Offshore manufacturing contract design based on transfer price considering green tax: a bilevel programming approach

The problem of designing offshore manufacturing contract resulting in optimal transfer price is troubling multinational companies over the past few years. This paper proposes designing offshore manufacturing contracts based on the transfer price in the form of bilevel programming problems after considering green tax. In these contract designs, a firm in a developed country sells a single product in its market. The same product is simultaneously being manufactured by another firm in a developing country with lower manufacturing cost. After anticipating the consumer demand, the seller places an order, based on which the manufacturer manufactures the ordered quantity, and offers a transfer price which in turn maximises its net profit after paying green tax to its government. While setting the transfer price, the manufacturer considers the manufacturing cost, the export duty payable to its government and the cost of shipping the product to the developed country. After buying the product from the manufacturer at the transfer price, the seller then sets the retail price which maximises its net profit after paying the import duty to its government; the retail price, however, must not be more than the maximum retail price applicable to the market. Thus, offshore manufacturing contract results in optimal after-tax profits for both the firms. An experimental study has been carried out to discuss the practical aspects of the results developed, where a US firm is offshoring its manufacturing activity to a Chinese firm in order to draw maximum profit.