Transfer and peak load pricing technique

1. Definition
• Transfer pricing refers to the rules and
methods for pricing transactions within and
between enterprises under common
ownership or control. Wikipedia
• Transfer pricing is defined as the
determination of price of intermediate
product sold by one semiautonomous division
of the same product.

2. • Production.
• Research and Development (often
abbreviated to R&D)
• Purchasing.
• Marketing (including the selling function)
• Human Resource Management.
• Accounting and Finance.

3. • If the decision makers in each division attempt to
maximize profit for their units, the total profit of
the firm might be reduced .
• So, the price of intermediate product should be
set so as to maximize overall profit rather than
divisional profit.

4. Example
Marketing
Department
Production Department
Pricing of compressor is transfer
pricing

5. Transfer Pricing without External Market
Total production
of Pro. Dep.
(Total No. of
Compressor
produced by A
firm)
Marketing
Division
Supplies to
No External Market
for Compressor

6. Diagram
AR
MR
MC(M)
MC(P)
MC=MCp + MCm
E
Pm
Pt
o
Q(M) = Q(P)

7. Transfer pricing when external market exists
Total production
of Pro. Dep.
(Total No. of
Compressor
produced by A
firm)
Supplies to
Marketing
Division
External Market

8. Diagram
AR
MR
MC(M)
MC=MCm + Pt
E
P
Pt
o
Q
D(P) = MR(P)
Q(P)

9. Peak-load Pricing
• It is a form of inter-temporal price discrimination based
on efficiency.
• For goods and services, demand peaks at particular
times — for roads and public transport during
commuter rush hours, for electricity during late
afternoon and so on.
• Peak Load Pricing is a pricing strategy that
implies price will be set at the highest level during
times when demand is at a peak. The pricing strategy
is an attempt to shift demand, or at least consumption
of the good or service, to accomodate supply.

10. • MC is also high during these peak periods
because of capacity constraints. Prices should,
thus, be higher during peak periods
• For example, a movie theatre, which charges
more for the evening show than for the
matinee show because for theatres, the MC of
serving customers during the matinee show is
independent of the MC during the evening.

11. • The owner of a movie theatre can determine
the optimal prices for the evening and
matinee shows independently, using estimates
of demand in each period and of MC.

13. Merits
I. Peak load pricing would help balance capacity
usage.
II. Reducing growth in peak load.
III. Decreasing the need for capacity expansion,
through charging customers in peak time a
higher peak price.
IV. Shifting part of the load from the peak to the
base load plants which called valley filling and
charging off peak customer a lower off peak
price, thus having some savings in used fuels
during peak time.

14. Demerits
1. The investment cost of installing time-sensitive measuring
equipment. The new technology may entail switching costs.
Producers may also have to hire field personnel and
supervisors
2. Introducing PLP has some costs that need to be taken into
consideration and must be weighed against the welfare gains
of more efficient pricing. PLP requires sophisticated
measurement of customer usage and advanced metering.
Many utilities may lack information that allows differential
pricing across periods of consumption and would therefore
need to upgrade metering equipment so as to introduce PLP.
3. The drawback of this theory is that it abstracts from a more
general behaviour in which at least some consumers may
choose to shift their demand from one season to another in
response to a lower price during their “less desirable” season.
4. False prediction leads to wrong pricing regulation