23rd annual health sciences tax conference - ey · 23rd annual health sciences tax conference...

23rd Annual Health Sciences Tax ConferenceTrends in supply chain planning — what’s next and how changes could impact existing structures

December 9, 2013

Trends in supply chain planning — what’s next and how changes could impact existing structures

Disclaimer

Any US tax advice contained herein was not intended or written to be used, and cannot be used, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions.


Disclaimer

EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. Ernst & Young LLP is a client-serving member firm of Ernst & Young Global Limited operating in the US. For more information about our organization, please visit ey.com.This presentation is © 2013 Ernst & Young LLP. All rights reserved. No part of this document may be reproduced, transmitted or otherwise distributed in any form or by any means, electronic or mechanical, including by photocopying, facsimile transmission, recording, rekeying, or using any information storage and retrieval system, without written permission from Ernst & Young LLP. Any reproduction, transmission or distribution of this form or any of the material herein is prohibited and is in violation of US and international law. Ernst & Young LLP expressly disclaims any liability in connection with use of this presentation or its contents by any third party.Views expressed in this presentation are not necessarily those of Ernst & Young LLP.


Presenters

Karen HoldenErnst & Young LLP5 Times SquareNew York, NY+1 212 773 [email protected]

AnaMaria RomeroErnst & Young LLP5 Times SquareNew York, NY+1 212 773 [email protected]

Antoinette LagerwijErnst & Young LLP370 17th StreetDenver, CO+1 720 931 4430 [email protected]

Donald E. WhittVice President — Tax PlanningPfizer [email protected]

Jeffrey H. HoltzTax Director — Global Supply ChainMedical Devices and Diagnostics

Global Services, LLCJohnson & [email protected]

Supply chain transformation trends


Understanding the strategies and changes within the current life sciences landscape

Geographic mix is changing

Current operating models limiting opportunities for growth

Operating model evolution toward more globally aligned functions

The changing business landscape for life sciences companies continues to evolve. As a response, companies are striving to improve shareholder value, maximize margin and reduce cost. One area of transformation has been supply chain business processes. The operational benefits of these changes also include aspects of tax planning to maximize value to the company.Drivers for supply chain transformation

Platform to drive end-to-end process improvement

A new or revised existing structure is emerging as the platform to drive efficiencies and increased effectiveness across global business functions.Tax-effective supply chain structures are beginning to include strategic functions such as S&OP, supply and demand planning, global quality and inventory management.

Many companies have moved toward operating models with a matrix organization that includes global functions that cut across the business units (BUs) (e.g., sales and operations planning (S&OP), procurement, supply chain, manufacturing, commercial).They are focusing on innovation, driving lower costs and operations improvement through the centralization of functional expertise and leading practices.

Legacy operating models were not designed to be efficient, resulting in increased costs to keep pace with growth in demand; cost reduction initiatives are imperative as companies face more generic competition — generics market share is expected to be 39% by 2015 vs 20% in 2005 (source: IMS Health).Companies are balancing global decision making with regional priorities and opportunities.Increased bargaining power of integrated provider networks, governments, payers and individuals has exerted pressure on pricing and therapy options, disrupting the traditional operating model.

The contribution of emerging markets in terms of sales, volume and profit will continue to grow significantly. Sources of revenue are shifting from the US and Europe to Asia and Latin America.There is an increasing need to balance the capabilities of resources and skills to confirm that the relevant expertise is deployed in the regions to keep pace with these changes in geographic mix.


The evolution from supply chain to value chain is driven by integration and significant operational and financial benefits

Operational benefitsHow an integrated business structure adds value

Integrated supply chain management leads to more effective and efficient business transformation.The business change process creates visibility into changing market demand and centralizes key decisions.The structure integrates tax considerations to acknowledge that management is focused on maximizing shareholder value.Product costs are reduced by integrating customs planning in the value chain management design.Tax-effective financing techniques make certain that cash flow is freely accessible within the company.

Aligned organizationClear governance and performance managementImproved customer service relationships

Financial benefits

Reduced operating costsMore effective use of assets and working capitalOptimized effective tax rate

Reduced business risk

Better control over audit risk Improved compliance and governanceManaging conversion risks Better control over value chain risk


Many large pharma and device companies have implemented principal supply chain operating models

These companies have captured significant value through structures such as the one conceptually captured below.

USCoLicense

Principalcompany Logistics hub

Tollmanufacturer

(finishing)

MarketingCo

API/ device

Tolling services

Finished products

Customers

Finished products

SuppliersRaw materials

IP

Manufacturing locations Supply points

Marketing/ distributionR&D

Puerto Rico

Ireland

Singapore

APAC

LATAM

EMEA

Industry changes along the value chain require a review of these existing structures.

1

2

3


Changes to the value chain

Manufacturing

Redundant services and supply chain

flows

Commercial

Move to outsourcing manufacturingThe relative value of manufacturing is changing as more companies outsource the manufacturing function in an effort to remain cost competitive as generics flood the market.The traditional supply chain model has been functionally focused, with manufacturing typically driving the decision-making process — decisions were focused on local or regional objectives rather than global efforts.Traditional principal company planning was aligned with the supply chain model and principal function was often located at the manufacturing location.

There is a move to centralization of functions, including supply chain (e.g., sales and operations planning, logistics).Centralization is generally occurring across BUs or BUs are separated and the model replicated.

Challenges to limited risk distributor modelsReimbursement issues


For key categories (e.g., directs, logistics), the following activities could be centrally managed:

Approve all category strategies and supplier selection criteriaApprove an annual procurement material plan, including material pricesProvide oversight on sourcing strategy execution

Category management

As part of having a centrally managed sourcing function, the following SRM activities can be managed:

The execution of the SRM programThe management of Tier 1 and Tier 2, and select some of the Tier 3 suppliersSuppliers to both toller and turnkey manufacturersSupplier issue resolutionCost optimization of suppliers’ value chain through process improvementIdentification and execution of supplier-enabled innovation opportunities

Supplier relationship management

(SRM)

Within a centrally located sourcing team, you can also:Standardize processes for compliance with negotiated contracts and buying channel strategyConduct periodic reviews of site purchase price variances (PPV) reports, and lead follow-up actionHelp resolve invoice quantity and price mismatch issues when escalated by site procurement/business owners

Requisition to pay

Sourcing/procurement (including third-party manufacturing) in the new value chain model have key activities that should be considered


Tax and transfer pricing implications

Transfer pricing implicationsAs sourcing/procurement evolve into a value-added function in the new value chain model, compensation for these activities should be reconsidered.Traditional sourcing/procurement functions included demand aggregation and sourcing services. These functions have generally been compensated through the following different mechanisms (or a combination thereof):

Commission based on spendPercentage of total savings realizedCost plus based on sourcing/procurement cost basis (excluding spend procured)

From a value-chain perspective, sourcing/procurement has transformed to a value-added function that contributes to revenue and profit, thus a value-based compensation model may be more appropriate.

Tax implicationsSubstantial contribution based on involvement with third-party suppliers

Process engineering/process improvementPartnering for supplier-enabled innovationSupply planning Inventory management


There is an opportunity to capture additional operational benefits by expanding the functional activities that are covered by the operating model

Manufacturing and operationsPlant network and contractUtilization and capacity

Sourcing and procurementLocal site procurement and transactional activities

Logistics and distributionLocal inbound and outbound operationsLocal trade and freight forwarding

What is often in principal today Global operations

Operating entities with key brands under patent protection

FinanceInformation technologyLegalPublic affairsEnvironmental, health and safety (EH&S)

Logistics and distribution

Research and development

Global manufacturing services/quality

Sales and operations planning

Commercial

Illustrative example from other life sciences companies for discussionWhat is being added

Discounts and promotionsCompetitive bidding/tenders

Customer pricingCredit policy and terms

Operating model (business unit level)

Local operationsRegional operations

Demand/supply planningForecasting/inventory management

Management reviewsFinance/commercial reconciliation

BU1 BU3BU2 BU4 BU5

Sourcing and procurement



Transfer pricing considerationsSimilar to procurement/sourcing functions, compensation for these functions should be evaluated to determine if they should be priced as cost plus services, as a value-based fee or included in the overall principal remuneration. Pricing for these activities should also consider regional vs global contributions to the value chain.

Tax considerationsCharacterization of income as services or sales income depending on facts and circumstances


Adding additional activities and roles can increase the governance of certain accounting and finance processes.Key roles can review financial goals for each region/market (annually and quarterly).These key roles can manage credits risks, issue credit policies and guidelines.These roles can actively support the governance process and request financial data to verify compliance with issued guidance, procedures, etc.

Increased governance

Key finance areas can also be considered so that governance and compliance processes can effectively support the operating model

Annually, LE budgets will be developed in order to calculate updated transfer prices.A process will be defined to monitor LE profitability compared with targets; true-ups will be calculated and posted as necessary.

Legal entity (LE) budget and profitability

monitoring/true-ups


There are a number of commercial activities that can enhance the value of the operating model

The centralization of global demand and supply planning increases the oversight and governance of demand planning through a formal sales and operations planning process.The centralization of inventory strategy and management (e.g., min, max, safety stock, lead time, Days on Hand (DOH), turns) allows for global coordination and oversight of critical supply chain planning parameters.Global strategic objectives and operational mandates (e.g., forecast accuracy, lost sales, service levels) can be established and stipulated from a centralized location.Inventory allocation decisions can also be coordinated centrally to enhance value and add substance to the operating model.

Demand planning and inventory management

The review and approval of regional/market strategies and events can be coordinated globally for the regional/market marketing strategy and events.Also, the following activities can be performed:

Review and approve market research proposalsCross-pollinate competitive intelligences and market research results across marketsApprove regional recommendations for geographic product expansionCommunicate with new product management and research and development regarding life cycle management plans

Marketing and product management

activities

Set pricing targets, review and approve pricing recommendations and targets.Pricing



Transfer pricing/tax considerationsSustainability of limited risk distributor (LRD) model for certain marketsPricing implications for reimbursementAlignment between commercial and supply chain for certain functions (e.g., demand planning)


Challenges — where is your company in the continuum?

Jeff & Don to discuss their experienceAMR/Karen/Matt to discuss EY experiences

Leading practices in principal company governance


To keep pace with the evolution of leading practice principal supply chain structures, we have developed compliance guidelines and operational metrics to support adherence with the operating model

90

80

70

60

50

402012-Jun

2012-May

2012-Apr

2012-Mar

2012-Feb

2012-Jan

Compliance guidelines — process compliance

Operational metrics — site/market performance

Monitored monthly, compliance guidelines facilitate that key decisions such as S&OP exceptions, supplier contracting and operational issues are being made by the principal.They indicate if a site or market is in accordance with compliance guidelines (e.g., production schedule adherence).

Exceptions are escalated to the principal as they occur, plus a formal monthly review of the operational performance of sites and markets to acknowledge they are meeting performance parameters set by the principal.This helps to determine that the sites and markets are functioning efficiently and effectively (e.g., forecast accuracy, days inventory on hand).

Compliance guidelines and operational metrics are used together by the principal to drive strategy within the sites and markets. Together, these two tools support compliance with the principal’s guidelines so that sites and markets are aligned with management processes, function efficiently and effectively and meet agreed service levels.

Demand forecast submittal — Ex. compliance guideline

Reviewed and

approved by principal

Market is not compliant

Yes

No

Forecast error — Ex. operational metric

ToleranceEscalate toprincipal

Demand plan

amended by market

Market is compliant


We started with metrics that are centrally supported and managed today and selected those aligned to the model

Operational metrics will be used by the principals to monitor the performance of sites and markets. More than 80 metrics were reviewed and narrowed to a list of 15 reliable, action-oriented measures to drive the right behaviors and support compliance with principal guidelines.

Operationalmetrics

Centrally reported metrics

Critical operational metrics identified that measure key business process performance

Operationalfocused metrics

identified

Metrics reviewed with stakeholdersOperational focused metrics were reviewed

with stakeholders to determine validity

Metrics were reviewed and operational focused metrics identified

Centrally reported metrics were collected through various scorecards and dashboards


To provide focus and alignment with critical principal guidelines, compliance measures target specific principal functionsOperational metrics will be used by the principal to monitor the performance of sites and markets. The recommended compliance guidelines are tailored to the company’s fulfillment model and will measure if the sites and markets are “living the principal structure.”

Process area Itemno. Compliance guidelines Operational metrics

Planning

1 Demand plan submitted to principal monthlyPercent in stockForecast errorForecast biasInventory valueInventory turnover

2 Transportation plan submitted to principal monthly3 Supply constraints submitted to principal monthly4 Capacity constraints submitted to principal monthly5 Rough cut capacity plan submitted to principal monthly6 Supply chain agreements adjustments approved by principal

Procurement 7 Substantial direct material contracts executed by principal Percent spend on POs not signed by principal

Number of POs with spend >US$10k not approved by principal8 Purchase order (PO) quantity changes from plan

Global logistics and supply

9 Transportation plan adherence Distribution cost as percent of salesDistribution cost per unit shippedShipments not delivered on time (%)Shipments not delivered full (%)10 All inter-transfers approved by principal

Manufacturing

11 Master production schedule adherence Right first timeBoard of Health (BOH) commitmentsBudget varianceCritical findings

12 Material requirement plan adherence

13 Excess and obsolete inventory management costing performed at principal

Information flow to principal Plan adherence Other compliance

check


The recommended guidelines and metrics are aligned with activities that are critical to establish principal oversight

# Supply chain gov. activity Compliance guidelines Operational metrics

1Finished goods planning/manufacturing

Demand plan submitted to principal monthlyCapacity/supply constraint submission guidelinesMaster production schedule adherence guidelinesSupply chain agreements adjustments approved by principal

Percent in stockForecast errorForecast bias

2 Intermediate goods planning/manufacturing

Capacity/supply constraint submission guidelinesMaster production schedule/material requirement plan adherence guidelinesSupply chain agreement adjustments approved by principal

Forecast errorForecast bias

3 Direct materials sourcing

Substantial direct material contracts executed by principalPurchase order quantity changes from plan

Percent spend on POs not signed by principalNumber of POs with spend >US$75k not approved by principal

4 Manufacturing cost management

Excess and obsolete inventory management costing performed at principal

Budget varianceInventory valueInventory turnover

5 Logistics

All inter-transfers approved by principal Transportation plan submitted to principal monthlyTransportation plan adherence

Distribution cost as percent of salesDistribution cost per unit shippedShipments not delivered on time (%)Shipments not delivered full (%)

6 QualityRight first timeCritical findings


To improve operational efficiencies and compliance, principal guidelines have been embedded in our ways of working

Mar

ket

Prin

cipa

lSi

te

Statistical DemandForecast (Logility )

Review and Adjust Statistical Forecast

Proposed DemandForecast

Demand ReviewReview and Approve Amended Forecast

CG1

Review Distribution Requirement Plan

Capacity Constraints

Supply Constraints

Supply ReviewReview and Approve

Amended Plans

CG3

Operational Meetings – Principal/Market/Site CG11 CG12

Transportation Plan

Review and AmendProposed

Transportation Plan and

Rough Cut Capacity Plan (RCCP)

Management BusinessReview

CG4

Metrics Consolidation

CG9CG8

GovernanceDashboard

Operational Metrics

D&

OP

EscalatedIssues

Proposed RCCP

AmendedTransportation Plan

Amended RCCP

CG6 CG7 CG10 CG13

ApprovedTrans. Plan

CG2 CG5

Distribution Requirement Plan


90

95

100

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

Tolerances for operational metrics will be set based on historical performance and stakeholder interviews. Determining meaningful tolerances for the operational metrics will enable the principal to manage the performance of the supply chain and minimize the impact on operations.

Operational metric: percent in stock Definition: percent in stock = 1 — [total days out of stock/(total # stock-keeping units (SKUs) X total days in month)]

Illustrative example

Performance tolerance 96%

Escalated to principal

% in stock performance

90

95

100

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

% in stock performance

Performance tolerance

97%

Exception tolerances have been developed to minimize the impact to business operations and meet principal guidelines

Out of stock = if inventory falls below the forecasted one day of inventory Total days in month = total sales days in the month


Tax controversy

Recent audit experiences for substantial contributionInformation requested as part of informal document requests (IDRs) but most audits have focused on transfer pricingClient experiences

Questions?

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