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GST impact on Business Strategy of Pharmaceutical Companies

Jun 06, 2017

With the government targeting implementation of GST in the next financial year, the Indian industry will be busy with understanding its impact and deciding on how to do business in the changed environment. The ~$40 bn Pharmaceutical industry will be the most impacted by GST as they have long supply chains which span across India.

Historical policies such as complex multi-stage taxation and drug regulation, location based incentives provided by certain states have resulted in bringing inefficiency and undue complexity supply chains in India. But the imminent roll-out of GST provides a silver lining for companies to simplify their operations, and achieve better efficiencies enabling them to serve customers better.

The GST – Supply Chain Challenge

The supply chain challenge for companies lies in redesigning their supply chain networks right from the sourcing stage till reaching the end consumer along with optimizing their sales and operations planning. Companies must do a comprehensive evaluation of their existing supply chain and associated business processes in order to identify how they can achieve better economies of scale and adopt better processes in order to drive down costs and better serve customers.

GST - Supply Chain Challenge

From the perspective of legal and tax compliance, companies will also have to redesign their business processes to adhere to the rules set by GST. This will require them to invest in redesigning their systems and further enable change management within their organization. Companies will also have to engage with their supply chain stakeholders such as suppliers and logistics service providers in order to create a common platform for working together post GST implementation.

Driving such change management across the organization would require a dedicated Project Management Office (PMO) which can manage all the requisite aspects of preparing the company for the post-GST business environment. The change management would require a phased approach,

· The first stage would be to design and implement the systems for legal and tax compliance

· Next step is assessing the existing supply chain to identify opportunities for improvement such as sales and operations planning and network realignment

· The last step would be the change management process for aligning people and business processes to the modified structure and generating gains from it.

Network realignment may reduce costs and improving serviceability

On implementation of GST, the biggest benefit companies can see is reduction in their logistics and distribution costs along with improvement in market responsiveness by reconfiguring their distribution networks. Companies can do away with the current practice of having a warehouse in each state which was designed to reduce the tax burden in the current tax regime and adopt an optimized network with hub and spoke model consisting of larger warehouses, better routes and ideal modal mix to serve their customers better in the GST scenario (Fig.2).

GST Network

Savings along the logistics and distribution chain can amount to ~5-8% in transportation, ~10-12% in warehousing and up to 25% in inventory holding costs, leading to an overall savings in the range of 10-12% of the total overall supply chain cost. For example, a company having multiple CFAs in Northern states can look at consolidating its network and having a regional hub to serve different markets. This is possible mainly because of the easier accessibility to key consumer clusters from a central warehouse (in most cases the transit times are less than 12hrs).

Another important benefit will be the mechanism of input credit offset which will be provided in the GST regime. The utilization of credit available in the electronic ledgers of IGST, CGST and SGST towards input credits at each value addition stage will result in avoiding the now prevailing cascading taxation which raises the final prices of goods and services to the consumer.

Empowering domestic API manufacturing

In the Make in India initiative, the Pharmaceutical industry is a priority sector for increasing the domestic manufacturing footprint. Even as India has become the largest source of high quality, low cost generic drugs for the world, we are still lagging behind in terms of domestic Active Pharmaceutical Ingredient (API) manufacturing.

Inverted duty structure currently prevailing in India is a key factor undermining the domestic manufacturing of API. Key raw materials imported for domestic production of API are taxed at a higher rate than the imported API. Rationalizing this practice with the implementation of GST will benefit the country in the long run by developing domestic production capabilities. In 2002, the implementation of Auto policy and reversion of inverted duty has now resulted in India becoming a manufacturing hub.

Current location based tax benefits may be converted into tax refunds

One major concern would be the discontinuance of the area based tax exemptions that the companies enjoy for setting up their manufacturing plants in specific states and regions. Numerous pharmaceutical companies have setup their manufacturing plants in Baddi, Himachal Pradesh and Sikkim as the tax exemptions overrode higher logistics costs due to poor accessibility of these regions.

The discussion papers on GST proposed converting these to a tax refund mechanism, but even so it would have a neutral impact on the Pharmaceutical companies. Another drawback would be the taxation of free supplies to the sales and distribution in the form of schemes and bonuses which would require a rethink on the promotional practices of Pharmaceutical companies.

Looking forward

Pharmaceutical companies must pro-actively act on assessing their readiness for GST and reconfigure their supply chain and business processes by setting up a dedicated Project Management Office. Network Optimization can help companies in assessing their supply chains and realigning them to take advantage of the GST policy as India becomes a single market without taxation-related supply chain bottlenecks. Those who move early are likely to gain an advantage on cost and service levels over their competitors and deliver a better value proposition to the customer.

This article was first published on LinkedIn by Arun Raj

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