Setting the transfer price at market value solves many of the problems that crop up with the other methods of setting transfer price. If an outside market exists for the transferred goods, managers can set the transfer price equal to the listed market value of the goods. This listed market value is often readily available through listings published with commodity markets. These published listings eliminate the need for negotiations.
When the selling division operates at full capacity, market pricing usually encourages both divisions to do what’s in the best interest of the whole company. When the transfer price equals market value, the selling division doesn’t care who it sells to as long as the sale maximizes its revenue and profit.
The purchasing division doesn’t care who it buys from; it, too, makes choices to earn the highest revenue and profit possible. As each division maximizes its revenues and profits, so too does the whole company.
However, when the selling division has excess capacity, making additional sales in-house to the purchasing division increases the selling division’s revenues and helps cover its fixed costs.
In this scenario, market-value pricing may encourage the purchasing division to buy cheaper goods from outside sources instead of buying higher-priced goods from the selling division. (The full-cost and markup pricing strategies may also have this effect.) This move hurts the selling division’s sales and profitability, possibly also damaging the whole company’s performance.