Goods & Services Tax = A New Supply Network for India Inc?

Spread the thoughts

Many a supply infrastructure decisions (factories, warehouses, value-adding facilities) of many a firms out there to begin with, have motivations that go beyond the traditional rationale of cost to serve. Viz. being closer to the markets, optimal end to end laid down costs, cost of utilities and labor and the prevailing taxes on just about everything incl. tax on manufactured output (excise duty). Several hundreds of crores of investments happen in India purely on the back of some enticements by the state. Sometimes by the central Govt. in the form of SEZ (special economic zones) schemes and import duty waivers. Sometimes in the form of tax holidays and concessions by the provincial Govt. to attract new investments incl. foreign investments. Sometimes by virtue of opportunistic trade treaties between nations where one of the nations has more to gain!. Only to be revoked a few years later when the Govt changes on either sides. Then there are closed door deals with the Govt. to fix things retrospectively. Shortsighted policies of the Govt. means Jurisprudence may be forsaken for the sake of teaser benefits. Existing firms lose out or move out elsewhere and this is not cheap. There is no one right or best way to get some additional taxes. So can't always blame the state either.

Many a firms have burnt their fingers given their original profitability calculations based on cost-revenue estimates went haywire overnight when the import duties of raw materials were raised from e.g. 12 % to 25% (well local farmers and industries are dying is the often cited reason but that is another topic) or some or all of concessions are arbitrarily withdrawn or the state reneges on the promises made after the investments are committed. The point is Tax savings of myriad kinds outweigh ‘supply chain costs’ by order of magnitude. No matter how meticulous one is with assumptions, profitably can go for a toss one fine day.

What is the insurance here?

None, except finding ways to increase revenues to maintain the same profitability. This may mean aggressive marketing and expanding capacity in the same (non-viable!) location. Only option beyond a point is to move out or find other ways to save costs. Or Become more efficient. Or change the business model completely. Growing firms cannot afford the latter.

Until now many pan India firms, esp. those dealing in consumer foods, items and durable products (white goods), had at least one warehouse in each state. At least in all the major ones. Some have multiple warehouses to cater to remote markets quickly. A common sight for many such firms is they have a warehouse or two in Delhi and a warehouse in Ghaziabad or Faridabad which though in the vicinity of greater Delhi area are actually in separate states. Sales cannot happen from Delhi to Ghaziabad without paying local taxes in Delhi as well as Ghaziabad. There can be other taxes depending on the states involved. So there are compulsive 'stock transports' (sometimes on paper that is often subject to scrutiny by bogus law makers who do not themselves have a clue of the law) that must happen and all of the associated non-sense paper work that vary from state to state. This also adds quite some liability by limiting the nature of relationships that a firm may like to have with supply chain ‘partners’. The firm is forced to open a ‘branch’ under the same financial entity. That means fixed costs that does not make sense in all locations. Similarly a warehouse in Kolhapur can perhaps serve the whole of Goa and some large profitable/ affluent markets of Maharashtra. For many firms a warehouse in Goa can be quite a liability. High fixed costs esp. for half the non-season year.

Then there is the square root law of buffer stocks for each additional location in the network. Much of such stock expires esp. in the case of Pharmaceutical and packaged food and bottled beverages like milk and meats. 80/20 rules applies.

Willingly or unwillingly, consciously or whimsically, many firms have created quite some bulky-spread out supply infrastructure over the decades. Not all of which is aligned to ‘markets’. Quite some costs buried there. I see the proposed Goods and Services Tax (making compulsive STO’s meaningless) perhaps prompting rejig of supply infra here. Notably reduction in the number of warehouses and/or increasing the size of some existing ones and shutting down some. This would now mean much detailed analysis of the logistical costs that was previously left to the local ‘ecosystem’ of carriers who organized themselves to serve the larger ecosystem and did a very good job of on time delivery. They too learnt over the years. This means investing in technologies/software for scheduling the vehicles, routes and deliveries precisely. Good opportunity for some modern 3PL firms out there until such time the firms want to / are keen to spend monies on transportation planning and vehicle scheduling tools for better efficiency and costs. This way the firms may still be able to manage the same service level. One single warehouse in Faridabad to cover the markets in Haryana, Delhi and Eastern UP. Instead of original three. The size of such a warehouse need not be sum of the three. I love this square root law of variability!

The incentives and concessions of the state can still continue to exist. The local Governments need to market themselves for new business and that is fine. That may perhaps be an added bonus for business growth. At the proposed rates of 26% (the highest anywhere in the world) this is nothing but conservation of original constituent tax revenues that the states and center will split amicably while taxing the 'consumption' at source. So too much book-keeping now for the Govt. Not sure how much additional bureaucracy it may mean for firms that are not 'tech savvy'. Hope the GST itself comes down over the years

Much remains to be seen in 2016. Perhaps exciting times for India Inc. in the coming decade.