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I N DU STR I A L MA R K E T S




New Markets
Cost, insight and opportunity




KPM G I NT E R N A T I O N A L
“You may not be able to get the results
 you want today in China, but the point
 of being there is this: whoever wins
 in China in the next 5 years will
 win in the next 100 years.”
 – CFO, a U.S. industrial and 

 construction machinery maker.
New Markets: cost, insight and opportunity 1




Foreword





How do companies seek to increase and secure
value from operations in new markets?


Companies often ask KPMG                         new markets, as seen by CEOs and             and value in terms of ability to deliver
member firms to help them compare                CFOs at some of the world’s biggest          sustainable profits in the markets and
themselves with their peers. The                 manufacturers. Using an extensive            businesses of the future. The survey
Global Manufacturing Benchmark                   series of telephone surveys and              concentrated on value in four specific
Survey was designed to meet this                 personal interviews with companies           areas: risk, regulation, compliance,
need. This survey compares value                 in the automotive and industrial             and new markets. In the absence
creation and preservation in                     products sectors, executives at 269          of a commonly accepted definition
269 manufacturing companies with                 manufacturing companies were asked           of corporate value, the survey does
global operations and allows each                to cite their key concerns about new         not define ‘value’ itself. Instead it
participating company to generate                market operations – whether selling          measures a number of underlying
a unique comparison of their                     in, manufacturing in, or sourcing from       performance and operational indicators
performance with peers in their own              new markets – and then go on to              which together form a database from
industry, as well as across industries.          break down these areas of concern            which companies can draw conclusions
                                                 into detailed specific management            about value creation.
As part of a recent wide-ranging survey          challenges over the next five years.
of large manufacturing businesses
across the world1, KPMG International            Today, companies are focused on the
created a new objective score of                 increase of value – both present-day
how corporate value is derived from              valuation in corporate asset markets,




                                                                          Bill Kimble                           Uwe Achterholt
                                                                          Global Chair, Industrial Markets      Global Chair, Automotive
                                                                          KPMG in the U.S.                      KPMG in Germany


1 KPMG’s Global Manufacturing Benchmark Survey, 2008
2 New Markets: cost, insight and opportunity




New Markets:
cost, insight and
opportunity



Companies surveyed report that responding to the
challenges of new market competition and the opportunities
of new market production and sales are top of the business
agenda now and for the foreseeable future.


Manufacturing companies agree that               Companies were asked: which of these is
the reason for that interest is growth:          the main business growth strategy for your
the big four new markets (Brazil,                company over the next five years?
Russia, India and China, – the ‘BRICs’)
are growing at between two and five             100%
times the rate of growth in the older            90%
industrial economies – while many                80%
manufacturing companies are positive             70%                                                                          Automotive equipment
about manufacturing in Brazil, India and         60%                                                                          Automotive components
China, they remain cautious or neutral           50%                                                                          Industrial manufacturing
on the prospects for manufacturing               40%                                                                          Aerospace
investment in Russia. The view of a              30%                                                                          Metal industry
                                                 20% 
                                                                        Other
European industrial products group
is typical: “for us Brazil is expanding,         10% 

China is expanding. India probably                0% 

                                                                  Enter new
                                                                   countries




                                                                                            Gain new
                                                                                        customers in
                                                                                   existing countries



                                                                                                                  Sell more
                                                                                                                products to
                                                                                                        existing customers




will be expanding. Russia is a maybe.
The issue with Russia is that Russian
customers need to make a technology
leap if they are going to buy from us”.

Companies report that their growth
                                                 Source: KPMG International 2008
strategies are more concentrated on
winning new customers and new
business in existing markets than on           Brazil, Russia, India and China as
entering new markets. However, in              existing markets (as suggested by
interviews, companies stress that in           the above graph).
many cases they are already active
in new markets, and therefore count
New Markets: cost, insight and opportunity 3




Two issues dominate corporate               Manufacturing in low-cost east Asia –                                       A large Indian auto parts maker with
concerns regarding sourcing from or         especially China – is more problematic,                                     global auto customers adds that
manufacturing in low cost economies:        although several companies argue that                                       “on quality, we consider India to be
cost and quality. Some companies            quality failings are often the fault of the                                 as good as it can be. China is not so
surveyed also voice concerns about the      manufacturer rather than the location.                                      good, but training and investment will
challenges of managing through joint-       The CFO of one large east Asian auto                                        push that quality up. There is no doubt
venture approaches, but these are in the    components maker says that his                                              that quality is the biggest challenge in
minority as most companies report that      company remains reluctant to commit                                         low-cost country sourcing, and getting
the manufacturing that they consider        to manufacturing in China on quality                                        and keeping the right skills is the next
critical is almost always accomplished      grounds: “quality is very important to                                      most difficult issue”.
through wholly owned subsidiaries.          a manufacturer in our business.
                                            We make things like brakes – these
New Markets: quality challenges             are critical components that lives
Many companies surveyed remained            depend on. We would do a lot more
concerned about the achievement             manufacturing in low-cost locations if
of quality in emerging market               we could be sure of the quality”.
locations. However, companies
with manufacturing operations in              Companies were asked: are you engaging in,
intermediate cost locations – such as         or considering, low-cost country sourcing for
economies on the European periphery –         production?
frequently report very positive results
on both cost and quality. “We have
more quality issues in high-cost
                                              70%
countries than in low-cost countries,”
says one European industrial machinery        60%
maker. “We make all our critical              50%
                                                                                                                                             Automotive equipment
components in places such as the              40%                                                                                            Automotive components
Czech Republic and Portugal: we have          30%                                                                                            Industrial manufacturing
low cost and the highest quality.”
                                              20%                                                                                            Aerospace
And this company adds: “achieving                                                                                                            Metal industry
                                              10%
quality from low-cost markets is entirely                                                                                                    Other
dependent on how long you have had             0%
                                                              Considering



                                                                                    Engaged in –
                                                                                but only recently



                                                                                                    Engaged in – for
                                                                                                      several years


                                                                                                                                   Neither
                                                                                                                                engaged in
                                                                                                                           nor considering




to manage the issue”.




                                              Source: KPMG International 2008
4 New Markets: cost, insight and opportunity




Many companies report that achieving           Some companies, especially those                          less concern. “Labor costs may be
quality from low-cost manufacturing            domiciled in emerging markets, are                        rising in low-cost countries, but the
depends less on location and more on           concerned about the relative rise in                      absolute differential between low-cost
recruitment, training and error correction.    emerging market direct labor costs.                       and high-cost is still increasing,” says
“The fact is people always want to             “The rise in Indian labor costs means                     a European industrial and automotive
improve: look at manufacturing in a            that a huge advantage is becoming                         products group. “For us it is still the
location like the Czech Republic, and          a smaller advantage,” says an Indian                      case that Germany is seven times
how passionate they are about achieving        automotive components group.                              more costly than the Czech Republic.”
quality levels,” says a European               “Even for a company that50% a large
                                                                           has
industrial products group. “You must           labor pool to draw upon, it is still an
never underestimate the work ethic             emerging problem.” For companies
and the motivation of your partners.”          domiciled in western Europe and the
                                               U.S., relative cost increases are of
New Markets: cost and
productivity challenges
Almost without exception, companies
report that productivity rather                  Companies were asked how significant
than direct labor cost is the key to             low-cost country sourcing was in terms
profitable manufacturing operations              of cost and quality on a scale of 1-5
in new markets. “Labor costs are
                                                      50%
not increasing,” says a large Indian
auto components maker with global                     40%
customers. “The cost per person is
increasing, but so is productivity –                  30%
so overall there is no cost increase.”
                                                                                                                                                                                           Cost
                                                      20%                                                                                                                                  Quality

                                                      10%

                                                        0%
                                                                                                           1 Worse quality than
                                                                                                                local sourcing
                                                                                                                                  2 Somewhat worse quality
                                                                                                                                        than local sourcing
                                                                                                                                                                     3 The same quality
                                                                                                                                                                       as local sourcing
                                                                                                                                                              4 Somewhat better quality
                                                                                                                                                                    than local sourcing
                                                                                                                                                                   5 Better quality than
                                                                                                                                                                          local sourcing
                                                                                         5 Significant
                                                                                           reductions
                                                                   1 No cost reduction




                                                 Source: KPMG International 2008
New Markets: cost, insight and opportunity 5




KPMG comment





Beyond low-cost manufacturing              KPMG firms believe there are three          • Implementing corporate social
Companies should treat low-cost            critical issues for global managers.           responsibility. The global networks
manufacturing solutions as part of                                                        of manufacturers are getting more
a larger strategy that embraces            • Identifying true cost. Traditional           complex, and more challenging
the total supply chain. Low-cost              manufacturing operations do                 to manage. One dimension of
manufacturing is not a strategy that          not represent the greatest cost             this complexity is the difficulty of
should be pursued in isolation: today         or risk areas for companies that            implementing the corporate social
companies need to understand that             see themselves primarily as                 responsibility agenda. Companies
as their operations grow increasingly         manufacturers. People often assume          that focus on manufacturing costs
global, the risk and opportunity profile      that manufacturers’ greatest costs          alone without considering the impact
of their supply chain operations has          are in labor, whereas in fact, the          on their CSR agenda are not truly
grown correspondingly complex.                greatest costs are associated with          optimizing costs or managing risks.
                                              distribution and logistics. These are       Driving the efficiency of processes
Companies surveyed for this report            also areas which are most likely to         through lean manufacturing or Six
say that new market access is more            be fully outsourced, which itself           Sigma is fine, but companies need
important than low labor costs; that          creates risk. Companies should ask          to take a broader and multi-faceted
there is no obvious correlation between       themselves whether they understand          approach that sees operations in the
labor cost and quality; and that there        the true risks in distribution and          global context.
are no hands-off management solutions         logistics.
in new markets. These are just some                                                    Companies that do understand the
of the indicators of the fundamental       • Choosing and using information.           wider risk and cost implications of
challenge of globalized operations.          When companies expand operations          globalized operations can be shown
Operating with a global footprint            globally, managers need access to a       to achieve a higher level of profitability.
can increase risk very significantly.        much wider base of information than       But taking the holistic view is not easy.
Companies should find new ways               when they operate in tried-and-tested     Many companies can find it difficult to
of understanding and managing                markets. How companies gather and         step outside their own world. However,
those risks.                                 collate and analyze information is        when you are committed to a path that
                                             becoming a critical issue. This is not    inevitably leads to greater complexity,
How should companies integrate low-          a technology challenge. The issue is      you should also have internal and
cost manufacturing into a larger total       knowing what it is that companies         external perspectives if you are going
supply chain strategy?                       need to know, being able to analyze       to manage that complexity.
                                             it and act on it.
6 New Markets: cost, insight and opportunity




However, in interviews, companies               investments remain on hold. This view                However, one U.S. construction
said that labor availability, flexibility and   is supported by research from the                    machinery maker considers
productivity in emerging markets were           World Bank2, which shows that despite                that industrial and automotive
more important than direct labor cost.          Russia having one of the world’s most                manufacturers can protect their
“Labor is not an issue for us,” says an         highly educated workforces, industry-                intellectual property more easily than
Indian industrial products manufacturer         specific skill shortages remain the                  other businesses. “The Chinese are
with global clients. “In Hyderabad              second most important constraint on                  very entrepreneurial, and there is a real
we have flexible hiring – we can hire           growth (after tax levels) according                  competitive threat there,” says the
somewhere between three times                   to 1,000 large and medium sized                      CFO of this company. “But we are less
and five times our current workforce            companies surveyed by the World                      worried about the intellectual property
without difficulty, tomorrow if we want         Bank.                                                issue than say a consumer goods
to. That is the essential advantage in                                                               company – it is pretty difficult to
being in a location like this.”                 Intellectual property in new markets                 hide a big tractor factory.”
                                                Is there a special threat to companies’
A European industrial products and              intellectual property (IP) in emerging               When asked in KPMG’s Global
automotive group concurs, saying “it is         markets? Some companies believe so:                  Manufacturing Benchmark Survey
not really fair just to focus on cost –         “I think there is an issue with intellectual         about overall new market risks, supply
you have to look at flexibility. When           property rights in China, and also in the            chain management, transport and
it comes to low-cost countries’ labor           Czech Republic and in Poland,” says                  quality assurance were assigned
cost increases, you have to factor in           one European automotive components                   more importance than IP by the full
the greater impact of productivity              manufacturer. Such concerns are                      sample of surveyed companies. Those
improvements in those countries,                shared globally. A Korean automotive                 companies that did identify intellectual
that outweigh direct-cost increases.            manufacturer also comments “there is                 property as challenging, considered
Plus you have more labor flexibility            no question, we are concerned about                  that understanding intellectual property
and often a superior work ethic”.               intellectual property when it comes to               protection and formulating intellectual
                                                outsourcing manufacturing. That is                   property protection were the leading
However, in interviews some                     why manufacturing that is critical from              challenges.
companies caution that localized                a business point of view is kept
skills shortages will continue to               in-house. And when we go overseas
inhibit investment in certain large             to manufacture, we go with someone
emerging economies: one large U.S.              that we know”.
headquartered global automotive
manufacturer comments that
localized skill shortages in Russia
remain so acute that some large plant


                                                2 Skills Shortages and Training in Russian Enterprises, World Bank May 2007.
New Markets: cost, insight and opportunity 7




KPMG comment





Intellectual property protection           In Asia there is not necessarily the           The combination of public lobbying,
remains unfinished business                same transparency, and everyone                private enforcement actions, and
Companies that participated in our         feels that they have a right to profit.        incentive-based management of
Global Manufacturing Benchmark             It is true that there are many cases           IP-sensitive relationships can ameliorate
Survey did not assign intellectual         where companies do not understand              risks to intellectual property for
property (IP) a very large weighting       the terms of contracts, but there              manufacturers. As emerging economies
relative to other concerns. However,       are also many cases of intentional             become more mature, they are drawn
companies should be aware that public      misreporting.                                  into the global business network and
policy lobbying as well as IP protection                                                  respect for law and intellectual property
strategy remain important issues for       But while many companies do                    tends to improve. But companies have
companies with global manufacturing        achieve a measure of IP protection             to remember that it is up to them
operations.                                by pro-actively pursuing infringements         to ensure that respect for IP makes
                                           of their property rights, public policy        business sense to their partners.
Companies extending operations             lobbying is also valuable. This is not
into new markets still need to ask         just an issue for the courts, it is a broad
themselves whether it is reasonable        governance issue. If companies do not
for them to expect their intellectual      all tackle the acceptance of IP violations,
property rights to be respected. IP        then business may just degenerate
issues are becoming more important         into a free-for-all, where only the ‘fast
as supply chains have become more          followers’ are rewarded.
globalized. Companies should be
seeking global consistency on IP,          Companies can also work to reduce
and it does not appear they are            IP risks by building rewards for
there yet.                                 IP compliance into contracts with
                                           manufacturing partners. There is
Companies concerned about IP risks         already a recognition in Asia that lack
cite China and some eastern European       of transparency can be an obstacle
locations as new markets where risks       in developing business relationships.
are highest. Businesses entering Asian     Some companies grade their suppliers
markets should be aware of a higher        on issues like transparency, and
level of IP risk, especially when it       suppliers are aware of this.
comes to manufacturing outsourcing.
8 New Markets: cost, insight and opportunity




New Markets: managing operations                 Companies were asked: which are the biggest risks
                                                                                                 QB4

Companies surveyed agree: the                    or challenges in low-cost country sourcing?
quality of management of new
market operations is critical. “Low             100%
cost country manufacturing has to be             90%
hands-on,” says a U.S. automotive                80%
components maker. “The difficult part            70%
                                                 60%
of it is not running the manufacturing,
                                                 50%
it is establishing and maintaining the           40%
relationship. But if you don’t do it             30%
yourself and rely on a third party, you          20%
are likely to fail. You have to be there,        10%
you have to know people by name –
                                                  0%
                                                          Intellectual
                                                             property
                                                                         Labor cost

                                                                                      Material costs
                                                                                                       Warehousing/
                                                                                                       infrastructure
                                                                                                         General and
                                                                                                       administrative
                                                                                                                        Tax benefits

                                                                                                                                       Transport
                                                                                                                                                         Customer
                                                                                                                                                   responsiveness
                                                                                                                                                      Supply chain
                                                                                                                                                     management
                                                                                                                                                           Quality
                                                                                                                                                        assurance
                                                                                                                                                                     Other
it is the only way to make it work.”

Some executives interviewed
for the Global Manufacturing
Benchmark Survey commented that
underestimation of the management                 Source: KPMG International 2008
challenges of successful low-cost
country operations is common,
                                               Companies may also underestimate                                                         However, the same companies agree
especially in China. For example, a
                                               customer risk when manufacturing                                                         that the risks and challenges of long-
Korean auto components maker says
                                               for local customers. “The challenge in                                                   term investment in new markets, and
“some people think you can just move
                                               China is not to do with manpower,”                                                       especially in China, are justified by the
to China and make the same stuff
                                               says a European industrial products                                                      potential returns. “You may not be
cheaper, but unfortunately that is not
                                               group. “It is customer risk –                                                            able to get the results you want today
how it works. It actually takes a huge
                                               establishing what customers want to                                                      in China,” says the CFO of one U.S.
commitment to develop a capacity for
                                               buy and then actually being able to                                                      industrial and construction machinery
quality in a location like that. This is
                                               deliver it. The customer may place an                                                    maker. “But the point of being there
something that creates a lot of tension
                                               order in good faith, but when it comes                                                   is this: whoever wins in China in the
in a lot of companies”.
                                               to shipping it they may suddenly not                                                     next five years will win in the next
                                               have the money – often because of                                                        100 years.”
                                               some government policy change.
                                               It is not a question of how you
                                               manufacture, it is all a question of
                                               how you serve the market.”
New Markets: cost, insight and opportunity 9
10 New Markets: cost, insight and opportunity




New Markets:                                    Companies were asked: how do
investment approaches                           you plan to enter new countries?
Results show that most companies
in the survey sample prefer wholly-             100%
owned investment approaches to                   90%
joint ventures or entering through               80%
third parties.                                   70%
                                                 60%
These results were confirmed in                  50%
detailed interviews. “My personal                40%
                                                                                                                                                         QC7
view of joint ventures is that I dislike         30%
them,” says a European automotive                20%
components group. “The agreement                 10%
process takes far too long. You have              0%




                                                                                                                                   Joint venture
                                                             Wholly owned
                                                               operation –
                                                               acquisition

                                                                                              Wholly owned
                                                                                                operation –
                                                                                                 green field


                                                                                                                   Through a
                                                                                                                   third party
to make compromises. And often
enough the outcome is not what you
expect or need, especially in terms of
product quality.” And this company
adds that quality problems go beyond
the product itself: “with joint ventures        Source: KPMG International 2008

there are likely to be problems with
the quality of the whole process. One
hundred percent ownership is better             Companies were asked: what are the main                                           QA10 TAX SAV

in itself, but that takes more time and         benefits of participating in joint ventures?
more cash”.
                                                100%
Other reservations about joint venture           90%
approaches included the reduced                  80%                                                                                   High performers
potential for rapid expansion of the             70%
business, or rapid exit from the market.         60%
“The issue is not cost, the issue is             50%
people and control,” says an east                40%
Asian automotive components maker.               30%
“Without full ownership it is really just        20%
too much of a headache when the day              10%
comes when you want to do some                    0%
                                                                                             Understanding
                                                                                            of local practice
                                                            Market access

                                                                            Reduced costs
                                                                                                  Learn from
                                                                                                local partner



                                                                                                                Other



                                                                                                                          Regulatory
                                                                                                                        requirements
                                                                                                                                            Sharing
                                                                                                                           Increased
                                                                                                                               speed




                                                                                                                                        technology




major expansion.”

When asked what are the main
benefits of a joint-venture approach in
new markets, those companies that
                                                Source: KPMG International 2008
did favor this approach cited market
access and learning from the joint
venture partner over increased speed
of operation, dealing with regulatory
requirements, or the opportunity to
share technology.
New Markets: cost, insight and opportunity 11




KPMG comment





The return of the joint venture?               Data from Thomson Financial shows
The majority of companies interviewed          that the recent increase in joint
or surveyed for this report say they           ventures is not just a result of greater
prefer not to engage in joint ventures:        cross-border activity overall. When
they consider that joint ventures              taken in conjunction with the number
have a higher risk of failure than             of strategic alliance deals announced,
either acquisition or wholly owned             the total of joint venture and strategic
investment. Yet experience suggests            alliance activity has been reasonably
that the relative advantages of a joint-       flat for six years, hovering between
venture approach may be increasing.            4,000 and 5,000 deals. In the latter
                                               three years though, joint ventures have
The joint-venture approach to new              been steadily gaining on their strategic
market expansion has suffered a marked         alliance counterparts and now account
decline in popularity over the last six        for 36 percent of the total, as opposed
years, but nevertheless it has remained        to the low point of 19 percent in 2004.
an important part of the strategic
armoury. The number of such deals              In terms of their involvement with joint
peaked in 2000 at the height of the            venture and strategic alliance deals,
dotcom boom, with 3,391 global joint           the U.S., Japan, U.K., Canada, China,
ventures announced. By 2004 the figure         Australia, India, Germany, France and
had fallen to 810, but thereafter the total    Hong Kong have been the top 10 most
began to rise once more. By 2007 the           active countries over an eight-year
total had risen to 1,759 deals in the year.1   period. Japan dropped out of the top
                                               five for the first time in 2007, while
The low cost of capital during this            Russia has seen the biggest increase
period was one factor behind the               in joint venture formation in recent
relative decline of the joint venture.         times, breaking into the top 15 for the
Companies were able to raise the               first time in 2006. The U.S. remains the
finance for takeovers and greenfield           single biggest participant in the joint
investments without difficulty.                venture market, responsible for 404
                                               joint ventures in 2007 alone.
However, low-cost capital alone cannot
explain the joint venture trend. Debt
remained freely available during the last
three years, yet the total of announced
joint ventures rose in the three years
from 2005.
                                                                                            1 Thomson Financial, 2008.
12 New Markets: cost, insight and opportunity




These figures suggest that companies              goals, the joint venture means that
are increasingly choosing joint ventures          a company may avoid having to
out of both necessity and choice.                 obtain debt financing for, say, general
That is because joint ventures offer              goodwill – or the takeover premium
certain advantages in themselves,                 which may have been required if
a well as in the context of current               it went for an outright acquisition.
financial conditions.                             In the absence of cheap debt, the
                                                  potential benefits should be clear.
• Financial conditions are tighter.
  Access to cheap debt may have                 This year-on-year increase in announced
  been removed for now, but the                 global joint ventures is likely to
  vocal demands from activist                   continue in 2008. Despite everything
  investors to realize or release               happening in the world economy,
  shareholder value have not                    growth opportunities still remain –
  gone away. As more proposed                   especially in the emerging markets – yet
  transactions collapse due to an               companies risk missing out. In times of
  inability to raise mezzanine and              falling corporate debt issuance, a joint
  senior takeover debt, then the smart          venture can be very powerful in quickly
  money should be on a significant              achieving exposure to new technologies
  increase in joint venture activity.           and products, distribution channels and
                                                markets – and all with limited capital
• Joint ventures are relatively 
               investment. The joint venture may
  simple, and relatively cheap.
                suddenly find itself back in vogue.
  Many joint ventures involve matching
  existing assets and corporate
  networks – they do not have to be
  built (as in the case of a greenfield
  investment) or reconciled (as in
  the case of an outright acquisition).
  Assets, market know-how and
  market access are pooled, and there
  may be no cash component at all.
  As well as securing strategic market
New Markets: cost, insight and opportunity 13




New Markets: tax planning                   One of the largest Indian automotive
In interviews, many companies               component makers agrees. “Frankly
appeared unaware of the risk dimension      we believe you can’t do much through
of global tax compliance, and also          tax planning,” says the CFO. “Even
appeared unfamiliar with the concept        within India there are hardly any tax
of structured tax planning.                 incentives left. And if I need to spend
                                            money on a new investment, I will do
A common comment was that in                it – those kinds of decisions are never
industrial manufacturing, client            driven by tax.”
demands dictated location – so
opportunities for tax planning
were limited.

For example, a European diversified
industrial products maker comments
“you may be able to get a lower tax
rate, but that might be negative in
other ways. If you start to make your
business dependent on tax decisions
you will start to go wrong. You see a
lot of companies that concentrate on
financial restructuring and then start to
lose focus on operations. And the tax
advantages you may get are marginal”.
14 New Markets: cost, insight and opportunity
New Markets: cost, insight and opportunity 15




One exception was an east Asian           Yet where companies do engage in
automotive component maker: the           formal tax planning projects, they say
CFO of this company says “before          the benefits are great. A European auto
I came to this company nobody had         components group with operations in
heard of tax planning. But now I am       Europe’s emerging markets says that it
starting a process that looks at what     began a tax planning review to address
structural tax planning opportunities     uneven profitability and uneven tax
we have – in terms of structuring         liabilities across the group. The CFO
legal entities, reorganizing our inter­   of the company says “we went into
company transactions and dealing          an overall tax review process to tackle
with our intellectual property. All of    this with the help of tax advisors –
these factors give opportunities to       and we think we have solved it in a
generate tax savings and increase our     way that will be acceptable to the tax
net income. Cash is also important: you   authorities. If we had to do this all over
have to make sure you don’t end up        again, we would do it more quickly; and
with cash that is trapped in a certain    we would do it earlier”.
location for tax reasons. It is not so
much a matter of relocating operations
but relocating activities, such as
purchasing”.
16 New Markets: cost, insight and opportunity




Many companies comment that tax                 To gauge the importance companies
planning seldom influences location             attach to tax planning they were asked
decisions directly, not least because tax       in survey questions whether they were
breaks associated with direct inward            achieving their optimal effective tax
investment have all but disappeared.            rate – and if not, whether they had
For example, a south Asian industrial           specific plans in place to remedy this.
products manufacturer says that
“there are no specific tax advantages
in manufacturing in China for us. You
might get certain duty free advantages,
but those are eroding rapidly – both in
terms of currency and in terms of the
scaling back of the duty and incentives.
The party is over there”. The company
adds, that in emerging markets – as in
all markets – companies are concerned
more with sourcing efficiency than
they are with tax barriers. “Tax is just          Companies were asked: are you currently
an overlay of the complexity of the               achieving your optimal effective tax rate,
market,” says the company. “Today                 and if not do you have plans in place to
it is possible to import anything and             remedy this?
everything into India. That means that
sourcing efficiency has become not
only possible, but also a vital element.”        Achieving your             No
                                                 optimal effective         Yes
                                                 tax rate          Don’t know

                                                                                     No
                                                 Do you have                        Yes
                                                 plans in place?
                                                                            Don’t know

                                                                                      0%   10% 20% 30% 40% 50% 60% 70% 80%

                                                 Source: KPMG International 2008
New Markets: cost, insight and opportunity 17




KPMG comment





Manufacturers should revisit                – according to a survey conducted              operations imply different levels
tax planning                                by KPMG in the U.K., compliance                of risk, and thus different levels of
Companies participating in the KPMG         and reporting activities continue to           profitability – and that makes tax
Global Manufacturing Benchmark              dominate the tax department’s time             planning important.
Survey were divided as to the benefits      – nearly 60 percent, while only 11
of tax planning in manufacturing. Some      percent is spent providing tax input         • A global approach can confer
held that tax planning offered extensive    into business decisions2. A survey             advantage. Consistency and
benefits to manufacturers with globally-    conducted by KPMG in the U.S. found            stability are important in effective
distributed operations and profit levels,   similar results: “The tax department           tax planning. First, that’s because
but others believed that allowing           will spend most of its time on                 you are unlikely to get the best
manufacturing strategy to be driven         accurate, timely financial reporting and       returns if you are constantly chopping
by tax concerns was a mistake.              compliance versus effective tax rate/          and changing on the fundamental
                                            cash tax savings”.3                            issue of what is driving your profits.
We believe that the latter view is                                                         Secondly, because tax authorities
based on a misapprehension. In the          What determines successful tax                 can often take comfort in a globally
manufacturing business, tax directly        planning can vary between companies,           consistent approach.
or indirectly, is a pertinent factor in     but some themes emerge consistently,
many aspects of the business that tax       KPMG member firms can find:                  Effective tax planning can also
planning should be part of the strategy                                                  influence a manufacturer’s standing
process. While it would be quite wrong      • Tax planning should embrace                with investors and cost of capital.
to let tax purposes dictate the location      all potential tax issues. Heads of         Financial analysts are extremely
of a major manufacturing plant, it is         tax do not appear to be sufficiently       interested in the after-tax returns your
also wrong to exclude the tax function        aware of all the dimensions of tax.        strategy is getting. Companies that
from the manufacturing strategy.              They tend to be primarily concerned        don’t have a tax planning dimension to
                                              with managing corporation tax. But         their manufacturing strategy are more
Tax planning is not about locating for        do they understand the full impact         likely to be rated down.
tax purposes, but rather about seeking        of sales taxes, do they understand
to manage the effects of tax rates.           customs issues? It should all be
Many companies in the survey say they         brought into the strategic process.
want to achieve their optimal effective
tax rate: KPMG member firms can             • Tax can be a tool for mapping
find that they cannot effectively do          functions and risks. Manufacturing
that unless the head of tax is closely        is a very wide term, embracing all
involved in commercial decisions and          kinds of activities. It may be fully-      2 The Tax Function – Facing up to the Changing
in the formation of strategy. Many            fledged manufacturing; it may be             World. KPMG in the U.K., 2006.

heads of tax will tell you that their job     contract manufacturing; it may be toll     3 Six Highlights of the Tax Function for 2008.
is to manage the tax rate – however           or ‘screwdriver’ operations. All these       KPMG 2008 Tax Department Survey. KPMG in
                                                                                           the U.S., 2008.
18 New Markets: cost, insight and opportunity
New Markets: cost, insight and opportunity 19




Conclusion




The globalization of manufacturing has     Joint venture approaches to new market           Although current conditions impose
been one of the great transformational     manufacturing have largely given way             higher investment costs on companies,
trends of the last quarter century.        to wholly owned subsidiary approaches,           coupled with the likelihood of
KPMG’s Global Manufacturing                a change that is symptomatic of an               somewhat slower growth in global
Benchmark Survey seeks to gauge            expansion phase in global operations             demand, the fundamental drivers of
both the present progress and future       (companies report that joint ventures            globalization of manufacturing remain
direction of this trend.                   can be typically difficult to expand             in place. Manufacturers report a
                                           rapidly). However, higher cost of capital        continued need to cut costs year on
The survey finds that expansion into       is likely to dictate some revival of the         year, and a continued expectation
new markets is reaching a mature           joint-venture approach.                          that most of the growth in their
phase. Manufacturers are now                                                                businesses will come from fast-
primarily concerned with consolidating     The survey also reveals other limiting           growing new markets. The question
their existing market presences –          factors. While approaches to new                 for many manufacturers participating
winning new customers and new              market manufacturing structures                  in the KPMG Global Manufacturing
business – rather than on further new      and management have evolved fast,                Benchmark Survey is not whether
market entry. KPMG International           concerns over intellectual property              they will continue to globalize their
believes this reflects the fact that for   vulnerabilities remain. Many companies           manufacturing operations, but how
many of the companies interviewed          report continued caution over their              profitably they can do so.
entry into the most important emerging     intellectual property exposure in
growth markets has already been            markets lacking a strong tradition of
achieved. Maturity is also evident in      intellectual property protection, and this
the increasingly sophisticated view        factor is likely to limit the value achieved
that companies take of new market          in new market manufacturing. KPMG
opportunities. Low direct costs are no     International also finds that a strategic
longer the most important component        understanding of the tax implications
of the new market strategy: rather         and opportunities of increasingly
companies are concerned with the           globalized manufacturing operations
longer-term management challenges          remains limited, and it seems likely that
of finding and retaining skills, and       the elimination of many direct national
optimizing productivity and flexibility.   tax subsidies has led companies
The structure of global manufacturing      to underestimate the continuing
operations has also changed rapidly.       opportunities in tax planning.
New markets-cost-insight-opportunity
New markets-cost-insight-opportunity
kpmg.com



KPMG’s Global Diversified Industrials
and Automotive contacts

Bill Kimble
Global Chair, Industrial Markets
KPMG in the U.S.
wkimble@kpmg.com
Tel: +1 713 319 2148

Uwe Achterholt
Global Chair, Automotive
KPMG in Germany
uachterholt@kpmg.com
Tel: +49 89 9282 1355

Michele Hendricks
Global Executive, Diversified Industrials
KPMG in the U.S.
mhhendricks@kpmg.com
Tel: +1 212 872 3641

Roland Schmid
Global Executive, Automotive
KPMG in Germany
rolandschmid@kpmg.com
Tel: +49 89 9282 1147

Fiona Sheridan
Global Senior Marketing Manager,
Automotive
KPMG in the U.K.
fiona.sheridan@kpmg.co.uk
Tel: +44 20 7311 8507

Dan Coonan
Marketing Manager, Diversified Industrials
KPMG in the U.K.
daniel.coonan@kpmg.co.uk
Tel: +44 20 7896 4823
Tel: +49 89 9282 1147




The information contained herein is of a general nature and is not intended to address the circumstances of any particular        © 2008 KPMG International. KPMG International is
individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that             a Swiss cooperative. Member firms of the KPMG
such information is accurate as of the date it is received or that it will continue to be accurate in the future. No-one should   network of independent firms are affiliated with KPMG
act upon such information without appropriate professional advice after a thorough examination of the particular situation.       International. KPMG International provides no client
                                                                                                                                  services. No member firm has any authority to obligate
The views and opinions expressed herein are those of the interviewees and do not necessarily represent the views and              or bind KPMG International or any other member firm
opinions of KPMG International or KPMG member firms.                                                                              vis-à-vis third parties, nor does KPMG International have
                                                                                                                                  any such authority to obligate or bind any member firm.
                                                                                                                                  All rights reserved. Printed in the U.K.

                                                                                                                                  KPMG and the KPMG logo are registered trademarks of
                                                                                                                                  KPMG International, a Swiss cooperative.
                                                                                                                                  Designed by Roundel
                                                                                                                                  Publication name: New Markets: cost, insight and
                                                                                                                                  opportunity
                                                                                                                                  Publication number: RDL - 1855
                                                                                                                                  Publication date: November 2008
                                                                                                                                  Printed on recycled material

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New markets-cost-insight-opportunity

  • 1. I N DU STR I A L MA R K E T S New Markets Cost, insight and opportunity KPM G I NT E R N A T I O N A L
  • 2. “You may not be able to get the results you want today in China, but the point of being there is this: whoever wins in China in the next 5 years will win in the next 100 years.” – CFO, a U.S. industrial and construction machinery maker.
  • 3. New Markets: cost, insight and opportunity 1 Foreword How do companies seek to increase and secure value from operations in new markets? Companies often ask KPMG new markets, as seen by CEOs and and value in terms of ability to deliver member firms to help them compare CFOs at some of the world’s biggest sustainable profits in the markets and themselves with their peers. The manufacturers. Using an extensive businesses of the future. The survey Global Manufacturing Benchmark series of telephone surveys and concentrated on value in four specific Survey was designed to meet this personal interviews with companies areas: risk, regulation, compliance, need. This survey compares value in the automotive and industrial and new markets. In the absence creation and preservation in products sectors, executives at 269 of a commonly accepted definition 269 manufacturing companies with manufacturing companies were asked of corporate value, the survey does global operations and allows each to cite their key concerns about new not define ‘value’ itself. Instead it participating company to generate market operations – whether selling measures a number of underlying a unique comparison of their in, manufacturing in, or sourcing from performance and operational indicators performance with peers in their own new markets – and then go on to which together form a database from industry, as well as across industries. break down these areas of concern which companies can draw conclusions into detailed specific management about value creation. As part of a recent wide-ranging survey challenges over the next five years. of large manufacturing businesses across the world1, KPMG International Today, companies are focused on the created a new objective score of increase of value – both present-day how corporate value is derived from valuation in corporate asset markets, Bill Kimble Uwe Achterholt Global Chair, Industrial Markets Global Chair, Automotive KPMG in the U.S. KPMG in Germany 1 KPMG’s Global Manufacturing Benchmark Survey, 2008
  • 4. 2 New Markets: cost, insight and opportunity New Markets: cost, insight and opportunity Companies surveyed report that responding to the challenges of new market competition and the opportunities of new market production and sales are top of the business agenda now and for the foreseeable future. Manufacturing companies agree that Companies were asked: which of these is the reason for that interest is growth: the main business growth strategy for your the big four new markets (Brazil, company over the next five years? Russia, India and China, – the ‘BRICs’) are growing at between two and five 100% times the rate of growth in the older 90% industrial economies – while many 80% manufacturing companies are positive 70% Automotive equipment about manufacturing in Brazil, India and 60% Automotive components China, they remain cautious or neutral 50% Industrial manufacturing on the prospects for manufacturing 40% Aerospace investment in Russia. The view of a 30% Metal industry 20% Other European industrial products group is typical: “for us Brazil is expanding, 10% China is expanding. India probably 0% Enter new countries Gain new customers in existing countries Sell more products to existing customers will be expanding. Russia is a maybe. The issue with Russia is that Russian customers need to make a technology leap if they are going to buy from us”. Companies report that their growth Source: KPMG International 2008 strategies are more concentrated on winning new customers and new business in existing markets than on Brazil, Russia, India and China as entering new markets. However, in existing markets (as suggested by interviews, companies stress that in the above graph). many cases they are already active in new markets, and therefore count
  • 5. New Markets: cost, insight and opportunity 3 Two issues dominate corporate Manufacturing in low-cost east Asia – A large Indian auto parts maker with concerns regarding sourcing from or especially China – is more problematic, global auto customers adds that manufacturing in low cost economies: although several companies argue that “on quality, we consider India to be cost and quality. Some companies quality failings are often the fault of the as good as it can be. China is not so surveyed also voice concerns about the manufacturer rather than the location. good, but training and investment will challenges of managing through joint- The CFO of one large east Asian auto push that quality up. There is no doubt venture approaches, but these are in the components maker says that his that quality is the biggest challenge in minority as most companies report that company remains reluctant to commit low-cost country sourcing, and getting the manufacturing that they consider to manufacturing in China on quality and keeping the right skills is the next critical is almost always accomplished grounds: “quality is very important to most difficult issue”. through wholly owned subsidiaries. a manufacturer in our business. We make things like brakes – these New Markets: quality challenges are critical components that lives Many companies surveyed remained depend on. We would do a lot more concerned about the achievement manufacturing in low-cost locations if of quality in emerging market we could be sure of the quality”. locations. However, companies with manufacturing operations in Companies were asked: are you engaging in, intermediate cost locations – such as or considering, low-cost country sourcing for economies on the European periphery – production? frequently report very positive results on both cost and quality. “We have more quality issues in high-cost 70% countries than in low-cost countries,” says one European industrial machinery 60% maker. “We make all our critical 50% Automotive equipment components in places such as the 40% Automotive components Czech Republic and Portugal: we have 30% Industrial manufacturing low cost and the highest quality.” 20% Aerospace And this company adds: “achieving Metal industry 10% quality from low-cost markets is entirely Other dependent on how long you have had 0% Considering Engaged in – but only recently Engaged in – for several years Neither engaged in nor considering to manage the issue”. Source: KPMG International 2008
  • 6. 4 New Markets: cost, insight and opportunity Many companies report that achieving Some companies, especially those less concern. “Labor costs may be quality from low-cost manufacturing domiciled in emerging markets, are rising in low-cost countries, but the depends less on location and more on concerned about the relative rise in absolute differential between low-cost recruitment, training and error correction. emerging market direct labor costs. and high-cost is still increasing,” says “The fact is people always want to “The rise in Indian labor costs means a European industrial and automotive improve: look at manufacturing in a that a huge advantage is becoming products group. “For us it is still the location like the Czech Republic, and a smaller advantage,” says an Indian case that Germany is seven times how passionate they are about achieving automotive components group. more costly than the Czech Republic.” quality levels,” says a European “Even for a company that50% a large has industrial products group. “You must labor pool to draw upon, it is still an never underestimate the work ethic emerging problem.” For companies and the motivation of your partners.” domiciled in western Europe and the U.S., relative cost increases are of New Markets: cost and productivity challenges Almost without exception, companies report that productivity rather Companies were asked how significant than direct labor cost is the key to low-cost country sourcing was in terms profitable manufacturing operations of cost and quality on a scale of 1-5 in new markets. “Labor costs are 50% not increasing,” says a large Indian auto components maker with global 40% customers. “The cost per person is increasing, but so is productivity – 30% so overall there is no cost increase.” Cost 20% Quality 10% 0% 1 Worse quality than local sourcing 2 Somewhat worse quality than local sourcing 3 The same quality as local sourcing 4 Somewhat better quality than local sourcing 5 Better quality than local sourcing 5 Significant reductions 1 No cost reduction Source: KPMG International 2008
  • 7. New Markets: cost, insight and opportunity 5 KPMG comment Beyond low-cost manufacturing KPMG firms believe there are three • Implementing corporate social Companies should treat low-cost critical issues for global managers. responsibility. The global networks manufacturing solutions as part of of manufacturers are getting more a larger strategy that embraces • Identifying true cost. Traditional complex, and more challenging the total supply chain. Low-cost manufacturing operations do to manage. One dimension of manufacturing is not a strategy that not represent the greatest cost this complexity is the difficulty of should be pursued in isolation: today or risk areas for companies that implementing the corporate social companies need to understand that see themselves primarily as responsibility agenda. Companies as their operations grow increasingly manufacturers. People often assume that focus on manufacturing costs global, the risk and opportunity profile that manufacturers’ greatest costs alone without considering the impact of their supply chain operations has are in labor, whereas in fact, the on their CSR agenda are not truly grown correspondingly complex. greatest costs are associated with optimizing costs or managing risks. distribution and logistics. These are Driving the efficiency of processes Companies surveyed for this report also areas which are most likely to through lean manufacturing or Six say that new market access is more be fully outsourced, which itself Sigma is fine, but companies need important than low labor costs; that creates risk. Companies should ask to take a broader and multi-faceted there is no obvious correlation between themselves whether they understand approach that sees operations in the labor cost and quality; and that there the true risks in distribution and global context. are no hands-off management solutions logistics. in new markets. These are just some Companies that do understand the of the indicators of the fundamental • Choosing and using information. wider risk and cost implications of challenge of globalized operations. When companies expand operations globalized operations can be shown Operating with a global footprint globally, managers need access to a to achieve a higher level of profitability. can increase risk very significantly. much wider base of information than But taking the holistic view is not easy. Companies should find new ways when they operate in tried-and-tested Many companies can find it difficult to of understanding and managing markets. How companies gather and step outside their own world. However, those risks. collate and analyze information is when you are committed to a path that becoming a critical issue. This is not inevitably leads to greater complexity, How should companies integrate low- a technology challenge. The issue is you should also have internal and cost manufacturing into a larger total knowing what it is that companies external perspectives if you are going supply chain strategy? need to know, being able to analyze to manage that complexity. it and act on it.
  • 8. 6 New Markets: cost, insight and opportunity However, in interviews, companies investments remain on hold. This view However, one U.S. construction said that labor availability, flexibility and is supported by research from the machinery maker considers productivity in emerging markets were World Bank2, which shows that despite that industrial and automotive more important than direct labor cost. Russia having one of the world’s most manufacturers can protect their “Labor is not an issue for us,” says an highly educated workforces, industry- intellectual property more easily than Indian industrial products manufacturer specific skill shortages remain the other businesses. “The Chinese are with global clients. “In Hyderabad second most important constraint on very entrepreneurial, and there is a real we have flexible hiring – we can hire growth (after tax levels) according competitive threat there,” says the somewhere between three times to 1,000 large and medium sized CFO of this company. “But we are less and five times our current workforce companies surveyed by the World worried about the intellectual property without difficulty, tomorrow if we want Bank. issue than say a consumer goods to. That is the essential advantage in company – it is pretty difficult to being in a location like this.” Intellectual property in new markets hide a big tractor factory.” Is there a special threat to companies’ A European industrial products and intellectual property (IP) in emerging When asked in KPMG’s Global automotive group concurs, saying “it is markets? Some companies believe so: Manufacturing Benchmark Survey not really fair just to focus on cost – “I think there is an issue with intellectual about overall new market risks, supply you have to look at flexibility. When property rights in China, and also in the chain management, transport and it comes to low-cost countries’ labor Czech Republic and in Poland,” says quality assurance were assigned cost increases, you have to factor in one European automotive components more importance than IP by the full the greater impact of productivity manufacturer. Such concerns are sample of surveyed companies. Those improvements in those countries, shared globally. A Korean automotive companies that did identify intellectual that outweigh direct-cost increases. manufacturer also comments “there is property as challenging, considered Plus you have more labor flexibility no question, we are concerned about that understanding intellectual property and often a superior work ethic”. intellectual property when it comes to protection and formulating intellectual outsourcing manufacturing. That is property protection were the leading However, in interviews some why manufacturing that is critical from challenges. companies caution that localized a business point of view is kept skills shortages will continue to in-house. And when we go overseas inhibit investment in certain large to manufacture, we go with someone emerging economies: one large U.S. that we know”. headquartered global automotive manufacturer comments that localized skill shortages in Russia remain so acute that some large plant 2 Skills Shortages and Training in Russian Enterprises, World Bank May 2007.
  • 9. New Markets: cost, insight and opportunity 7 KPMG comment Intellectual property protection In Asia there is not necessarily the The combination of public lobbying, remains unfinished business same transparency, and everyone private enforcement actions, and Companies that participated in our feels that they have a right to profit. incentive-based management of Global Manufacturing Benchmark It is true that there are many cases IP-sensitive relationships can ameliorate Survey did not assign intellectual where companies do not understand risks to intellectual property for property (IP) a very large weighting the terms of contracts, but there manufacturers. As emerging economies relative to other concerns. However, are also many cases of intentional become more mature, they are drawn companies should be aware that public misreporting. into the global business network and policy lobbying as well as IP protection respect for law and intellectual property strategy remain important issues for But while many companies do tends to improve. But companies have companies with global manufacturing achieve a measure of IP protection to remember that it is up to them operations. by pro-actively pursuing infringements to ensure that respect for IP makes of their property rights, public policy business sense to their partners. Companies extending operations lobbying is also valuable. This is not into new markets still need to ask just an issue for the courts, it is a broad themselves whether it is reasonable governance issue. If companies do not for them to expect their intellectual all tackle the acceptance of IP violations, property rights to be respected. IP then business may just degenerate issues are becoming more important into a free-for-all, where only the ‘fast as supply chains have become more followers’ are rewarded. globalized. Companies should be seeking global consistency on IP, Companies can also work to reduce and it does not appear they are IP risks by building rewards for there yet. IP compliance into contracts with manufacturing partners. There is Companies concerned about IP risks already a recognition in Asia that lack cite China and some eastern European of transparency can be an obstacle locations as new markets where risks in developing business relationships. are highest. Businesses entering Asian Some companies grade their suppliers markets should be aware of a higher on issues like transparency, and level of IP risk, especially when it suppliers are aware of this. comes to manufacturing outsourcing.
  • 10. 8 New Markets: cost, insight and opportunity New Markets: managing operations Companies were asked: which are the biggest risks QB4 Companies surveyed agree: the or challenges in low-cost country sourcing? quality of management of new market operations is critical. “Low 100% cost country manufacturing has to be 90% hands-on,” says a U.S. automotive 80% components maker. “The difficult part 70% 60% of it is not running the manufacturing, 50% it is establishing and maintaining the 40% relationship. But if you don’t do it 30% yourself and rely on a third party, you 20% are likely to fail. You have to be there, 10% you have to know people by name – 0% Intellectual property Labor cost Material costs Warehousing/ infrastructure General and administrative Tax benefits Transport Customer responsiveness Supply chain management Quality assurance Other it is the only way to make it work.” Some executives interviewed for the Global Manufacturing Benchmark Survey commented that underestimation of the management Source: KPMG International 2008 challenges of successful low-cost country operations is common, Companies may also underestimate However, the same companies agree especially in China. For example, a customer risk when manufacturing that the risks and challenges of long- Korean auto components maker says for local customers. “The challenge in term investment in new markets, and “some people think you can just move China is not to do with manpower,” especially in China, are justified by the to China and make the same stuff says a European industrial products potential returns. “You may not be cheaper, but unfortunately that is not group. “It is customer risk – able to get the results you want today how it works. It actually takes a huge establishing what customers want to in China,” says the CFO of one U.S. commitment to develop a capacity for buy and then actually being able to industrial and construction machinery quality in a location like that. This is deliver it. The customer may place an maker. “But the point of being there something that creates a lot of tension order in good faith, but when it comes is this: whoever wins in China in the in a lot of companies”. to shipping it they may suddenly not next five years will win in the next have the money – often because of 100 years.” some government policy change. It is not a question of how you manufacture, it is all a question of how you serve the market.”
  • 11. New Markets: cost, insight and opportunity 9
  • 12. 10 New Markets: cost, insight and opportunity New Markets: Companies were asked: how do investment approaches you plan to enter new countries? Results show that most companies in the survey sample prefer wholly- 100% owned investment approaches to 90% joint ventures or entering through 80% third parties. 70% 60% These results were confirmed in 50% detailed interviews. “My personal 40% QC7 view of joint ventures is that I dislike 30% them,” says a European automotive 20% components group. “The agreement 10% process takes far too long. You have 0% Joint venture Wholly owned operation – acquisition Wholly owned operation – green field Through a third party to make compromises. And often enough the outcome is not what you expect or need, especially in terms of product quality.” And this company adds that quality problems go beyond the product itself: “with joint ventures Source: KPMG International 2008 there are likely to be problems with the quality of the whole process. One hundred percent ownership is better Companies were asked: what are the main QA10 TAX SAV in itself, but that takes more time and benefits of participating in joint ventures? more cash”. 100% Other reservations about joint venture 90% approaches included the reduced 80% High performers potential for rapid expansion of the 70% business, or rapid exit from the market. 60% “The issue is not cost, the issue is 50% people and control,” says an east 40% Asian automotive components maker. 30% “Without full ownership it is really just 20% too much of a headache when the day 10% comes when you want to do some 0% Understanding of local practice Market access Reduced costs Learn from local partner Other Regulatory requirements Sharing Increased speed technology major expansion.” When asked what are the main benefits of a joint-venture approach in new markets, those companies that Source: KPMG International 2008 did favor this approach cited market access and learning from the joint venture partner over increased speed of operation, dealing with regulatory requirements, or the opportunity to share technology.
  • 13. New Markets: cost, insight and opportunity 11 KPMG comment The return of the joint venture? Data from Thomson Financial shows The majority of companies interviewed that the recent increase in joint or surveyed for this report say they ventures is not just a result of greater prefer not to engage in joint ventures: cross-border activity overall. When they consider that joint ventures taken in conjunction with the number have a higher risk of failure than of strategic alliance deals announced, either acquisition or wholly owned the total of joint venture and strategic investment. Yet experience suggests alliance activity has been reasonably that the relative advantages of a joint- flat for six years, hovering between venture approach may be increasing. 4,000 and 5,000 deals. In the latter three years though, joint ventures have The joint-venture approach to new been steadily gaining on their strategic market expansion has suffered a marked alliance counterparts and now account decline in popularity over the last six for 36 percent of the total, as opposed years, but nevertheless it has remained to the low point of 19 percent in 2004. an important part of the strategic armoury. The number of such deals In terms of their involvement with joint peaked in 2000 at the height of the venture and strategic alliance deals, dotcom boom, with 3,391 global joint the U.S., Japan, U.K., Canada, China, ventures announced. By 2004 the figure Australia, India, Germany, France and had fallen to 810, but thereafter the total Hong Kong have been the top 10 most began to rise once more. By 2007 the active countries over an eight-year total had risen to 1,759 deals in the year.1 period. Japan dropped out of the top five for the first time in 2007, while The low cost of capital during this Russia has seen the biggest increase period was one factor behind the in joint venture formation in recent relative decline of the joint venture. times, breaking into the top 15 for the Companies were able to raise the first time in 2006. The U.S. remains the finance for takeovers and greenfield single biggest participant in the joint investments without difficulty. venture market, responsible for 404 joint ventures in 2007 alone. However, low-cost capital alone cannot explain the joint venture trend. Debt remained freely available during the last three years, yet the total of announced joint ventures rose in the three years from 2005. 1 Thomson Financial, 2008.
  • 14. 12 New Markets: cost, insight and opportunity These figures suggest that companies goals, the joint venture means that are increasingly choosing joint ventures a company may avoid having to out of both necessity and choice. obtain debt financing for, say, general That is because joint ventures offer goodwill – or the takeover premium certain advantages in themselves, which may have been required if a well as in the context of current it went for an outright acquisition. financial conditions. In the absence of cheap debt, the potential benefits should be clear. • Financial conditions are tighter. Access to cheap debt may have This year-on-year increase in announced been removed for now, but the global joint ventures is likely to vocal demands from activist continue in 2008. Despite everything investors to realize or release happening in the world economy, shareholder value have not growth opportunities still remain – gone away. As more proposed especially in the emerging markets – yet transactions collapse due to an companies risk missing out. In times of inability to raise mezzanine and falling corporate debt issuance, a joint senior takeover debt, then the smart venture can be very powerful in quickly money should be on a significant achieving exposure to new technologies increase in joint venture activity. and products, distribution channels and markets – and all with limited capital • Joint ventures are relatively investment. The joint venture may simple, and relatively cheap. suddenly find itself back in vogue. Many joint ventures involve matching existing assets and corporate networks – they do not have to be built (as in the case of a greenfield investment) or reconciled (as in the case of an outright acquisition). Assets, market know-how and market access are pooled, and there may be no cash component at all. As well as securing strategic market
  • 15. New Markets: cost, insight and opportunity 13 New Markets: tax planning One of the largest Indian automotive In interviews, many companies component makers agrees. “Frankly appeared unaware of the risk dimension we believe you can’t do much through of global tax compliance, and also tax planning,” says the CFO. “Even appeared unfamiliar with the concept within India there are hardly any tax of structured tax planning. incentives left. And if I need to spend money on a new investment, I will do A common comment was that in it – those kinds of decisions are never industrial manufacturing, client driven by tax.” demands dictated location – so opportunities for tax planning were limited. For example, a European diversified industrial products maker comments “you may be able to get a lower tax rate, but that might be negative in other ways. If you start to make your business dependent on tax decisions you will start to go wrong. You see a lot of companies that concentrate on financial restructuring and then start to lose focus on operations. And the tax advantages you may get are marginal”.
  • 16. 14 New Markets: cost, insight and opportunity
  • 17. New Markets: cost, insight and opportunity 15 One exception was an east Asian Yet where companies do engage in automotive component maker: the formal tax planning projects, they say CFO of this company says “before the benefits are great. A European auto I came to this company nobody had components group with operations in heard of tax planning. But now I am Europe’s emerging markets says that it starting a process that looks at what began a tax planning review to address structural tax planning opportunities uneven profitability and uneven tax we have – in terms of structuring liabilities across the group. The CFO legal entities, reorganizing our inter­ of the company says “we went into company transactions and dealing an overall tax review process to tackle with our intellectual property. All of this with the help of tax advisors – these factors give opportunities to and we think we have solved it in a generate tax savings and increase our way that will be acceptable to the tax net income. Cash is also important: you authorities. If we had to do this all over have to make sure you don’t end up again, we would do it more quickly; and with cash that is trapped in a certain we would do it earlier”. location for tax reasons. It is not so much a matter of relocating operations but relocating activities, such as purchasing”.
  • 18. 16 New Markets: cost, insight and opportunity Many companies comment that tax To gauge the importance companies planning seldom influences location attach to tax planning they were asked decisions directly, not least because tax in survey questions whether they were breaks associated with direct inward achieving their optimal effective tax investment have all but disappeared. rate – and if not, whether they had For example, a south Asian industrial specific plans in place to remedy this. products manufacturer says that “there are no specific tax advantages in manufacturing in China for us. You might get certain duty free advantages, but those are eroding rapidly – both in terms of currency and in terms of the scaling back of the duty and incentives. The party is over there”. The company adds, that in emerging markets – as in all markets – companies are concerned more with sourcing efficiency than they are with tax barriers. “Tax is just Companies were asked: are you currently an overlay of the complexity of the achieving your optimal effective tax rate, market,” says the company. “Today and if not do you have plans in place to it is possible to import anything and remedy this? everything into India. That means that sourcing efficiency has become not only possible, but also a vital element.” Achieving your No optimal effective Yes tax rate Don’t know No Do you have Yes plans in place? Don’t know 0% 10% 20% 30% 40% 50% 60% 70% 80% Source: KPMG International 2008
  • 19. New Markets: cost, insight and opportunity 17 KPMG comment Manufacturers should revisit – according to a survey conducted operations imply different levels tax planning by KPMG in the U.K., compliance of risk, and thus different levels of Companies participating in the KPMG and reporting activities continue to profitability – and that makes tax Global Manufacturing Benchmark dominate the tax department’s time planning important. Survey were divided as to the benefits – nearly 60 percent, while only 11 of tax planning in manufacturing. Some percent is spent providing tax input • A global approach can confer held that tax planning offered extensive into business decisions2. A survey advantage. Consistency and benefits to manufacturers with globally- conducted by KPMG in the U.S. found stability are important in effective distributed operations and profit levels, similar results: “The tax department tax planning. First, that’s because but others believed that allowing will spend most of its time on you are unlikely to get the best manufacturing strategy to be driven accurate, timely financial reporting and returns if you are constantly chopping by tax concerns was a mistake. compliance versus effective tax rate/ and changing on the fundamental cash tax savings”.3 issue of what is driving your profits. We believe that the latter view is Secondly, because tax authorities based on a misapprehension. In the What determines successful tax can often take comfort in a globally manufacturing business, tax directly planning can vary between companies, consistent approach. or indirectly, is a pertinent factor in but some themes emerge consistently, many aspects of the business that tax KPMG member firms can find: Effective tax planning can also planning should be part of the strategy influence a manufacturer’s standing process. While it would be quite wrong • Tax planning should embrace with investors and cost of capital. to let tax purposes dictate the location all potential tax issues. Heads of Financial analysts are extremely of a major manufacturing plant, it is tax do not appear to be sufficiently interested in the after-tax returns your also wrong to exclude the tax function aware of all the dimensions of tax. strategy is getting. Companies that from the manufacturing strategy. They tend to be primarily concerned don’t have a tax planning dimension to with managing corporation tax. But their manufacturing strategy are more Tax planning is not about locating for do they understand the full impact likely to be rated down. tax purposes, but rather about seeking of sales taxes, do they understand to manage the effects of tax rates. customs issues? It should all be Many companies in the survey say they brought into the strategic process. want to achieve their optimal effective tax rate: KPMG member firms can • Tax can be a tool for mapping find that they cannot effectively do functions and risks. Manufacturing that unless the head of tax is closely is a very wide term, embracing all involved in commercial decisions and kinds of activities. It may be fully- 2 The Tax Function – Facing up to the Changing in the formation of strategy. Many fledged manufacturing; it may be World. KPMG in the U.K., 2006. heads of tax will tell you that their job contract manufacturing; it may be toll 3 Six Highlights of the Tax Function for 2008. is to manage the tax rate – however or ‘screwdriver’ operations. All these KPMG 2008 Tax Department Survey. KPMG in the U.S., 2008.
  • 20. 18 New Markets: cost, insight and opportunity
  • 21. New Markets: cost, insight and opportunity 19 Conclusion The globalization of manufacturing has Joint venture approaches to new market Although current conditions impose been one of the great transformational manufacturing have largely given way higher investment costs on companies, trends of the last quarter century. to wholly owned subsidiary approaches, coupled with the likelihood of KPMG’s Global Manufacturing a change that is symptomatic of an somewhat slower growth in global Benchmark Survey seeks to gauge expansion phase in global operations demand, the fundamental drivers of both the present progress and future (companies report that joint ventures globalization of manufacturing remain direction of this trend. can be typically difficult to expand in place. Manufacturers report a rapidly). However, higher cost of capital continued need to cut costs year on The survey finds that expansion into is likely to dictate some revival of the year, and a continued expectation new markets is reaching a mature joint-venture approach. that most of the growth in their phase. Manufacturers are now businesses will come from fast- primarily concerned with consolidating The survey also reveals other limiting growing new markets. The question their existing market presences – factors. While approaches to new for many manufacturers participating winning new customers and new market manufacturing structures in the KPMG Global Manufacturing business – rather than on further new and management have evolved fast, Benchmark Survey is not whether market entry. KPMG International concerns over intellectual property they will continue to globalize their believes this reflects the fact that for vulnerabilities remain. Many companies manufacturing operations, but how many of the companies interviewed report continued caution over their profitably they can do so. entry into the most important emerging intellectual property exposure in growth markets has already been markets lacking a strong tradition of achieved. Maturity is also evident in intellectual property protection, and this the increasingly sophisticated view factor is likely to limit the value achieved that companies take of new market in new market manufacturing. KPMG opportunities. Low direct costs are no International also finds that a strategic longer the most important component understanding of the tax implications of the new market strategy: rather and opportunities of increasingly companies are concerned with the globalized manufacturing operations longer-term management challenges remains limited, and it seems likely that of finding and retaining skills, and the elimination of many direct national optimizing productivity and flexibility. tax subsidies has led companies The structure of global manufacturing to underestimate the continuing operations has also changed rapidly. opportunities in tax planning.
  • 24. kpmg.com KPMG’s Global Diversified Industrials and Automotive contacts Bill Kimble Global Chair, Industrial Markets KPMG in the U.S. wkimble@kpmg.com Tel: +1 713 319 2148 Uwe Achterholt Global Chair, Automotive KPMG in Germany uachterholt@kpmg.com Tel: +49 89 9282 1355 Michele Hendricks Global Executive, Diversified Industrials KPMG in the U.S. mhhendricks@kpmg.com Tel: +1 212 872 3641 Roland Schmid Global Executive, Automotive KPMG in Germany rolandschmid@kpmg.com Tel: +49 89 9282 1147 Fiona Sheridan Global Senior Marketing Manager, Automotive KPMG in the U.K. fiona.sheridan@kpmg.co.uk Tel: +44 20 7311 8507 Dan Coonan Marketing Manager, Diversified Industrials KPMG in the U.K. daniel.coonan@kpmg.co.uk Tel: +44 20 7896 4823 Tel: +49 89 9282 1147 The information contained herein is of a general nature and is not intended to address the circumstances of any particular © 2008 KPMG International. KPMG International is individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that a Swiss cooperative. Member firms of the KPMG such information is accurate as of the date it is received or that it will continue to be accurate in the future. No-one should network of independent firms are affiliated with KPMG act upon such information without appropriate professional advice after a thorough examination of the particular situation. International. KPMG International provides no client services. No member firm has any authority to obligate The views and opinions expressed herein are those of the interviewees and do not necessarily represent the views and or bind KPMG International or any other member firm opinions of KPMG International or KPMG member firms. vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved. Printed in the U.K. KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative. Designed by Roundel Publication name: New Markets: cost, insight and opportunity Publication number: RDL - 1855 Publication date: November 2008 Printed on recycled material