The restaurant division of a hotel provides a catering service for the convention center of the hotel and for external organizations. The restaurant charges $70 per person to cater events for external clients; but to cater these non-convention events, the restaurant incurs additional costs of $5 per person. These additional costs include the cost of transporting and re-heating the food. What transfer price should be used
between the restaurant division and the convention center to encourage decentralized decision making that will maximize total profit for the hotel?
The transfer price should be the market price of $70 less the additional transaction and contracting costs of $5, or $65 per person. The restaurant is indifferent at that transfer price between catering internally or externally. The $65 transfer price will encourage the convention center to buy from the restaurant division. Otherwise the convention center would have to pay a price of about $70, reflecting additional costs if the convention center purchases from an outside supplier.