Goods and Services Tax

Responding to an unprecedented opportunity to transform supply chain performance in India

A bus journey beyond the suburbs of most Indian cities gives a glimpse of the supply chain problems that dog the nations businesses. But one statistic really spells it out: Logistics costs consume 15 percent of the nations gross domestic product (GDP) compared with just 7 percent of GDP in the US and 6 percent in UK. India is not alone in this respect, of course: In China, logistics account for more than 15 percent of GDP, while in Brazil the figure is 20 percent.1 Indian business leaders need no reminders that the countrys road infrastructure is poor and freight rail movement is disproportionately low despite the expanse of rail networks nationwide. Its well-known that

truck ownership is fragmented and dominated by sole proprietors and other elements of the unorganized industry segment. On the demand side, retailing is highly fragmented, characterized largely by the unorganized segment. And Indias current tax structure exacerbates the problem because tax issues rather than operational efficiencies dictate the locations of stocking points and other supply chain facets. (See Figure 1.) When designing and implementing supply chains, most business leaders take into account the factors they are familiar withfactors such as the intensity of competition and the preferences of their customers. But now, with the

explosive demand that the Indian market is witnessing and with the coming introduction of the Goods and Services Tax (GST), it becomes imperative for businesses to re-evaluate their supply chain structures and strategies.

Indiastat.com

Figure 1: Supply chain design is also a function of tax rates

Market Responsiveness

Taxes or Fiscal costs

Changes in customer preferences

Cost Efficiencies

Changes in demand patterns or growth

Supply Chain

Competitive Intensities

Supply Chain Designs are impacted by factors either internal to the company or governed by the market place or by the government.

The economic imperative for supply chain change

The challenges in Indias logistic sector are quickly coming to a head. The primary pressure point is economic. The Indian economy has grown strongly since 2003averaging annual growth rates above 8 percentand is projected to maintain that momentum until 2020. By 2025, India is projected to become the world's fifth-largest consumer market; a decade after that, forecasters expect it to be the worlds third largest economy just after US and China. A swelling middle class already propels spending in Indias urban areas, and tens of millions more people will move to the cities in the coming decades. But the strongest growth will come from the hinterlandsfrom a burgeoning marketplace of more than 720 million rural customers. Yet it is in the countryside where infrastructure is weakest, and where supply chains are most in need of transformation.

The countrys rural economy was largely untouched by the global economic slowdown, blessed as it was by four years of continuous growth in agriculture that have sent rural incomes soaring. Rural demand for fast-moving consumer goods (FMCG), pharmaceuticals, automobiles, and consumer durables is soon likely to match that generated in urban areas. Both government and private industry are actively addressing the needs of the bulk of Indias population who live outside of urban and suburban areas. The private sector is investing heavily in product launches, research and development (R&D), and in capacity upgrades at manufacturing plants focused on the rural population. And the Mahatma Gandhi National Rural Employment Guarantee Act (NREGA) is playing a part. Signed into law in August 2005, the NREGA is a public-work job scheme designed to

improve the purchasing power of rural communities; a third of the NREGA jobs are to go to women. The 20092010 union budget hiked the NREGA allocation to US$8.03 billiona big boost to the rural economy.

Coming soon: A fiscal catalyst for change

An upcoming move by the GOI will act as a powerful catalyst for change. The introduction of a national goods and services tax is expected to give business leaders the push they need to transform their physical, financial and information supply chains. It will compel them to look at their supply chains at a national level rather than regionally. The GST will significantly improve logistics efficiency. It will speed the movement of goods across India with a single consumption tax structure that replaces the current multiple tax system, which includes central excise, state VAT and service tax -- the sum of which can add as much as 30 percent to the manufactured cost. If manufacturers can align their supply chains with the new tax structure, they can expect to see real benefits from decreased costs at each point in supply chainsavings that will help them become more competitive. At the very least, alignment with the GST will give producers the opportunity to lower prices.

To reach Indias fast-growing markets flexibly and cost-effectively and to take full advantage of the upcoming changes in the tax structure, supply chains need to improve on three fronts: physical, financial, and in terms of the information flow that underpins all supply chain transactions. Lets look at each aspect in turn:

Figure 2: Indias current tax structure and how it will look under GST

Present Tax structure

Services State A Service Tax (10.3%) Exports

Import BCD (10%)+ AD(14%) Excise duty (10.3%) +State A VAT (13.5%)

Factory State A

Excise Duty (10.3%) (Credit of Excise, Service Tax and AD)

Factory warehouse State A

VAT strives to eliminate cascade of taxes Central and state tax do not mix Many taxes (CST, Surcharge) still get cascaded

State A VAT*(13.5%) Distributor State A

State A VAT(13.5%) Retailer

Supplier State A CST (2%) Supplier State B Regional WH State A CFA State A

State B VAT(13.5%) Distributor State A CST(2%) Retailer

Tax % mentioned are based on close industry estimates No credit for Excise and other central taxes available after goods move out of warehouses Credit for CST not available at any point BCD - Basic Customers Duty, AD Additional Duty

GST Structure
Services State A SGST(5%) + CGST(6%) Exports

Import PoE State A

Custom (10%) + SGST(5%) + CGST(6%)

Factory State A

SGST(5%)+ CGST(6%) - Full Credit of (CGST+SGST +IGST )

Factory warehouse State A

GST eliminates cascading of most of the central and state taxes Interstate and intra state transactions have same tax liability

SGST(5%) + CGST(6%) Supplier State A SGST(5%)+ CGST(6%)(Full Credit) IGST(11%) Supplier State B Regional WH State A CFA State A

SGST-State A(5%)+ CGST(6%) (Full Credit) Distributor State A

SGST-State A(5%)+ CGST(6%) (Full Credit) Retailer

Distributor State A IGST(11%)Credit of (SGST+CGST+IGST)

SGST State B (5%) + CGST(6%) (Full Credit) Retailer

Tax % mentioned are forecast. PoE Port of Entry

The physical supply chain

Figure 3: Key questions about how the GST structure might affect supply chain networks

GST presents a opportunity to get business mandate re-design the supply chain independent of tax implications
Some relevant questions Supplier Sourcing & Purchasing
Which suppliers should supply to which manufacturing sites? Which categories should we purchase from each supplier? Can suppliers be consolidated? Can purchase prices be renegotiated with the suppliers? How will my long term contracts with suppliers be affected, any change in clause required?

Manufacturing
What should be the manufacturing locations? What should we manufacture at each plant? Do we shift/expand/remove existing facilities? Should we go for contract manufacturing or self manufacturing (make vs. buy)? How will the competitive scenario change and how should this impact our manufacturing strategy?

Transportation & Distribution

Which DCs do we need? Which markets and products should they serve? Where do we locate the new regional DC? Should we have a Factory DC? What is the optimal product flow? Direct shipments or stock transfers? Who should be my logistics partners? Should we consolidate warehouses?

Customer and Markets

Which are my current and future demand clusters? How should we design our logistics network to best serve new geographies? Do we need to re-price our products? How do my working capital requirements change?

Warehousing
What is the better option - own the warehouse or lease it? What will work better self managing or outsourcing?

The logistics challenges are the most glaring. The nations physical infrastructure is substandard, to put it mildly. Roads carry more than half of the country's total freight. Although India has one of the worlds largest road networks, less than half of the roads are paved and less than 2,000 kilometers are express highways. Indias railways arent much better from a logistics managers perspective. Since Indian Railways has a monopoly in freight and passenger trains, there is an enormous strain on its existing track network. Indeed, Indias booming truck transportation sector has been taking market share from rail, helped by truckings relative speed over short distances and its door-to-door capabilities. The nations port system is also overburdened. Seventy percent of seaborne trade is handled by two of its 12 major ports, which run at 95 percent utilization ratesa number that looks even less comfortable since Indias 180 minor ports go largely unutilized.
2 3

At the same time, warehousing and distribution centers are poorly developed compared to world-class standards. Even the nations bestorganized logistics players have few offerings across multiple modes (air, water, rail, and road) or across servicesspanning transportation, warehousing and value-added services such as packaging, cold chain, and customs clearance. Furthermore, India largely lacks the big trucking fleets common in the West; instead, there are hosts of independent players with regional or national permits, most with just one or two single-axle trucks. Low costs come from low wages (few drivers have much education), minimal use of technology, poor equipment maintenance, chronic overloading, and cut-throat price competition. These factors combine to make it very difficult for companies from the organized segment to compete. Efforts are under way to improve the physical supply chain nationwide, and in every state. A few highlights:

The GOI has granted a 100 percent income tax exemption for 10 years for all road development projects. The National Highways Authority of India (NHAI) is considering grants for viability gap funding for marginal projects.2 At the same time, the New Delhi government has decided to invest about US$5billion to enhance rail routes nationwide.3 There are efforts to increase the capacity of rail lines in critical traffic sectors and to modernize signaling systems. Other initiatives are focused on strengthening the track structure, standardizing the rail gauge, and opening container transport to private-sector competition.4 Another key effort is the Dedicated Freight Corridor (DFC)rail lines that will be isolated from passenger traffic. The GOI has also instituted its National Maritime Development Policy to facilitate private investment in a bid to improve service quality at Indias ports. The government is also encouraging private investment from overseas,

http://www.legalserviceindia.com/article/l306-Infrastructure-Investments-in-India.html http://www.legalserviceindia.com/article/l306-Infrastructure-Investments-in-India.html 4 Enam Indias Report on Logistics Sector, Aug 2007 10

Figure 4: A simulation on the effect of GST is done using the real supply chain data of a CPG company.

A simulation was done using the real Supply Chain data of a major CPG company Two scenarios were run keeping the same demand and supply, changing the taxation structure Scenario 1 As Is network with CST, Excise and VAT liability Scenario 2 As Is network with GST

Number of active DC Locations 27 Service Level (1 Day) 81.1% permitting foreign businesses to own 100 percent of the construction and operation of terminals and berths. And to improve air cargo efficiency, the GOI has made it mandatory for all new airports to have separate cargo facilities. The GST will begin to make a difference to decisions about the physical supply chain, freeing executives from having to locate manufacturing bases and distribution networks with tax benefits foremost in mind and allowing them to think about operating flexibility and efficiency from the customers standpoint. (See Figure 3.) As such, the GST will put domestic business leaders on an even keel with importers that do not need to pay consumption taxes. The new tax is expected to reduce the number of warehouses that manufacturers are required to maintain in different states, resulting in a big increase in demand for integrated logistics solutions. Its very probable that companies will move to newer and more centralized hub and spoke distribution models. (See Figure 4.) The growth opportunity for 3PL players is expected to come predominantly from warehousing, which is likely to be driven by the implementation of VAT. At the same time, reduced documentation and lower overhead will likely make 3PLs more efficient. The benefits should show up when the central sales tax is abolished. It is expected that international giants such as retailers Walmart and Carrefour will spur the growth of 3PLs by making the use of those services mandatory for their suppliers.

Number of active DC Locations 19 Service Level (1 Day) 81.1%

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Key Facts
# of DCs 1-day Service Level Days of Inventory Total Sales Primary Freight Cost Secondary Freight Cost CST Excise VAT GST

Scenario 1
23 81.10% 45 676 4.82 3.42 0.88 57 85 -

Scenario 2
17 80.60% 32 676 4.62 4.16 135

There is a reduction in the number of warehouses required to have the same service levels There is a reduction in primary freight cost due to consolidation of freight Secondary freight cost increases because of increase in the weighted average distance between the warehouse and customers In the present tax structure, CST, Excise and VAT are the main taxes levied. These are proposed to be subsumed in GST

* Al figures in crores * 1 day Service Level => 250 kms distance travel for secondary freight * GST assumed at 10% State GST and 10% Central GST * Primary Freight Cost is the transportation cost between the plants and the warehouses * Secondary Freight Cost is the transportation cost incurred between the warehouses and the customers

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The financial supply chain

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The financial supply chain that supports the tangible supply chain is equally challenging for business leaders. Fees levied by carry-and-forward agents (CFAs) are a burden. Access to credit continues to be a challenge. And Indias complex tax structure is especially onerous. Sales taxes that differ from state to state mean significant diseconomies of scale for trans-state logistics service providers. Although value-added tax (VAT) was implemented on April 1, 2005, it has not been implemented uniformly across the states. At the same time, Indian transport firms have to pay various other taxes and octrois, and face multiple check posts. Complying with the varied tax documentation requirements of different states adds cost and delay: On average, a vehicle on Indian roads loses between 24 and 48 hours complying with paperwork and formalities at check posts en route.5 The introduction of the GST in its current form is set to benefit cash flow. First, physical working capital costs are likely to decrease as GST would be paid at the time of sale or supply and not at the time of manufacture. Second: The
5

GST is expected to do away with excise duty on manufacturing. And the new tax should open up broader availability of credit in inter-state transactionsa powerful lubricant for commerce. The GST will make management of cash flow much more efficient since it will permit businesses to claim input credits from output GST obligations. Also, they can pay taxes with available central GST (CGST), state SGST (SGST), and interstate GST (IGST) credits to the state or the central government. Since GST payments affect cash flows, it becomes essential to decide whether to opt for cash-based accounting or accrual accounting. For instance, when considering the timing of the availability of input tax credits, cash basis refers to all payments actually made by the manufacturer during the period whereas accrual refers to all invoices issued to the business in that period. And when discussing the timing of the liability to pay GST, cash-based accounting applies to all payments actually received in the period while accrual relates to all invoices issued during the period. [Right?]

The GST will affect the availability of working capital. In the case of stock transfers, working capital would reduce since GST is levied during stock transfer but credit is given only when stock is sold. The input tax credit (ITC) available can be utilized only the end of the supply chain, after the goods are sold, which is a function of the lead times of the company. Compared to the present scenario, the GST would delay the realization of cash, reducing working capital. The new tax will also increase the need for working capital. It will be payable in lieu of service tax. Similarly, it comes on top of existing custom duties. Even though the credit for these taxes can be claimed downstream, more working capital will be needed if GST is higher than the existing tax rates. Any unutilized credit for the CGST (8 percent) and SGST will be refunded at the end of the fiscal year, meaning that cash in the form of utilized credit would be locked until the fiscal year closes. Furthermore, tax exemptions available presently will be converted into a cash refund scheme, raising working capital requirements.

Logistics Industry: Global and Indian Perspectives by Subrata Mitra 95th ISM Annual International Supply Chain Management Conference Report, April 2010 14

The information supply chain

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These days, those who run world-class supply chains are attuned to the need to make their information supply chains as efficient and effective as possible. They use IT tools to see far up or down the supply chain to sense endcustomer demand or supply constraints and to help synchronize activities in order to reduce costs and quicken responses to fluctuations in demand. India, however, does not have much of an information supply chain to speak of. Little is known about what data buyers and suppliers use, let alone what information they might share. Use of technology is quite limited, and the siloed nature of the logistics sector effectively blocks easy dissemination of vital information about shipment times, freight manifests, order accuracy, and much more. The paucity of information creates uncertainty, unnecessary paperwork and delays. The fragmented state of the sector creates another vicious cycle: It makes it much more difficult for technologies such as global positioning system (GPS) vehicle tracking and radio frequency identification (RFID) to catch on. Indias business leaders understand that they have to be able to capture and analyze information related to customer needs and use it to improve their products and services in order to remain competitive. So they are eager to assemble the collection of information and communication technologies necessary to collect information from discrete processes, transform this information from data into knowledge, and distribute this information efficiently and in a timely manner to the appropriate data consumers.

The GST will help to enrich the information supply chain. It will remove the need for CFA agents since businesses will no longer need to bother about taxation due to interstate transfers. This will help make information visible much further up and down the supply chain and make it easier to integrate processes for sharing data such as demand signals, inventory levels, alternate transportation routes, etc. a definite plus in terms of demand planning and inventory rationalization. Also, with stocks aggregated at fewer warehouses, information management can improve, which in turn will improve planning and assortment availability. In effect, CFAs can now become bona fide third-party logistics providers. At the same time, customers demands for more valueadded services will boost the adoption of technology solutions such as warehouse management systems and track-and-trace offerings. The same cannot be said of RFID technologies. Although RFID is designed to enrich the flow of useful supply-chain information, it will not yet become mainstream, and quantifying returns on investment on RFID technology will remain a challenge.

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A major new opportunity for business leaders

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This is not the place to get into the finer points of taxation. Suffice it to say that the GST will materialize in some form sooner rather than later even though it is still the subject of impassioned debate and debate at state and GOI levelsand even though the tax structure faces hurdles before, during and after implementation. Some of the issues still being hashed out include: Uniform legislation for collection of the tax at state and central levels, as well as binding agreement among the states to prevent unilateral amendments in their respective legislations. It will also be incumbent on the government to protect the interests of the states that have lower revenue potential. Octroi and state permits will still exist in the new regime, and thus may be an impediment following implementation of the GST. As yet, there is little discussion about training of field officers to ensure the smooth administration and implementation of the GST regime. Nor does there seem to be a robust technology-based credit infrastructure to support GST implementation. The main point for business leaders is that the GST is on its way, and they should be ready to use it as a key rationale for transforming their supply chains. Here are several logistics initiatives that can be considered now: Design a multi-tiered distribution network to reduce the impact of unreliable transportation. Manufacturers will probably need to adopt multi-echelon networks that cover local, regional and central points. Since the GST can enable a reduction in the number of warehouses, companies can consider efficient hub-and-spoke distribution models. One of Indias leading communications industry players is currently experimenting with this mode.

Develop inventory strategies that call for staging of inventory in the multi-echelon network. This would entail investments to create additional capacity flow, such as staging floor space. It is expected that this investment would offset currently high transportation costs. Partner with a fast-growing 3PL provider with demonstrated supply chain planning skills and expertise in areas such as operation of warehousing and distribution centers, after-market distribution, fleet management, and logistics network modeling. Major international players in the electronics, communication and cosmetics industries are already partnering with leading 3PLs in India to be ready for the challenges ahead. Major Indian companies in the power and resources industries are partnering with 4th party logistics providers thus leveraging the competencies of both 3PL providers as well as leading consulting and technology firms. Build core logistics teams on the ground in the markets being served. The teams would be responsible for: scoping out and building relationships with service providers in the region; determining criteria for selecting supply chain partners; being familiar with inter-state regulations to remove procedural snafus; and managing local operations. Take advantage of growth in the telecom sector and invest in technology that enables better tracking and reporting capabilities. Most Indian companies have already started using techniques such as palletization and are now turning to technology tools such as warehouse management systems software. The next wave of technology use is expected to involve RFID for pallet tracking and returnables and GPS for tracking of vehicles, especially in the food and fast-moving consumer goods (FMCG) sectors. Increase asset utilization by building shared infrastructure in warehousing, distribution and transportation space. This investment would cut costs in the short term but it could also be a source of extra revenue in the long term when proper supply chain maturity is established. 3PLs

are expected to be prominent players in the effort to better use assets. Some FMCG companies are already moving in that direction with their 3PL partners. Make use of cross-docking techniques. With the inception of GST, companies need far less documentation for the inter-state movement of their goods, making cross-docking an attractive way to further reduce costs. Leading global players in the electronics and communications industries have been doing this for many years outside India. Now they are keen to implement the same techniques in their Indian distribution networks. When the GST finally takes effect, its initial impact will be to hike supply chain costs. Companies will have to maintain parallel networks and invest in new facilities; truck owners will almost certainly purchase largercapacity vehicles, and more of them. On top of that, the governments tax infrastructure may not be ready to pass on the GST credits. Nevertheless, the GST affords an unprecedented opportunity to improve supply chain efficiency all across India. It will help improve operating performance in small- and mid-sized businesses as well as large national and international enterprises. And it will help many of Indias foremost corporations close the gap with their global competitors in crucial functions that, until now, they have had relatively little power to improve. Now is the time for Indias business leaders to act on the opportunity. Their customers will be expecting it. And their shareholders have a right to demand it.

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Authors
Anurag Sekhri
Anurag Sekhri is a Partner and a member of Accentures Global Supply Chain Practice, specializing in Supply Chain Strategy. A specialist in Fast Moving Consumer Goods, he has led several transformational programmes spanning European Operating Models, Retailer/ Supplier Collaboration, Innovation and Tax Optimised Structures. Anurag can be reached at anu.sekhri@accenture.com.

Accenture Supply Chain practice in practice

Accenture Supply Chain Management consulting services help clients across a broad range of industries to develop dynamic supply chains by aligning operating models to support business strategies, optimizing global operations, and enabling profitable product launches. Committed to helping clients achieve high performance through supply chain mastery, we combine global industry expertise and skills in supply chain strategy, sourcing and procurement, supply chain planning, manufacturing, product design, fulfillment, and service management to help organizations transform their supply chain capabilities. We collaborate with clients to implement innovative consulting, technology and outsourcing solutions, and enhance the skills and capabilities of the supply chain workforce. For more information, visit www.accenture.com/supplychain.

Disclaimer
This Report has been published for information and illustrative purposes only and is not intended to serve as advice of any nature whatsoever. The information contained and the references made in this Report is in good faith, neither Accenture nor any its directors, agents or employees give any warranty of accuracy nor accepts any liability as a result of reliance upon the information, advice, statement or opinion contained in this Report. This Report also contains certain information available in public domain, created and maintained by private and public organizations. Accenture does not control or guarantee the accuracy, relevance, timelines or completeness of such information. This Report constitutes a view as on the date of publication and is subject to change. Accenture does not warrant or solicit any kind of act or omission based on this Report.

Ganesan Ramachandran

Ganesan Ramachandran is a senior manager in Accenture's Supply Chain Management Service Line. He has more than 17 years of experience in supply chain management spanning from vendor development to service management in a variety of global companies. Ganesan has experience working with companies in the automotive and consumer goods & services industries. Based in New Delhi, India, he can be reached at ganesan. ramachandran@accenture.com.

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