A large business consultancy firm is organized into several divisions. One of the divisions is the Information Technology (IT) Division which provides consultancy services to its clients as well as to the other divisions of the firm. The consultants in the IT Division always work in a team of three professional consultants on each day of consulting assignment. The external clients are charged a fee at the rate of TZS.45,000 for each consulting day. The fee represents the cost plus 150% profit mark up. The breakup of cost involved in the consultancy fee is estimated at 80% as being variable and the balance is fixed.
The Textiles Division of the consultancy firm which has undertaken a big assignment requires the services of two teams of IT consultants to work five days in a week for a period of 48 weeks. While the Director of the Textiles division intends to negotiate the transfer price for the consultancy work, the Director of the IT division proposes to charge the textiles division at TZS.45,000 per consulting day. In respect of the consulting work of the textiles division, the IT division will be able to reduce the variable costs by TZS.2,000 per consulting day. This is possible in all cases of internal consultations because of the use of specialized equipment.
Explain the implications and set transfer prices per consulting day at which the IT division can provide consultancy services to the Textiles division such that the profit of the business consultancy firm as a whole is maximized in each of the following scenarios:
- Every team of the IT division is fully engaged during the 48 week period in providing consultancy services to external clients and that the IT division has no space capacity of consultancy teams to take up the textiles division assignment.
- IT division will be able to spare only one team of consultants to provide services to the Textiles division during the 48 week period and all other teams are fully engaged in providing services to external clients.
- A new external client has come forward to pay IT division a total fee of TZS.15,840,000 for engaging the services of two teams of consultants during the aforesaid period of 48 weeks.
(b) Discuss the potential for maximization of income by a multinational corporation through the use of transfer pricing mechanism.