Strategic transfer pricing in a marketing‐operations interface with quality level and advertising dependent goodwill

Determining an appropriate transfer price is of importance to a firm composed of divisional profit centers since it significantly affects decision-makings of each profit center and then the firm's profit. In this paper, we investigate the effects of negotiated and administered transfer pricing on the profits of each center and the firm based on a differential game involving an operations department and a marketing department within a firm. The operations department is responsible for the quality improvement of a particular product and sells this product to end customers through the marketing department who controls the retail price and advertising effort. Our results suggest that compared with the administered transfer price, the negotiation between the operations department and the marketing department leads to a higher transfer price, and then a higher retail price, lower advertising effort and higher quality improvement effort. What's more, the decentralized departments can be coordinated by a committed dynamic transfer price of the operations department, and both departments and the firm can benefit from this coordination.