Proposal

Global Supply Chain Planning:Impact of International Taxation and

Transfer Pricing

Masha ShunkoCommittee members:

Alan Scheller-Wolf

Srinagesh Gavirneni

Laurens Debo

Lin Nan

Agenda

• Motivation• Transfer Pricing 101• Thesis objectives• 3 Essays• Proposed work

2

Motivation

3

e

Motivation

4

e

Motivation

5

e

Motivation

6

e

Motivation

7

Transfer pricing 101

8

Selling division, USA; Tax rate = 30%,

Sales price = $20,Demand = 1000

Manufacturing division, Estonia;

Tax rate = 0%, Cost = $10


9





$10


10





$10

$7,000


11





$10

$7,000

$0


12





$10

$7,000

$0

$7,000


13









$10

$7,000

$0

$7,000

?


14









$10 $20

$7,000

$0

$7,000

$0

$10,000

$10,000

Transfer pricing Legal background

• Flexibility of Transfer Pricing Rules (§1.482 IRC)– Cost based methods – Retail price methods – Profit split method– Negotiated method– Alternate methods

• “Best method”

15


• Repatriation of profit– Residence based taxation, deferral of taxation

16


• Repatriation of profit– Residence based taxation, deferral of taxation– Unrepatriated profits:

17



18

* Wall Street Journal, April 22nd, 2009 “Titans Vow Overseas – Tax Fight”

Company* 2008 All years Tax rate reduction

General Electric $13B $75B 26.9

Cisco Systems $5.6B $21.9B 16.1

Merck & Co $4.8B $22B 11.7



– General Electric** average tax rate reduction over 2008-2010 is 30.2

19

* Wall Street Journal, April 22nd, 2009 “Titans Vow Overseas – Tax Fight”

Company* 2008 All years Tax rate reduction

General Electric $13B $75B 26.9

Cisco Systems $5.6B $21.9B 16.1

Merck & Co $4.8B $22B 11.7

Transfer pricing Incentive issues









$10 $20

$7,000

$0

$7,000

$0

$10,000

$10,000

20










$10 $20

$7,000

$0

$7,000

$0

$10,000

$10,000• Transfer price has two roles:

– Tax: income shifting;

21










$10 $20

$7,000

$0

$7,000

$0

$10,000

$10,000• Transfer price has two roles:

– Tax: income shifting;– Incentive: divisional performance.

22

Transfer priceIncentive = Tax ?

• Halperin• Chechowitz (1980)

23

Literature review

• Accounting– Transfer pricing models: Hirshleifer (1956), Horst (1972), Copithorne

(1971), Hoffman (2001), Baldenius and Reichelstein (2006)– Offshoring: Altshuler et al. (2001), Desai and Hines (2003), Clausing

(2005)

• Operations Management– Global sourcing: Kogut and Kulatilaka (1994), Kouvelis (1999)– Global supply chain logistics: Vidal and Goetschalkcx (2001),

Nieckels (1976), Cohen et al. (1989)– Transfer pricing: Huh and Park (2008)

24

Thesis research objective

• Study the impact of tax considerations on the transfer pricing and operational decisions of global supply chains facing different sources of uncertainty

25

Thesis research objective

• Study the impact of tax considerations on the transfer pricing and operational decisions of global supply chains facing different sources of uncertainty

26

Essay Source of uncertainty

Decisions Transfer price

1 Demand Price, Quantity Single

2 Cost Price, Sourcing Single

3 Cost and Exchange rate

Sourcing, Flexibility

Dual

27

Essay 1: Role of Transfer Prices in Global Supply Chains with Random

Demands

Masha Shunko

Joint work with:

Srinagesh Gavirneni, The Johnson School, Cornell University

Published at: Journal of Industrial and Management Optimization, Volume 3, Number 1, February 2007, Pages 99 - 117

Essay 1: Research objective

• What is the impact of optimizing transfer prices on the global supply chain performance of a price-setting firm facing random demand?

28

Essay 1: Supply Chain Model

29

Headquarters

Local selling divisiont

Foreign producing division

c, ¿

Decision variablesRandom variablesParameters

P

D(P, ² )


30

Headquarters



c, ¿


P

D(P, ² )


31

Headquarters



c, ¿


D(P)=a - b P + ²

P

D(P, ² )


32

Headquarters



c, ¿


D(P)=a - b P + ²

Q at T

P

D(P, ² )


33

Headquarters

Local selling divisiont, cO, cU


c, ¿


Q at T

P

D(P, ² )


34

Headquarters



c, ¿


Q at T

P

D(P, ² )


35

Headquarters



c, ¿


Q at T

Essay 1: Timeline

36

Stage 1: HQ sets the transfer price T

Stage 2: Selling division sets selling price P and ordering quantity Q


Essay 1: Timeline

37

Stage 1: HQ sets the transfer price T

Stage 2: Selling division sets selling price P and ordering quantity Q


Essay 1: Stochastic vs. Deterministic

38


• Stochastic

39


• Stochastic • Deterministic

40


• Stochastic

• Optimal Profit:

• Deterministic

• Optimal Profit

41


• Stochastic

• Optimal Profit:

• Profit Improvement:

• Deterministic

• Optimal Profit


42


• Stochastic

• Optimal Profit:


• Deterministic

• Optimal Profit


43

Essay 1: Why ?

44

Essay 1: Why ?

• Selling price effect:

45

Essay 1: Why ?


46

Essay 1: Why ?


47

Essay 1: Why ?


48

Essay 1: Conclusions

• Supply chains facing random demand achieve more benefit from optimizing transfer pricing

• The effects is highest for supply chains with:– Low customer base– High price elasticity– High demand variability

49

50

Essay 2: Transfer Pricing and Offshoring in Global Supply Chains

with Cost Uncertainty

Masha Shunko

Joint work with:

Laurens Debo, Booth School of Business, University of Chicago


Award: POMS Best Student Paper Award, May 2009

Essay 2: Research objectives

1. What are the optimal pricing, sourcing, and transfer pricing strategies of global firms that face different tax rates and uncertain production costs at various business locations?

2. How does organizational structure affect the sourcing and transfer pricing strategies of the global firm?

51

Essay 2: Global Supply Chain

52

Headquarters

Local selling division t


c, ¿


P

D(P)=a–bP


53

Headquarters

Local selling division t


c, ¿


External suppliercE

P

D(P)=a–bP


54

Headquarters


Offshore:

D(P) (1-¸)


c, ¿


External suppliercE

Outsource: D(P) ¸

P

D(P)=a–bP


55

Headquarters


Offshore:

D(P) (1-¸)


c, ¿


External suppliercE

Outsource: D(P) ¸

P

D(P)=a–bP


56

Headquarters


Offshore:

D(P) (1-¸)


c, ¿


External suppliercE

Outsource: D(P) ¸

P

D(P)=a–bP

Information asymmetry


57

Headquarters


Offshore:

D(P) (1-¸)


c, ¿

Two point distribution:


External suppliercE

Outsource: D(P) ¸

P

D(P)=a–bP

Information asymmetry

Essay 2: Organizational structures

Structure Headquarters Local division

Centralized T, P, ¸

Decentralized Pricing

T, ¸ P

Decentralized Sourcing

T, P ¸

Decentralized Pricing and Sourcing

T P, ¸

58

Essay 2: Organizational structures


Centralized T, P, ¸


T, ¸ P

Decentralized Sourcing

T, P ¸

Decentralized Pricing and Sourcing

T P, ¸

59

Essay 2: Modeling details

Cost for the local division

Revenue for the foreign division=

Comply with legal rules

Consolidated profit

60

Essay 2: Centralized model


Centralized


Profit function for the headquarters is linear in the external cost, hence:

61

Essay 2: Centralized modelOptimal Solution

1. Offshoring policy: all-or-nothing

2. Tax advantage offshore earlier3. Full offshoring T at upper bound

Parameters: » =4, b=1, t=0.4, c =1, ®=0.9, ¿ = 0.4 (no TA) or ¿ = 0 (TA)

Profit

Average external cost

Tax advantage

No tax advantage

Foreign cost

No offshoring

Full offshoring

62

Parameters: » =1, b=0.1, t=0.35, cE =0.5, and ® = 0.5

Essay 2: Centralized ModelTradeoff Curve

Foreign cost

Foreign tax rate

C: No offshoring

B: Full offshoring

A: Full offshoring

Local tax rate

Avg external cost

63

Essay 2: Decentralized pricing


Centralized


64

Essay 2: Decentralized pricingOffshoring solution

Transfer Price

Offshoring Offshoring

Profit

Parameters: ¹=0.4; »=1; b=0.4; t=0.35; ¿=0.2; c = 0.41; ®=1; CV=1;

Ignore legal constraints…

65

Essay 2: Decentralized pricingPartial offshoring solution

• But there are legal bounds on T…

T(¸)<® P(T(¸),¸)

Partial offshoring solution

Profit

Offshoring

T(¸)=® P(T(¸),¸)

Parameters: ¹=0.4; »=1; b=0.4; t=0.35; ¿=0.2; c = 0.41; ®=1; CV=1;

66

Essay 2: What is the best organizational structure?

67

Low tax differential, high coefficient of variation

Fixed parameters:Foreign tax rate = 35%Local tax rate >= 30%CV=1

67


• Tradeoff curve• Tax benefits lead to

– More full offshoring for centralized supply chains– Partial offshoring for decentralized supply chains

• Optimal supply chain structure depends on the expected cost advantage

68

69

Essay 3: Transfer Pricing and Sourcing Strategies in Global Supply Chains

Facing Cost and Exchange Rate Uncertainty

Masha Shunko

Joint work with:

Laurens Debo, Booth School of Business, University of Chicago



1. How does the foreign tax advantage impact the global sourcing decision?

70



2. What strategies can supply chains use to facilitate global sourcing decisions under cost and exchange rate uncertainty?

71



2. What strategies can supply chains use to facilitate global sourcing decisions under cost and exchange rate uncertainty?

a) Decentralization strategy

b) Flexibility strategy

72


73

Headquarters

Local selling divisionp, t

Foreign producing divisionc e, ¿



74

Headquarters



External supplierθ



75

Headquarters


External supplierθ

Outsource

Offshore Foreign producing divisionc e, ¿



76

Headquarters



Two point distributions:


External supplierθ

Outsource


77

Headquarters



Two point distributions:


External supplierθ

Outsource


78

Headquarters



External supplierθ

Offshore

Transfer at T

Outsource



79

Headquarters



External supplierθ

Offshore

Transfer at T

Outsource



80

Headquarters



External supplierθ

Offshore

Transfer at T

Outsource



81

Headquarters



External supplierθ

Offshore

Transfer at T

Outsource


Essay 3: Decentralized Supply ChainTimeline

82

Stage 1: HQ sets the transfer price (TF) and offers it to the LD

Stage 2: LD makes the sourcing decision

θ e, θLD

HQ


Essay 3: Decentralized Supply ChainModel

83



θ e, θLD

HQ

Stage 1:



84



θ e, θLD

HQ

Stage 1:

Stage 2:



85



θ e, θLD

HQ

Stage 1:

Stage 2:


Incentive constraints

Essay 3: Decentralized Supply ChainSolution

• Outsource (offshore) when cost is low (high)• Transfer price:

86



87

Expected outsourcing cost

HQ

pro

fit



88


HQ

pro

fit

Relaxing incentive constraints…

With incentive constraints…



• Look at the brown line…

89


HQ

pro

fit



Essay 3: Decentralized Supply ChainImpact on Profit

• HQ profit without tax advantage:

90


HQ

pro

fit

Parameters: ¿ = 0.2, t = 0.2 ® = 1, p = 1.5, Á = 0.5, ¾µ = 0.1, c = 1



91


HQ

pro

fit


Outsourcing is always better



92


HQ

pro

fit


Outsourcing is always better

Offshoring is always better



93


HQ

pro

fit


Sourcing strategy depends on the realization



• HQ profit with tax advantage:

94


HQ

pro

fit


Parameters: ¿ = 0, t = 0.2, ® = 1, p = 1.5, Á = 0:5, ¾µ= 0.1, c=1


HQ

pro

fit




95


HQ

pro

fit




HQ

pro

fit




96


HQ

pro

fit




HQ

pro

fit




97


HQ

pro

fit




HQ

pro

fit




98


HQ

pro

fit




HQ

pro

fit




99


HQ

pro

fit




HQ

pro

fit




100


HQ

pro

fit




HQ

pro

fit

Essay 3: Decentralized Supply ChainBut… can we do better?


101


HQ

pro

fit



Essay 3: Decentralized Flex-GSCTimeline

102

Stage 1: HQ makes flexibility investment (x) and sets contract with LD (TO,TF)

Stage 2: LD chooses a transfer price from the contract and makes sourcing decision for non-flexible proportion (1-x)

Stage 3: HQ makes sourcing decision for the flexible proportion x

θ e, θLD

HQ


Essay 3: Decentralized Flex-GSCLocal profit

103

Headquarters




External supplierθ

Offshore

Transfer at T

Outsource

Essay 3: Decentralized Flex-GSCForeign profit

104

Headquarters




External supplierθ

Offshore

Transfer at T

Outsource

Essay 3: Decentralized Flex-GSCHQ after-tax profit

105

Headquarters




External supplierθ

Offshore

Transfer at T

Outsource

Essay 3: Decentralized Flex-GSCOptimization model

106




θ e, θLD

HQ

Stage 1:


107




θ e, θLD

HQ

Stage 1:

Stage 2:





θ e, θLD

HQ

Stage 1:

Stage 3:

Stage 2:

108

Essay 3: Decentralized Flex-GSCSolution


109




HQ

pro

fit



110




HQ

pro

fit



Adding flexibility

111


Essay 3: Decentralized Flex-GSCBut… flexibility is not free


HQ

pro

fit



Adding flexibility

112


• As cost of flexibility increases, profit decreases



HQ

pro

fit



Adding flexibility

113


• As cost of flexibility increases, profit decreases• How much flexibility do we need?



HQ

pro

fit



Adding flexibility

114

• Flexibility investment without tax advantage:

Essay 3: Decentralized Flex-GSCImpact of variability

Fle

xibi

lity

inve

stm

ent

Outsourcing cost variability

Fle

xibi

lity

inve

stm

ent

Parameters: ¿ = 0, t = 0 ® = 1, p = 1.5, Á = 0:5, ¹µ = 1, c = 1.

115



Fle

xibi

lity

inve

stm

ent


Fle

xibi

lity

inve

stm

ent


116




Fle

xibi

lity

inve

stm

ent


Fle

xibi

lity

inve

stm

ent

• Flexibility investment with tax advantage:


Parameters: ¿ = 0, t = 0.35, ® = 1, p = 1.5, Á = 0:5, ¹µ = 1, c=1;

Fle

xibi

lity

inve

stm

ent

117




Fle

xibi

lity

inve

stm

ent


Fle

xibi

lity

inve

stm

ent




Fle

xibi

lity

inve

stm

ent

118




Fle

xibi

lity

inve

stm

ent


Fle

xibi

lity

inve

stm

ent




Fle

xibi

lity

inve

stm

ent

119




Fle

xibi

lity

inve

stm

ent


Fle

xibi

lity

inve

stm

ent




Fle

xibi

lity

inve

stm

ent

120




Fle

xibi

lity

inve

stm

ent


Fle

xibi

lity

inve

stm

ent




Fle

xibi

lity

inve

stm

ent

121

Essay 3: Decentralized Flex-GSC vs.Centralized GSC

122

• No tax advantage:

• A: Centralized GSC > Decentralized Flex-GSC


Expected foreign cost

Out

sour

cing

cos

t var

iabi

lity

A

C

Parameters: ¿ = 0:1, t=0.1, ® = 0.8, p = 2, Á = 0:5, » =0.5, ¹µ = 1, ¾e = 0:4

123

• No tax advantage:

• A: Centralized GSC > Decentralized Flex-GSC• C: Decentralized Flex-GSC > Centralized GSC



Out

sour

cing

cos

t var

iabi

lity

A

C


124

• With tax advantage:

• A & B: Centralized GSC > Decentralized Flex-GSC• C: Decentralized Flex-GSC > Centralized GSC



Out

sour

cing

cos

t var

iabi

lity


125


• Incorporate tax perspective into global SCM;

126


• Incorporate tax perspective into global SCM;• Dual role of transfer price: incentive and tax;

127


• Incorporate tax perspective into global SCM;• Dual role of transfer price: incentive and tax;• Incentive role pushes the transfer price down;

128



– Higher outsourcing cost can be profitable for the firm.

129




• Flexibility loosens the incentive constraint on the transfer price and leads to higher tax benefits;

130




• Flexibility loosens the incentive constraint on the transfer price and leads to higher tax benefits;– Flexibility is helpful when the cost variability is low.

131




• Flexibility loosens the incentive constraint on the transfer price and leads to higher tax benefits;– Flexibility is helpful when the cost variability is low.

• Tax benefits make the centralized control optimal in more cases.

132

Proposal

• Incorporate flexibility in the form of postponement of the sourcing decision into Essay 3

• Do pair-wise comparisons of decentralized structures

• Show the effect of exchange rate variability on the aforementioned comparisons

133

Thank you !

134

BACK-UP SLIDES…

135

Why is it important for global SCM?

• What other factors are important for the global sourcing decision?– Cost– Exchange rate– Demand– Lead times– Tariffs– Availability– Political stability– Local content rules– Import quotas and tariffs– …

136

Decentralized Flex-GSCLocal profit

137

Headquarters




External supplierθ

Offshore

Transfer at T

Outsource

Decentralized Flex-GSCForeign profit

138

Headquarters




External supplierθ

Offshore

Transfer at T

Outsource

Decentralized Flex-GSCHQ after-tax profit

139

Headquarters




External supplierθ

Offshore

Transfer at T

Outsource

Research overview

• Shunko M., L. Debo, S. Gavirneni “Transfer Pricing and Sourcing Strategies in Global Supply Chains”;

• Shunko M., L. Debo, S. Gavirneni “Transfer Pricing and Offshoring in Price-Setting Global Supply Chains with Cost Uncertainty”;

• Shunko M., S. Gavirneni “Role of Transfer Prices in Global Supply Chains with Random Demands”.

GlobalTaxation,Transfer Pricing

Supply Chain Management

Accounting

Research overview

• Shunko M., G. Fenu, S. Kekre, A. Scheller-Wolf, V. Tardiff , S. Tayur, and T. Yunes· “Implementing a Bundling, Lane and Price Sheet Strategy for Caterpillar's Compact Construction Equipment Division”

Cost ofComplexity


Accounting

Research overview

• Shunko M., S.H. Cho, P. Enders, and A. Scheller-Wolf, “Impact of Emergency Departments’ Delay Signaling on Patient and Hospitals Welfare”.

• Shunko M., A. Scheller-Wolf “Value of Information Sharing between Emergency Departments and Ambulance Crews”.

ED Operations, Ambulance

Diversion


Health Care Management

5-Year Research Agenda

• International Taxation and Transfer Pricing– Intellectual Property, Royalty, Licensing– Local Content Rules

• Healthcare Management– Value of Information Sharing in Hospital Networks– Inpatient Bed Assignment Strategies for ED Patients

143

Documents

Proposal