Consumer Currents 01 Issue for decision-makers in the retail and consumer goods industry can you account for it? Why effective management of trade spend is essential for retailers and consumer goods companies so-little gem: An overview on retailing in India Getting more out of your intellectual property in M&A? Can trade players compete with the growing impact of Private Equity houses? Earning respect: The importance of stakeholder respect culture China: land of more opportunity Summer 05 Trade spend: India’s not- from Shopper’s Stop What’s hot in a corporation’s
Transcript
ConsumerCurrents 01Issu
e
for decision-makers in the retail and consumer goods industry
can you account for it? Why effective management of trade spend is essential for retailers and consumer goods companies
so-little gem: An overview on retailing in India
Getting more out of your intellectual property
in M&A? Can trade players compete with the growing impact of Private Equity houses?
Earning respect: The importance of stakeholder respect
culture
China: land of more opportunity
Summer 05
Trade spend: India’s not-
from Shopper’s Stop
What’s hot
in a corporation’s
ConsumerCurrents is published by KPMG’s Global Consumer Markets practice for senior executives in consumer markets companies around the world. Here topical industry issues and global trends come under the scrutiny of KPMG firms’ industry professionals and specially chosen guests.
03 ContentsConsumerCurrents01 An informed view on a variety of topical issues for consumer businesses around the world.
Trade spend: can you account for it? 03 Managing trade spend effectively has never been a higher priority as suppliers and retailers not only seek to maximize their return on investment but also deal with increasing levels of SEC interest.
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19
Shoppers’ Stop: India’s not-so-little gem 08 Interview with B.S. Nagesh, Managing Director of Shoppers’ Stop, a large chain of Indian department stores, giving his views on retailing in India, the importance of customer care and prospects for the future.
Getting more out of your intellectual property10 There’s more to intellectual property (IP) than patents and property rights. Take a look at the potential for reducing your effective tax rate by managing your IP appropriately.
What’s hot in M&A? 13 Can trade players compete with the growing impact of Private Equity houses?
Earning respect16 The importance of stakeholder respect in a corporation’s culture.
China: land of more opportunity19 With the lifting of onerous restrictions that once stood in the way of trade, will foreign consumer goods companies find business in China plain sailing?
ConsumerCurrents An informed view on a variety of topical issues for consumer businesses around the world
Neil Austin is Global Chair of KPMG’s Consumer Markets practice with overall responsibility for services to our leading clients in the Retail, Food and Beverage consumer product sectors. As a Corporate Finance partner with KPMG in the U.K., Neil has particular experience of international divestitures, acquisitions and fundraisings, as well as advising Boards on the strategic issues.
Welcome to the first issue of ConsumerCurrents, a regular KPMG
publication for senior executives in retail and consumer businesses
around the world. We aim to provide a range of articles in each
edition covering a variety of topical issues in a way that is both
stimulating and informative.
The business environment in which consumer companies operate is complex and challenging and senior executives need to be constantly seeking ways to grow and improve performance while at the same time understanding their competitors and changes in the market place and ensuring their own business is managing its risks.
KPMG firms are committed to helping you achieve your goals, working with you to build your businesses. We are constantly seeking to develop forward-thinking strategies to problems our clients face, and each issue of ConsumerCurrents will include articles on selected topical areas. We also intend to feature businesses – and business people – whose experiences can offer learning points of value to others.
In a world where many markets are relatively mature for consumer businesses there is naturally a high level of interest in emerging markets. These offer the prospect of high growth rates and an expanding and increasingly affluent consumer base – the Brazilian, Russian, Indian and Chinese (BRIC) economies are some of the most often-quoted examples together with CEE. We will regularly feature aspects of these emerging markets, reflecting our member firms’ strength in helping companies enter such markets, expand their operations once established and, importantly, control them effectively. The interview with B.S. Nagesh, Managing Director of Shoppers’ Stop, is the first example of this focus on the growth economies around the world.
… we are committed to helping you achieve your goals …
In a world where many markets are relatively mature for consumer businesses there is naturally a high level of interest in emerging markets.
The large and growing impact of regulatory requirements and changes should also not be ignored. The most recent major examples that are affecting many businesses around the world, and not just those in the consumer sector, are the implementation of Sarbanes Oxley and its equivalent in other countries. In addition to assisting with regulatory compliance, KPMG firms are committed to helping companies achieve this efficiently and, crucially, learning to get value out of such processes. This is likely to be a recurring theme in ConsumerCurrents as regulators of all kinds seek to refine and inevitably expand the myriad of rule books – and companies strive to, not only keep abreast of requirements, but also anticipate changes and seek, wherever possible, to implement them in ways which yield value.
As we move into the second half of 2005 many of the challenges facing retail and consumer businesses are familiar but some of the economic background is changing. In the developed economies consumer spending has been strong for some time in several countries, most notably the U.S.A. and the U.K., albeit much weaker in parts of the Eurozone, especially Germany. Cheap credit, a rising property market and, in the U.S., tax cuts, have helped growth in demand from consumers who have demonstrated a general ‘feel good’ factor in several countries.
There are now signs that this growth is certainly slowing, with consumers seemingly seeking to limit their debt and also losing the sense of increasing prosperity that is brought about by rising property prices – although the U.S. housing market remains buoyant. Any slowdown will be felt by retailers and consumer goods companies alike – reinforcing the need to reduce costs, to seek competitor-beating innovation, and to focus on growth opportunities.
One way of growing is through acquisition and while activity has been relatively slow in the last few years there have recently been signs of a pick-up. In an article in this issue, Rob Coble, Partner in Charge from KPMG in the U.S. and David McCorquodale, partner from KPMG’s U.K. member firm examine some ofthe key drivers and discuss how this trend might develop.
Cutting costs – or at least improving the value derived from every dollar spent – is likely to remain high on executives’ agendas. Trade spend is a massive, and growing, cost for businesses which supply retailers. Increasing the effectiveness of this spend is critical but can also be extremely difficult and complex. At a basic level, maintaining adequate controls over the huge sums expended is vital and has been brought into sharper focus by the requirements of
regulatory regimes such as Sarbanes Oxley. At a more complex level, the challenge is to increase the effectiveness of expenditure. Tom Hartley, partner from the U.K. member firm and John Rittenhouse, partner from KPMG’s U.S. member firm examine this area in more detail in their article in this issue.
We hope you find the articles interesting and that you look forward to further issues of ConsumerCurrents. Feedback is always welcome – what you liked, what you didn’t like and what else you would like to see covered. Contact details for the authors are given at the end of each article and they would be delighted to hear from you with any questions or comments you may have.
KPMG’s Global Consumer Markets practice wishes you every success and look forward to working with you to achieve your goals.
Why effective management of trade spend is essential for retailers and consumer goods companies
* Companies known as FMCGcompanies in Europe and CPG companies in the U.S., are referred to as ‘suppliers’ throughout this article.
There are two strong reasons for
increasing the effectiveness of trade
spend management. As one of the
biggest cost lines for suppliers*
and a huge source of revenue for
retailers, the business case for
enhancing the return on this
investment in an industry where
margins are tight is compelling.
There is also now a legal onus to
get it right, as executives face the
prospect of prosecution and jail
following increased SEC interest
and investigations in the area of
accounting for trade spend.
Tom Hartley, a partner in KPMG’s U.K. member firm, warns: “It can now cost more to promote the product than to produce it. Marketing investment is diverting from advertising to trade spend, but suppliers sense that they are being bullied into giving more and
more while retailers are insecure about who’s getting the best deals. It adds up to both missing out on valuable mutual benefits.”
Not so many years ago, consumers were loyal to a brand. Suppliers ploughed money into TV advertising and, fingers crossed, sales went up. Today’s consumers are probably more likely to be loyal to a supermarket – after all, they bank, collect their dry cleaning and shop for groceries, electrical goods, clothes and hardware there. If the supermarket doesn’t stock their favorite brand, the shopper is increasingly likely to take whatever alternative the supermarket offers. Brands are fighting to avoid becoming a secondary consideration to the pulling power of the supermarket.
The supplier has a problem. To make a sale, it has to get its product in front of customers. So it pays the supermarket a hefty sum to stock its lines. To get an end-of-aisle promotion or to feature in customer flyers, it hands over a bit more. If it brings out a special product, more money goes into the supermarket’s kitty. The sales team’s jobs depend on innovation and clinching supermarket deals, but the executive team often cannot evaluate return on investment (ROI) and track and control initiatives. Driven by increasing retail power, trade spend is rising at an inexorable rate – currently estimated to be somewhere between 12 percent and 30 percent of total sales … and rising. Something has to give.
But from the supplier perspective,
is this investment giving an
acceptable return?
“The situation has reached a point where ROI on trade spend can be erratic and difficult to measure”, says John Rittenhouse, Head of Operations Risk Management for KPMG’s U.S. member firm. “Getting your hands around what is happening, particularly on a cross-border level in Asia and Europe, can be a huge challenge. With multiple complex promotions going on and often different terms and conditions in place in each country, developing an overall picture of activity and distinguishing profitable deals from poor performers can be a complex undertaking for retailers and suppliers alike.”
It is estimated that somewhere between 12 and 30 percent of supplier costs are monies paid to retailers in the form of trade spend.
The state we’re in Ten to fifteen years ago, as suppliers reviewed their costs they identified that cost of sales was one of their largest expenses. Traditional cost savings programs led them to consolidate their suppliers. They implemented professional purchasing systems and leant hard on those costs. Superior buying has, for many, resulted in a significant reduction in cost of goods sold. But that success has been surpassed by the rise in trade spend. And other global pressures are putting trade spend under the microscope too.
• Regulation The importance of accounting for and managing trade spend effectively has never been greater. Suppliers and retailers are increasingly under the SEC spotlight as it steps up scrutiny of the reporting of trade spend management. Recent SEC investigations are likely to result in jail sentences for senior retail executives for booking trade funds out of revenue periods, falsifying documents and generally being unable to account properly for trade spend. In any investigation, suppliers are likely to find themselves just as liable to prosecution as their retailing counterparts.
As a consequence, the sales force, with a limited bag of tools with which to clinch a supermarket deal, has had its wings clipped. Trade deals, once solely practiced by sales, are now increasingly recognized as a critical issue for marketing, finance, logistics/supply and the CEO too.
• Industry consolidation The creation of global supermarket chains has led to pressure for consistent terms of trade and pricing across geographies and distribution channels. The biggest
players – Tesco, Carrefour, Metro and Wal-Mart – all seek to equalize their terms of trade across geographies.
Add in the effect of the euro and it’s easier to spot what deals are being done by the same suppliers in different EU locations.
As it appears that these big retailers will continue to get bigger, at least for the foreseeable future, they are likely to flex their muscles in areas other than trade spend, such as the ownership of inventory, pushing these costs back on to suppliers.
Even though the balance of power appears to lie predominantly with retailers, they too are edgy and under pressure. Unhappy with systems that can be costly and complicated to administer, they also worry that their competitors may be getting a better deal. Faced with difficult and competitive markets and demanding investors, they continually ask for more financial support from their suppliers.
Unraveling the conundrum A problem as big as this has no single solution. Before even beginning to redress the balance, retailers and suppliers should have three things in mind:
Tailoring: Trade spend is highly It’s a leadership issue: Trade spend Treat the cause: The problem does relationship based and consumer goes right to the heart of the not usually lie where the symptoms goods companies have different organization and its ability to compete. manifest themselves. If a supermarket relationships and different commercial Trade spend is a leadership issue in chain deducts the cost of trade spend circumstances. What is right for a every sense. It involves financial from an invoice, the problem will show food supplier in the U.S., will probably controls and commercial strategy. itself in the accounts department but not work for a drinks manufacturer Sales, marketing, the executive the cause could likely stem from a in France. board, finance and logistics should breakdown in the sales relationship.
be involved in the allocation of trade spend.
Distinguishing profitable deals from poor performers can be a complex undertaking.
The advantages of improving trade spend efficiency
can benefit retailers and suppliers alike.
KPMG firms are working with many leading consumer goods organizations and retailers to help them improve
return and to meet compliance requirements.
Our approach is to step back and re-evaluate the business through four lenses. Rather than starting from the point of
and ask, “How can I improve my return on this investment and ensure full visibility and control over my spend?”
Lens 1. Strategy: How much to spend and where
Start by determining which channels you intend to use to market your products and how much trade spend you are prepared to allocate to each.
•
•
• to trade funds/promotions?
• Does trade spend reflect my strategic objectives within this channel?
Lens 2. Effectiveness: How to improve ROI
Retailers and suppliers should understand what works to their mutual and individual advantage. Suppliers need to
and which brands they most want to promote. Retailers need to enhance their own brand and consumer appeal.
•
• brand objectives?
• Can I measure the return on my trade investment and if not, why not?
• by account/client and by product/category?
• How can these processes and procedures be made more effective (lower cost)?
• the range of benefits from trade funds and how can information effectiveness be improved?
Clarify terms internally and to stakeholders
Research in the U.S. suggests that for retailers the single biggest concern is that a competitor is getting a better trade marketing deal from suppliers.
Consumer goods companies can help remedy this anxiety by standardizing terms across geographies. And, by
that salespeople may offer deals that contravene corporate
to effective management of relationships and risk to stakeholders.
with these programs?
and also in Europe and Asia?
geographies? Is there a legitimate commercial reason for this?
merging across geographies?
Lens 4. Control:
Measure and manage the people and processes
Consumer goods companies need measures and processes in place that control information flows and decision-making within their teams. Fail to do this and they can run the risk of off-invoice deductions, unaccountable trade spend and other erratic consequences.
of spend?
my business?
It involves an internal audit assessment that looks at the business processes, helps to ensure compliance and identifies how preferred practices might be replicated across geographies. It also identifies what spend works and where real commercial benefits are generated.
trade spend efficiency, both to enhance the financial
wanting to spend less, or to reduce invoice processing costs, we believe that organizations need to look at trade spend
What is my medium term brand strategy?
How will spend with trade impact my brand value?
What is the customer’s strategic plan as it relates
evaluate which promotions they believe to be most effective
Are the programs achieving the plan goals?
Does the level and type of trade funds support
What is the profitability of the trade fund programs
What information is required to measure and track
Lens 3. Visibility:
communicating trade terms within the company, the risk
guidelines can be reduced. Visibility is a key requirement
• Where are my areas of vulnerability?
• What are the market, pricing and volume risks associated
• What is my visibility of trade spend funds in the U.S.
• Why are my trade spend patterns different in different
• What would be the impact of my major customers
• Are policies and procedures in place to ensure control
• Are the right people involved in making decisions?
• Do I know which levers to pull to make a change in
KPMG’s four lens approach is a diagnostic process.
On the same side On the face of it, suppliers and retailers are on the same side. In a deflationary environment where the cost of goods is steadily coming down, with unimpressive profit margins, it is the consumer that is on a winning streak. Capturing a greater share of customer spend can benefit both supplier and retailer.
A little more give and take can benefit both in terms of understanding, planning and profitably executing the business plan. But it takes a change in attitude.
“For a commercial issue as big as trade spend there is no magic bullet. Also, for an issue this complex, the ‘holy grail’ of perfect measurement is unrealistic. The retailer and supplier have a shared interest in controlling and understanding trade spend. Both can improve their businesses with a better understanding of profitability by product, product grouping and customer,” says Tom Hartley.
“For now, the fact remains that trade spend is managed so consistently badly that getting it broadly right will give forward-thinking companies significant edge.”
Potential benefits of effective
trade spend management
to retailers
• Allows for better decision-making to take place in the promotion and pricing of products to improve profits
• Helps to reduce cost and risk
• Provides improved cash flow by securing off-invoice discounts on a more timely basis versus quarterly or annual volume-based performance programs
• Encourages suppliers to give more trade spend support
John Rittenhouse is a partner within KPMG’s Risk Advisory Services, and heads the U.S. member firm’s Operations Risk Management practice in the U.S. Based in San Francisco, John focuses on identifying enterprise-wide operational risks and supply chain/operations performance improvements. Previously he was Chief Logistics Officer for Wal-Mart.
• Helps determine a more accuratereturn on investment for trade fund spend
• Can determine the profit position of individual products or groups by client and by client/region
• Helps determine regulators’compliance level and risksassociated with current trade fund practices
• Creates a closer partnerrelationship with key retailcustomers to develop programs that drive volume, revenue and net profit
Tom Hartley is a partner in KPMG’s U.K. member firm and part of the Strategic and Commercial Intelligence group based in London. He focuses on leading strategy planning and performance improvement engagements, including in the area of trade spend, for consumer markets companies. An alumnus of Harvard’s MBA program, Tom was previously a National Account Manager for Procter & Gamble.
India’s not-so-little gemIndia’s fortunes seem to be on the up. A stable economy, increase in direct investment and domestic as well as export demand for its goods and services have seen to that. The economic climate is keeping B.S. Nagesh, CEO at Shoppers’ Stop, happy. Expansion is on his mind. But not, for now at least, outside his native India.
Shoppers’ Stop changed the shape of Indian retailing back in 1991 when B.S.Nagesh opened his first store. Indian people, more accustomed to small-scale enterprises, found in Nagesh a man prepared to think big. Very big. This first department store, selling own brand as well as domestic and international clothing, accessories, home furnishings, books and music, was ten times the size of any other. It didn’t stop there. Nagesh is still committed to big thinking.
Today the business operates 18 stores and has plans to open 12 more by 2007. It also owns Crossword, the country’s largest book chain, with 22 stores and a further ten planned each year. Turnover has grown by 28.3 percent on 2003 figures; there’s been 38.8 percent growth in gross cash margin and EBIDTA (earnings before interest depreciation and tax) is up by 50.5 percent.
“We won’t violate our principles to become number one.”
But what next for Shoppers’ Stop? And are there any limits to growth?We spoke to the man himself to find out.
ConsumerCurrents: You aim to be
number one in India, but what does
this really mean?
Nagesh: We want to be the number one department store brand – not just by turnover but by dint of sticking to our value system and mission statement to be ‘Nothing but the best’. We won’t violate our principles to become number one. We don’t want success by compromise.
ConsumerCurrents: You say that
India needs to change from being a
nation of shopkeepers to a nation of
shoppers. What needs to be in place
to achieve this?
Nagesh: The retail infrastructure needs to evolve to support this transformation. That means roads and shopping malls that are on a par with or better than those elsewhere in the world. We also need an Indian government that takes retail seriously and echoes the experiences of Dubai, Singapore and Malaysia in using retail to boost internal consumption as well as draw in foreign tourists.
We believe that twenty million Indians will travel abroad this year, each spending on average U.S.$800. India needs to provide the incentive and infrastructure for them to spend that money at home. On top of that, we estimate there are 300 million potential customers on our doorstep.
But taxation and retail laws need finessing too. With a sensible duty structure in place, we will be better able to map imports to domestic production and reduce wastage in our value chain.
ConsumerCurrents: And what is
the Shoppers’ Stop game plan for
staying on top of the market?
Nagesh: We start by understanding our sectors. In lifestyle apparel, customer behavior is typically the same across the country. But in books and food [Shoppers’ Stop’s newest activity] large regional variations call for different sourcing strategies.
Customer care is how we keep customers loyal. It is the philosophy, culture and fabric of our organization. Every employee is a customer care associate; my office is responsible for handling complaints directly;
the management committee’s bonuses are linked to improvements in customer satisfaction indicators (CSI) and employee satisfaction indicators (ESI). An external agency benchmarks our customer service against four other competitors. All this information helps us to learn more about our customers and how we can best meet their needs.
Our loyalty program – First Citizen – now has 370,000 members and is expected to top 500,000 over the next 12 months. Today 52 percent of our business comes from these loyalty customers. To understand them better and personalize our service, we’ve used our skills and technology to subdivide the membership into around 500 groupings which we will target more specifically. We know our customers at a profitability level – longer term the plan is to attract more profitable members and to cultivate and grow our relationship with them.
The shopper we’re after is Indian middle class, aged 25 to 40, who chooses us more for the shopping experience and our fashion than for value and convenience.
ConsumerCurrents: For a non-
listed company, you take corporate
governance very seriously.
Why is that?
Nagesh: We are a private business that runs like a listed company. Our statutory and internal auditors are ‘Big Four’ firms. And even though governance on this scale costs more, it provides comfort to stakeholders. There is a board of 10 – I am the only executive director – including an international retail representative from Selfridges and a retail academic. The founding family, although it holds 80 percent of the stock, has a minority seat on the board.
Good governance influences how the business is perceived by customers, employees and suppliers. Coupled with our CSI, ESI and now our partner satisfaction index (PSI), these measures will ensure the future health of our business. I also firmly believe that shareholder value grows most in an environment where creativity and productivity are not compromised.
ConsumerCurrents: But there must
be some gaps in this success story.
What doesn’t work as well as you
would like?
Nagesh: Our weakness is our supply chain. Indian manufacturers tend to be small-scale enterprises; the big players are into exports, not the domestic market.
The road infrastructure that we touched on earlier isn’t quite there yet – but is developing fast. For now, though, it leads to hiccups in distribution and logistics with a knock-on effect on inventory levels – we hold more stock than we need because of uncertain supply.
And there are insufficient professionals in this business. That’s why we look to the West for people who can help us exploit our resources and sell to the rest of the world. Our retail industry is also still tarred with the ‘nation of shopkeepers’ stigma, although that too is shifting fast.
ConsumerCurrents: So what next
in the Shoppers’ Stop story?
Nagesh: The opportunities in India are far from exhausted. There are plenty more places to explore nationally, which means international expansion is not on our immediate agenda. But we’re definitely not adverse to bringing global best practices here.
Issue 1 ConsumerCurrents 9
In five to 10 years I believe that India will be a ‘happening place’ with the largest proportion of mature adults (25 to 35 age group) with incomes in certain metropolitan areas comparable to the West’s top 20 cities. By then I predict that ‘organized’ retail will be an accepted part of India’s economy and account for around 15 percent of the market.
Nagesh’s optimism appears to be reflected in the burgeoning health of the Indian economy. Although he currently has no plans to move outside India, his big thinking speaks volumes to outsiders looking in. Ten years from now he reckons that India will be a ‘happening place’. The infrastructure and supply chain isn’t there yet … but it will be. For global retailers, India may well be the next big market to crack.
B.S. Nagesh is Managing Director of Shoppers’ Stop, a large Indian retailing chain. In recent years both have been the recipients of a number of awards, including Retailer of the Year in 2000, 2002 and 2004, Top CEO in 2001, 2002 and 2004, as well as awards for the management team, use of IT and advertising campaigns. Shoppers’ Stop is the only Indian retailer to become a member of the prestigious Intercontinental Group of Department Stores (IGDS) which includes Selfridges (U.K.), Karstadt (Germany), Shanghai No.1 (China), and Manor (Switzerland).
This article is a follow up to an interview by Templeton College Oxford’s European Retail Digest. Templeton is a full graduate college of the
University of Oxford dedicated to management studies. You can view the article at: http://www.templeton.ox.ac.uk/oxirm/SampleERD.htm
Getting more out of your intellectual property There’s more to intellectual property (IP) than patents and copyrights. Appropriate management of IPs can lead to a sustainable reduction in the effective tax rate. Here are some of the options.
` IP is a catch-all term. It neatly wraps Some countries have general anti-up trademarks, brands, copyrights, avoidance provisions that can negate patents and R&D-developed technology strategies to avoid or defer tax. that generate an economic benefit. The U.K., currently, has not. And so an You might consider anything over and aggressive tax planning environment above a routine return – the profits has evolved, resourced by an industry ascribed to manufacturing, distribution of loophole spotters, where short-term and other routine functions – as a tax advantages are to be had. return from IP. It’s a critical asset in any successful business, and you That was until 2004. In the pre-election
should manage it accordingly. year, and with a growing budget deficit, Chancellor Gordon Brown clamped
John Burns, tax partner from KPMG’s down hard on tax avoidance. Rather U.K. member firm, says: than putting up taxes, he sought to
ensure that existing tax laws were “Managing the tax on profits strenuously applied. Companies are
from IP effectively, with a now obliged to disclose certain tax planning initiatives to the Revenue.practical approach rather
than artificial arrangements, The Revenue reports to the Chancellor and, no surprises, artificial planning
is commercially sound and and loopholes that exploit tax law arebrings sustainable benefits.” being swiftly identified and closed.
There are potential business benefits from moving your tax people closer to the business ‘doers’, marketers and R&D developers.
Business and tax harmony There are legitimate strategies to help ensure that profits from IP are taxed in an efficient way. And this comes from aligning business and tax planning strategy so that one complements the other.
For some companies this may mean a rethink and revamp of where and how the business is structured. There are downsides to watch out for – but there are potential business benefits from moving your tax people closer to the business ‘doers’, marketers and R&D developers.
Take the scenario of a Public Limited Company (PLC) that currently pays a low amount of tax in the U.K. It takes a good look at its group scenario and identifies how it can link tax and business planning effectively. It has a loss-making U.K. head office with manufacturing and distribution facilities scattered around the world. By shifting IP to the U.K. and by making a charge against other global entities and subsidiaries that use it, pre-tax profits are brought back to the U.K. where they can be taxed more efficiently.
This is not about putting IP into a ‘tax haven’ – which, in any event, is likely to fall foul of Controlled Foreign Corporation rules. Rather it is about trying to ensure that the group’s tax position is made effective and that charges such as withholding taxes on royalty flows are limited.
On the face of it, businesses can organize themselves as they see fit. And so long as it is sensible, legitimate and the numbers stack up, tax authorities should not object to business-linked means of securing effective tax rates.
a tax strategy that may mean upheaval in order to leverage returns. Start by considering:
• What constitutes IP in your business?
• Who owns it – legally and economically?
• What future business strategies may impact your IP?
• What are your group tax imperatives?
• What exit/transfer taxes might apply?
• What are the accounting considerations?
When looking at IP, rather than rushing in with wholesale changes, the tax people need to
understand how the business makes its money. And the business people need to buy into
• Would centralized management of IP enhance its value and protect the ongoing investment?
“Rather than waiting for the next short-term fix to bring down or stabilize your effective tax rate, it may be better to identify a sustainable business-linked strategy.”
Centralized vs shared IP management Given the significant contribution that IP makes to profit generation, many companies are opting for centralized IP management. The trend is away from shared marketing, research and development (R&D) or IT development that everyone dips into. More common is an accountable, centralized cost centre that charges for its services and which, depending on the quality of its output, makes a profit or a loss.
Take a company with high R&D expenditure. It centralizes its R&D as a single entity in Switzerland, relocating disparate teams lock, stock and barrel. From a business perspective, it discovers additional synergistic benefits:
• Innovation is more easily carried into other products and services – reducing cost and improving returns.
• It is easier to monitor spend andreturns more closely.
• Better identification and ownership ofIP – including improved registration of IP assets.
• Shared methodologies andcollaboration within the team.
• Culture of accountability with moredrive to succeed – internal profits depend on it.
• Protection of the ‘crown jewels’ (e.g., patents, trademarks) from takeover threats or litigation by housing them appropriately.
On a tax level, it may find Switzerland a more efficient location for the economic management of IP. Beware, however, some tax authorities may claim that a disposal has taken place where there used to be a cost-sharing arrangement.
Wills and ways curtailed Artificial tax wheezes are still around – where there’s a loophole there will always be a ruse to exploit it. But Gordon Brown’s plan in the U.K. means most will be closed down sooner rather than later. Elsewhere, anti-avoidance measures effectively stamp out such tactics.
Rather than waiting for the next short-term fix to bring down or stabilize your effective tax rate, it may be better to identify a sustainable business-linked strategy. Leveraging tax benefits from anticipated profits created by IP in the business is a viable, commercially sensible and legitimate alternative..
John Burns
a portfolio of multinational clients, providing corporate taxation advice, focusing
principally on international tax issues including transfer pricing. He also has
extensive experience in negotiations with the revenue authorities, both in
respect of corporate taxation and transfer pricing matters.
registered trademarks of KPMG International, a Swiss cooperative.
Issue 1 ConsumerCurrents 13
What’s hot in M&A?
As 2004 drew to a close M&A activity overall was on the increase, indicating that 2005 is likely to be a busier year. The first quarter of 2005, however, has provided some mixed messages, with Global activity up 16 percent by value, a substantial increase by value in the U.S. but a slowdown in Europe. As far as retail and consumer companies are concerned, in terms of value, consumer products and retail sectors recorded the largest increase during Quarter 1, up 391 percent and 175 percent respectively.1
As well as offering cost benefits, emerging economies are gaining attention as potential markets.
What types of trends is this sector
likely to experience for the rest of
2005? In order to answer that
question, it is worth considering
some of the factors that have
influenced M&A in the consumer
sector over recent years to
determine how these key inputs
may affect M&A in the sector
going forward.
For many retail and consumer businesses, the last few years have been a time for re-examining their strategies, focusing on what is core and learning how to survive in a situation where their major markets are relatively mature, with intense competition and downward pressure on prices. Cost cutting, inventory
management, gross margin improvement, and profitable top-line growth are key issues retailers are facing. In addition, manufacturers have been faced with rapidly growing competition from lower-cost producers in developing economies whose ability to deliver high-quality products in large quantities at compelling prices has grown very rapidly. Retailers have been taking advantage of these low-cost suppliers, but have equally been facing very strong competition with challenges to established players and formats from rapidly growing value retailers. In addition, consumers have grown even more demanding in their shopping experience and want more value, at a lower cost, in addition to stylish and innovative products.
As well as offering cost benefits, emerging economies are gaining attention as potential markets. These countries, perhaps best characterized by China, have high growth rates, improving business environments, and a growing middle class of consumers who are rapidly becoming both wealthier and more discerning.
A focus on their existing business coupled with investment in developing markets has made it necessary for retailers and consumer companies to improve cash flows and strengthen their balance sheets. They have also been reassessing what value they have derived from previous M&A activity.
All these factors have combined to produce a relatively subdued M&A market for corporate buyers. However, the deal market has been enlivened by the emergence of the private equity (PE) houses as much more serious buyers of businesses. These funds are active around the world although they have been far more visible in the mature markets of the U.S. and Western Europe. They already have very significant fire power which is
being increased by further fundraisings. Private Equity accounts for 11 percent of Global M&A deal value. Already in the first quarter of 2005 we have seen Private Equity transactions of U.S.$72 billion, a 25 percent increase from Q1 2004.2
Of course their required returns on equity are above those looked for by the publicly quoted companies that make up the majority of the retail and consumer sector. On the face of it, therefore, a PE house shouldn’t be able to afford to pay as much for a business as a trade player even without taking into account the fact that the latter may well have synergies which the former cannot achieve.
In real life, however, an examination of completed deals does not bear this out. So why is this and what are the implications for future M&A activity?
In Q1 2005, retail was the second busiest industry sector for PE with transactions reaching $12.6 billion, more than double its Q1 2004 total. Since the end of the quarter the sector has seen the $5.1 billion acquisition of
2: Dealogic Global M&A Review, Q1 2005
Neiman Marcus by PE houses, which reinforces this trend. The current financial environment creates several advantages for PE houses, which explains their activity in the market. PE houses are raising record amounts in new funds. Current interest rates are relatively low, making debt relatively cheap, and financial institutions are willing to lend. Taken together this means that PE houses today have substantial equity resources available and can not only borrow quite cheaply, they can also borrow significantly more than they could even one or two years ago.
One main reason why PE houses have been and indeed still are in a position to pay high prices is a simple question of financial structuring.
By taking on this level of leverage they have been able to pay prices which quite often are in excess of those that trade bidders are willing to pay. By contrast, many retail and consumer companies have been adopting a relatively cautious approach to acquisitions for a number of reasons. First, the target must fit with the company’s chosen strategy and many companies have been focusing on core assets, which instead has resulted in divesting unrelated, non-core business units or concepts.
Secondly, some companies are being more cautious because they did not necessarily get the value they expected out of previous M&A deals and don’t want to repeat the mistake – clearly the higher the price, the more risk there is of failure. Thirdly, while many acquisitions may yield synergies for the acquirer, companies have become more reluctant to pay more than a small proportion of these in the purchase price for any business, hence limiting one of the advantages that they have over their PE competitors.
Finally, most companies have some form of internal hurdle rate or required rate of return on investment against which they measure acquisition candidates. Clearly in many cases this is yielding maximum prices for businesses which are below the prices which a PE house is prepared to pay. Does this indicate that PE houses are overpaying or that companies are seeking too high a return in the current economic environment?
The activity levels in the market indicate that retail and consumer companies are preparing to get more serious about M&A both at a strategic level (such as the acquisition of Gillette by Procter & Gamble) and at the tactical level, where acquisitions are being used to fill holes in geographic coverage or product ranges. The competition for high-quality assets will be intense, not least because there are a very limited number of businesses with strong market positions or leading brands that are likely to come to the market.
In the absence of a cooling in the debt market, making it more difficult to pay high prices, PE houses are going to remain stiff competition for established corporations. Some of these corporations will need to push the limits if they are going to be successful in acquiring attractive assets. While this inevitably increases the risk, the alternative may be to face being outbid on a regular basis and dropping behind the competition in both market position and growth.
Even with larger deals, established companies are not going to have it all their own way. First, they have to contend with regulatory authorities which are examining the competition or anti-trust aspects of large deals with an ever more critical eye.
Even with larger deals, established companies are not going to have it all their own way.
Secondly, until recently, these large deals would have been viewed as beyond the reach of PE houses, but larger fundraisings and the willingness of PE houses to join together to mount large bids means that almost all large deals are now within their capacity.
It looks as though we will be seeing an increase in M&A activity as we move through 2005 and into 2006. Funding such deals may not be a problem – companies have strong balance sheets and cash flow, PE houses have large war chests and banks are currently keen to lend. It is a good time to be a seller – but who will be the buyers? If established retail and consumer companies are going to succeed in taking a major share of completed transactions, they probably need to examine how they can compete in the deal market with PE houses.
Rob Coble is Partner in Charge of KPMG’s South Eastern Transaction Services practice in the U.S. He has advised numerous domestic and multinational companies and private equity funds in areas of mergers, acquisitions, and due diligence in a wide range of consumer markets companies. He also has extensive experience in accounting for business combinations and SEC compliance.
David McCorquodale is a partner in KPMG’s Corporate Finance Practice in the U.K. member firm and is U.K. Head of Corporate Finance’s Consumer Markets team. He has advised a wide range of consumer markets companies, both public and private, on acquisitions, disposals and fundraisings.
Earning respectDesire for respect enters the cultures of corporations.
Respect is a universally positive concept. But what exactly does it mean to a corporation?
In recent years, many of the major embarrassments and loss of market capitalization suffered by certain companies have primarily come from senior executive failure and violation of public trust. These consequences have resulted in many corporations pursuing corporate governance, ethics and respect as primary objectives.
“Respect is a fundamental part of our culture at Wal-Mart,” stresses Mario Pilozzi, President & Chief Executive Officer (CEO), Wal-Mart Canada. “Respect means a company is admired not only for its business performance but for its culture, ethics, and above all its people. Respect is a vital factor in achieving and retaining the confidence of employees, customers and shareholders.”
In broader terms, Mario Pilozzi is referring to the so-called ‘softer’ set of business issues such as social and environmental responsibility, ethical business practices, fair and equitable employment practices, and regulatory compliance. The potential benefits of embracing these issues far outweigh the perils of ignoring them. And these benefits can be tangible, in the form of higher share prices, ability to recruit and retain good employees, ease of entering new markets, less unwelcome attention from regulators, fewer lawsuits, and even competitive advantage.
According to Willy Kruh, KPMG partner in charge of the Consumer and Industrial Businesses practice in the Canadian firm: “Corporations are realizing the value of respect in the context of global business. Respect is not easily achieved in this environment, but it can definitely give an advantage to companies that are willing to pursue it, and are able to attain it.”
Respected Corporations’, conducted, for 10 years by independent pollster Ipsos Reid. This survey has provided a scientifically based measure of how Canadian CEOs view their peers and the organizations around them.
CEOs across Canada were surveyed to determine which single company
In 2004, RBC Financial Group was
Respected Corporation for the
Consumer markets companies on the top 25 honor roll list include:
• Loblaw Companies Limited (9),
and a leading provider of general merchandise products and services.
• The Jean Coutu Group (PJC) Inc. (14), one of the top 10 retailers of pharmaceuticals and parapharmaceutical products in North America.
ire Corporation Limited (20),
wigas bars.
that has opened over 240 outlets since entering Canada in 1994.
To learn more about the ‘respect’ factor
an ongoing survey called ‘Canada’s Most
was ‘Top of Mind Most Respected’.
chosen as Top of Mind Most
third consecutive year.
Canada’s largest food distributor
• Canadian TCanada’s most shopped-at retailer
th more than 1,100 stores and
• Wal-Mart Canada Corp. (24), Canadian arm of the world’s leading retailer
Issue 1 ConsumerCurrents 17
Vision on the rise What does it take to make it to the top? More CEOs than ever (52 percent) believe that “Vision, focus, discipline or good strategy” are needed to make it to the top. “Vision and strategy are key to success,” says Pilozzi of Wal-Mart. “The leaders of tomorrow will be those who are able to master and execute long-term strategy and thinking in a truly global business world.”
Reflecting on their corporate experiences, CEOs ranked a number of attributes that are key ingredients to making it to the top. The top five are:
• Vision, focus, discipline or good strategy (52 percent)
• Financial performance (34 percent)
• Track record (27 percent)
• Shareholder or investment value (22 percent)
• Honesty, trustworthiness or ethics (19 percent)
Respect reflected in share price CEOs spend more time and give higher priority to building respect for their companies among the general public, a point noted by over two-thirds of respondents. This clearly indicates that building respect is a deliberate strategy and not merely an accidental by-product of other initiatives. Wayne Sales, President & CEO Canadian Tire Corporation, says, “Respect has been a key element of our business success and is part of being what we term a national champion. It means we’re listening to our customers – as well as to our shareholders and all other stakeholders.”
Wal-Mart’s Mario Pilozzi adds, “We live in an era where business ethics and corporate social responsibility have taken center stage all over the world. It’s important for corporations to demonstrate progress in these areas and for business leaders to communicate that progress.”
An overwhelming 84 percent of the CEOs believe corporations that enjoy more respect from the public also enjoy a premium in their share price. “Public companies caught in scandals often see their share prices and overall market capitalization plummet,” explains Kruh. “I would argue that there is a positive association between corporate social performance and financial performance. And it comes as no surprise that corporations worldwide are devoting more resources to building respect in order to differentiate themselves in a positive way.”
Canadian Tire CEO Wayne Sales adds, “Consumers, investors and employees have many choices, and they’ve been disappointed in the business community in recent years, so we must do everything we can to earn their respect and lessen their cynicism.”
Unless otherwise stated, information sources in this article are based on Canada’s ’Most Respected Corporations’ survey
Willy Kruh can also observe corporate priorities from the perspective of an independent professional. “Based on our experience at KPMG, our firms’ clients worldwide are definitely giving high priority to implementing risk
Ensuring the long-term financial health of the company 82% management initiatives and
Attracting and retaining high-caliber employees 68% strengthening their internal controls in order to help ensure the long-term
Customer loyalty growth 64% financial health of their company.”
Increasing productivity and performance improvement 64% On the tenth anniversary of Canada’s
Ensuring trust from shareholders 48% Most Respected Corporations survey,
Risk management 41% two things are clear. First, a corporation worthy of respect can make a positive
Transparency and public reporting 38% difference to customers, employees,
Corporate governance 37% suppliers, regulators and investors – and, secondly, this respect factor
Increasing short-term profitability 30% stays relatively constant over time
Expanding into new markets either inside or outside Canada 28% and across the global scale of today’s enterprises. In the words of Mike
Expanding into new product or services 27% Rake, Chairman of KPMG International,
Growth through merger and acquisition 19%
Priorities for the year The survey also explored CEO priorities for 2005. Eighty-two percent of CEOs held the same top priority as last year, ensuring the long-term financial health of the company. However, “Attracting and retaining high-caliber employees” has become a higher priority, capturing the number two spot. CEOs clearly see a connection between hiring bright people and maintaining aggressiveness in today’s global economy. Mario Pilozzi reinforces this point: “Wal-Mart is a people-driven business, and recruiting and retaining high-caliber individuals will probably always be a top priority for us. Every achievement at Wal-Mart Canada is rooted in our people.”
Wayne Sales explains, “At Canadian Tire, a key purpose for being in business is to create customers for life. To earn the trust and entrench our position as one of the most recommended retailers in Canada means the needs of our customers must always come first.”
François J. Coutu, President and CEO of the Jean Coutu Group, sees many of the listed priorities as closely interrelated. “For example, dedicated and competent employees will help build customer loyalty, and loyal customers will ensure the company’s growth, enabling us to retain high-caliber employees.”
Dedicated and competent employees can help build customer loyalty.
“Great companies do not succeed by concentrating on the bottom line alone. Growth and investment are important, but the world’s most respected businesses all know how much influence that standing allows them.”
For more information about
Canada’s Most Respected
Corporations visit
www.mostrespected.ca.
Willy Kruh is the Partner in Charge of KPMG in Canada’s Consumer and Industrial Businesses practice. Based in Toronto, Willy has over 20 years’ experience as an audit and business adviser to leading consumer markets companies with a presence in Canada, the U.S. and internationally. He also has substantial experience in the areas of mergers, acquisitions, divestitures, initial public offerings and restructuring services to public and private companies in a wide range of consumer markets. He regularly makes presentations at seminars and conferences on topics pertinent to the consumer markets sector.
With the lifting of onerous restrictions that once stood in the way of trade, will foreign consumer goods companies find business in China plain sailing?
It is not necessarily the cheapest place to do business – in fact, other emerging economies compare favorably – but the sheer vastness and scope of the market make China a place where everyone wants to be in business.
China, the world’s most populous nation, officially recorded 1.3 billion inhabitants in January 2000 – the majority between the ages of 20 and 39. Its economy is growing rapidly too. GDP growth in 2003 stood at 9.1 percent; inflation was down at 3.2 percent and per capita wealth in urban areas was RMB 8,472, three times greater than in rural China.1
1: The Economist, China Retail and Distribution:Changes for the Better? An industry report series exclusively written for KPMG in China and Hong Kong, 2004
It is a massive market to tap into. Once barred from operating in China, foreign retailers often found a way in via the back door. But now the front door is wide open.
Going shopping Enter consumer goods companies ready to take on a market that is no longer off limits. As wholly foreign-owned enterprises, they can now manufacture, sell and distribute in China without needing to liaise with a Chinese partner.
Among the first movers are likely to be Western companies with wholesale operations in free trade zones (FTZs) such as the Shanghai Waigaoqiao zone. Permitted to import and manufacture goods within the zone, any after-sales services, such as repairs, were
Changing China The catalyst for change came in 2001 when China joined the World Trade Organization (WTO), earmarked by the lifting of rigid sanctions and the advent of freer trade. By 2003, Foreign Direct Investment (FDI) into China reached U.S.$57 billion.1
The odds, once firmly stacked in favor of overseas hi-tech and manufacturing companies – the desirable industries – evened. In December 2004 came landmark tax decree number eight which gave foreign retailers, wholesalers and traders the green light to operate in China. Instead of tie-ins with Chinese joint venture partners, these Western companies can now officially go it alone as wholly foreign-owned enterprises (WFOEs) with vastly reduced minimum capital thresholds.
But only fools rush in, warn Peter Kung and David Ling of KPMG’s Chinese member firm. “It is a land of opportunity but, before setting up or expanding operations in China, companies should consider how they are structured and where to locate to take advantage of tax efficiencies. Get it wrong and they could pay heavily.”
The company often found that quality and control were out of its grasp.
formerly undertaken by a representative office set up outside the zone for that purpose. The company often found that quality and control were out of its grasp.
But despite the lifted sanctions, there are still very good reasons to stay put within the FTZs:
• Attractive waivers on customs duties and VAT within the FTZ.
• Foreign companies in bonded zones need to run for 10 years to escape payback penalties on tax incentives.
• An opportunity to bide their time, to see what’s going on outside the FTZ, to look at the competition and to build a strategy.
Under tax decree number eight, manufacturers and service companies are now permitted to expand their offerings to include the trade and distribution of goods within China. The catch is that their products must carry the ‘Made in China’ tag. That is fine for the likes of Ikea and casual clothing company Baleno, which can now manufacture own-brand goods and sell them through their own outlets, but not so impressive for label conscious consumers at Armani and Rolex.1
Companies setting up an own-brand business can also buy other manufacturers’ goods and sell them under their own label. Longer term, China can expect to see supermarket and chain store shelves buckling under
Also affected are some of the big names whose goods are already sold in China – Louis Vuitton, Häagen Dazs and many more. Once unable to trade in their own right, they were forced to hand over their operations to contracted agents, giving rise to control and IP issues. Now free to operate and manage their own stores, they are collecting revenue themselves rather than waiting for payments from agents.
However, there’s still an element of Chinese control. Retailers are obliged to fit in with the urban development plan of the markets in which they wish to operate.
For foreign companies, the most common route into China used to be via a representative office, staffed with Chinese and used as a base from which to explore the market or to identify investment opportunities. Taxed on 10 percent of their overall expenses, representative offices are expected to dwindle as retailers, distributors and traders find wholly foreign-owned enterprises a cheaper tax vehicle.
Tax tangle Investing in China, is, for many companies, driven by business rather than tax incentives. However, it is vital to undertake due diligence prior to set up and to consult locally and with tax professionals to make sense of the complex mass of tax laws and reliefs available.
Historically, China has offered tax incentives to manufacturing and hi-tech companies and operated special economic zones with tax breaks for non-trading businesses. Geographic regions had their own incentives for foreign-invested enterprises (FIEs) – in Shenzhen, for instance, a FIE could enjoy a 15 percent corporate tax rate.
Under the new regime, companies will have to weigh up their best options. Do they leave the FTZ or other special investment area and lose their tax incentives, or do they set up their business as they want, where they want and hope that the move will pay off?
Companies also need to watch out for tax mixes. Services are subject to 5 percent business tax; the sale of goods attracts 17 percent VAT. If a company sells goods and provides an after-sale service, it will need to consider the segregation of its income to avoid an unwarranted tax burden.
From 2007, it is likely that a unified tax law will come into effect which could end the preferential tax advantages that foreign investors have over local counterparts. The special tax policies offered in FTZs are also under threat.
For now, Peter Kung and David Ling advocate sitting tight and making the most of the measures in their current form. Decisions must be dictated by individual company circumstances. “If you’re a loss-making company, you may be better off expanding your
1: The Economist, China Retail and Distribution:Changes for the Better? An industry report series exclusively written for KPMG in China and Hong Kong, 2004
operations and taking advantage of the five-year tax holiday to offset the loss against income. But a profitable manufacturer may not want to risk losing its preferential tax incentives by changing its business scope. Better that it sets up a new company than threaten the status of the existing one.”
Before you invest Start by examining your objectives for investing in China and decide whether you are really capable of cracking this market on your own. The sheer size and uniqueness of the country, its macroeconomics, logistics and wealth distribution across rural and urban pockets of consumers mean the need for local advice should not be underestimated.
Know your way around the complex regulations and designated trading zones, each offering different incentives. Decide whether the tax incentives are more alluring and commercially sound than the opportunity to make your own decisions about where you locate and how you structure your business.
Western retailers, traders and wholesalers now share equal rights with their manufacturing and hi-tech counterparts in China. And with them come logistical, supply chain and retailing skills that are very often absent among local players. With the freedom to choose how they move their goods in and out of China, how they make and receive payments, a population of 1.3 billion with money to spend is open to the shrewdest players.
Remember, though, a Western tag does not guarantee success. The world order of brands does not necessarily follow in China and discerning Chinese consumers may be just as happy with a cheaper, locally produced alternative.
Peter Kung is the tax partner in charge of KPMG’s China tax practices in Hong Kong, Guangzhou and Shenzhen. He concentrates on the People's Republic of China (PRC) taxation, customs duty and business advisory matters. He has advised many multinational corporations on how to structure their investment into the PRC and has also assisted numerous clients to negotiate with PRC authorities to help minimize their tax burdens He also has extensive experience in assisting foreign enterprises to establish foreign investment enterprises (FIEs) and other business vehicles to conduct business in the PRC.
David Ling is a partner based in Beijing, and part of KPMG’s Chinese firm. He has over 12 years of tax advisory experience with multinational companies in the areas of tax planning strategies in respect of their investments in China, devising ways to ringfence tax risks and successfully negotiate with tax authorities and the Ministry of Commerce on issues such as tax exemptions or establishment of foreign investment enterprises in China.
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