Centralized decision of internal transfer-prices with congestion externalities for two modes of repair with limited repair capacity

The internal transfer-prices set by an organization are what an organization’s bases ‘pay’ its service centre, the depot, for its services. Since each base has a limited budget, these transfer-prices control and motivate the base’s usage of two types of repair services: normal and expedited. In this paper, we implement a unique approach – transfer-prices with congestion externalities – to determine the optimal transfer-price for the expedited repair service. Inventory systems with limited repair capacity are affected by congestion externalities, which reflect the negative externalities caused by the use of a shared service. We also describe different models that develop transfer prices schemas, and which differ in the way they consider congestion externalities. Numerical illustrations based on data from an air force display the incompatibility between two optimization models. One model ignores congestion externalities, while another considers congestion externalities. In the case of congestion externalities, the base must pay extra for the expedited repair service. The increased costs are due to expanded usage of the limited repair capacity which a particular base is imposing on the rest of the system in the form of longer queues that degrade service quality.