Implications of Goods and Service Tax on logistics: a case study on a FMCG company in India Abstract In the present scenario

the distribution network in the country is far from what should be called optimal. It is because of the staggered tax structure. This tax structure will be replaced by GST that is aimed at being comprehensive for most goods and services. GST is expected to be implemented in the country from next fiscal year i.e. April 2012 onwards. GST will facilitate investment decisions based purely economic concerns, independent of tax considerations. It will have a great impact on the supply chain for almost all companies. The cost of logistics, warehouses, C&FA, depots etc will be reduced significantly. Companies need to re-evaluate their existing supply chains with respect to the new tax structure to reap its maximum benefits. In this paper we present a case depicting the impact of GST on the distribution network of one of the FMCG companies in India. According to the present tax structure it is profitable to have a warehouse in each state. But with the implementation of GST a warehouse in every state may not be the optimal case. Some of the existing warehouses need not be required in the post GST scenario. Identifying those warehouses defines the objective of this case. Keywords: GST, supply chain, logistics, optimization 1. Introduction 1.1. Present tax structure India presently has multi-staged value added tax structure. While the CENVAT and Service Tax are levied by the Centre; the state levies VAT. Though the present system of tax is much better than what existed few years earlier (Poddar & Ahmad, 2009), the present system has many short comings. The primary deficiencies are: a) Taxation at Manufacturing Level The CENVAT is levied on goods manufactured or produced in India. Manufacturing is just a part of supply chain and it does not include the values added beyond manufacturing up to the customer. It also subjective to the definition of manufacturing and the value added during the process. b) Exclusion of Services The stated are not allowed to tax services. In this era of information technology, the gap between goods and services is blurring, this arrangement has posed many difficulties. It also has a negative impact on State tax revenues. Services account for growing fraction of consumer basket and state is not allowed to tax it. c) Tax Cascading The most serious flaw of the current system is tax cascading. It increases the cost of production and leads to a sub optimal supply chain design. It drives Indian suppliers at competitive disadvantage in the increasing competitive global market.

d) Complexity The main reasons for complexity are the various exemptions, multiple tax rates and the complicated multi-hierarchical structure of levying tax. There are a lot of definitional issues as to what constitutes of services or sales of a good. The tax rate varies from region to region for different products. 1.2. Goods and service Tax GST is seen as the single most important tax reform initiative in India since independence. It is expected to provide a significant boost to investment and growth of the economy (GST in India, 2010). The Goods and Services Tax (GST) is a value added tax to be implemented in India by April 2012 (Mukherjee, 2010). GST will have a significant impact on almost all aspects of businesses operating in the country, including the supply chain, sourcing and distribution decisions, inventory costs and cash flows, pricing policy, accounting and IT systems and transactions management. GST will facilitate investment decisions based purely economic concerns, independent of tax considerations. It will redistribute the burden of taxation fairly between manufacturing and services. Exemptions will be minimized will reduce the distortions by switching from point of origin principle to destination principle. Some of the noticeable features of the GST are: a) All India tax will be based on value added. It means that no tax will be paid to the government if no value is added. b) Creation of tax neutral optimal supply chain. c) Efficiency of supply chain will depend on cost minimization of logistics, C&FA, warehouse, depots etc. Hence it will affect the number of warehouses, transportation mode, safety stock, cycle inventory and design of distribution network. d) It will eliminate the cascading of taxes prevalent in present tax structure. In order to prepare for the GST, the companies need to understand its full implications, make and test the system changes and prepare a roadmap for a smooth transition to GST. While the important dimensions of the new tax structure are being closely examined, the time is ripe for the businesses to start making preparations for a successful changeover and implementation. In this paper we present a case depicting the impact of GST on the distribution network of one of the FMCG companies in India. According to the present tax structure it is profitable to have a warehouse in each state. But with the implementation of GST a warehouse in every state may not be the optimal case. Some of the existing warehouses need not be required in the post GST scenario. Identifying those warehouses defines the objective of this case. 2. Case 2.1 Assumptions Only the current depot location are considered as potential future depot locations GST is assumed to be implemented in the form mentioned above The difference between Loading/ Unloading charges & other depot maintenance charges between various depot locations is considered negligible are considered

A distributor is served only from one depot

2.1. Mathematical Model Parameters i = Depot j= Distributor Dij = Distance between i and j dj= average monthly demand at distributor j Tij= Transportation cost per unit between i and j Fi= Fixed cost associated with depot i Vi= Variable cost at depot I (depends on required area) L= Maximum distance for which a depot can serve Variables Si= binary variable denoting if depot i is open or closed Cij= binary variable denoting if goods can be sent from depot i to distributor j Objective function { Minimize z = [ Such that

}] +

+[

}]

In the following case we demonstrate the implementation of the above model for designing the distribution network of one of the FMCG companies operating in India. The company operates in two sections personal care and washing and holds a range of more than 200 active SKUs. According to the present tax structure company has 25 depots pan India. We will be focussing only on the south zone of the company distribution network. Distribution network in South zone for the company consists of 6 depots located in Chennai, Trichy, Cochin, Hyderabad, Palghat & Bangalore. The distributor base is located in 81 cities. The list of distributors is attached in the Appendix. So, fitting the data in the above model, i=6 j=81 Also given to us is the distance matrix (81 X 6) containing the distance (Dij ) between distributors and depots. The company policy says that a depot cannot serve to a distributor having a distance of more than 500 Km from depot. So, L=500

Based on the demand data of last 12 months we also know the average demand at each distributor location. The demand given is the combined demand of all the SKUs at that distributor location. The demand data (dj) for all the 81 distribution location is added in the appendix. Transportation cost per unit can be calculated by a general freight calculation template which considers the distance, toll tax, transporters margin, handling charges, fuel prices, and mileage of the vehicle, load per vehicle, per carton weight and other overhead expenses. The formula agreed by company for freight calculation after all these considerations is: Tij = 1.07* Avg Load per truck * (Fuel Price *(2.2* Dij / Mileage of vehicle)/ Avg load per truck + 500/ Avg. load per truck + 6/ Per carton weight )/ (Dij * 15) The standards used in the company at the time of study are Avg. load per truck = 15000 Kg Per Carton Weight = 18 Kg Fuel Price = Rs. 43 for 1 litre Mileage of Vehicle= 3.5 km/ litre Using the above standards and the distance data we can calculate the transportation cost between dealers and distributor locations. The transportation cost matrix is attached in the appendix. Company uses 3rd party warehouse operators for managing the depots. The amount paid to 3rd party warehouse operators can be classified into 2 broad categories Fixed Cost (Fi ): This cost doesnt depend on the quantity stored in the depot Variable Cost (Vi): It depends on the quantity stored in the depot

For some depots like Chennai depot the expenses doesnt depend on the area used. There is no variable cost for such depots. Company has to pay a fixed amount to the 3rd party for the use of depot. For other depots company pays a fixed amount as well as a variable amount which depends on the area used by the company. The data for fixed and variable cost as well as area used is given in the appendix. This data is used to calculate the variable cost per MT. Results: As already mentioned the model was applied for South Zone only. The optimal results obtained were based on average demand, depot costs, distances between depots & distributors, current distribution base and the mentioned assumptions. The solution indicates that out of 6 depots in South Zone Chennai depot needs to be closed after the implementation of GST. This model can be replicated on a Pan India basis to get an optimal solution for whole of Indias distribution network of any company. Future Scope:

The model can be replicated at a Pan India level to design the complete distribution network for any company. One step ahead can also be taking the primary distribution also into consideration. If primary distribution is considered then the scope of model is widened and a better solution can be found out. Moreover, the first assumption i.e. only present depots are potential depot locations can be relaxed and any location in India can be considered as potential location for company depot. 3. Bibliography

GST in India. (2010). Retrieved November 15, 2011, from Ernst & Young - India: http://www.ey.com/IN/en/Services/Tax/Indirect-Tax/VAT---GST---Sales-tax Mukherjee, P. (2010, April 18). Introduction of GST by April 2011 - FMs Address at meeting with Empowered Committee of state Finance Ministers. Retrieved Novemer 2011, from The Tax Management India: http://www.taxmanagementindia.com/visitor/detail_rss_feed.asp?ID=1226 Poddar, S., & Ahmad, E. (2009). GST Reforms and Intergovernmental Considerations in India. Department of Economic Affairs, Ministry of Finance, Government of India.