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23rd Annual Health Sciences Tax ConferenceTrends in supply chain planning — what’s next and how changes could impact existing structures
December 9, 2013
Page 2 Trends in supply chain planning — what’s next and how changes could impact existing structures
Disclaimer
Any US tax advice contained herein was not intended or written to be used, and cannot be used, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions.
Page 3 Trends in supply chain planning — what’s next and how changes could impact existing structures
Disclaimer
EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. Ernst & Young LLP is a client-serving member firm of Ernst & Young Global Limited operating in the US. For more information about our organization, please visit ey.com.This presentation is © 2013 Ernst & Young LLP. All rights reserved. No part of this document may be reproduced, transmitted or otherwise distributed in any form or by any means, electronic or mechanical, including by photocopying, facsimile transmission, recording, rekeying, or using any information storage and retrieval system, without written permission from Ernst & Young LLP. Any reproduction, transmission or distribution of this form or any of the material herein is prohibited and is in violation of US and international law. Ernst & Young LLP expressly disclaims any liability in connection with use of this presentation or its contents by any third party.Views expressed in this presentation are not necessarily those of Ernst & Young LLP.
Page 4 Trends in supply chain planning — what’s next and how changes could impact existing structures
Presenters
Karen HoldenErnst & Young LLP5 Times SquareNew York, NY+1 212 773 [email protected]
AnaMaria RomeroErnst & Young LLP5 Times SquareNew York, NY+1 212 773 [email protected]
Antoinette LagerwijErnst & Young LLP370 17th StreetDenver, CO+1 720 931 4430 [email protected]
Donald E. WhittVice President — Tax PlanningPfizer [email protected]
Jeffrey H. HoltzTax Director — Global Supply ChainMedical Devices and Diagnostics
Global Services, LLCJohnson & [email protected]
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Supply chain transformation trends
Page 6 Trends in supply chain planning — what’s next and how changes could impact existing structures
Understanding the strategies and changes within the current life sciences landscape
Geographic mix is changing
Current operating models limiting opportunities for growth
Operating model evolution toward more globally aligned functions
The changing business landscape for life sciences companies continues to evolve. As a response, companies are striving to improve shareholder value, maximize margin and reduce cost. One area of transformation has been supply chain business processes. The operational benefits of these changes also include aspects of tax planning to maximize value to the company.Drivers for supply chain transformation
Platform to drive end-to-end process improvement
A new or revised existing structure is emerging as the platform to drive efficiencies and increased effectiveness across global business functions.Tax-effective supply chain structures are beginning to include strategic functions such as S&OP, supply and demand planning, global quality and inventory management.
Many companies have moved toward operating models with a matrix organization that includes global functions that cut across the business units (BUs) (e.g., sales and operations planning (S&OP), procurement, supply chain, manufacturing, commercial).They are focusing on innovation, driving lower costs and operations improvement through the centralization of functional expertise and leading practices.
Legacy operating models were not designed to be efficient, resulting in increased costs to keep pace with growth in demand; cost reduction initiatives are imperative as companies face more generic competition — generics market share is expected to be 39% by 2015 vs 20% in 2005 (source: IMS Health).Companies are balancing global decision making with regional priorities and opportunities.Increased bargaining power of integrated provider networks, governments, payers and individuals has exerted pressure on pricing and therapy options, disrupting the traditional operating model.
The contribution of emerging markets in terms of sales, volume and profit will continue to grow significantly. Sources of revenue are shifting from the US and Europe to Asia and Latin America.There is an increasing need to balance the capabilities of resources and skills to confirm that the relevant expertise is deployed in the regions to keep pace with these changes in geographic mix.
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The evolution from supply chain to value chain is driven by integration and significant operational and financial benefits
Operational benefitsHow an integrated business structure adds value
Integrated supply chain management leads to more effective and efficient business transformation.The business change process creates visibility into changing market demand and centralizes key decisions.The structure integrates tax considerations to acknowledge that management is focused on maximizing shareholder value.Product costs are reduced by integrating customs planning in the value chain management design.Tax-effective financing techniques make certain that cash flow is freely accessible within the company.
Aligned organizationClear governance and performance managementImproved customer service relationships
Financial benefits
Reduced operating costsMore effective use of assets and working capitalOptimized effective tax rate
Reduced business risk
Better control over audit risk Improved compliance and governanceManaging conversion risks Better control over value chain risk
Page 8 Trends in supply chain planning — what’s next and how changes could impact existing structures
Many large pharma and device companies have implemented principal supply chain operating models
These companies have captured significant value through structures such as the one conceptually captured below.
USCoLicense
Principalcompany Logistics hub
Tollmanufacturer
(finishing)
MarketingCo
API/ device
Tolling services
Finished products
Customers
Finished products
SuppliersRaw materials
IP
Manufacturing locations Supply points
Marketing/ distributionR&D
Puerto Rico
Ireland
Singapore
APAC
LATAM
EMEA
Industry changes along the value chain require a review of these existing structures.
1
2
3
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Changes to the value chain
Manufacturing
Redundant services and supply chain
flows
Commercial
Move to outsourcing manufacturingThe relative value of manufacturing is changing as more companies outsource the manufacturing function in an effort to remain cost competitive as generics flood the market.The traditional supply chain model has been functionally focused, with manufacturing typically driving the decision-making process — decisions were focused on local or regional objectives rather than global efforts.Traditional principal company planning was aligned with the supply chain model and principal function was often located at the manufacturing location.
There is a move to centralization of functions, including supply chain (e.g., sales and operations planning, logistics).Centralization is generally occurring across BUs or BUs are separated and the model replicated.
Challenges to limited risk distributor modelsReimbursement issues
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For key categories (e.g., directs, logistics), the following activities could be centrally managed:
Approve all category strategies and supplier selection criteriaApprove an annual procurement material plan, including material pricesProvide oversight on sourcing strategy execution
Category management
As part of having a centrally managed sourcing function, the following SRM activities can be managed:
The execution of the SRM programThe management of Tier 1 and Tier 2, and select some of the Tier 3 suppliersSuppliers to both toller and turnkey manufacturersSupplier issue resolutionCost optimization of suppliers’ value chain through process improvementIdentification and execution of supplier-enabled innovation opportunities
Supplier relationship management
(SRM)
Within a centrally located sourcing team, you can also:Standardize processes for compliance with negotiated contracts and buying channel strategyConduct periodic reviews of site purchase price variances (PPV) reports, and lead follow-up actionHelp resolve invoice quantity and price mismatch issues when escalated by site procurement/business owners
Requisition to pay
Sourcing/procurement (including third-party manufacturing) in the new value chain model have key activities that should be considered
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Tax and transfer pricing implications
Transfer pricing implicationsAs sourcing/procurement evolve into a value-added function in the new value chain model, compensation for these activities should be reconsidered.Traditional sourcing/procurement functions included demand aggregation and sourcing services. These functions have generally been compensated through the following different mechanisms (or a combination thereof):
Commission based on spendPercentage of total savings realizedCost plus based on sourcing/procurement cost basis (excluding spend procured)
From a value-chain perspective, sourcing/procurement has transformed to a value-added function that contributes to revenue and profit, thus a value-based compensation model may be more appropriate.
Tax implicationsSubstantial contribution based on involvement with third-party suppliers
Process engineering/process improvementPartnering for supplier-enabled innovationSupply planning Inventory management
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There is an opportunity to capture additional operational benefits by expanding the functional activities that are covered by the operating model
Manufacturing and operationsPlant network and contractUtilization and capacity
Sourcing and procurementLocal site procurement and transactional activities
Logistics and distributionLocal inbound and outbound operationsLocal trade and freight forwarding
What is often in principal today Global operations
Operating entities with key brands under patent protection
FinanceInformation technologyLegalPublic affairsEnvironmental, health and safety (EH&S)
Logistics and distribution
Research and development
Global manufacturing services/quality
Sales and operations planning
Commercial
Illustrative example from other life sciences companies for discussionWhat is being added
Discounts and promotionsCompetitive bidding/tenders
Customer pricingCredit policy and terms
Operating model (business unit level)
Local operationsRegional operations
Demand/supply planningForecasting/inventory management
Management reviewsFinance/commercial reconciliation
BU1 BU3BU2 BU4 BU5
Sourcing and procurement
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Tax and transfer pricing implications
Transfer pricing considerationsSimilar to procurement/sourcing functions, compensation for these functions should be evaluated to determine if they should be priced as cost plus services, as a value-based fee or included in the overall principal remuneration. Pricing for these activities should also consider regional vs global contributions to the value chain.
Tax considerationsCharacterization of income as services or sales income depending on facts and circumstances
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Adding additional activities and roles can increase the governance of certain accounting and finance processes.Key roles can review financial goals for each region/market (annually and quarterly).These key roles can manage credits risks, issue credit policies and guidelines.These roles can actively support the governance process and request financial data to verify compliance with issued guidance, procedures, etc.
Increased governance
Key finance areas can also be considered so that governance and compliance processes can effectively support the operating model
Annually, LE budgets will be developed in order to calculate updated transfer prices.A process will be defined to monitor LE profitability compared with targets; true-ups will be calculated and posted as necessary.
Legal entity (LE) budget and profitability
monitoring/true-ups
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There are a number of commercial activities that can enhance the value of the operating model
The centralization of global demand and supply planning increases the oversight and governance of demand planning through a formal sales and operations planning process.The centralization of inventory strategy and management (e.g., min, max, safety stock, lead time, Days on Hand (DOH), turns) allows for global coordination and oversight of critical supply chain planning parameters.Global strategic objectives and operational mandates (e.g., forecast accuracy, lost sales, service levels) can be established and stipulated from a centralized location.Inventory allocation decisions can also be coordinated centrally to enhance value and add substance to the operating model.
Demand planning and inventory management
The review and approval of regional/market strategies and events can be coordinated globally for the regional/market marketing strategy and events.Also, the following activities can be performed:
Review and approve market research proposalsCross-pollinate competitive intelligences and market research results across marketsApprove regional recommendations for geographic product expansionCommunicate with new product management and research and development regarding life cycle management plans
Marketing and product management
activities
Set pricing targets, review and approve pricing recommendations and targets.Pricing
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Tax and transfer pricing implications
Transfer pricing/tax considerationsSustainability of limited risk distributor (LRD) model for certain marketsPricing implications for reimbursementAlignment between commercial and supply chain for certain functions (e.g., demand planning)
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Challenges — where is your company in the continuum?
Jeff & Don to discuss their experienceAMR/Karen/Matt to discuss EY experiences
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Leading practices in principal company governance
Page 19 Trends in supply chain planning — what’s next and how changes could impact existing structures
To keep pace with the evolution of leading practice principal supply chain structures, we have developed compliance guidelines and operational metrics to support adherence with the operating model
90
80
70
60
50
402012-Jun
2012-May
2012-Apr
2012-Mar
2012-Feb
2012-Jan
Compliance guidelines — process compliance
Operational metrics — site/market performance
Monitored monthly, compliance guidelines facilitate that key decisions such as S&OP exceptions, supplier contracting and operational issues are being made by the principal.They indicate if a site or market is in accordance with compliance guidelines (e.g., production schedule adherence).
Exceptions are escalated to the principal as they occur, plus a formal monthly review of the operational performance of sites and markets to acknowledge they are meeting performance parameters set by the principal.This helps to determine that the sites and markets are functioning efficiently and effectively (e.g., forecast accuracy, days inventory on hand).
Compliance guidelines and operational metrics are used together by the principal to drive strategy within the sites and markets. Together, these two tools support compliance with the principal’s guidelines so that sites and markets are aligned with management processes, function efficiently and effectively and meet agreed service levels.
Demand forecast submittal — Ex. compliance guideline
Reviewed and
approved by principal
Market is not compliant
Yes
No
Forecast error — Ex. operational metric
ToleranceEscalate toprincipal
Demand plan
amended by market
Market is compliant
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We started with metrics that are centrally supported and managed today and selected those aligned to the model
Operational metrics will be used by the principals to monitor the performance of sites and markets. More than 80 metrics were reviewed and narrowed to a list of 15 reliable, action-oriented measures to drive the right behaviors and support compliance with principal guidelines.
Operationalmetrics
Centrally reported metrics
Critical operational metrics identified that measure key business process performance
Operationalfocused metrics
identified
Metrics reviewed with stakeholdersOperational focused metrics were reviewed
with stakeholders to determine validity
Metrics were reviewed and operational focused metrics identified
Centrally reported metrics were collected through various scorecards and dashboards
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To provide focus and alignment with critical principal guidelines, compliance measures target specific principal functionsOperational metrics will be used by the principal to monitor the performance of sites and markets. The recommended compliance guidelines are tailored to the company’s fulfillment model and will measure if the sites and markets are “living the principal structure.”
Process area Itemno. Compliance guidelines Operational metrics
Planning
1 Demand plan submitted to principal monthlyPercent in stockForecast errorForecast biasInventory valueInventory turnover
2 Transportation plan submitted to principal monthly3 Supply constraints submitted to principal monthly4 Capacity constraints submitted to principal monthly5 Rough cut capacity plan submitted to principal monthly6 Supply chain agreements adjustments approved by principal
Procurement 7 Substantial direct material contracts executed by principal Percent spend on POs not signed by principal
Number of POs with spend >US$10k not approved by principal8 Purchase order (PO) quantity changes from plan
Global logistics and supply
9 Transportation plan adherence Distribution cost as percent of salesDistribution cost per unit shippedShipments not delivered on time (%)Shipments not delivered full (%)10 All inter-transfers approved by principal
Manufacturing
11 Master production schedule adherence Right first timeBoard of Health (BOH) commitmentsBudget varianceCritical findings
12 Material requirement plan adherence
13 Excess and obsolete inventory management costing performed at principal
Information flow to principal Plan adherence Other compliance
check
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The recommended guidelines and metrics are aligned with activities that are critical to establish principal oversight
# Supply chain gov. activity Compliance guidelines Operational metrics
1Finished goods planning/manufacturing
Demand plan submitted to principal monthlyCapacity/supply constraint submission guidelinesMaster production schedule adherence guidelinesSupply chain agreements adjustments approved by principal
Percent in stockForecast errorForecast bias
2 Intermediate goods planning/manufacturing
Capacity/supply constraint submission guidelinesMaster production schedule/material requirement plan adherence guidelinesSupply chain agreement adjustments approved by principal
Forecast errorForecast bias
3 Direct materials sourcing
Substantial direct material contracts executed by principalPurchase order quantity changes from plan
Percent spend on POs not signed by principalNumber of POs with spend >US$75k not approved by principal
4 Manufacturing cost management
Excess and obsolete inventory management costing performed at principal
Budget varianceInventory valueInventory turnover
5 Logistics
All inter-transfers approved by principal Transportation plan submitted to principal monthlyTransportation plan adherence
Distribution cost as percent of salesDistribution cost per unit shippedShipments not delivered on time (%)Shipments not delivered full (%)
6 QualityRight first timeCritical findings
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To improve operational efficiencies and compliance, principal guidelines have been embedded in our ways of working
Mar
ket
Prin
cipa
lSi
te
Statistical DemandForecast (Logility )
Review and Adjust Statistical Forecast
Proposed DemandForecast
Demand ReviewReview and Approve Amended Forecast
CG1
Review Distribution Requirement Plan
Capacity Constraints
Supply Constraints
Supply ReviewReview and Approve
Amended Plans
CG3
Operational Meetings – Principal/Market/Site CG11 CG12
Transportation Plan
Review and AmendProposed
Transportation Plan and
Rough Cut Capacity Plan (RCCP)
Management BusinessReview
CG4
Metrics Consolidation
CG9CG8
GovernanceDashboard
Operational Metrics
D&
OP
EscalatedIssues
Proposed RCCP
AmendedTransportation Plan
Amended RCCP
CG6 CG7 CG10 CG13
ApprovedTrans. Plan
CG2 CG5
Distribution Requirement Plan
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90
95
100
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
Tolerances for operational metrics will be set based on historical performance and stakeholder interviews. Determining meaningful tolerances for the operational metrics will enable the principal to manage the performance of the supply chain and minimize the impact on operations.
Operational metric: percent in stock Definition: percent in stock = 1 — [total days out of stock/(total # stock-keeping units (SKUs) X total days in month)]
Illustrative example
Performance tolerance 96%
Escalated to principal
% in stock performance
90
95
100
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
% in stock performance
Performance tolerance
97%
Exception tolerances have been developed to minimize the impact to business operations and meet principal guidelines
Out of stock = if inventory falls below the forecasted one day of inventory Total days in month = total sales days in the month
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Tax controversy
Recent audit experiences for substantial contributionInformation requested as part of informal document requests (IDRs) but most audits have focused on transfer pricingClient experiences
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Questions?