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Offshoring and outsourcing in a global supply chain: Impact of the arm’s length regulation on transfer pricing

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  • Kim, Bosung
  • Park, Kun Soo
  • Jung, Se-Youn
  • Park, Sang Hun

Abstract

We consider the structure of a global supply chain for operational decisions in a multinational firm (MNF) with tax considerations. The MNF consists of two divisions: one for production and the other for retailing. While the retail division of the MNF and the market for its product is located in a domestic country, the production division may be located in either the domestic (high-tax) country or a foreign (low-tax) country. When the two divisions of a MNF are co-located in the domestic country, the firm enjoys the benefit of a centralized operational decision on the order quantity to maximize its total profit although there is no tax saving opportunity. On the other hand, a MNF can enjoy a tax saving benefit when offshoring its production division to a low-tax country although its operational decision on the order quantity is decentralized, which is harmful to the supply chain profit due to double marginalization. The MNF may further pursue the low procurement cost of its retail division by allowing the retail division to search for an outsourcing opportunity from an outside supplier. However, outsourcing can hurt the profit of the MNF from the loss of the production division due to competition with outside suppliers. We analyze the trade-offs in the MNF’s optimal choice of supply chain structure. In addition, we incorporate a regulation on the MNF’s internal transaction by tax authorities, which is commonly called the arm’s length regulation. We study how the MNF’s choice of the operational structure of its supply chain changes in consideration of this regulation. Our results suggest that tax considerations deserve attention from managers when designing the supply chain structure.

Suggested Citation

  • Kim, Bosung & Park, Kun Soo & Jung, Se-Youn & Park, Sang Hun, 2018. "Offshoring and outsourcing in a global supply chain: Impact of the arm’s length regulation on transfer pricing," European Journal of Operational Research, Elsevier, vol. 266(1), pages 88-98.
    • Handle: RePEc:eee:ejores:v:266:y:2018:i:1:p:88-98
    DOI: 10.1016/j.ejor.2017.09.004
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    References listed on IDEAS

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    2. Niu, Baozhuang & Mu, Zihao & Cao, Bin & Gao, Jie, 2021. "Should multinational firms implement blockchain to provide quality verification?," Transportation Research Part E: Logistics and Transportation Review, Elsevier, vol. 145(C).
    3. Niu, Baozhuang & Chen, Lingyun & Wang, Jingmai, 2022. "Ad valorem tariff vs. specific tariff: Quality-differentiated e-tailers’ profitability and social welfare in cross-border e-commerce," Omega, Elsevier, vol. 108(C).
    4. Amit Kumar Gupta & Narain Gupta, 2019. "Innovation and Culture as a Dynamic Capability for Firm Performance: A Study from Emerging Markets," Global Journal of Flexible Systems Management, Springer;Global Institute of Flexible Systems Management, vol. 20(4), pages 323-336, December.
    5. Lioara-Veronica Pasc & Camelia-Daniela Hațegan, 2020. "Related Parties’ Transactions: A Literature Overview on Auditor’s Risk," Ovidius University Annals, Economic Sciences Series, Ovidius University of Constantza, Faculty of Economic Sciences, vol. 0(2), pages 1021-1030, December.
    6. Niu, Baozhuang & Li, Qiyang & Liu, Yaoqi, 2020. "Conflict management in a multinational firm's production shifting decisions," International Journal of Production Economics, Elsevier, vol. 230(C).
    7. da Silva Stefano, Gustavo & Antunes, Tiago dos Santos & Lacerda, Daniel Pacheco & Wolf Motta Morandi, Maria Isabel & Piran, Fabio Sartori, 2022. "The impacts of inventory in transfer pricing and net income: Differences between traditional accounting and throughput accounting," The British Accounting Review, Elsevier, vol. 54(2).
    8. Huang, Hongfu & He, Yong & Li, Dong & Li, Shanshan, 2023. "Competing multinationals’ backshoring decisions: Tax arbitrage versus production reliability tradeoff," European Journal of Operational Research, Elsevier, vol. 311(2), pages 515-532.
    9. Niu, Baozhuang & Shen, Zifan & Xie, Fengfeng & Liu, Yaoqi & Xu, Xin, 2022. "Real-time payment in cross-border operations considering local competition and tax-planning," International Journal of Production Economics, Elsevier, vol. 245(C).
    10. Niu, Baozhuang & Xu, Jingwen & Lee, Carman K.M. & Chen, Lei, 2019. "Order timing and tax planning when selling to a rival in a low-tax emerging market," Transportation Research Part E: Logistics and Transportation Review, Elsevier, vol. 123(C), pages 165-179.
    11. Jung, Se-Youn & Huh, Woonghee Tim & Park, Kun Soo, 2022. "Impact of the arm’s length regulation on a supply chain with asymmetric retailers," European Journal of Operational Research, Elsevier, vol. 300(3), pages 865-883.
    12. Shi, Xiutian & Tang, Jianxi & Dong, Ciwei, 2022. "Should a domestic firm carve out a niche in overseas markets? Value of purchasing agents," European Journal of Operational Research, Elsevier, vol. 300(1), pages 85-94.
    13. Sumin Yu & Zhijiao Du & Xuanhua Xu, 2021. "Hierarchical Punishment-Driven Consensus Model for Probabilistic Linguistic Large-Group Decision Making with Application to Global Supplier Selection," Group Decision and Negotiation, Springer, vol. 30(6), pages 1343-1372, December.
    14. Changwen Li & Bin Cao & Yong-Wu Zhou & T. C. Edwin Cheng, 2023. "Pricing, coalition stability, and profit allocation in the pull assembly supply chains under competition," OR Spectrum: Quantitative Approaches in Management, Springer;Gesellschaft für Operations Research e.V., vol. 45(3), pages 977-1011, September.
    15. Li, Wei & Zhao, Xuan & Chen, Jing, 2023. "Co-opetition or decentralization? A study of manufacturers’ sourcing and distribution strategies," European Journal of Operational Research, Elsevier, vol. 311(3), pages 867-886.
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    17. Agata Marcysiak, 2020. "Conditions for the functioning of outsourcing in enterprises," Entrepreneurship and Sustainability Issues, VsI Entrepreneurship and Sustainability Center, vol. 8(1), pages 539-554, September.

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