The complexities of digital transformation for TP can be
illustrated by the case previously discussed from the
agrochemical industry. In that situation, the group's
headquarters had well-known brands and active ingredients,
while the group's local entities had valuable customer
relationships with farmers globally.
However, the group then started to expand by building new
digital offerings through an in-house start-up (this new entity
develops field management software allowing farmers to estimate
yields and target the use of herbicides more efficiently).
This complicated the company's value chain by turning it
into a value network.
Before its digital initiative, the situation was a
comparatively simple two-party set-up with value and products
mainly flowing one way: from its company headquarters to the
local affiliates. Now, there are intertwined dependencies as
the start-up relies on the technical expertise of the
headquarters to design the software and on its local affiliates
to persuade farmers to use it.
The software enhances the value proposition of the local
affiliates towards the farmers, and allows the group to gather
data and target future sales campaigns more accurately.
Furthermore, the software enables the group's headquarters to
further analyse the gathered data and improve its research and
development efforts. Much of the value creation happens in this
network of effects.
Due to the complexity of the case, standard TP methods with
guaranteed fixed margins will lose their usefulness in such
situations. It is clear that the chosen TP methods in such an
intertwined business, with such unique contributions from many
parties, has to be the profit-split method, which applies TP in
accordance with the contributions to the profitability of a
However, while the profit-split method is a recognised OECD
method, a critical factor in its application is the
profit-split ratio (the method by which the parties'
contributions are measured).
In the given example, we could establish a profit-split
ratio by the 'shapley value' method (named after Economics
Nobel Prize laureate Lloyd Shapley). The method measures the
marginal contribution by each party to the various possible
combinations of entities (coalitions). Economically, the method
uses a bargaining split method (i.e. it looks at how much value
each entity could withhold from the others in various
The groundwork in this case revolved around the economic
analysis of how much profit could be achieved by various entity
combinations. Without other entities, the tech company alone
would likely not earn more than a third-party IT development
firm and could be benchmarked.
However, in combination with local sales companies, it can
drive additional revenue through better-targeted sales
campaigns, and in conjunction with the headquarters, it can
improve the research and development (R&D) process through
Importantly, these effects can typically be measured through
A/B testing. Typically, new features are only introduced for
some clients, and the effect is closely monitored before being
rolled out to all clients. This allows for a detailed modelling
of the direct improvements due to the software itself.
Likewise, the bargaining power of the headquarters and the
local sales entities can be measured through their stand-alone
contributions (which can be assessed through benchmarking the
activities and intangibles respectively), and their joint value
contribution (which can be assessed through reference to the
The overall results of this framework imply that between 21%
and 34% of the segmented profits are attributable to the
group's start-up entity.
This profitability was achieved through a combined license
fee from the headquarters and sales companies, with the
headquarters contributing a larger part.
Importantly, this method allowed a much higher profit share
for the start-up company than a simple cost-based or
headcount-based allocation key would allow, which reflects the
digitalisation trends and the importance of joint value
creation to digital business models.
Yves Hervé (firstname.lastname@example.org) and Philip de Homont (email@example.com)
NERA Economic Consulting
Tel: +49 69 710 447 502 and +49 69 710 447 508