Regionalisation and the CFO’s changing role in Asia

February 14, 2013

Today’s Chief Financial Officer (CFO) is expected to don many hats.

While CFOs are still responsible for the traditional finance functions of reporting, control and analysis, they are increasingly expected to play a more strategic role in shaping the business, creating value, and contributing to meeting revenue growth targets in addition to managing costs.

This article explores how regionalisation presents new challenges for CFOs in understanding the company’s value drivers and assessing the health of the business in Asia.

By Matthew Andrew and Michael Nixon. Matthew Andrew is a Partner and Michael Nixon is a Senior Manager at the Asia-Pacific Tax Centre in Ernst & Young Solutions LLP.

The changing Asia business landscape

The substantial shift in global economic activity to Asia is by now a well-documented phenomenon, with both demand and supply side factors driving this trend. On the demand side, the rapidly-growing markets of Asia offer multinational companies (MNC) prospects of higher sales and profits growth. Amidst slowing economic growth and lower consumption, European and US MNCs are developing an Asia footprint to fuel future growth.

For Asia MNCs, once they have achieved suitable scale in their domestic markets, they are seeking new growth from neighbouring Asia countries. On the supply side, global price competition and the resulting pressure on margins are driving MNCs to Asia, where labour and raw material costs are lower.

Not only do MNCs have access to a growing pool of highly-skilled talent in the region, but the proximity to suppliers of key intermediate goods and raw materials means they can procure at lower costs. Foreign investment into Asian countries has increased substantially, both from outside Asia and from Asia-based MNCs looking to expand to other countries in the region.

Many MNCs are also looking beyond “first-tier” markets such as China and India to other markets such as Indonesia, Thailand and Malaysia to take advantage of lower manufacturing costs. Given that MNCs have developed a significant presence in Asia, it makes sense for them to regionalise their supply chains to capitalise on market opportunities, streamline costs and simplify their operations through removing duplicated activities.

However, we have observed that many MNCs in Asia have grown in an unplanned manner over time, whether organically or by acquisition. Often, they have a network of standalone local country operations, rather a regional or global business operating model.

Under this scenario, inefficiencies occur due to duplication of functions across business units (such as customer support and invoicing), complex transactions and high transaction costs. This decentralized approach to may lead to high supply chain costs and an underutilization of resources.

To be more agile and efficient, create better opportunities for synergies across the supply chain, and manage tax leakage, MNCs seek to restructure their businesses.

Regionalisation and restructuring of MNC groups in Asia

Traditionally, MNCs have established centralized structures in locations such as Singapore or Hong Kong. These are often focused on one area of the value chain, usually procurement or shared services operations.

They have also been clustered in particular industries, for example textiles or electronics, where low-cost suppliers are located throughout the region. Over time, many of these centralized entities have located additional functions (and substance) in a regional hub, restructuring inter-company transaction flows into and out of Asia in the process.

The hub is quite common in Singapore. Further, we observe many MNCs centralizing control and management of their Asia value chain through “principal” structures, in which the centralized entity bears trading risks, owns key assets such as intellectual property and has the necessary substance in relation to what they bear, own and do.

Sometimes, the implementation of such operating structures poses challenges such as the reconfiguration of IT systems or legal contracts with key suppliers or customers. To mitigate these challenges, we have observed MNCs implementing “centre-led principal” structures that centralize only selected value-added services for their Asia operations and therefore does not alter transactional flows.

The changing CFO role, given the changing business landscape

In tandem with the growing footprint of MNCs in Asia and the regionalisation of their businesses, the structure of the MNC board and the responsibilities of its members have significantly changed. Historically, core functions within companies were specialized to achieve optimal commercial outcomes.

Indeed, business units have evolved to focus on specific areas of responsibility or geographies, often with discrete and unrelated key performance indicators. The renewed focus on creating and optimizing value across the company’s entire value chain in a regionalized business means business objectives need to be aligned across a company’s functional and regional operations.

Decision makers operating in this environment are both enabled and incentivized to view the business as a whole in order to drive value for the shareholders of the company. In this context, the CFO role has also evolved.

CFOs are asked to utilize their traditional analytical, reporting and control skills outside of the finance function, for example assessing the impact of various strategic initiatives in the business. Further, instead of being viewed as “business prevention units”, the finance function is increasingly an “enabler” to the business by playing a key role in identifying and evaluating opportunities for organizational change.

The CFO’s role in developing business strategy varies. Some actively develop and define the overall strategy, while most provide insight and analysis to support the chief executive officer (CEO) and ensure that business decisions are grounded in sound financial criteria.

The added complexity of regional operations means CFOs have to go beyond being an “information provider” to understanding the impact of different strategic options such as through “what-if analyses”. Such input draws on their commercial experience and analytical skills.

That said, the CFO needs to strike a balance between being the “objective, independent voice” of the business and assuming a broader responsibility for strategic outcomes in the business. With more CFOs adding operational responsibilities to their portfolios, they may find that competition for limited resources creates conflicts across their various portfolios.

As achieving a balance requires both finance fundamentals and management capabilities, it is easy to see why their roles are expanding in this manner. Further, whilst the CFO role is now more embedded in the development and enablement of corporate strategy, the onset of the financial crisis has brought the focus back to finance fundamentals.

The core tasks of cost management, risk management, cash flow and controls therefore dominate the CFO’s priority list more than ever before. Whilst the impact of this focus may appear to limit the CFOs role in broader corporate strategy development, they can still have strategic inputs that will drive value in the business.

The CFO contribution to business strategy

The CFO can actively contribute to business strategy by providing insight and analysis, funding, and enabling and helping to execute strategies set by the CEO. The CFO also sets key financial criteria for the business, directs key initiatives within the finance function that support overall business goals and leads the defining and execution of business strategy.

Finance leaders have an in-depth understanding of both a company’s performance as well as where value is created. As they are often more informed about a business’s operations and underlying performance, they best positioned to contribute to strategy development and execution.

As more MNCs shift their supply chain activities to Asia, CFOs have a valuable opportunity to capitalise on their insights and play a greater role in developing effective regionalisation and expansion strategies for Asia operations. Tax effectiveness, a key area of responsibility for the CFO function in many organizations, and a real potential cost to the business, has usually been considered separately from the overall strategy of the business.

However, this is changing as MNCs take a more holistic view of the business – one aimed at optimizing the regional or global supply chain model to best position the organization to take advantage of the market opportunities available.

Leading CFOs are working together with the business units to develop overall tax and commercial strategies that achieve optimal value. This is done through driving operationally efficient business models that are aligned with tax-effective structures.

Only then can value creation be optimized. In addition to compliance, the CFO role is evolving to include the embedding of the tax function into the operational framework of the business. Integrating tax and commercial strategies to drive value for the business is a complex task. For MNCs with an existing Asia footprint and that are undertaking new investments in Asia, there are additional challenges when making changes to existing business models.

Such MNCs typically have grown in an unplanned manner over time and have a network of operations in local countries – not having undertaken any cross-border tax planning. The greater the degree of embedding in local countries, the more challenging it is for the CFO to make substantive changes in the future.

It is therefore critical to integrate cross-border tax planning in commercial operations at the earliest possible stage in order to optimize the potential value and mitigate the risks. To unlock the potential value in a company’s operations, many regional organizations have used tax-effective supply chain management (TESCM) strategies.

TESCM takes companies through a structured process to review their regional business model, identify opportunities to centralize high value functions, and optimize regional tax settings (tax, transfer pricing and customs and duties arrangements). A TESCM program brings together key functional decision-makers from across the business, and drives change and value creation across the business.

The operating model strikes a balance between the centralization of key decision making functions, assets and risks, and ensuring the right level of substance, locally. The business case for change involves both operational and tax costs and benefits.

TESCM can deliver reduced inventory levels, better visibility on systems and processes, direct tax savings or reduced operating costs. TESCM programs can be implemented on a function-by-function basis or all at once, depending on the specific requirements of a company and their appetite for change.

The CFO may operate as a critical project sponsor, manager or delivery leader. Execution of TESCM programs led by the CFO and CEO involves blended teams, drawing on specialists across multiple, relevant disciplines – both within an MNC and their professional advisors.

The teams work throughout to assess, design and implement an integrated business model for Asia and the processes necessary to realize sustained benefits. Today’s CFO has the potential to influence corporate strategy and drive business change and results.

Finance leaders therefore enjoy increasing responsibility and impact, playing an increasingly broader and more vital role in strategic development in today’s organizations.

This article was first published in the Ernst & Young You and the Taxman, Issue 4, December 2012 (pdf, 1,9 MB)

To read Ernst & Young reports about the evolving role of the cfo, visit ey.com/cfo

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