value chain analysis: an analytical framework to ... march 15 gonnet-llinares... · value chain...

Value Chain Analysis:

An Analytical Framework to Understand

Value Creation in a Multinational Enterprise

London

March 11th, 2015

Emmanuel Llinares

Senior Vice President

NERA— Paris/London/Geneva

Sébastien Gonnet

Vice President

NERA—Paris/Geneva

1

Objectives

An Economic Perspective on Transfer

Pricing

Link between Value Chain Analysis and

Transfer Pricing Method Selection

An Economic Perspective on

Transfer Pricing

3

Fifteen Years of

One-Sided Transfer Pricing

Routine Local Functions Benchmark

Low Risks

Industry Information Within the IQ Range

Critical Success Factors

Group Value Chain

Roles and Responsibilities

Strategic and Non-Strategic Risks Contribution Analysis

Intangibles Mapping

Economic Analysis

Arm’s Length Pricing System

4

Relational Arm’s Length

Transfer Pricing

Historically, compliance with the arm’s-length principle is

transaction-based. Over time, entity-based outcome

comparisons have been introduced as the primary

testing method

The arm’s-length principle itself, however, refers to

commercial and financial relations

Relational Arm’s Length Transfer Pricing defines arm’s

length transfer prices that are consistent with both tax and

business objectives. The focus is shifted from testing stand-

alone entities (the “tested parties”) to mapping the relative

position of group entities involved in the process of

jointly creating value

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Analytical Framework

Value Creation, Functional Analysis and Roles and Responsibilities

The analytical process described hereinafter aims at understanding*

– How value is being created in the enterprise,

– How individual parties/entities take part in the joint process of creating value,

– What their respective contributions are, and

– How each if them operates and carries responsibility for the relevant types of risk

Ultimately, those elements drive the entitlement to (parts of the) profits of the individual entities

The way in which they carry part of the risks in the enterprise decides not only on the level of suitable remuneration, but also its dynamics

Note: * This section of the presentation is inspired by the article “Understanding Risk in the Enterprise: The Key to Transfer Pricing for Today’ s Business Models,”

by Pim Fris, Sébastien Gonnet and Ralph Meghames, International Transfer Pricing Journal, November/December 2014

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Value Chain Analysis: Understand, in addition to an analysis of functions, how value is created in the Enterprise

‒ Identify the key value drivers as part of a company’s value chain which influence the most the Critical Success Factors of the Enterprise within its industry

‒ Identify the key value drivers in the value chain which can be held accountable for the Enterprise’s major risks within its industry and its chosen business model

Value Driver

#1

Value Driver #3

Value Driver #2

Value Driver #5

Value Driver

#4

Support Functions

STEP 1.

Value Chain

Analysis

A Four-Step Process Step 1—Value Chain Analysis

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Support Functions

STEP 1.

Value Chain

Analysis

Critical

Sucess

Factors

Major Risks

Strategic Operational

CSF 1 CSF 2 CSF 3 CSF 4 CSF 6 CSF 5

Value Driver

#1

Value Driver #3

Value Driver #2

Value Driver #5

Value Driver

#4

8



Survey Style

Interviews

Statistical

Treatment

Treatment of Data and Information


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Support Functions

STEP 1.

Value Chain

Analysis

STEP 2.

Functions

STEP 2.

Risks

STEP 2.

Assets Technology related intangibles

Marketing intangibles


A Four-Step Process

Step 2—Mapping of the Enterprise Functions, Assets and

Risks with Value Creation

STEPS

Each person is a proxy for group-wide headcount involved in the activity

Value Driver

#1

Value Driver #3

Value Driver #2

Value Driver #5

Value Driver

#4

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The Risk And Volatility Paradigm

Risks that are core business risks and which can

not be (fully) diversified

Strategic Risks

Financial Risks

Operational Risks

Hazard Risks

Human and Intellectual

Capital

Risks that can be diversified on insurance markets

or subcontracted

External Internal Source of volatility

Upside

Downside

Imp

act

of

vo

lati

lity

Risk and volatility can be approached in a two-dimensional scheme. The

first dimension is the source of the volatility (external or internal) and

the second dimension is the potential impact of the volatility (downside

impact or upside impact allowing value creation)

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STEP 1.

Value Chain

Analysis

STEP 2.

Functions

STEP 2.

Risks

STEP 2.

Assets

A Four-Step Process

Step 3—Role, Responsibilities and Control of the Individual

Group Entities

STEPS

STEP 3.

Entities Define roles of the entities in the joint value creation and responsibilities

in respect of the different value drivers and related risks


Each person is a proxy for group-wide headcount involved in the activity

Technology related intangibles

Marketing intangibles

Value Driver

#1

Value Driver #3

Value Driver #2

Value Driver #5

Value Driver

#4

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Step 4 involves the definition of how the relevant parties, now properly

identified and assessed in terms of their role in the total set of relationships

in the enterprise, can expect to be rewarded—transactions are the

expression of the relationships

This step includes analysis of how prices are set—ex ante and ex post

Risk being the impact of volatility, the responsibilities of group entities for

different risks drive the dynamics in establishing the final remunerations for

those entities—ex post outcomes can only be understood and

explained in view of those responsibilities

For this reason, it is important to understand how prices are set for the

intercompany transactions—reference should be how independent parties

behave in similar relationships

A Four-Step Process

Step 4—Relational Dynamics

Link between Value Chain Analysis and

Transfer Pricing Method Selection

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Link Between Value Chain Analysis and

Profit Splits

Value Chain Analysis is a tool for a qualitative assessment of steps in a company’s value creation and can serve as a framework for identifying bargaining positions of entities involved therein

– It helps the selection and application of the most appropriate transfer pricing methods for the case at hand, including the Profit Split Method when appropriate

When the Profit Split Method is applicable, it should find its origin and justification in the Value Chain Analysis

– Application of the Profit Split Method should rely on solid economic analyses (analysis of external long-term relationships, investment-based models, game theory, compensation-based models, surveys, etc.)

Contact Us

Emmanuel Llinares

Senior Vice President and Chair of NERA’s Transfer Pricing Practice NERA—Paris/London/Geneva +33 1 70 75 01 93 +44 20 7659 8652 +41 79 517 68 95 [email protected]

© Copyright 2015

NERA SAS

All rights reserved.

Sébastien Gonnet

Vice President NERA—Paris/Geneva +33 1 70 75 01 92 +41 79 692 0553 [email protected]

value chain analysis: an analytical framework to ... march 15 gonnet-llinares... · value chain...

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