Transfer pricing: Behind the numbers

Transfer pricing, aka charge-backs, may look good in PowerPoint presentations, but as applied to real enterprises, it rarely makes sense

For a change of pace, I inserted my answers following each question in this letter from a reader we'll call Troubled by Transfer Pricing. - Bob

Troubled by Transfer Pricing: Dear Bob, I've been enjoying your diatribes about transfer pricing (the practice formerly known as charge-backs) for ages now, and also routinely read chapter 9 (or was it 10) of your latest book where you talk about it. I completely agree, and my company is the poster child for dysfunction when it comes to the havoc that this transfer pricing model can wreak (and referring to your users as "clients").

Bob: It was chapter 10 of "Keep the Joint Running: A Manifesto for 21st Century Information Technology," and thanks for the opportunity to give it a plug.

[ Also on InfoWorld, Bob Lewis suggests there's a bright side to transfer pricing in "Stuck with charge-backs, but not necessarily drawbacks" | Get sage advice on IT careers and management from Bob Lewis in InfoWorld's Advice Line newsletter. ]

Troubled by Transfer Pricing: A few things I still stumble on, that I'm hoping you can help with. I know there is an answer, and it isn't transfer pricing, but I would lose a debate should one occur with our finance people because I don't know how to respond. Can you distill this?

-- Only one business unit (BU) in our large enterprise uses the transfer pricing model, but from their perspective, everyone else is deficient. One common comment I hear is that every BU has the same basic costs for commodities like providing a user account and mailbox ... but in the other BUs, those costs are just buried in the mix. The BU that uses the transfer pricing model provides a way to very clearly show how much the business spends on IT -- that is, from a reporting perspective it is much better and provides more insight to the executive.

In a sense, I guess it's true that the other BUs might not be able to say that they spend X amount to provide user account and mailbox services, because it just all comes from one big pot in each BU's IT budget, so I'm not sure how to argue against them on this point.

Bob: To be more accurate, the transfer pricing model shows how much money they're transferring from one corporate pocket to another, labeled "IT spend." Whether it reflects what the company is actually spending is an entirely different matter, one that depends on how accurately the pricing analysts have done their work -- which won't be accurate at all, either. The way these things are always done is to allocate fixed overhead in some semi-arbitrary manner that distorts how actual costs behave by pretending that fixed costs are variable costs so as to facilitate their allocation.

If the executives want to know how much their information technology costs the company, the same analysts could answer their question by producing a report that shows them the answer, without adding the further expenses incurred by actually transferring money from one pocket to another and without building up the company's silo walls -- the main result of transfer pricing.

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