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ConsumerCurrents 01

for decision-makers in the retail and consumer goods industry

Indias notso-little gem:


An overview on retailing in India from Shoppers Stop

Trade spend: can you account for it?


Why effective management of trade spend is essential for retailers and consumer goods companies

Getting more out of your intellectual property Whats hot in M&A?


Can trade players compete with the growing impact of Private Equity houses?

Earning respect:
The importance of stakeholder respect in a corporations culture

China: land of more opportunity

Summer 05

Issue

ConsumerCurrents is published by KPMGs Global Consumer Markets practice for senior executives in consumer markets companies around the world. Here topical industry issues and global trends come under the scrutiny of KPMG firms industry professionals and specially chosen guests.

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Contents

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ConsumerCurrents
An informed view on a variety of topical issues for consumer businesses around the world.

Trade spend: can you account for it?


Managing trade spend effectively has never been a higher priority as suppliers and retailers not only seek to maximize their return on investment but also deal with increasing levels of SEC interest.

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08 10 13

Shoppers Stop: Indias not-so-little gem


Interview with B.S. Nagesh, Managing Director of Shoppers Stop, a large chain of Indian department stores, giving his views on retailing in India, the importance of customer care and prospects for the future.

Getting more out of your intellectual property


Theres more to intellectual property (IP) than patents and property rights. Take a look at the potential for reducing your effective tax rate by managing your IP appropriately.

Whats hot in M&A?


Can trade players compete with the growing impact of Private Equity houses?

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Earning respect
The importance of stakeholder respect in a corporations culture.

China: land of more opportunity


With the lifting of onerous restrictions that once stood in the way of trade, will foreign consumer goods companies find business in China plain sailing?

2005 KPMG LLP, the UK member firm of KPMG International, a Swiss cooperative. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative.

Issue 1 ConsumerCurrents 1

ConsumerCurrents
An informed view on a variety of topical issues for consumer businesses around the world
Welcome to the first issue of ConsumerCurrents, a regular KPMG publication for senior executives in retail and consumer businesses around the world. We aim to provide a range of articles in each edition covering a variety of topical issues in a way that is both stimulating and informative. The business environment in which consumer companies operate is complex and challenging and senior executives need to be constantly seeking ways to grow and improve performance while at the same time understanding their competitors and changes in the market place and ensuring their own business is managing its risks. KPMG firms are committed to helping you achieve your goals, working with you to build your businesses. We are constantly seeking to develop forward-thinking strategies to problems our clients face, and each issue of ConsumerCurrents will include articles on selected topical areas. We also intend to feature businesses and business people whose experiences can offer learning points of value to others. In a world where many markets are relatively mature for consumer businesses there is naturally a high level of interest in emerging markets. These offer the prospect of high growth rates and an expanding and increasingly affluent consumer base the Brazilian, Russian, Indian and Chinese (BRIC) economies are some of the most often-quoted examples together with CEE. We will regularly feature aspects of these emerging markets, reflecting our member firms strength in helping companies enter such markets, expand their operations once established and, importantly, control them effectively. The interview with B.S. Nagesh, Managing Director of Shoppers Stop, is the first example of this focus on the growth economies around the world.

Neil Austin is Global Chair of KPMGs Consumer Markets practice with overall responsibility for services to our leading clients in the Retail, Food and Beverage consumer product sectors. As a Corporate Finance partner with KPMG in the U.K., Neil has particular experience of international divestitures, acquisitions and fundraisings, as well as advising Boards on the strategic issues. Tel: +44 (0) 20 7311 8805 e-Mail: neil.austin@kpmg.co.uk

we are committed to helping you achieve your goals


2005 KPMG LLP, the UK member firm of KPMG International, a Swiss cooperative. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative.

2 ConsumerCurrents Issue 1

In a world where many markets are relatively mature for consumer businesses there is naturally a high level of interest in emerging markets.
The large and growing impact of regulatory requirements and changes should also not be ignored. The most recent major examples that are affecting many businesses around the world, and not just those in the consumer sector, are the implementation of Sarbanes Oxley and its equivalent in other countries. In addition to assisting with regulatory compliance, KPMG firms are committed to helping companies achieve this efficiently and, crucially, learning to get value out of such processes. This is likely to be a recurring theme in ConsumerCurrents as regulators of all kinds seek to refine and inevitably expand the myriad of rule books and companies strive to, not only keep abreast of requirements, but also anticipate changes and seek, wherever possible, to implement them in ways which yield value. As we move into the second half of 2005 many of the challenges facing retail and consumer businesses are familiar but some of the economic background is changing. In the developed economies consumer spending has been strong for some time in several countries, most notably the U.S.A. and the U.K., albeit much weaker in parts of the Eurozone, especially Germany. Cheap credit, a rising property market and, in the U.S., tax cuts, have helped growth in demand from consumers who have demonstrated a general feel good factor in several countries. There are now signs that this growth is certainly slowing, with consumers seemingly seeking to limit their debt and also losing the sense of increasing prosperity that is brought about by rising property prices although the U.S. housing market remains buoyant. Any slowdown will be felt by retailers and consumer goods companies alike reinforcing the need to reduce costs, to seek competitor-beating innovation, and to focus on growth opportunities. One way of growing is through acquisition and while activity has been relatively slow in the last few years there have recently been signs of a pick-up. In an article in this issue, Rob Coble, Partner in Charge from KPMG in the U.S. and David McCorquodale, partner from KPMGs U.K. member firm examine some of the key drivers and discuss how this trend might develop. Cutting costs or at least improving the value derived from every dollar spent is likely to remain high on executives agendas. Trade spend is a massive, and growing, cost for businesses which supply retailers. Increasing the effectiveness of this spend is critical but can also be extremely difficult and complex. At a basic level, maintaining adequate controls over the huge sums expended is vital and has been brought into sharper focus by the requirements of regulatory regimes such as Sarbanes Oxley. At a more complex level, the challenge is to increase the effectiveness of expenditure. Tom Hartley, partner from the U.K. member firm and John Rittenhouse, partner from KPMGs U.S. member firm examine this area in more detail in their article in this issue. We hope you find the articles interesting and that you look forward to further issues of ConsumerCurrents. Feedback is always welcome what you liked, what you didnt like and what else you would like to see covered. Contact details for the authors are given at the end of each article and they would be delighted to hear from you with any questions or comments you may have. KPMGs Global Consumer Markets practice wishes you every success and look forward to working with you to achieve your goals.

2005 KPMG LLP, the UK member firm of KPMG International, a Swiss cooperative. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative.

Issue 1 ConsumerCurrents 3

Trade spend: can you account for it?


Why effective management of trade spend is essential for retailers and consumer goods companies
* Companies known as FMCG companies in Europe and CPG companies in the U.S., are referred to as suppliers throughout this article.
There are two strong reasons for increasing the effectiveness of trade spend management. As one of the biggest cost lines for suppliers* and a huge source of revenue for retailers, the business case for enhancing the return on this investment in an industry where margins are tight is compelling. There is also now a legal onus to get it right, as executives face the prospect of prosecution and jail following increased SEC interest and investigations in the area of accounting for trade spend. Tom Hartley, a partner in KPMGs U.K. member firm, warns: It can now cost more to promote the product than to produce it. Marketing investment is diverting from advertising to trade spend, but suppliers sense that they are being bullied into giving more and more while retailers are insecure about whos getting the best deals. It adds up to both missing out on valuable mutual benefits. Not so many years ago, consumers were loyal to a brand. Suppliers ploughed money into TV advertising and, fingers crossed, sales went up. Todays consumers are probably more likely to be loyal to a supermarket after all, they bank, collect their dry cleaning and shop for groceries, electrical goods, clothes and hardware there. If the supermarket doesnt stock their favorite brand, the shopper is increasingly likely to take whatever alternative the supermarket offers. Brands are fighting to avoid becoming a secondary consideration to the pulling power of the supermarket.

2005 KPMG LLP, the UK member firm of KPMG International, a Swiss cooperative. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative.

4 ConsumerCurrents Issue 1

It is estimated that somewhere between 12 and 30 percent of supplier costs are monies paid to retailers in the form of trade spend.

The supplier has a problem. To make a sale, it has to get its product in front of customers. So it pays the supermarket a hefty sum to stock its lines. To get an end-of-aisle promotion or to feature in customer flyers, it hands over a bit more. If it brings out a special product, more money goes into the supermarkets kitty. The sales teams jobs depend on innovation and clinching supermarket deals, but the executive team often cannot evaluate return on investment (ROI) and track and control initiatives. Driven by increasing retail power, trade spend is rising at an inexorable rate currently estimated to be somewhere between 12 percent and 30 percent of total sales and rising. Something has to give. But from the supplier perspective, is this investment giving an acceptable return? The situation has reached a point where ROI on trade spend can be erratic and difficult to measure, says John Rittenhouse, Head of Operations Risk Management for KPMGs U.S. member firm. Getting your hands around what is happening, particularly on a cross-border level in Asia and Europe, can be a huge challenge. With multiple complex promotions going on and often different terms and conditions in place in each country, developing an overall picture of activity and distinguishing profitable deals from poor performers can be a complex undertaking for retailers and suppliers alike.

The state were in


Ten to fifteen years ago, as suppliers reviewed their costs they identified that cost of sales was one of their largest expenses. Traditional cost savings programs led them to consolidate their suppliers. They implemented professional purchasing systems and leant hard on those costs. Superior buying has, for many, resulted in a significant reduction in cost of goods sold. But that success has been surpassed by the rise in trade spend. And other global pressures are putting trade spend under the microscope too. Regulation The importance of accounting for and managing trade spend effectively has never been greater. Suppliers and retailers are increasingly under the SEC spotlight as it steps up scrutiny of the reporting of trade spend management. Recent SEC investigations are likely to result in jail sentences for senior retail executives for booking trade funds out of revenue periods, falsifying documents and generally being unable to account properly for trade spend. In any investigation, suppliers are likely to find themselves just as liable to prosecution as their retailing counterparts.

2005 KPMG LLP, the UK member firm of KPMG International, a Swiss cooperative. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative.

Issue 1 ConsumerCurrents 5

As a consequence, the sales force, with a limited bag of tools with which to clinch a supermarket deal, has had its wings clipped. Trade deals, once solely practiced by sales, are now increasingly recognized as a critical issue for marketing, finance, logistics/supply and the CEO too. Industry consolidation The creation of global supermarket chains has led to pressure for consistent terms of trade and pricing across geographies and distribution channels. The biggest

players Tesco, Carrefour, Metro and Wal-Mart all seek to equalize their terms of trade across geographies. Add in the effect of the euro and its easier to spot what deals are being done by the same suppliers in different EU locations. As it appears that these big retailers will continue to get bigger, at least for the foreseeable future, they are likely to flex their muscles in areas other than trade spend, such as the ownership of inventory, pushing these costs back on to suppliers.

Even though the balance of power appears to lie predominantly with retailers, they too are edgy and under pressure. Unhappy with systems that can be costly and complicated to administer, they also worry that their competitors may be getting a better deal. Faced with difficult and competitive markets and demanding investors, they continually ask for more financial support from their suppliers.

Unraveling the conundrum


A problem as big as this has no single solution. Before even beginning to redress the balance, retailers and suppliers should have three things in mind: Tailoring: Trade spend is highly relationship based and consumer goods companies have different relationships and different commercial circumstances. What is right for a food supplier in the U.S., will probably not work for a drinks manufacturer in France. Its a leadership issue: Trade spend goes right to the heart of the organization and its ability to compete. Trade spend is a leadership issue in every sense. It involves financial controls and commercial strategy. Sales, marketing, the executive board, finance and logistics should be involved in the allocation of trade spend. Treat the cause: The problem does not usually lie where the symptoms manifest themselves. If a supermarket chain deducts the cost of trade spend from an invoice, the problem will show itself in the accounts department but the cause could likely stem from a breakdown in the sales relationship.

Distinguishing profitable deals from poor performers can be a complex undertaking.

2005 KPMG LLP, the UK member firm of KPMG International, a Swiss cooperative. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative.

6 ConsumerCurrents Issue 1

Restoring the equilibrium


The advantages of improving trade spend efficiency can benefit retailers and suppliers alike. KPMG firms are working with many leading consumer goods organizations and retailers to help them improve trade spend efficiency, both to enhance the financial return and to meet compliance requirements. Our approach is to step back and re-evaluate the business through four lenses. Rather than starting from the point of wanting to spend less, or to reduce invoice processing costs, we believe that organizations need to look at trade spend and ask, How can I improve my return on this investment and ensure full visibility and control over my spend? Lens 1. Strategy: How much to spend and where Where are my areas of vulnerability? Start by determining which channels you intend to use to market your products and how much trade spend you are prepared to allocate to each. What is my medium term brand strategy? How will spend with trade impact my brand value? What is the customers strategic plan as it relates to trade funds/promotions? Does trade spend reflect my strategic objectives within this channel? Lens 2. Effectiveness: How to improve ROI Retailers and suppliers should understand what works to their mutual and individual advantage. Suppliers need to evaluate which promotions they believe to be most effective and which brands they most want to promote. Retailers need to enhance their own brand and consumer appeal. Are the programs achieving the plan goals? Does the level and type of trade funds support brand objectives? Can I measure the return on my trade investment and if not, why not? What is the profitability of the trade fund programs by account/client and by product/category? How can these processes and procedures be made more effective (lower cost)? What information is required to measure and track the range of benefits from trade funds and how can information effectiveness be improved? What are the market, pricing and volume risks associated with these programs? What is my visibility of trade spend funds in the U.S. and also in Europe and Asia? Why are my trade spend patterns different in different geographies? Is there a legitimate commercial reason for this? What would be the impact of my major customers merging across geographies? Lens 4. Control: Measure and manage the people and processes Consumer goods companies need measures and processes in place that control information flows and decision-making within their teams. Fail to do this and they can run the risk of off-invoice deductions, unaccountable trade spend and other erratic consequences. Are policies and procedures in place to ensure control of spend? Are the right people involved in making decisions? Do I know which levers to pull to make a change in my business? KPMGs four lens approach is a diagnostic process. It involves an internal audit assessment that looks at the business processes, helps to ensure compliance and identifies how preferred practices might be replicated across geographies. It also identifies what spend works and where real commercial benefits are generated. Lens 3. Visibility: Clarify terms internally and to stakeholders Research in the U.S. suggests that for retailers the single biggest concern is that a competitor is getting a better trade marketing deal from suppliers. Consumer goods companies can help remedy this anxiety by standardizing terms across geographies. And, by communicating trade terms within the company, the risk that salespeople may offer deals that contravene corporate guidelines can be reduced. Visibility is a key requirement to effective management of relationships and risk to stakeholders.

2005 KPMG LLP, the UK member firm of KPMG International, a Swiss cooperative. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative.

Issue 1 ConsumerCurrents 7

On the same side


On the face of it, suppliers and retailers are on the same side. In a deflationary environment where the cost of goods is steadily coming down, with unimpressive profit margins, it is the consumer that is on a winning streak. Capturing a greater share of customer spend can benefit both supplier and retailer. A little more give and take can benefit both in terms of understanding, planning and profitably executing the business plan. But it takes a change in attitude. For a commercial issue as big as trade spend there is no magic bullet. Also, for an issue this complex, the holy grail of perfect measurement is unrealistic. The retailer and supplier have a shared interest in controlling and understanding trade spend. Both can improve their businesses with a better understanding of profitability by product, product grouping and customer, says Tom Hartley. For now, the fact remains that trade spend is managed so consistently badly that getting it broadly right will give forward-thinking companies significant edge.

Potential benefits of effective


trade spend management
to retailers
Allows for better decisionmaking to take place in the promotion and pricing of products to improve profits Helps to reduce cost and risk Provides improved cash flow by securing off-invoice discounts on a more timely basis versus quarterly or annual volume-based performance programs Encourages suppliers to give more trade spend support

Potential benefits of effective


trade spend to the supplier
Helps determine a more accurate
return on investment for trade
fund spend
Can determine the profit position
of individual products or groups
by client and by client/region
Helps determine regulators
compliance level and risks
associated with current trade
fund practices
Creates a closer partner
relationship with key retail
customers to develop
programs that drive volume,
revenue and net profit

John Rittenhouse is a partner within KPMGs Risk Advisory Services, and heads the U.S. member firms Operations Risk Management practice in the U.S. Based in San Francisco, John focuses on identifying enterprise-wide operational risks and supply chain/operations performance improvements. Previously he was Chief Logistics Officer for Wal-Mart.

Tom Hartley is a partner in KPMGs U.K. member firm and part of the Strategic and Commercial Intelligence group based in London. He focuses on leading strategy planning and performance improvement engagements, including in the area of trade spend, for consumer markets companies. An alumnus of Harvards MBA program, Tom was previously a National Account Manager for Procter & Gamble.

Tel: + 1 (415) 963 7017 e-Mail: jrittenhouse@kpmg.com

Tel: +44 (0) 20 7694 8318 e-Mail: tom.hartley@kpmg.co.uk

2005 KPMG LLP, the UK member firm of KPMG International, a Swiss cooperative. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative.

8 ConsumerCurrents Issue 1

Indias not-so-little gem

Indias fortunes seem to be on the up. A stable economy, increase in direct investment and domestic as well as export demand for its goods and services have seen to that. The economic climate is keeping B.S. Nagesh, CEO at Shoppers Stop, happy. Expansion is on his mind. But not, for now at least, outside his native India.

Shoppers Stop changed the shape of Indian retailing back in 1991 when B.S.Nagesh opened his first store. Indian people, more accustomed to small-scale enterprises, found in Nagesh a man prepared to think big. Very big. This first department store, selling own brand as well as domestic and international clothing, accessories, home furnishings, books and music, was ten times the size of any other. It didnt stop there. Nagesh is still committed to big thinking. Today the business operates 18 stores and has plans to open 12 more by 2007. It also owns Crossword, the countrys largest book chain, with 22 stores and a further ten planned each year. Turnover has grown by 28.3 percent on 2003 figures; theres been 38.8 percent growth in gross cash margin and EBIDTA (earnings before interest depreciation and tax) is up by 50.5 percent. But what next for Shoppers Stop?
And are there any limits to growth?
We spoke to the man himself to find out.
We believe that twenty million Indians will travel abroad this year, each spending on average U.S.$800. India needs to provide the incentive and infrastructure for them to spend that money at home. On top of that, we estimate there are 300 million potential customers on our doorstep. But taxation and retail laws need finessing too. With a sensible duty structure in place, we will be better able to map imports to domestic production and reduce wastage in our value chain.

ConsumerCurrents: You aim to be number one in India, but what does this really mean? Nagesh: We want to be the number one department store brand not just by turnover but by dint of sticking to our value system and mission statement to be Nothing but the best. We wont violate our principles to become number one. We dont want success by compromise. ConsumerCurrents: You say that India needs to change from being a nation of shopkeepers to a nation of shoppers. What needs to be in place to achieve this? Nagesh: The retail infrastructure needs to evolve to support this transformation. That means roads and shopping malls that are on a par with or better than those elsewhere in the world. We also need an Indian government that takes retail seriously and echoes the experiences of Dubai, Singapore and Malaysia in using retail to boost internal consumption as well as draw in foreign tourists.

ConsumerCurrents: And what is the Shoppers Stop game plan for staying on top of the market? Nagesh: We start by understanding our sectors. In lifestyle apparel, customer behavior is typically the same across the country. But in books and food [Shoppers Stops newest activity] large regional variations call for different sourcing strategies.
Customer care is how we keep customers loyal. It is the philosophy, culture and fabric of our organization. Every employee is a customer care associate; my office is responsible for handling complaints directly;

We wont violate our principles to become number one.

2005 KPMG LLP, the UK member firm of KPMG International, a Swiss cooperative. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative.

Issue 1 ConsumerCurrents 9

the management committees bonuses are linked to improvements in customer satisfaction indicators (CSI) and employee satisfaction indicators (ESI). An external agency benchmarks our customer service against four other competitors. All this information helps us to learn more about our customers and how we can best meet their needs. Our loyalty program First Citizen now has 370,000 members and is expected to top 500,000 over the next 12 months. Today 52 percent of our business comes from these loyalty customers. To understand them better and personalize our service, weve used our skills and technology to sub divide the membership into around 500 groupings which we will target more specifically. We know our customers at a profitability level longer term the plan is to attract more profitable members and to cultivate and grow our relationship with them. The shopper were after is Indian middle class, aged 25 to 40, who chooses us more for the shopping experience and our fashion than for value and convenience.

Good governance influences how the business is perceived by customers, employees and suppliers. Coupled with our CSI, ESI and now our partner satisfaction index (PSI), these measures will ensure the future health of our business. I also firmly believe that shareholder value grows most in an environment where creativity and productivity are not compromised.

In five to 10 years I believe that India will be a happening place with the largest proportion of mature adults (25 to 35 age group) with incomes in certain metropolitan areas comparable to the Wests top 20 cities. By then I predict that organized retail will be an accepted part of Indias economy and account for around 15 percent of the market. Nageshs optimism appears to be reflected in the burgeoning health of the Indian economy. Although he currently has no plans to move outside India, his big thinking speaks volumes to outsiders looking in. Ten years from now he reckons that India will be a happening place. The infrastructure and supply chain isnt there yet but it will be. For global retailers, India may well be the next big market to crack.

ConsumerCurrents: But there must be some gaps in this success story. What doesnt work as well as you would like? Nagesh: Our weakness is our supply chain. Indian manufacturers tend to be small-scale enterprises; the big players are into exports, not the domestic market.
The road infrastructure that we touched on earlier isnt quite there yet but is developing fast. For now, though, it leads to hiccups in distribution and logistics with a knock-on effect on inventory levels we hold more stock than we need because of uncertain supply. And there are insufficient professionals in this business. Thats why we look to the West for people who can help us exploit our resources and sell to the rest of the world. Our retail industry is also still tarred with the nation of shopkeepers stigma, although that too is shifting fast.

ConsumerCurrents: For a nonlisted company, you take corporate governance very seriously. Why is that? Nagesh: We are a private business that runs like a listed company. Our statutory and internal auditors are Big Four firms. And even though governance on this scale costs more, it provides comfort to stakeholders. There is a board of 10 I am the only executive director including an international retail representative from Selfridges and a retail academic. The founding family, although it holds 80 percent of the stock, has a minority seat on the board.

B.S. Nagesh is Managing Director of Shoppers Stop, a large Indian retailing chain. In recent years both have been the recipients of a number of awards, including Retailer of the Year in 2000, 2002 and 2004, Top CEO in 2001, 2002 and 2004, as well as awards for the management team, use of IT and advertising campaigns. Shoppers Stop is the only Indian retailer to become a member of the prestigious Intercontinental Group of Department Stores (IGDS) which includes Selfridges (U.K.), Karstadt (Germany), Shanghai No.1 (China), and Manor (Switzerland).

ConsumerCurrents: So what next in the Shoppers Stop story? Nagesh: The opportunities in India are far from exhausted. There are plenty more places to explore nationally, which means international expansion is not on our immediate agenda. But were definitely not adverse to bringing global best practices here.

This article is a follow up to an interview by Templeton College Oxfords European Retail Digest. Templeton is a full graduate college of the University of Oxford dedicated to management studies. You can view the article at: http://www.templeton.ox.ac.uk/oxirm/SampleERD.htm

2005 KPMG LLP, the UK member firm of KPMG International, a Swiss cooperative. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative.

10 ConsumerCurrents Issue 1

Getting more out of your intellectual property


Theres more to intellectual property (IP) than patents and copyrights. Appropriate management of IPs can lead to a sustainable reduction in the effective tax rate. Here are some of the options.
` IP is a catch-all term. It neatly wraps up trademarks, brands, copyrights, patents and R&D-developed technology that generate an economic benefit. You might consider anything over and above a routine return the profits ascribed to manufacturing, distribution and other routine functions as a return from IP. Its a critical asset in any successful business, and you should manage it accordingly. John Burns, tax partner from KPMGs U.K. member firm, says: Some countries have general antiavoidance provisions that can negate strategies to avoid or defer tax. The U.K., currently, has not. And so an aggressive tax planning environment has evolved, resourced by an industry of loophole spotters, where short-term tax advantages are to be had. That was until 2004. In the pre-election year, and with a growing budget deficit, Chancellor Gordon Brown clamped down hard on tax avoidance. Rather than putting up taxes, he sought to ensure that existing tax laws were strenuously applied. Companies are now obliged to disclose certain tax planning initiatives to the Revenue. The Revenue reports to the Chancellor and, no surprises, artificial planning and loopholes that exploit tax law are being swiftly identified and closed.

Managing the tax on profits from IP effectively, with a practical approach rather than artificial arrangements, is commercially sound and brings sustainable benefits.

2005 KPMG LLP, the UK member firm of KPMG International, a Swiss cooperative. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative.

Issue 1 ConsumerCurrents 11

There are potential business benefits from moving your tax people closer to the business doers, marketers and R&D developers.

Business and tax harmony


There are legitimate strategies to help ensure that profits from IP are taxed in an efficient way. And this comes from aligning business and tax planning strategy so that one complements the other. For some companies this may mean a rethink and revamp of where and how the business is structured. There are downsides to watch out for but there are potential business benefits from moving your tax people closer to the business doers, marketers and R&D developers.

Take the scenario of a Public Limited Company (PLC) that currently pays a low amount of tax in the U.K. It takes a good look at its group scenario and identifies how it can link tax and business planning effectively. It has a loss-making U.K. head office with manufacturing and distribution facilities scattered around the world. By shifting IP to the U.K. and by making a charge against other global entities and subsidiaries that use it, pre-tax profits are brought back to the U.K. where they can be taxed more efficiently.

This is not about putting IP into a tax haven which, in any event, is likely to fall foul of Controlled Foreign Corporation rules. Rather it is about trying to ensure that the groups tax position is made effective and that charges such as withholding taxes on royalty flows are limited. On the face of it, businesses can organize themselves as they see fit. And so long as it is sensible, legitimate and the numbers stack up, tax authorities should not object to business-linked means of securing effective tax rates.

When looking at IP, rather than rushing in with wholesale changes, the tax people need to understand how the business makes its money. And the business people need to buy into a tax strategy that may mean upheaval in order to leverage returns. Start by considering: What constitutes IP in your business? Who owns it legally and economically? Would centralized management of IP enhance its value and protect the ongoing investment? What is your groups policy towards IP? What future business strategies may impact your IP? What are your group tax imperatives? What exit/transfer taxes might apply? What are the accounting considerations?

2005 KPMG LLP, the UK member firm of KPMG International, a Swiss cooperative. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative.

12 ConsumerCurrents Issue 1

Rather than waiting for the next short-term fix to bring down or stabilize your effective tax rate, it may be better to identify a sustainable business-linked strategy.

Centralized vs shared IP management


Given the significant contribution that IP makes to profit generation, many companies are opting for centralized IP management. The trend is away from shared marketing, research and development (R&D) or IT development that everyone dips into. More common is an accountable, centralized cost centre that charges for its services and which, depending on the quality of its output, makes a profit or a loss. Take a company with high R&D expenditure. It centralizes its R&D as a single entity in Switzerland, relocating disparate teams lock, stock and barrel. From a business perspective, it discovers additional synergistic benefits: Innovation is more easily carried into other products and services reducing cost and improving returns. It is easier to monitor spend and returns more closely. Better identification and ownership of IP including improved registration of IP assets. Shared methodologies and collaboration within the team.

Culture of accountability with more drive to succeed internal profits depend on it. Protection of the crown jewels (e.g., patents, trademarks) from takeover threats or litigation by housing them appropriately. On a tax level, it may find Switzerland a more efficient location for the economic management of IP. Beware, however, some tax authorities may claim that a disposal has taken place where there used to be a cost-sharing arrangement.

Wills and ways curtailed


Artificial tax wheezes are still around where theres a loophole there will always be a ruse to exploit it. But Gordon Browns plan in the U.K. means most will be closed down sooner rather than later. Elsewhere, anti-avoidance measures effectively stamp out such tactics. Rather than waiting for the next shortterm fix to bring down or stabilize your effective tax rate, it may be better to identify a sustainable business-linked strategy. Leveraging tax benefits from anticipated profits created by IP in the business is a viable, commercially sensible and legitimate alternative..

John Burns is the lead partner for KPMGs IP Tax group in the U.K. and is part of

KPMGs Consumer and Industrial Markets practice. He is the lead tax partner on a portfolio of multinational clients, providing corporate taxation advice, focusing principally on international tax issues including transfer pricing. He also has extensive experience in negotiations with the revenue authorities, both in respect of corporate taxation and transfer pricing matters.

Tel: +44 (0) 20 7694 3123 e-Mail: john.burns@kpmg.co.uk

2005 KPMG LLP, the UK member firm of KPMG International, a Swiss cooperative. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative.

Issue 1 ConsumerCurrents 13

Whats hot in M&A?

As 2004 drew to a close M&A activity overall was on the increase, indicating that 2005 is likely to be a busier year. The first quarter of 2005, however, has provided some mixed messages, with Global activity up 16 percent by value, a substantial increase by value in the U.S. but a slowdown in Europe. As far as retail and consumer companies are concerned, in terms of value, consumer products and retail sectors recorded the largest increase during Quarter 1, up 391 percent and 175 percent respectively.1
What types of trends is this sector likely to experience for the rest of 2005? In order to answer that question, it is worth considering some of the factors that have influenced M&A in the consumer sector over recent years to determine how these key inputs may affect M&A in the sector going forward. For many retail and consumer businesses, the last few years have been a time for re-examining their strategies, focusing on what is core and learning how to survive in a situation where their major markets are relatively mature, with intense competition and downward pressure on prices. Cost cutting, inventory
1: Dealogic Global M&A Q1 2005 Review
2005 KPMG LLP, the UK member firm of KPMG International, a Swiss cooperative. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative.

As well as offering cost benefits, emerging economies are gaining attention as potential markets.

management, gross margin improvement, and profitable top-line growth are key issues retailers are facing. In addition, manufacturers have been faced with rapidly growing competition from lower-cost producers in developing economies whose ability to deliver high-quality products in large quantities at compelling prices has grown very rapidly. Retailers have been taking advantage of these lowcost suppliers, but have equally been facing very strong competition with challenges to established players and formats from rapidly growing value retailers. In addition, consumers have grown even more demanding in their shopping experience and want more value, at a lower cost, in addition to stylish and innovative products.

14 ConsumerCurrents Issue 1

As well as offering cost benefits, emerging economies are gaining attention as potential markets. These countries, perhaps best characterized by China, have high growth rates, improving business environments, and a growing middle class of consumers who are rapidly becoming both wealthier and more discerning. A focus on their existing business coupled with investment in developing markets has made it necessary for retailers and consumer companies to improve cash flows and strengthen their balance sheets. They have also been reassessing what value they have derived from previous M&A activity. All these factors have combined to produce a relatively subdued M&A market for corporate buyers. However, the deal market has been enlivened by the emergence of the private equity (PE) houses as much more serious buyers of businesses. These funds are active around the world although they have been far more visible in the mature markets of the U.S. and Western Europe. They already have very significant fire power which is

being increased by further fundraisings. Private Equity accounts for 11 percent of Global M&A deal value. Already in the first quarter of 2005 we have seen Private Equity transactions of U.S.$72 billion, a 25 percent increase from Q1 2004.2 Of course their required returns on equity are above those looked for by the publicly quoted companies that make up the majority of the retail and consumer sector. On the face of it, therefore, a PE house shouldnt be able to afford to pay as much for a business as a trade player even without taking into account the fact that the latter may well have synergies which the former cannot achieve. In real life, however, an examination of completed deals does not bear this out. So why is this and what are the implications for future M&A activity? In Q1 2005, retail was the second busiest industry sector for PE with transactions reaching $12.6 billion, more than double its Q1 2004 total. Since the end of the quarter the sector has seen the $5.1 billion acquisition of
2: Dealogic Global M&A Review, Q1 2005

Neiman Marcus by PE houses, which reinforces this trend. The current financial environment creates several advantages for PE houses, which explains their activity in the market. PE houses are raising record amounts in new funds. Current interest rates are relatively low, making debt relatively cheap, and financial institutions are willing to lend. Taken together this means that PE houses today have substantial equity resources available and can not only borrow quite cheaply, they can also borrow significantly more than they could even one or two years ago.

One main reason why PE houses have been and indeed still are in a position to pay high prices is a simple question of financial structuring.

Q1 2005 Private Equity Deal Activity Consumer Market Acquirer


Ann Date 17 Mar 2005 Target Target Nationality U.S. Acquirer Value U.S.$m 8,176 Ann Date 28 Jan 2005

Q1 2005 Trade Deal Activity Consumer Market Acquirer


Target Target Nationality U.S. Acquirer Value U.S.$m 56,863

Toys R Us

Investor Group

Gillette

Procter & Gamble

7 Mar 2005

CSM NV-Sugar Netherlands Confectionery Div

Investor Group

1,130

28 Feb 2005

May Department Stores

U.S.

Federated Department Stores

16,377

30 Jan 2005

Bi-Lo Inc

U.S.

Lone Star Fund

660

13 Mar 2005

PT Hanjaya Mandala Sampoerna Shopping Centres (101 property First Washington Portfolio)

Indonesia

Altria Group 5,013

12 Jan 2005

Haitai Confectionery & Foods

South Korea

Investor Group

584

15 Feb 2005

U.S.

Macquarie 2,741 Countrywide Trust

27 Jan 2005

Alliance Laundry Holdings LLC

U.S.

Teachers Private Capital

450

17 Jan 2005

Southcorp (81.2%)

Australia

Fosters Group

2,356

Source: Thomson Financial, March 2005

Source: Dealogic Global M&A Review, Q1 2005

2005 KPMG LLP, the UK member firm of KPMG International, a Swiss cooperative. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative.

Issue 1 ConsumerCurrents 15

By taking on this level of leverage they have been able to pay prices which quite often are in excess of those that trade bidders are willing to pay. By contrast, many retail and consumer companies have been adopting a relatively cautious approach to acquisitions for a number of reasons. First, the target must fit with the companys chosen strategy and many companies have been focusing on core assets, which instead has resulted in divesting unrelated, noncore business units or concepts. Secondly, some companies are being more cautious because they did not necessarily get the value they expected out of previous M&A deals and dont want to repeat the mistake clearly the higher the price, the more risk there is of failure. Thirdly, while many acquisitions may yield synergies for the acquirer, companies have become more reluctant to pay more than a small proportion of these in the purchase price for any business, hence limiting one of the advantages that they have over their PE competitors. Finally, most companies have some form of internal hurdle rate or required rate of return on investment against which they measure acquisition candidates. Clearly in many cases this is yielding maximum prices for businesses which are below the prices which a PE house is prepared to pay. Does this indicate that PE houses are overpaying or that companies are seeking too high a return in the current economic environment?

The activity levels in the market indicate that retail and consumer companies are preparing to get more serious about M&A both at a strategic level (such as the acquisition of Gillette by Procter & Gamble) and at the tactical level, where acquisitions are being used to fill holes in geographic coverage or product ranges. The competition for highquality assets will be intense, not least because there are a very limited number of businesses with strong market positions or leading brands that are likely to come to the market. In the absence of a cooling in the debt market, making it more difficult to pay high prices, PE houses are going to remain stiff competition for established corporations. Some of these corporations will need to push the limits if they are going to be successful in acquiring attractive assets. While this inevitably increases the risk, the alternative may be to face being outbid on a regular basis and dropping behind the competition in both market position and growth. Even with larger deals, established companies are not going to have it all their own way. First, they have to contend with regulatory authorities which are examining the competition or anti-trust aspects of large deals with an ever more critical eye.

Secondly, until recently, these large deals would have been viewed as beyond the reach of PE houses, but larger fundraisings and the willingness of PE houses to join together to mount large bids means that almost all large deals are now within their capacity. It looks as though we will be seeing an increase in M&A activity as we move through 2005 and into 2006. Funding such deals may not be a problem companies have strong balance sheets and cash flow, PE houses have large war chests and banks are currently keen to lend. It is a good time to be a seller but who will be the buyers? If established retail and consumer companies are going to succeed in taking a major share of completed transactions, they probably need to examine how they can compete in the deal market with PE houses.

Rob Coble is Partner in Charge of KPMGs South Eastern Transaction Services practice in the U.S. He has advised numerous domestic and multinational companies and private equity funds in areas of mergers, acquisitions, and due diligence in a wide range of consumer markets companies. He also has extensive experience in accounting for business combinations and SEC compliance.

Tel: +1 401 222 3014 e-Mail: rcoble@kpmg.com

Even with larger deals, established companies are not going to have it all their own way.

David McCorquodale is a partner in KPMGs Corporate Finance Practice in the U.K. member firm and is U.K. Head of Corporate Finances Consumer Markets team. He has advised a wide range of consumer markets companies, both public and private, on acquisitions, disposals and fundraisings.

Tel: +44 (0) 20 7311 8493


e-Mail:
david.mccorquodale@kpmg.co.uk

2005 KPMG LLP, the UK member firm of KPMG International, a Swiss cooperative. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative.

16 ConsumerCurrents Issue 1

Vision and strategy are key to success.

Earning respect

Desire for respect enters the cultures of corporations.

Respect is a universally positive concept. But what exactly does it mean to a corporation?
In recent years, many of the major embarrassments and loss of market capitalization suffered by certain companies have primarily come from senior executive failure and violation of public trust. These consequences have resulted in many corporations pursuing corporate governance, ethics and respect as primary objectives. Respect is a fundamental part of our culture at Wal-Mart, stresses Mario Pilozzi, President & Chief Executive Officer (CEO), Wal-Mart Canada. Respect means a company is admired not only for its business performance but for its culture, ethics, and above all its people. Respect is a vital factor in achieving and retaining the confidence of employees, customers and shareholders.

In broader terms, Mario Pilozzi is referring to the so-called softer set of business issues such as social and environmental responsibility, ethical business practices, fair and equitable employment practices, and regulatory compliance. The potential benefits of embracing these issues far outweigh the perils of ignoring them. And these benefits can be tangible, in the form of higher share prices, ability to recruit and retain good employees, ease of entering new markets, less unwelcome attention from regulators, fewer lawsuits, and even competitive advantage. According to Willy Kruh, KPMG partner in charge of the Consumer and Industrial Businesses practice in the Canadian firm: Corporations are realizing the value of respect in the context of global business. Respect is not easily achieved in this environment, but it can definitely give an advantage to companies that are willing to pursue it, and are able to attain it.

2005 KPMG LLP, the UK member firm of KPMG International, a Swiss cooperative. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative.

Issue 1 ConsumerCurrents 17

The Most Respected Corporations


To learn more about the respect factor in business, KPMG in Canada sponsors an ongoing survey called Canadas Most Respected Corporations, conducted, for 10 years by independent pollster Ipsos Reid. This survey has provided a scientifically based measure of how Canadian CEOs view their peers and the organizations around them. CEOs across Canada were surveyed to determine which single company was Top of Mind Most Respected. In 2004, RBC Financial Group was chosen as Top of Mind Most Respected Corporation for the third consecutive year.

Consumer markets companies on the top 25 honor roll list include: Loblaw Companies Limited (9), Canadas largest food distributor and a leading provider of general merchandise products and services. The Jean Coutu Group (PJC) Inc. (14), one of the top 10 retailers of pharmaceuticals and parapharmaceutical products in North America. Canadian Tire Corporation Limited (20), Canadas most shopped-at retailer with more than 1,100 stores and gas bars. Wal-Mart Canada Corp. (24), Canadian arm of the worlds leading retailer that has opened over 240 outlets since entering Canada in 1994.

Respect reflected in share price


CEOs spend more time and give higher priority to building respect for their companies among the general public, a point noted by over two-thirds of respondents. This clearly indicates that building respect is a deliberate strategy and not merely an accidental by-product of other initiatives. Wayne Sales, President & CEO Canadian Tire Corporation, says, Respect has been a key element of our business success and is part of being what we term a national champion. It means were listening to our customers as well as to our shareholders and all other stakeholders. Wal-Marts Mario Pilozzi adds, We live in an era where business ethics and corporate social responsibility have taken center stage all over the world. Its important for corporations to demonstrate progress in these areas and for business leaders to communicate that progress.

An overwhelming 84 percent of the CEOs believe corporations that enjoy more respect from the public also enjoy a premium in their share price. Public companies caught in scandals often see their share prices and overall market capitalization plummet, explains Kruh. I would argue that there is a positive association between corporate social performance and financial performance. And it comes as no surprise that corporations worldwide are devoting more resources to building respect in order to differentiate themselves in a positive way. Canadian Tire CEO Wayne Sales adds, Consumers, investors and employees have many choices, and theyve been disappointed in the business community in recent years, so we must do everything we can to earn their respect and lessen their cynicism.

Vision on the rise


What does it take to make it to the top? More CEOs than ever (52 percent) believe that Vision, focus, discipline or good strategy are needed to make it to the top. Vision and strategy are key to success, says Pilozzi of Wal-Mart. The leaders of tomorrow will be those who are able to master and execute long-term strategy and thinking in a truly global business world.

Reflecting on their corporate experiences, CEOs ranked a number of attributes that are key ingredients to making it to the top. The top five are: Vision, focus, discipline or good strategy (52 percent) Financial performance (34 percent) Track record (27 percent) Shareholder or investment value (22 percent)

Unless otherwise stated, information sources in this article are based on Canadas Most Respected Corporations survey

Honesty, trustworthiness or ethics (19 percent)

2005 KPMG LLP, the UK member firm of KPMG International, a Swiss cooperative. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative.

18 ConsumerCurrents Issue 1

CEOs ranked the following as major priorities for 2005.


Ensuring the long-term financial health of the company Attracting and retaining high-caliber employees Customer loyalty growth Increasing productivity and performance improvement Ensuring trust from shareholders Risk management Transparency and public reporting Corporate governance Increasing short-term profitability Expanding into new markets either inside or outside Canada Expanding into new product or services Growth through merger and acquisition 82% 68% 64% 64% 48% 41% 38% 37% 30% 28% 27% 19%

Willy Kruh can also observe corporate priorities from the perspective of an independent professional. Based on our experience at KPMG, our firms clients worldwide are definitely giving high priority to implementing risk management initiatives and strengthening their internal controls in order to help ensure the long-term financial health of their company. On the tenth anniversary of Canadas Most Respected Corporations survey, two things are clear. First, a corporation worthy of respect can make a positive difference to customers, employees, suppliers, regulators and investors and, secondly, this respect factor stays relatively constant over time and across the global scale of todays enterprises. In the words of Mike Rake, Chairman of KPMG International, Great companies do not succeed by concentrating on the bottom line alone. Growth and investment are important, but the worlds most respected businesses all know how much influence that standing allows them. For more information about Canadas Most Respected Corporations visit www.mostrespected.ca.

Priorities for the year


The survey also explored CEO priorities for 2005. Eighty-two percent of CEOs held the same top priority as last year, ensuring the long-term financial health of the company. However, Attracting and retaining high-caliber employees has become a higher priority, capturing the number two spot. CEOs clearly see a connection between hiring bright people and maintaining aggressiveness in todays global economy. Mario Pilozzi reinforces this point: Wal-Mart is a people-driven business, and recruiting and retaining high-caliber individuals will probably always be a top priority for us. Every achievement at Wal-Mart Canada is rooted in our people.

Wayne Sales explains, At Canadian Tire, a key purpose for being in business is to create customers for life. To earn the trust and entrench our position as one of the most recommended retailers in Canada means the needs of our customers must always come first. Franois J. Coutu, President and CEO of the Jean Coutu Group, sees many of the listed priorities as closely interrelated. For example, dedicated and competent employees will help build customer loyalty, and loyal customers will ensure the companys growth, enabling us to retain highcaliber employees.

Dedicated and competent employees can help build customer loyalty.

Willy Kruh is the Partner in Charge of KPMG in Canadas Consumer and Industrial Businesses practice. Based in Toronto, Willy has over 20 years experience as an audit and business adviser to leading consumer markets companies with a presence in Canada, the U.S. and internationally. He also has substantial experience in the areas of mergers, acquisitions, divestitures, initial public offerings and restructuring services to public and private companies in a wide range of consumer markets. He regularly makes presentations at seminars and conferences on topics pertinent to the consumer markets sector. Tel: +1 (416) 777 8710 e-Mail: wkruh@kpmg.ca

2005 KPMG LLP, the UK member firm of KPMG International, a Swiss cooperative. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative.

Issue 1 ConsumerCurrents 19

China: land of more opportunity


With the lifting of onerous restrictions that once stood in the way of trade, will foreign consumer goods companies find business in China plain sailing?
It is not necessarily the cheapest place to do business in fact, other emerging economies compare favorably but the sheer vastness and scope of the market make China a place where everyone wants to be in business. China, the worlds most populous nation, officially recorded 1.3 billion inhabitants in January 2000 the majority between the ages of 20 and 39. Its economy is growing rapidly too. GDP growth in 2003 stood at 9.1 percent; inflation was down at 3.2 percent and per capita wealth in urban areas was RMB 8,472, three times greater than in rural China.1
1: The Economist, China Retail and Distribution: Changes for the Better? An industry report series exclusively written for KPMG in China and Hong Kong, 2004

It is a massive market to tap into. Once barred from operating in China, foreign retailers often found a way in via the back door. But now the front door is wide open.

Going shopping
Enter consumer goods companies ready to take on a market that is no longer off limits. As wholly foreignowned enterprises, they can now manufacture, sell and distribute in China without needing to liaise with a Chinese partner. Among the first movers are likely to be Western companies with wholesale operations in free trade zones (FTZs) such as the Shanghai Waigaoqiao zone. Permitted to import and manufacture goods within the zone, any after-sales services, such as repairs, were

2005 KPMG LLP, the UK member firm of KPMG International, a Swiss cooperative. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative.

20 ConsumerCurrents Issue 1

Changing China
The catalyst for change came in 2001 when China joined the World Trade Organization (WTO), earmarked by the lifting of rigid sanctions and the advent of freer trade. By 2003, Foreign Direct Investment (FDI) into China reached U.S.$57 billion.1 The odds, once firmly stacked in favor of overseas hi-tech and manufacturing companies the desirable industries evened. In December 2004 came landmark tax decree number eight which gave foreign retailers, wholesalers and traders the green light to operate in China. Instead of tie-ins with Chinese joint venture partners, these Western companies can now officially go it alone as wholly foreign-owned enterprises (WFOEs) with vastly reduced minimum capital thresholds. But only fools rush in, warn Peter Kung and David Ling of KPMGs Chinese member firm. It is a land of opportunity but, before setting up or expanding operations in China, companies should consider how they are structured and where to locate to take advantage of tax efficiencies. Get it wrong and they could pay heavily.

The company often found that quality and control were out of its grasp.

formerly undertaken by a representative office set up outside the zone for that purpose. The company often found that quality and control were out of its grasp. But despite the lifted sanctions, there are still very good reasons to stay put within the FTZs: Attractive waivers on customs duties and VAT within the FTZ. Foreign companies in bonded zones need to run for 10 years to escape payback penalties on tax incentives. An opportunity to bide their time, to see whats going on outside the FTZ, to look at the competition and to build a strategy. Under tax decree number eight, manufacturers and service companies are now permitted to expand their offerings to include the trade and distribution of goods within China. The catch is that their products must carry the Made in China tag. That is fine for the likes of Ikea and casual clothing company Baleno, which can now manufacture own-brand goods and sell them through their own outlets, but not so impressive for label conscious consumers at Armani and Rolex.1 Companies setting up an own-brand business can also buy other manufacturers goods and sell them under their own label. Longer term, China can expect to see supermarket and chain store shelves buckling under the weight of own-brand products.

Also affected are some of the big names whose goods are already sold in China Louis Vuitton, Hagen Dazs and many more. Once unable to trade in their own right, they were forced to hand over their operations to contracted agents, giving rise to control and IP issues. Now free to operate and manage their own stores, they are collecting revenue themselves rather than waiting for payments from agents. However, theres still an element of Chinese control. Retailers are obliged to fit in with the urban development plan of the markets in which they wish to operate. For foreign companies, the most common route into China used to be via a representative office, staffed with Chinese and used as a base from which to explore the market or to identify investment opportunities. Taxed on 10 percent of their overall expenses, representative offices are expected to dwindle as retailers, distributors and traders find wholly foreign-owned enterprises a cheaper tax vehicle.

2005 KPMG LLP, the UK member firm of KPMG International, a Swiss cooperative. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative.

Issue 1 ConsumerCurrents 21

Tax tangle
Investing in China, is, for many companies, driven by business rather than tax incentives. However, it is vital to undertake due diligence prior to set up and to consult locally and with tax professionals to make sense of the complex mass of tax laws and reliefs available. Historically, China has offered tax incentives to manufacturing and hi-tech companies and operated special economic zones with tax breaks for non-trading businesses. Geographic regions had their own incentives for foreign-invested enterprises (FIEs) in Shenzhen, for instance, a FIE could enjoy a 15 percent corporate tax rate. Under the new regime, companies will have to weigh up their best options. Do they leave the FTZ or other special investment area and lose their tax incentives, or do they set up their business as they want, where they want and hope that the move will pay off? Companies also need to watch out for tax mixes. Services are subject to 5 percent business tax; the sale of goods attracts 17 percent VAT. If a company sells goods and provides an after-sale service, it will need to consider the segregation of its income to avoid an unwarranted tax burden. From 2007, it is likely that a unified tax law will come into effect which could end the preferential tax advantages that foreign investors have over local counterparts. The special tax policies offered in FTZs are also under threat. For now, Peter Kung and David Ling advocate sitting tight and making the most of the measures in their current form. Decisions must be dictated by individual company circumstances. If youre a loss-making company, you may be better off expanding your
1: The Economist, China Retail and Distribution: Changes for the Better? An industry report series exclusively written for KPMG in China and Hong Kong, 2004

operations and taking advantage of the five-year tax holiday to offset the loss against income. But a profitable manufacturer may not want to risk losing its preferential tax incentives by changing its business scope. Better that it sets up a new company than threaten the status of the existing one.

Before you invest


Start by examining your objectives for investing in China and decide whether you are really capable of cracking this market on your own. The sheer size and uniqueness of the country, its macroeconomics, logistics and wealth distribution across rural and urban pockets of consumers mean the need for local advice should not be underestimated. Know your way around the complex regulations and designated trading zones, each offering different incentives. Decide whether the tax incentives are more alluring and commercially sound than the opportunity to make your own decisions about where you locate and how you structure your business. Western retailers, traders and wholesalers now share equal rights with their manufacturing and hi-tech counterparts in China. And with them come logistical, supply chain and retailing skills that are very often absent among local players. With the freedom to choose how they move their goods in and out of China, how they make and receive payments, a population of 1.3 billion with money to spend is open to the shrewdest players. Remember, though, a Western tag does not guarantee success. The world order of brands does not necessarily follow in China and discerning Chinese consumers may be just as happy with a cheaper, locally produced alternative.

Peter Kung is the tax partner in charge of KPMGs China tax practices in Hong Kong, Guangzhou and Shenzhen. He concentrates on the People's Republic of China (PRC) taxation, customs duty and business advisory matters. He has advised many multinational corporations on how to structure their investment into the PRC and has also assisted numerous clients to negotiate with PRC authorities to help minimize their tax burdens He also has extensive experience in assisting foreign enterprises to establish foreign investment enterprises (FIEs) and other business vehicles to conduct business in the PRC. Tel: +852 2 826 8080 e-Mail: peter.kung@kpmg.com.hk David Ling is a partner based in Beijing, and part of KPMGs Chinese firm. He has over 12 years of tax advisory experience with multinational companies in the areas of tax planning strategies in respect of their investments in China, devising ways to ringfence tax risks and successfully negotiate with tax authorities and the Ministry of Commerce on issues such as tax exemptions or establishment of foreign investment enterprises in China. Tel: +86 (10) 8518 9280 e-Mail: david.ling@kpmg.com.cn

2005 KPMG LLP, the UK member firm of KPMG International, a Swiss cooperative. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative.

kpmg.com

Global Consumer Markets contacts Neil Austin Global Chair KPMG LLP (U.K.) 8 Salisbury Square EC4Y 8BB Tel: +44 (0) 20 7311 8805 Fax: +44 (0) 20 7311 3311 e-Mail: neil.austin@kpmg.co.uk Mark Twine Global Executive KPMG LLP (U.K.) Conway House 1-2 Dorset Rise London EC4Y 8EN Tel: +44 (0) 20 7311 3873 Fax: +44 (0) 20 7311 8936 e-Mail: mark.twine@kpmg.co.uk Fiona Sheridan Global Senior Marketing Manager KPMG LLP (U.K.) Conway House 1-2 Dorset Rise London EC4Y 8EN Tel: +44 (0) 20 7782 2676 Fax: +44 (0) 20 7311 8936 e-Mail: fiona.sheridan@kpmg.co.uk

The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that 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 act on such information without appropriate professional advice after a thorough examination of the particular situation. KPMG International is a Swiss cooperative that serves as a coordinating entity for a network of independent member firms. KPMG International provides no audit or other client services. Such services are provided solely by member firms in their respective geographic areas. KPMG International and its member firms are legally distinct and separate entities. They are not and nothing contained herein shall be construed to place these entities in the relationship of parents, subsidiaries, agents, partners, or joint venturers. No member firm has any authority (actual, apparent, implied or otherwise) to obligate or bind KPMG International or any member firm in any manner whatsoever or vice versa.

2005 KPMG International. KPMG International is a Swiss


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Designed and produced by Natural Publication name: ConsumerCurrents Issue 1 Publication number: 211-785 Publication date: Summer 2005

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