Intra-Firm Transfer Essay ⋆ Business Essay Examples ⋆ EssayEmpire

The price at which multinational enterprises sell their products to their own subsidiaries and affiliates is known as the intra-firm transfer price. In addition to products, the foreign subsidiary may be using techniques, machinery, or processes, owned, patented, and/or licensed by the multinational parent to whom the subsidiary must pay royalties or license fees. Theoretically these prices and fees are equivalent to market prices and fees, but it is often impossible to find such a product, machine, or process on the open market, as they may be unique to the multinational. Many multinational firms also spread overhead and management expenses incurred at the parent over their foreign affiliates and subsidiaries based on percentage of use. The result may be an intra-firm transfer price, fee, or overhead contribution that reduces the profitability of the subsidiary, exacerbated by the tax on gross revenue imposed on subsidiaries and affiliates by host country governments.

Intra-firm trade within the operating networks of multinational enterprises has become increasingly important in international trade. Haishun Sun argues that more than one-third of international trade in goods and services consists of intra-firm transfer and a further one-third consists of exports from transnational corporations.

The parent-subsidiary flow of resources is captured in the internalization theory of multinational enterprise. Internalization argues that multinational enterprises possess a bundle of proprietary firm-specific (ownership) advantages that enabled them to undertake foreign direct investment (FDI). Multinational enterprises were seen as transferring these proprietary advantages to subsidiaries and affiliates via the firm’s internal market compared to transfer via the market for final and intermediate products. Ownership advantages were thought to be in such things as proprietary product and process technologies, brand names, access to or ownership of channels of distribution, management, and capital.

The currently dominant resource-based view holds that a necessary, but not sufficient, condition for foreign direct investment is that the subsidiary abroad possesses the resources to compete with other firms in the host country industry. The subsidiary may come to possess these resources via intra-firm transfer from its parent, or from a joint venture partner (or partners) based in the host country or in another source country, or, if the foreign investment is by acquisition, from the subsidiary itself. Hence, the flow of resources may be subsidiary to parent or subsidiary to subsidiary.

The management of cash flows in a large multinational firm, one with possibly 10 or 20 subsidiaries, is obviously complex and critical to the success of the multinational business. Coordination between units requires planning and budgeting of intra-firm cash flows so that flows are “netted” between each subsidiary and the parent, and between the subsidiaries themselves, to reduce payments and currency exchange charges where multiple currencies are involved. Multinationals might economize by establishing a single large pool to negotiate better financial service rates with banking institutions, and flexible timing of payments between units, allowing the firm not only to position cash flows where they are needed most but also to help manage currency risk. A foreign subsidiary that is expecting its local currency to fall in value relative to the U.S. dollar may try to speed up or lead its payments to the parent; similarly, if the local currency is expected to rise versus the dollar, the subsidiary may want to wait, or lag, payments until exchange rates are more favorable.

Multinational firms with a variety of manufacturing and distribution subsidiaries scattered over a number of countries within a region may find it more economical to have one office or subsidiary taking ownership of all invoices and payments between units. Finally, some multinational firms have found that their financial resources and needs are becoming either too large or too sophisticated for the financial services that are available in many of their local subsidiary markets. One solution to this has been the establishment of an internal bank within the firm to buy and sell payables and receivables from the various units.

Intra-firm transfer is further complicated when the relevant knowledge is tacit, rather than codified, making both the transfer and the price difficult to predict or estimate because one or other (or both) of the parties to the transfer has to make a considerable investment to make the knowledge understandable to the transferee. In fact, James Love has argued that the costs of transferring tacit knowledge could be sufficient to prevent market transfer even if the contracting parties trusted each other completely, and therefore never felt constrained by opportunistic hazard or transaction cost expense.

Bibliography:

Giovanni Dosi, Richard R. Nelson, and Sidney Winter, The Nature and Dynamics of Organizational Capabilities (Oxford University Press, 2001);
John H. Dunning, Governments, Globalization and International Business (Oxford University Press, 1999);
John H. Dunning and Rajneesh Narula, Foreign Direct Investment and Governments: Catalysts for Economic Restructuring (Routledge, 1996);
James H. Love, “Knowledge, Market Failure and the Multinational Enterprise: A Theoretical Note,” Journal of International Business Studies (v.26/2, 1995);
Haishun Sun, “DFI, Foreign Trade and Transfer Pricing,” Journal of Contemporary Asia (v.29/3, 1999).

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