Tuesday, December 18, 2007

Outsourcing is not necessarily Offshoring

It is interesting how much noise and controversy there is about a topic over which there is so much misunderstanding and that at times is used to stir fear, uncertainty and doubt. This topic is open to being cynically exploited because so many people do not really understand it.

The main confusion surrounds the words outsourcing and off shoring. It is interesting that the two words are used indiscrimately and invariably assumed or interpreted to mean the same or are synonyms. They are not.

One can outsource without offshoring and one can do offshoring without outsourcing. Therefore outsourcing work can be done anywhere in the world including in ones own country.

To outsource a service or a function merely means that one will no longer be performing that service or function within ones own corporation or in house but instead subcontract it out to some organization or company outside ones own.

One of the main objectives of outsourcing is to get something done by someone who is either an expert at that service or function, can do it more efficiently or cheaper or both. The main drivers for outsourcing really came from the need for subject matter experts (SME’s) and achieving critical mass. Another major factor was the increasingly higher investments in plant and equipment required to keep an operation efficient and competitive.

The person who performs the function or service better and more efficiently than anyone else tends to have the most success in the market place.

So what happened that made outsourcing such a popular discipline and changed the world’s traditional business models?

In the 1990’s the market place began ruthlessly demanding lower prices, technology was advancing and changing at an increasingly rapid pace, but the investment necessary to produce all this complicated rapidly advancing technology at lower prices grew out of all proportion and soon became unaffordable for the smaller players.

One of the forerunners of outsourcing was the concept of Original Equipment Manufacturing (OEM). Many companies needed new products in a hurry, that they did not have the facilities for to produce, were operating at full capacity, did not have the money to build or it was not clear whether the product would be successful and worth the investment required.

So they started to look around for producers that had the expertise and could start production of these new products almost immediately at the right price. Therefore many corporations started subcontracting with other corporations to produce these products on their behalf and then stamping their logo on it as if the larger corporation had manufactured it in house.

Also, the combination of an inability to keep up with the investment required to keep an operation cost competitive and the concept of SME’s forced organizations to contemplate their future and look at what their expertise was and what they wanted to be when they grew up. So each company looked at their strengths and weaknesses and focused on their subjects/things that they were expert in and shed/outsourced activities that they knew least about.

Thus the SME component manufacturing focused on component manufacturing, the SME assembly focused on assembling products, the SME transport focused on logistics and so forth in order to attain critical mass and survive.

The transportation industry is an interesting example; you may have noticed that all the big guys now call themselves logistics experts. Whilst looking at their strengths and weaknesses the transportation industry found out that they were experts at moving stuff from place to place (distribution), they further knew that in operating their business efficiently they used hubs, huge ware houses where they sorted picked and packed and shipped their customer’s packages. Thus they were experts in logistics and started to offer their expertise to customers and offered them a bundled value proposition which included warehousing, distribution and logistics.

Bingo! They offered a specialty product of greater value in which they were the SME that would greatly increase the use of all their capital intensive assets in a sector that SME’s in another sector were ready to shed or outsource.

As the above illustrates that outsourcing does not have to be offshoring e.g. FedEx, UPS,Component Suppliers to GM Ford & Chrysler, IBM, ADP Total Source, Paychecks and so on.

Tomorrow I will share with you why offshoring does not have to be outsourcing.

As Featured On Ezine Articles

Monday, December 3, 2007



Tax is relevant to every company and any project of the type of Shared Services Organization) SSO will have to deal with tax issues.

An SSO project is loaded with tax issues, especially when it is international in scope. There can be tax effects also, but in terms of benefits and risks it is important to note that the set-up of an SSO as such is tax-neutral.
Setting up an SSO is not an organizational change triggered by tax-saving potentials.

However, an SSO is often discussed in connection with other organizational changes such as setting up a commissionaire model (also called ‘3P’ or ‘trading company structure’).

The commissionaire model works based on a simple logic: risk brings reward – the greater the risk, the higher the reward will be. Based on this, companies try to manage the risk by moving activities and personnel to a lower-cost country.

The risk of sitting in this lower-tax environment can be taxed there and the overall tax burden is thereby reduced. Because it is necessary to move a number of activities and people physically to the country of the so-called principal company, it is possible and even probable that the location decision for an SSO and the process flows inside the company will be affected by a commissionaire model set-up.

Philosophically, the commissionaire model and SSO fit together just fine, because both are based on centralized provision or control of activities, strict guidelines and documented standardized process flows.

The project of setting up an SSO in parallel with a commissionaire model will have a different twist to it, as the tax-savings target is often the overriding goal and synergies and other efficiencies are seen as a nice-to-have side product.

This is also true for similar models involving stripped-risk entities, buy-sell models and toll manufacturing.

If a trading company is in existence during an SSO project, it is possible that
this will affect the scope of the project.

A country or business unit with a trading company structure might lose significant tax advantages if the structure is changed. It might be, therefore, that the finance and accounting activities are not changed, so as not to endanger the tax model acceptance by local tax authorities, resulting in that country being left out of the SSO.

The main tax benefits achievable for an SSO project are limited to the selection of a location , because some countries offer SSO's special tax treatment.For example, beneficial tax treatment of SSO executives.

Virtual Shared Services Organizations (SSO)

Multinational enterprises are establishing ways to optimize the trading relationships between their different subsidiaries. Central research and production facilities, distribution and warehousing, shared service centers for technical support, marketing, customer service and finance are often providing resources across different entities and countries.

These relationships need to be represented in "Inter-company Transactions". Inter-company transactions represent and document a critical part of the revenue and expense stream for each entity and will influence the tax liabilities in each country substantially.

Commissionaire and Buy-Sell Relationships

Many of our clients are US based enterprises operating subsidiaries in many European and Asian countries. These local companies are the customer-facing entities in each country. In order to realize substantial organizational, administrative and tax advantages these companies have organized their subsidiaries as "Commissionaires" where possible. In other cases, the trading relationships are standard buy-sell arrangements with additional provisions for the centralized services in research, marketing, distribution and finance. The local companies maintain a minimal staff to support the administrative responsibilities of the company and some local marketing activities.

Commissionaire agreements establish the concept of "Deemed" inter-company purchases and sales on which revenue and taxation are evaluated. The locally registered subsidiaries enter into Commissionaire agreement with the "Principal" which allows them to conduct the customer facing business in their own name, while all inventory, operational, and sales risks remain with the Principal.

This model allows the determination of revenue for the subsidiary as an agreed commission rate (the discount rate for the Inter-Company trade). A set percentage of the customer sale is left with the local selling entity.The details of the Commissionaire agreements can vary widely and different country specific regulations may affect the structure and required transactions to be recorded.

In some countries individual inter-company purchase orders are needed for each sales transaction, whilst in others a monthly summary is sufficient. Other requirements may be to assign the customer receivables to the Principal and to record "deemed" inventory receipts at the local entity. At the core, however, is the commission or discount rate, which provides the local revenue. The local revenue covers the operating expenses of the local company and produces a fair proportion of profit for local income purposes.

The Commissionaire approach also needs to be incorporated for compliance with local sales tax requirements. In Europe and Asia these are generally value added tax (VAT) or goods and service tax (GST). The customer sale is made by the local entity. It needs to show the tax appropriate for the selling entity’s location and will depend on where the goods are shipped from and delivered to.

The inter-company sale is made showing the tax of the "Principal’s" country and location, again depending on ship-from and ship-to location.Although Buy/Sell and Commissionaire Agreements are recognized as effective and Tax efficient Trading Models, the full benefits are often only realized when the effort involved in processing and reconciling inter-company activity is efficient and automated.

We have done some of this effectively by modifying Baan systems and or implementing Oracle’s “virtual trader”.