This document is being provided for the exclusive use of murali dhara at T A Pai Management Institute

No part of this Report may be published/reproduced/distributed in any form without CRISIL's prior written approval

Annexure 1: The reforms in India's indirect tax regime

Tax reform in India since 1991 has been gradual the overall direction has been to broaden the tax base, reduce the rates, reduce rate differentiation
and make the tax system simple and transparent. India's indirect tax structure has evolved in three distinct phases or eras: a) the pre-2005 era; b) the
VAT era (since 2005); and c) the GST era, which will most likely set in 2016-17. To put this into perspective, a brief recall of India's tax reforms is
necessary.

Stages in India's indirect tax policies

Source: CRISIL Research

In a way the structure of India's indirect tax regime can be classified into the 'pre-VAT' and 'post-VAT' eras. Before the VAT structure was introduced,
India had multiple taxes on different commodities, which were also taxed at different rates across states and no set off of input taxes were available.
There was also an incidence of 'tax on tax', wherein, a good whose raw material has already been taxed, will still bear a levy at subsequent stages of
production, until attained its finished form. This was done away with the introduction of VAT.

In the VAT regime, a manufacturer is allowed to claim an input tax credit: simply, he sets off the tax he has paid on the input, and other purchases,
against the final tax paid on the finished good. Thus, this eliminates the issues with multiple taxation and cascading effects. Thus, while at the central
level, the VAT has brought in greater uniformity both in terms of the rate and number of taxes, certain problems persist, if we look at the concept from a
state-wise perspective.

While the introduction of the VAT in the states has been a more challenging task, it has not been without results. By eliminating the multiple taxes
levied at multiple rates and abolishing the burden of several of the existing taxes, such as turnover tax, surcharge on sales tax, additional surcharge,
special additional tax, etc., the VAT has widened the tax base and brought in greater transparency. However, there is one shortcoming that still remains
in the VAT regime. The VAT credit is not available on inter-state sales of goods.

1
 This document is being provided for the exclusive use of murali dhara at T A Pai Management Institute
No part of this Report may be published/reproduced/distributed in any form without CRISIL's prior written approval

While there is an input tax credit available on the VAT, the same doesn't work both ways: i.e. a manufacturer transporting goods from State A to State
B will not be able to claim an a credit on the input tax paid to State A from State B, and vice versa. This again creates an incidence of double taxation.

Decoding the VAT

Source: CRISIL Research

Moreover, the CST is a separate levy of 2 per cent on the price of the finished good that applies in case of interstate sale. This levy can be said to be
the main culprit behind the fragmented logistics policy adopted by most Indian companies, especially in the manufacturing sector. As there is no input
credit or set-off available against the CST, companies try to avoid the incidence of CST by setting up warehouses in each state/ region to transfer of
goods to the state of sale (CST is not levied on stock transfer).

For instance, in the case of FMCG industry particularly, companies have localised contract manufacturing set up in each state, to avail of a set off on
the input VAT against output VAT. The move also allowed companies to easily source inputs locally, given the low shelf life of products, especially,
food, dairy products, etc.

Annexure 2: To centralise or decentralise

Decision will depend on number of warehouses that will perfectly optimise costs
As the number of warehouses increases, transportation costs and cost of lost sales decline, whereas inventory cost and warehousing cost increase.
Transportation costs will reduce as shipments moving between hubs will attract a lower cost via full truck load shipments (FTL) while the expensive
less-than-truck load (LTL) shipments will only be required for last-mile deliveries. In a centralised model, the centralised warehouse will be much further
away from the retail points, increasing the lead distance for last mile deliveries.

On the other hand, warehousing costs increase as more warehouses are set up. This because the space consumed for other facilities like
maintenance, offices, lavatories, aisles etc is much higher in a smaller warehouse as compared to a large centralised warehouse. Thus, total costs will
reduce till the optimal point beyond which the rise in inventory carrying and warehousing costs offsets the benefits from lower costs of transportation
and cost of lost sales. The implications of the total cost curve and the range of warehouses it reflects would differ for each company and each sector (
See chart below).
This document is being provided for the exclusive use of murali dhara at T A Pai Management Institute
No part of this Report may be published/reproduced/distributed in any form without CRISIL's prior written approval

Chart on logistics costs relation with number of warehouses

Source: The Management of Business Logistics - A Supply Chain Perspective, CRISIL Research

Decentralized warehouses do not necessarily imply a poor logistics policy: for example, it is in fact optimal for certain industries like FMCG to maintain
a decentralized chain of warehouses and be as close to retail as possible, as it addresses the high substitutability of products and fast service
requirements and reduces the cost of lost sales. However, an efficient transportation system can allow a firm to improve customer service and lower
transportation costs even with fewer warehouses. Moreover, by increasing no of inventory turns, a company can lower its inventory carrying costs.

Finally, the decision to select a centralized or decentralized warehousing model would depend on the following key factors:

Which way post GST?

Source: The Management of Business Logistics - A Supply Chain Perspective, CRISIL Research

A company can decentralize its warehouses if

Products are highly substitutable: In sectors such as FMCG and pharma, the availability of substitutes makes it necessary for manufacturers to
maintain decentralized warehouses. Such an approach helps them reduce instances of lost sales owing to stock-outs or longer lead times for last-mile
delivery.

Order sizes are small: Again, the FMCG industry is an example here, as the nature of products lowers the shipments size. As such, it is more viable
for a player to maintain multiple warehouses, as multiple LTL shipments from a centralized warehouse would add up to a higher freight bill, as
compared to FTL shipments to decentralized warehouses followed by LTL shipments to local retailers. Clearly, transportation costs outweigh
warehousing considerations in this instance.

Need for high customer service: This usually correlates with high product substitutability. For instance, the lack of proper transport facilities or the

3
 This document is being provided for the exclusive use of murali dhara at T A Pai Management Institute
No part of this Report may be published/reproduced/distributed in any form without CRISIL's prior written approval

absence of proper road infrastructure result in longer lead times and builds the case for decentralized warehouses.

A company can centralize its warehouses if

High-value products are shipped: In such a case, the value of goods automatically drives up inventory carrying costs, if multiple warehouses are
used. An example is the consumer durables/ electronics industry, where the products (A/Cs, refrigerators, smartphones, etc) are of a high value.

It has a wide product line: In case of a wide product portfolio (across product segments) too, a centralised warehousing model will reduce heavy
investment in inventories.

Products need special warehousing: Investments on special warehousing systems, such as temperature-controlled storage, palletisation,
surveillance systems, and leak-proof structures, etc will necessitate a centralised warehouse, to reduce the expenditure on such equipment.

Post implementation of GST, firms will need to primarily identify and eliminate unproductive warehouses even if they may not necessarily opt for a
centralised model. In this process they will also have to carefully re-evaluate their supply chain network which will take into account the above major
factors.

Finally, for a company or sector, some of the factors listed above may be in favour of centralizing and some for decentralising, as in the case of the
FMCG industry, which has a diverse product portfolio as well as a higher potential for product substitution. Thus, to arrive at the optimum number of
warehouses, companies must analyse the total cost for different number of warehouses (as explained in the chart above). The resultant supply chain
decisions and the extent of consolidation will differ from sector to sector, as explained in forthcoming sections.

Annexure 3: Cross-country experiences with a GST

Revenue collection, current account balance have improved despite revenue neutral, contractionary rates;
Several countries have implemented the GST over the past few decades. Empirical studies of macroeconomic trends in these countries reveal several
interesting trends. We have considered three countries - one which implemented a revenue neutral rate (New Zealand), second with an expansionary
rate (Australia) and third with a contractionary rate (Canada). (A revenue neutral rate is the tax rate at which the there is no change in the amount of
revenue collected before and after the tax structure is changed). Moreover, it is to be noted that each country implemented the GST at a different
phase of the economic cycle.
This document is being provided for the exclusive use of murali dhara at T A Pai Management Institute
No part of this Report may be published/reproduced/distributed in any form without CRISIL's prior written approval

Irrespective of a neutral rate, all three countries witnessed a significant improvement in revenue collections after the GST was implemented. The
magnitude of fluctuations in the fiscal account balance reduced due to better tax collections during downturns compared to pre-GST era. In the long
run, the current account balance improved, as exports became more competitive, as lower tax rates resulted in more competitive prices. While the
actual impact on GDP and inflation cannot be established, as they are influenced by several other factors, during the year of implementation, GDP
growth reduced and inflation increased.

International comparison
Source: Working paper on Economics, University of New England