Research on the competition and pricing strategies of multinational firms with the outsourcing option for local competitors

Transfer pricing (TP), the pricing for transactions between divisions of a multinational firm (MNF), has been used not just as a tool to facilitate internal transactions; many MNFs also recognize the importance of combining the TP decisions with their tax considerations to improve the overall profitability. This paper focuses on the practice observed recently that MNFs do not only produce for themselves but also for the local competitors. TP decision has an ex-ante feature in the analytical model and the arm's length principle is applied also. The analysis shows the incentive for both the MNF and its local competitor to join the final market competition with certain extent of cooperation. Different from the traditional wisdom, choosing the relatively cheaper sourcing option may not be the only applicable rule for the local competitor. The MNF prefers to keep its competitor in the final market and continues making for it, even it has the opportunity to force its competitor out of the competition. The results help us to interpret this behavior by integrating both taxation and competition thinking.