The manufacture and sales of automobiles are often vertically related or integrated because the assembly and service of vehicles requires matched parts and knowledge. Most all of the components of the cars manufactured at General Motors are made by related or owned subsidiaries. Many of the Japanese automobile manufacturers have similar subsidiary or related suppliers back in Japan. Ford and Daimler Chrysler, purchase automobile parts from more independent and less related suppliers. However these suppliers are still interdependent with the manufacturers because the parts are made to the manufacturer/assembler's specifications, or because suppliers are restricted by contract from selling to the manufacturers' competitors.

The result of this vertical integration is that GM parts suppliers sell to GM Assembly and GM Assembly sells to GM dealers at prices that are only partly competitive. When the companies are related in ownership the selling prices from one related enterprise to another are transfer prices. The transfer price determines which related company is more profitable since higher prices increase revenue to the supplier and expense to the buyer. This choice of which related company has profits becomes critical when these enterprises are in different taxing jurisdictions. Higher transfer prices could increase expenses and avoid income tax on the buying firm, and lower transfer prices can lower revenues, profits, and taxes for supplier companies.

Many automobile purchasers are aware of dealers who offer to show a prospective customer their dealer's invoice, and then negotiate a selling price with the customer for small markups on the dealer invoice. That dealer's invoice includes charges which are actually returned to the dealer. The result is that the dealer can sell at a low markup over invoice but make extra money on each sale through those rebates or holdbacks. Consumers can find the true cost to dealers by consulting Edmunds.

1. Visit the site for General Motors, the most vertically integrated automobile manufacturer. What does GM reveal about its relationship with suppliers and dealers?

2. Visit the site for Ford. What does Ford reveal about its relationships among suppliers, manufacturing, and dealers?

3. Visit Daimler-Chrysler. What does Daimler-Chrysler reveal about its suppliers and dealers ownership relationships?

4. If Daimler-Chrysler begins to sell parts from Europe to America (a transfer within the one corporation) those transfer prices will affect the income of the German firm supplying the parts, and the income of the American firm buying them. Does Daimler-Chrysler's financial statements reveal which jurisdiction has the higher income taxes on corporations?

5. Prices between automobile manufacturers and dealerships are not fully competitive because the dealer has promised to sell only authorized brands, and the manufacturer has promised to supply the dealer with all inventory it needs to make sales. How do dealer holdbacks and rebates affect the "dealer invoice" price? (Hint: Check out the Edmunds site for an answer.)

6. What would happen if the sales manager at a dealership thought the "dealer invoice" was a true cost? What would happen if some dealerships told sales managers the real input price but others did not?

7. What happens to the combined revenues and profits when the real transfer price is above marginal cost to the supplier?

8. What happens to profits at the related firms if all transfers are made at marginal or incremental costs?

9. Why do manufacturers transfer new cars to franchisee dealerships at prices above the manufacturer's marginal cost, or even above the full allocated cost?

© 2002 by Prentice-Hall, Inc.A Pearson Education Company, Upper Saddle River, New Jersey 07458
PHLIP was originally conceived and developed for Prentice Hall with the expertise of Dan W. Cooper of Active Learning Technologies, Inc.and Scott R. Lyman.
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