhead costs 177 Table 4.37 Freedom to out-source 178 Table 4.38 Reasons for out-sourcing 180 Table 4.39 Importance of lowest sources of supply 180 Table 4.40 Extent of intra-corporate trade 181 Table 4.41 Proportion of inter-divisional trade (expressed as a 182 percentage of total company sales) 12 PDF created with pdfFactory trial version www.42 Value definition (Corporate perspective) 183 Table 4.43 Importance of value creation for internal customer in 187 setting transfer price Table 4.44 Relationship between value created for internal customers 189 and competitive advantage at product level Table 4.45 Relationship between satisfaction of internal customers 190 and external customers Table 4.46 Use of value chain analysis 193 Table 4.47 Sources of competitive advantage 199 Table 4.48 Sources of competitive advantage – mean scores 201 Table 4.49 Sustainability of sources of competitive advantage 203 Table 4.50 Cost drivers 205 Table 4.51 Control of operating costs 206 Table 4.52 Monitoring operations to control costs 207 Table 4.53 Efficiency improvement 207 Table 4.54 Better finance 208 Table 4.55 Marketing communications 208 Table 4.56 Development of service products 210 Table 4.57 New service products for internal customers 210 Table 4.58 Change in product line 211 Table 4.59 Unique services 212 Table 4.60 Superior products 212 Table 4.61 Service Level Agreements 215 Table 4.63 Competitive prices 217 Table 4.64 Kaiser-Meyer-Olkin and Bartlett’s Test 221 Table 4.65 Bartlett’s test of sphericity 222 Table 4.66 Reliability scores (Cronbach’s alpha) 227 Table 4.67 Total variance explained 232 Table 4.68 Interpretation of correlation co-efficients 234 Table 4.69 Seven-factor solution 239 13 PDF created with pdfFactory trial version www.com LIST OF FIGURES Figure 1.1 The value creation process 21 Figure 1.2 Types of customers 22 Figure 1.3 Value hierarchy 26 Figure 1.
