Role of transfer prices in global supply chains with random demands

Transfer prices are an effective strategy for improving the after-tax profits of global supply chains with differential tax rates. Rigorous evidence of their effectiveness has been established by many researchers for deterministic settings. To the best of our knowledge, there has been no research studying the impact of transfer prices in stochastic supply chain settings. We attempt to fill this void by studying a two-stage supply chain in which the end-customer demand is random. This forces the retailer to behave like a newsvendor and balance overage costs with underage costs. Using a combination of analytical and computational techniques, we show that randomness in a supply chain magnifies the impact of transfer prices. We analyze possible reasons behind this behavior and also summarize the impact of various supply chain parameters (customer base, price elasticity, overage and underage costs, etc.) on the magnitude of profit improvement.