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Reinvent your portfolio company operating model — and bring tax to the table from the start

May 04, 2021

Patrick Gordon
Principal, Private Equity Value Creation Leader, PwC US
Puneet Arora
Private Equity Tax Leader, PwC US

COVID-19 has been a shock to the global system, and private equity (PE) portfolio companies have hardly been immune. If anything, the pandemic has had an even greater impact on private equity because of its exposure to multiple portfolio companies, jurisdictions, investors and sociopolitical realities.

But there’s a flip side. The shock also triggered a long-needed reevaluation of portfolio company operating models. We recommend you focus on four key areas for your portfolio companies where tax can provide benefits: aligning tax strategy with business models, building in flexibility, going holistic in your assessments and operations, and finding the right balance between tax and ESG.

We’ve previously discussed why tax and scenario planning should be essential considerations as PE firms shape their portfolio companies’ strategies in a post-pandemic world. Let’s now take a deeper look at how the pandemic has accelerated and intensified issues that had been building for years — including digitalization, trade tensions and a growing focus on environmental, social and governance (ESG) issues.

A new way of thinking

Prior to the pandemic, PE generally approached key subjects such as tax strategy, supply chain, procurement, ESG and digital roadmaps as separate issues. The experience of the last 12 months has taught us that you can’t approach these issues as one-off items if you want to create value. Companies that respond to ESG requirements by engaging more proactively with their suppliers and diversifying countries of origin can reap substantial benefits in terms of a more resilient and cost efficient supply chain. As business savings from these initiatives materialize, there can be an opportunity to capture the resulting economic value in a tax-efficient way. 

This broader view takes advantage of each company’s new, hard-earned flexibility, embraces longer-term trends and more deeply embeds both tax considerations and digital enablement into core business strategy. Based on our experience in the market, we’re already seeing transitions from traditional models to tomorrow’s way of thinking.

    Yesterday Tomorrow
Supply chain

- Stable
- Single-site supplying
- Optimized for cost and efficiency

- Flexible
- Multi-regional/multi-local supplying
- Agile
- Resilient
- Risk/opportunity sensing
- Landed cost optimized
- Strategic to business growth
- Indirect tax impact

Tax strategy

- Post-deal
- Effective tax rate (ETR)-focused
- Inversions
- Use of duty drawbacks
- Low Tax Jurisdictions

- Embedded starting with pre-deal
- Modeled using latest value chain
- Focused locally on tax benefits and issues including: tariffs, synergies, intangible assets,and tax incentives

Procurement

- Traditional
- Centralized around traditional low-cost locations efficiency

- Investments in strategic sourcing
- Digitally enabled
- More distributed to improve resiliency

ESG

- Lower priority
- Standalone initiative

- Embedded as part of value creation
- Integrated with other key initiatives

Operating model

- Transactional
- Quantitative
- Linear

- Integrated
- Holistic
- Market aligned
- Integrated across commercial lifecycle
- Supportive of multi-channel
- Simplified

The mindset shift: Four guideposts

Adapting to the new model requires some changes in mindsets and longstanding practices. Fortunately, change management is easier when change has already been imposed by the outside world and you’ve had some time to start rethinking some of your processes. Here are four guideposts that we recommend.

1. Align your tax strategy with your business model. When the big strategic and operational decisions are being made from portfolio strategy development to due diligence to post-deal value capture, tax should have its seat at the table. How you organize your supply chain and demand chain, where you set up your procurement hub, your distribution center, your R&D center — even your headquarters — will have tax implications. Layering in tariffs, trade taxes, income tax, special incentives and other factors can help give you the sharpest picture of where optimal value lies.

For example, the lowest cost might be to go from country A to country B. But factoring in ESG, tariffs, income taxes (not to mention special tax regimes and incentives) might yield a completely different calculation. Keep in mind that many of the models and strategies used by companies over the past 30 years are either no longer compliant or have lost much of their usefulness due to increased government and stakeholder scrutiny. Some could even be a drag on today’s more strategic operating model. We’ve seen companies win in this space by building a simple combined business and tax model that aligns with the operating footprint and is transparent from a stakeholder perspective. Because many models are no longer fit for purpose, moving in this direction can help reduce costs and improve your risk profile. 

2. Take it further. To optimize value, go holistic. Every step of the value chain contains its own operational, reputational and tax considerations, and these can interact in unexpected ways — positively or negatively. Layer in multiple perspectives to help determine a better solution. And keep in mind that the more complex your value chain, the greater the risk of unexpected consequences.

Some companies have announced their decision to locate their headquarters or centers of expertise in lower cost jurisdictions. Others are examining how digitalization and ESG can enable new areas of value. Since the pandemic, for instance, remote work has expanded to functions such as supply chain management, commercial leadership, procurement and engineering. These functions were traditionally housed in physical proximity to manufacturing sites and/or customers, and many thought that it needed to be that way. By investing in strategic sourcing capabilities and establishing a center of expertise in a strategic location, companies can reduce materials costs by 2% to 4%.

With all of these changes, don’t pass up the opportunity to increase value even more by further adapting your operating model to integrate intellectual property (IP) assets, manufacturing footprint and demand channels. To get started, conduct a holistic global tax assessment early, preferably during due diligence, and build on it later in the deal life cycle.

3. Expect volatility, build in flexibility. Global supply chains have already had to deal with a litany of changes, including new tariffs, natural disasters, disrupted manufacturing and logistics, government scrutiny, and the pandemic. Monitor for changes in policy and the broader environment. In developing alternate sourcing and routing options, you should also incorporate tax and tariff impacts to create a “total cost” view of your supply chain.

Take a US-based multinational with overseas activity. If the company considers only manufacturing and freight costs when thinking about supply chain strategy, it could develop a completely different plan than if it also takes into account factors such as tariffs, duty drawbacks, foreign-derived intangible income and other tax issues. While companies need to weigh the relative stability of tax policies when factoring them into their permanent location decisions, companies can find tax savings by rethinking how they set up their high-value touchpoints such as sourcing offices and supply chain control towers. Don’t stop there. Consider strengthening your monitoring of risk and building playbooks that allow you to quickly shift suppliers and/or locations.

4. Find the right balance between effective tax rate (ETR) and ESG. Tax transparency is increasingly incorporated under the G (governance) of ESG. But ETR versus ESG doesn’t have to be a zero-sum decision. Examine the entire ESG impact of any proposed action before you decide from a strategic perspective what makes sense.

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