How to tax-optimize your procurement

Optimization of procurement costs has been a great savings generator since the early 90s. On their way to maturity in procurement excellence, organizations have optimized what to buy, where to buy and how to buy. However, we have noticed that even with mature clients the procurement savings through tax optimization remain mostly untapped. This is all the more interesting as for instance effective tax rates (ETR) differentials between highly industrialized and low-tax countries amount to more than 20%. The objective of this paper is to explain the reasons for this and to show a way to optimize the situation thoroughly.

 

Procurement tax component not optimized today 

With the professionalization of the procurement function main efforts are to optimize cost components and many organizations have done so successfully – with the remarkable exception of the tax component. Our experience shows four good reasons for that:

  • Tax costs are not only product related but depend also on the country, the selling and procuring organization are registered
  • Tax costs depend on the chosen legal and tax scheme from one single entrepreneur on the one side to multi-entrepreneur schemes on the other extreme
  • Operational business units do not have tax targets as optimization levers are bigger on corporate level
  • Tax is a major compliance issue for globally acting organizations and thus under direct control of the executive board, mainly the CFO

 

Complex savings potential calculation

Tax optimization in procurement is easy to imagine: if your supplier currently manufactures a finished good in China, your procurement organization operates in Germany and you sell it to France, the benefits will be generated in Germany with an ETR of around 30%. Moving your procurement department’s operations closer to China, for instance to Hong-Kong, will allow your organization to generate the benefits there and profit form an ETR of 16,5%.

The immediate conclusion would be to transfer all procurement orders to a tax optimized country. The apparent savings potential then sums up to 20% as the effective taxation rate in highly industrialized European countries is close to 30% and main interesting international locations offer importantly lower taxation rates.

In reality savings potentials are lower as transforming a procurement organization for tax reasons is very challenging and risky:

  • the cross-functional aspect (procurement, logistics and finance/tax) implies high organizational complexity
  • compliance risks are high, for instance with corporate tax, internal transfer pricing and function shifting: Highly industrialized countries’ tax authorities have put a major effort in controlling transfer pricing systems with the effect of lowering the benefits drastically. On top of that, these countries have also installed a “function shifting” taxation system which allows the authorities to tax the delocalization of a corporate function to a low-tax country.
  • tax advantages can only be realized on selected product categories and not the whole procurement volume
  • the future operating costs of building up a procurement function in a new location can be important and balance initial savings: Tomorrows salary levels, infrastructural costs and cost of living in location selected might be higher than today.

Knowing the different challenges and based on our operational expertise, we recommend strongly to first run a business case analysis, align executive and supervisory boards and then only start execution.

 

Structured approach leads to sustainable savings 

Pre-requisite 1: As the complexity of this cross-functional optimization approach is high, we strongly recommend to run such a project on executive board level. Pre-requisite 2: You will have to adapt your company’s legal/tax organization and should definitely build a cross-functional team with finance/tax, procurement, logistics, external legal advisors and external consultants: only the alignment of all involved corporate functions plus the challenge trough the external expertise from the very beginning will lead to a sustainable success.

The main tasks to be executed in the business case are the following:

  • tax1Analyze thoroughly your procured goods physical flows with the objective to build procurement category risk-classes for transferable procurement volumes. Focus especially on the value creation chain of your final products in order to illustrate your own organizational value add
  • tax2Analyze your current operating procurement model for the addressable categories: current supplier footprints, current purchaser locations, current associated procurement functions (supplier quality management, etc.), procurement IT-systems availability
  • tax3Assess your organizations current tax scheme between one single entrepreneur and multi-entrepreneur, integrate the current transfer price model used. Also integrate historical evolutions of this schema in order to address change risks with local authorities
  • tax4Run a location selection process in order to identify the best fitting country. Focus first on operational levers (proximity to supply base, availability of work-force, cost of operations, etc.) and then address potential tax advantages
  • tax5Build scenarios based on cost advantages and associated operational and tax risks in order to find best fitting solution for your organization

As a conclusion, our project experience shows tax-optimized procurement leads to a saving up to 10% on addressable scope. It is definitely a board task and requires a high excellence in project execution.

Marc Staudenmayer, Senior Partner, Advancy

Further information at www.advancy.de

Strategic Business Wargaming reloaded – the right strategy tool for top managers in faster moving business environments

Top managers often argue that Strategic Business Wargaming is a slightly old-fashioned tool from the late 90s, only applicable to very specific situations and with limited insights in overall market strategy. However, as current day-to-day business in an increasingly fast-moving world shows, managers are required to take decisions where uncertainty increases, time-pressure is high, budgets are limited and available human resources are scarce. We have experienced the Strategic Business Wargaming approach as a very powerful tool to support top managers’ strategic decision making processes:

  1. Even if Strategic Business Wargaming provides only a limited insight in overall strategy, it provides a lot more than no insight at all and it allows to derive generally valid strategic patterns out of given specific situations
  2. Strategic Business Wargaming definitely helps to find an answer to serious challenges which are or could become major threats to the whole company. In this situation it helps top managers to:
    • focus on the real issue,
    • bring competences and people in a common room,
    • get the capability to solve the problem,
    • find ways to convince their organization, that there is only one best solution for the challenge
  3. Due to the interactions between people with different capabilities and functions Strategic Business Wargaming assures that all participants act in concert to implement the commonly selected solution

And last but not least: top managers will definitively benefit from a transformational mindset created by Strategic Business Wargaming within the team for a long time.

 

Strategic Business Wargaming – understanding competitors’ reactions is key

Top managers dispose of a broad range of tools to evaluate business strategies today. They can be split into three situative segments: (1) tools to analyze situations (2) tools to project the future and (3) tools to validate specific situations. We have experienced that Strategic Business Wargaming fits best to deliver validated results in complex, highly dynamic and forward-looking issues. Which is basically what business today in our global, digitalized and fast moving world is all about. The main objective of Strategic Business Wargaming is to find out what strategy leads to the highest value for an organization based on the most valuable strategic options for its competitors. Even it state-of-the-art marketing and sales organizations today fully integrate the perspective of customers, suppliers and regulators, the additional value of Strategic Business Wargaming is to understand competitors’ reactions and subsequently understand threats, opportunities and strategic implications generated by a change in competitive dynamics. This is also where Strategic Business Wargaming differentiates from the regular strategy development process as it incorporates competitive behavior into own decision-making.

 

Methodology – how to simulate the best strategy scenario

Strategic Business Wargaming derives the best strategic option through so-called heat-maps integrating all major input factors: information about competitors, products, addressable markets and customer behavior. The as-is cost base, valid strategic levers like price, promotion, sales force and additional market data complements the input data for simulation. All simulations lead to a “best strategy”, to the definition of strategic breakpoints and to measures how to implement the strategy. It clearly shows the dependencies between the own strategy and the best strategies of the competitors.

SBW7 The output of Strategic Business Wargaming is structured and easy to understand, to communicate and to implement.

 

Not only the result matters – team interaction and transformational impact is key!

On top of giving a logical path to strategic decisions, our experience shows that Strategic Business Wargaming helps to foster a common understanding for the strategic situation and related challenges and thus to build a sound basis for transformational initiatives. Based on our experience, we recommend a 4-step approach:SBW5  The central part of the Strategic Business Wargaming approach is the workshop in step 3 which generally lasts 1,5 days. Organizations will build three teams with dedicated roles and tasks to fulfill:

  1. Market player team (own organization and every main competitor)
    • Define product offerings (price, positioning, features and capacities)
    • Picture the competitive dynamics
    • Evaluate the value of the options
  2. Market team
    • Judge offerings‘ attractiveness
    • React towards competitors‘ product offerings and strategies
    • Picture market dynamics
  3. Control team
    • Structure and monitor wargame
    • Invent external shocks and calculate implications, KPIs and financials, based on quantitative model developed

At the end of the process, the approach provides fundamental input for top managers: on the one hand clearly defined strategic options depending on strategic breakpoints derived from market dynamics and, on the other hand enabling actions to strengthen the organization’s capabilities to react.   Strategic Business Wargaming leads top managers to a clear picture of how to act in uncertain strategic situations and to a trained management team able to react to changes in competitors‘ behaviors. The investment for this stays very limited both in human resources and time. Our experience shows that both the clear picture of strategic options and the trained management team are essential in the current fast moving business environment and lead to a sustainable competitive advantage.   Burkhard Wagner, Senior Partner, Advancy Further information at www.advancy.de

How top managers focus on SG&A to create competitive advantage

SG&A has been investigated for three decades in detail now and might well look a little boring but still some companies are doing a much better job here than others. Recent research confirms SG&A optimization remains one of the decisive levers to create competitive advantage: a European-wide study with 1.254 companies has shown that poor performers (3. quartile) lose around 8% EBIT-points on good performers (1st quartile) and average performers (mean) still around 5%.

Graph1

Knowing that SG&A have been addressed over the years with multiple projects on headcount reduction, management span, etc. and that transparent benchmarks are publicly available in order to set reachable targets, the performance gaps seem totally incomprehensible.

In fact there are three reasons explaining why performance gaps are still existing:

  • Top performers address SG&A external cost with effective demand management (travel, fleet, IT, office equipment, office material, etc.) and not only headcount costs (management span, shared services, etc.). Answer first is: the indirect procurement department takes care of it. Second look shows that unit costs are an indirect procurement topic but total annual spend and thus the organizational demand is a financial budgeting topic. Analyzing traditional financial budgeting top performers have found an answer to fix organizational demand at best-in-class benchmarking standards and keep employees from emptying their budgets at year-end. To provide an almost caricatured example: top performers also address the number of pencils used per capita and not only the cost of one pencil.
  • Top performers address SG&A optimization even in sound economic times. Usually, SG&A is a typical stormy weather candidate with unpopular head-count reduction programs and standardized budget cuts (“-10% on everything”). Nevertheless, especially in these good times SG&A tends to increase heavily. Effective demand management does not encounter organizational resistance even in good times and guarantees additional savings even when the weather is good.
  • Top performers create a motivational cost consciousness culture. The cultural aspect has been largely underestimated when it comes to SG&A optimization. Traditional headcount reduction programs have a huge negative cultural impact and savings effects have generally been compensated few years later. On the contrary, optimizing SG&A costs by adapting the organizational demand to its real needs is a positive action with positive cultural impact.

Hence, even though the SG&A topic might look boring and totally explored from the outside, there are still important savings potentials which most companies have not tapped as they concentrate on traditional levers. As the SG&A leverage is really important, it might be thoughtful to spend a little time even after all these years of optimization to investigate the potentials that still exist in your organization.

Marc Staudenmayer, Senior Partner, Advancy

Further information at www.advancy.de