Disruptive supply chain trends in the evolving tax environmentBy Peter Anderson, Wes Cornwell, Yvonne Metcalfe and Alex Ward

EY | Assurance | Tax | Transactions | Advisory

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Global supply chains are changing at an ever-quickening pace. For supply chain professionals, it is perhaps the start of the most exciting and significant phase of our careers. Globalization, growth in emerging markets, industry consolidation and increasing regulatory pressures are but a few of the exciting challenges impacting supply chain professionals today. However, in addition to these existing trends, it is critical for supply chain professionals to understand how many emerging trends will impact how supply chains are designed and operated in the future.

We have recently reviewed many of these emerging supply chain trends and identified

six key trends that have significant impacts to both the physical supply chain and the broader business and tax operating model.

These trends are:

• Manufacturing developments, including additive manufacturing or 3D printing

• Big data

• Supplier and customer collaboration

• Enhanced procurement

• End-to-end cost optimization

• Supply chain segmentation

The business operating model forms the foundation of an enterprise’s tax profile. Therefore, if that foundation shifts, the global tax footprint will be impacted. In some cases this change might create a tax opportunity, but in others it may create tax risk. In either scenario, it should not be ignored if the enterprise wishes to maintain a competitive and sustainable tax rate. Understanding this relationship and developing internal governance to incorporate direct and indirect tax principles and considerations into your organization’s planning, design and implementation process will enable proactive alignment between the tax organization and its business partners to achieve integrated objectives.

One of the most common issues when driving alignment and collaborative planning and design efforts across tax and business partners is a lack of consistency in terminology. A tax person is more likely to

think of “centralization” as “co-location” of people — performing functions, managing assets and risks. A business person is equally likely to be contemplating virtual centralization. Centers of excellence are an example of a combination of these concepts with co-located, local and virtual personnel. Whatever the scenario, different tax profiles result depending upon what the organization looks like, how it operates and where the people are located, and this profile can result in instability if not properly planned for as it shifts from local to regional or global and possibly back again — or functions simply transcend geographies.

Moreover, as industry standards change, how the tax laws apply to them might not be as clear as with traditional standards. For example, the question of whether someone makes a substantial contribution to the manufacture of a finished product for US federal tax purposes might not be so clear in

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Supply chain trends – the big picture

The tax dimension

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the situation where 3D printing evolves to be a primary factor in the production of those goods. Similar questions arise in the context of big data where the value drivers might shift away from functional decision-making to more automated processes or newly created intangibles.

Coupled with the changing tax environment, including the OECD projects and local country reforms across multiple aspects of international tax planning and documentation, tax considerations should be embedded in the design of operating models of the future.

Near-shoring and re-shoring refer to the trend whereby many multinational organizations shift some of their manufacturing capacity from historically low-cost countries, such as China, to more cost-competitive countries nearer to their customer markets. Common examples of near-shoring include moving manufacturing operations to countries like Mexico or Costa Rica, to support demand in the United States, or to Eastern European countries such as Poland, to support demand in Western European markets. In the case of re-shoring, manufacturing operations are in some cases even being brought back to higher-cost countries, such as the United States, in favor of other business benefits. This trend is the result of the total cost economics of traditionally low-cost country supply chains being significantly impacted by growing labor rates and fuel costs such that the scale is tipping in favor of regional manufacturing strategies. Lessons learned related to intellectual property risks as well as the impact of long lead times on the broader supply chain have further contributed to this trend.

While traditional off-shoring will continue to have a key role in most manufacturers’ footprint strategy, supply chain executives will continue to adapt and optimize their manufacturing locations

as customer markets shift and low-cost sourcing economics change. In the automotive industry, for example, original equipment manufacturers and many of their tier one and two suppliers have been moving significant portions of their manufacturing capacity from Japan and China to countries such as South Korea to support both a growing domestic and export market, while automakers supporting US customer markets have continued to make manufacturing investments in the United States.

As we look forward and imagine supply chains in the next 5 to 10 years, developing technologies such as 3D printing, or additive manufacturing, also have the ability to drastically change how we think of supply chain architecture. Additive manufacturing, a technology that has been in use for some time for certain applications, allows the manufacturer to make a variety of components using many different materials one layer at a time, thereby effectively “printing” a part or finished good without the need for labor and asset-intensive processes. These technologies have often been leveraged for rapid prototyping but are now evolving and being used in a variety of applications in multiple industries. Everything from working airplane engines to organ tissues is already being “3D printed” today. While full-scale

traditional manufacturing for most industries may not be replaced anytime soon by additive manufacturing processes, organizations that are considering developing these capabilities need to be thinking now about how these technologies could support their manufacturing needs and how the supply chain could be transformed for the better in the process. Eventually, the production of a low volume, long lead time replacement part might be triggered by a customer order, the design sent electronically to an outsourced 3D manufacturer, and the part 3D printed and shipped to the customer on the same day from a relatively localized supplier.

Together these trends will require supply chain professionals to ask themselves fundamental questions about their operating models and evaluate everything from the skill sets that they need to acquire and develop, and in which locations, to how their planning and inventory management processes and investments will need to change. Changing the manufacturing footprint and exploring new manufacturing processes, such as 3D printing, will also have significant impacts on manufacturing quality control and customer perception. Additionally, near-shoring and re-shoring are perceived to help mitigate intellectual property risks in the supply chain and 3D printing has the potential to change the way we think of intellectual property in a manufacturing environment altogether.

Finally, supply chain professionals will also need to evaluate how these trends may impact their extended value chain. For example, what are the impacts 3D printing might have on your organization’s efforts to further outsource or vertically integrate your supply chain? How might re-shoring impact your supplier and customer relationships? Which competitive advantages

and market opportunities might be created by drastically improving customer responsiveness? And last, how might your organization collaborate differently throughout its supply chain as a result?

From the tax perspective, multiple issues need to be considered as manufacturing trends cause the value drivers of an organization to shift and potentially change in character. In moving manufacturing operations from one country to another, is there a taxable exit of tangible or intangible assets? To the extent that the resources responsible for manufacturing strategy and oversight are co-located, does that create a taxable centralization of profit and hence taxable value in that central location? As manufacturing personnel travel and operate on a more virtual global level, is a taxable presence of an enterprise being created in a jurisdiction by virtue of their presence and activities there? This might also be a concern in the case of mobile manufacturing whereby plants are literally brought onshore for a limited period of time and then shipped elsewhere. Is the movement of raw materials and finished goods being appropriately structured and documented from an indirect tax compliance and cash flow perspective? It is also important to recognize that the potential tax impact in this context is broader than just the countries where manufacturing activity may be moving to and from. The changes may also impact the global tax profile, including the deferral of parent company taxation or the overall repatriation strategy.

These questions are just a few examples of the challenges and opportunities that lie ahead, but they should quickly start to become part of the supply chain agenda if they haven’t already.

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Big data has been recognized by many supply chain executives as one of the most disruptive factors facing them. In essence, big data is changing how we collect and analyze consumer, customer, supplier and our own internal data.

This analysis of the data in many instances has been undertaken in the traditional supply chain world and has had dramatic effects on how supply chains are configured. At the simplest level, better planning and forecasting are facilitated with much of the data collection and first phase analysis being undertaken in low-cost countries, changing how supply chain organizations are geographically dispersed. As these organizations evolve and start to develop more predictive capabilities, this can change the organizational footprint of companies; correspondingly, alignment with other functions can become more difficult and virtual ways of working need to be developed. Perhaps most interesting is the impact that these types of organizations

may have on the tax profile of an organization that has previously created tax-effective supply chain structures.

Big data raises multiple tax considerations depending upon the context and manner in which the data is gathered, analyzed and exploited. A key question to be answered is, what is driving the value derived by enterprises from big data? Is it the data itself? Is it predictive analytics? Or is it software? The specific answers to these and other questions will determine the character, source and taxation of profits yielded by big data enhancements. Another area for consideration is the extent to which supply chain planning functions that previously required human intervention and that were co-located might now be automated and/or enabled by the organization’s intellectual property, thereby potentially changing the location, manner and tax outcome related to those activities.

As organizations integrate more closely with suppliers and customers, supply chain visibility is being enhanced. As visibility and control are enhanced, organizations are collaborating ever more deeply. What might this mean for the organization apart from operational benefits and the reliance on key third-party relationships? Have you considered what is really being handed over to your “extended team” and the value that is truly being driven in that relationship?

Deeper and broader collaboration will occur as technology makes the job of dealing with extended supply chain partners easier, but be careful around the activities that are being passed to suppliers and customers

as they may have consequences that are unintended and impact your organization financially from a tax perspective.

As the operating model and ownership of functions and risks shift, then so may the taxable profits between legal entities and jurisdictions. Care also needs to be taken to rationalize third-party arrangements and pricing with the intercompany pricing policies. The nature of collaborative arrangements should also be considered, as whether they create a contractual joint venture, partnership or other legal entity will carry differing tax consequences for all parties involved.

To optimize business benefits across the supply chain and improve after-tax profits, many companies have implemented sourcing or procurement entities that undertake strategic sourcing, supplier relationship and procurement risk management

activities in a tax-effective jurisdiction. This jurisdiction is carefully selected to achieve regional alignment with the local supply base and, increasingly, the company’s own regional operations. These “procurement companies” allow the organization to take

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Big data

Enhanced procurement

Supplier and customer collaboration

4 | Disruptive supply chain trends

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advantage of many benefits, including increased spend visibility, improved supplier qualification and selection capabilities, spend and supplier rationalization, improved supplier relationships and risk mitigation.

As more organizations successfully implement procurement companies, operations executives are increasingly evaluating and expanding the scope of these companies to encompass broader supply chain responsibilities. In many cases, a detailed Supplier Sales & Operations Planning process is being implemented whereby the procurement team is working more closely with

suppliers to integrate them into the mid- and long-term operations planning process. This approach not only yields increased supply chain savings but also has the opportunity to enhance the after-tax return from these “enhanced” procurement companies.

As supplier collaboration develops further, the opportunity will exist to extend the relationship between the organization and its key suppliers; as this happens, options exist for an organization to solely take the operational benefits or to enhance with potential tax benefits.

End-to-end cost optimization is the practice of understanding, managing, and optimizing specific product and service life cycle costs throughout the supply chain and is a converging trend with many of the other topics discussed in this paper. This approach takes special consideration of business segment objectives, such as customer service level targets and profitability objectives, as well as the total cost to serve particular customers and market segments, and most important, looks beyond the four walls of an organization to better understand the costs and value attributed to the broader supply chain.

Unlike many “activity based costing” and “cost to serve” approaches used by organizations today, end-to-end optimization efforts will evolve to include supply chain partners in new innovative ways, which will be enabled by converging trends such as the advancement of mobile technologies, cloud computing and analytics. As a result, end-to-end cost models will be more frequently developed through close collaboration with multiple tiers of suppliers and customers, generate new visibility into true total supply chain costs and provide this visibility in near real time.

Significant strides are already being made in the inventory planning space as supply chains are realizing significant cost and customer service level improvements from practices such as multi-echelon inventory optimization and leveraging real-time point-of-sale data in the demand planning process.

This emerging capability creates an exciting yet challenging opportunity for supply chain professionals. First and foremost, while the opportunity to drive significant benefits from end-to-end cost optimization exists, the infrastructure, business relationships, ways of working, talent and performance measures still need to be developed. The related trend of supplier and customer collaboration will

also be critical in order to define, invest in, and manage new business processes and infrastructure that will allow the sharing and analysis of data throughout the supply chain. However, if supply chain partners cannot develop mutually beneficial objectives and therefore agree upon how to track, model and implement cost optimization opportunities and share the resulting benefits, all will be for naught.

Furthermore, supply chain executives will need to collaborate with internal business leaders in ways to which they may not be accustomed. For example, an end-to-end cost optimization initiative may reveal significant opportunities to vertically integrate a supply chain partner, outsource a function, re-engineer a product or even change the way the organization takes a product to market. Although the supply chain organization may be a catalyst to driving many of these initiatives, getting support for and managing the change is another story.

Additional consideration must be given to how identified business benefits can be tracked, managed and sustained once a specific opportunity is implemented – among other things, this results in completely rethinking many of the key performance indicators an organization uses to manage its supply chain performance. For example, imagine what an “on time delivery” metric might look like with end-to-end thinking applied. If, for example, overall lead time and total freight-to-consumer costs can be reduced but would require more costs for your specific organization, then KPIs and business relationships must be structured to achieve “win/win” scenarios for all supply chain stakeholders.

As the scope of these end-to-end opportunities is better understood, supply chain professionals must reconsider where in their extended supply chain they can create the most value. While these opportunities may be realized by more

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traditional methods such as outsourcing or shifting manufacturing to lower-cost locations, many opportunities will exist outside of the traditional supply chain scope and within the extended value chain. As a result, the value of the supply chain organization and the way supply chain professionals interact with various business partners will continue to evolve.

It goes without saying that these kinds of enhancements will create additional taxable profit, and as functions, assets, and risks move between jurisdictions and new ones are created, the determination of where those profits are taxable could significantly impact the global enterprise’s effective tax rate.

Stated simply, supply chain segmentation aligns specific corporate goals with focused virtual pathways through a larger, more complex supply chain. For example, if your organization has an important subset of customers who are willing to pay more for customized products or faster-than-usual delivery or your organization has a high-volume, low-margin product for which the lowest cost is critical, then different supply chain segments can be tuned to meet those various needs. However, don’t get caught in the misconception that segmentation means creating many separate and redundant supply chains; rather, it’s about creating configurability in the context of a shared infrastructure.

Many organizations struggle with this relatively simple concept. The complexity in their supply chains is often the result of years of growth, merger and acquisition activity, and changing customer markets. As a result, instead of operating a concise set of “configurable” supply chain segments, many organizations instead wrestle with a web of complex and overlapping or underdeveloped supply chains. The reverse can also be true, where some organizations have standardized various supply chain segments to the point where they are no longer meeting customer requirements in the most efficient way possible. A common example for many organizations includes their return and service

supply chains, which often are allocated a disproportionate amount of resources and forced to comply with the policies and objectives of core product businesses, despite the relatively high margins and forecasted growth in this area for many industries.

The basic concept of supply chain segmentation is that an organization’s supply chain can be categorized or segmented in multiple ways by managing specific processes within the supply chain differently to achieve the desired outcome. These processes might include freight planning, inventory management, capacity planning, or order fulfillment and customer service.

The challenge in the segmentation process is to determine the factors upon which the operational structure should be based and how the broader supply chain operating model should be tailored to specific segments as a result. While there is a general objective to leverage a common infrastructure wherever possible, there is a debate in most organizations about what this really means. Ultimately, this debate will influence how organizational structures, roles and responsibilities, management processes and enabling transactional processes should be tailored or standardized relative to a specific supply chain segment.

When supply chain centralization is applied to an organization with a high degree of maturity in its supply chain segmentation execution, the next key questions become, “how can I centralize governance and create synergies across my various supply chain segments?” and “which processes, how much responsibility and

which decisions really should be centralized in the first place?” The right answer will certainly vary by the organization in question and its specific business objectives, but clearly the answers to these questions will have differing tax consequences as well.

Supply chains will continue to evolve and change dramatically in the years to come — in many cases the rate and impact of these changes will be higher than anything experienced since the credit crisis late in the last decade. Organizations that successfully navigate the next 5 to 10 years will respond to these challenges by working collaboratively across their extended enterprise. These successful organizations will assess not only the impacts to their own supply chain, but will collaborate internally and with their supply chain partners to create and manage value generation in new and innovative ways. They will harness the value of data, new manufacturing technologies and collaboration in ways that will allow them to redesign their supply chains to

deliver increased value to their customers. And finally, these successful organizations will plan, design and implement transformation programs that create value in a tax-effective manner.

Amid the existing challenges presented by globalization, emerging market growth, industry consolidation and increasing regulatory pressures, supply chain executives will not be able to ignore these new disruptive supply chain trends. Executives who are successful will embrace the opportunities these trends create and differentiate the supply chain’s value to the C-suite agenda – enabling the speed and flexibility at which their organizations can adapt to change, and doing so while enabling profitable growth.

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