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Tuesday, June 12, 2012

Corporations Must Manage Taxes More Intelligently

If you want to read more about my views on this topic, please check out a longer, more comprehensive research note on this topic at our Web site. ###

For the past couple of years, I’ve been asserting that most larger companies (those with 1,000 or more employees) need to adopt a new approach to using software to handle their taxes comprehensively, both the direct sort (income taxes) and the indirect variety (sales and use as well as value-added/goods and service taxes). It’s an emerging enterprise challenge driven by more competent and determined tax enforcement by governments worldwide. It will require corporations to make changes in how they employ software to manage their taxes Big Fat Finance, structure their tax-related data, and manage their tax processes. Increasingly, corporations will need to be able to have better control over tax data management, tax calculation, and associated tax processes buttoned down to be able to optimize their tax liabilities while minimizing their tax risk exposure.

There are a couple of important game changers at work that fundamentally alter the way larger companies need to manage their taxes. One is a more effective use of technology by governments to collect taxes; the other is increased cooperation between taxing authorities to share information. In the United States, the Internal Revenue Service (IRS) has long shared its tax return data with individual states, and now the number of international bilateral information sharing agreements is growing Big Fat Finance, which will have a profound impact on how companies manage transfer pricing. If you don’t think this is a seismic shift, think again. A generation ago, Swiss bank secrecy was inviolate. Today, tax authorities in the United States, United Kingdom, and (soon) Germany will be getting reports from Swiss banks about their respective citizens’ accounts.


Today, few companies are prepared to deal with a more challenging tax enforcement environment. Unless they deal with it strategically, they are likely to pay more taxes and incur greater fines than necessary. Corporations must step back and rethink how they manage taxes. They must address their information, technology, and process shortcomings to achieve the lowest possible tax expense and manage their tax-related risks more effectively.



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Failure to Innovate Can Be a Fatal Risk

Another company that did not continue to push the bounds of innovation is the social network provider, MySpace. As recently as 2006, MySpace was the most popular social networking website in the United States. At the height of its popularity, MySpace was acquired by media giant News Corp. According to a report this week in the Los Angeles Times, that acquisition severely limited MySpace’s ability to innovate. Here’s is how the Times contrasted MySpace with the leading social network provider, Facebook:


The focus of many risk management programs today is to avoid risk or, at the very least Big Fat Finance, to minimize risk to its lowest level. While that may seem like a rational approach given the economic crisis we have just experienced, it is not necessarily a wise approach. One of the greatest risks to any company is its failure to continually innovate. Examples abound of companies that did not continue to question how to create new products or deliver new services to meet the fickle demand of consumers. Once wildly successful companies like Blockbuster Video or America Online have seen their fortunes turn very quickly as other companies have invested in new delivery channels.


“There’s no short explanation for Myspace’s stunning fall, but people with knowledge of the situation say the social network struggled to innovate once it had been absorbed by the old-media giant. Also Big Fat Finance, Myspace’s managers came under pressure to wring profits from the site, while Facebook’s private investors were willing to absorb losses to invest in the future. Facebook engineers were ordered to make the site more engaging for users while more independent software developers were attracted to make popular applications for the site.”

Now, there are reports from various sources that News Corp. either will spin-off MySpace as a separate entity or shut down the operation altogether. Whatever path they choose, it is clear in this case that failure to innovate can be a fatal risk. ###


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Successful Price Optimization Has Multiple Dimensions



Price and revenue optimization (PRO) is a business discipline used to effect demand-based pricing; it applies market segmentation techniques to achieve strategic objectives such as increased profitability or higher market share. PRO first came into wide use in the airline and hospitality industries in the 1980s as a way of maximizing returns from less flexible travelers (such as people on business trips) while minimizing the unsold inventory by selling incremental seats on flights or hotel room nights at discounted prices to more discretionary buyers (typically vacationers). Today, it is a well-developed part of any business strategy in the travel industry and increasingly used in others.

People and process meet in the ongoing evaluation of price-setting practices by a cross-functional team that incorporates all stakeholders. Initially these people will meet frequently (at least once a month), but it may only require a quarterly review as PRO matures. There also must be a well-defined price analytics review process to ensure the methodologies the company is using are sound.

Pricing strategy and execution must take into account external factors. In particular, different cultures and businesses often have their own attitudes toward fixed and negotiated pricing. In some cases, especially in consumer markets where fixed prices have been the norm, people may consider price optimization “unfair.” Companies that try to implement a PRO strategy must realize that they may encounter resistance and be careful in how their marketing and communications position their approach to pricing. That noted, despite some annoyance, people have grown accustomed to highly variable airline and hotel pricing. Also, there may be legal and regulatory issues that impinge on a company’s pricing flexibility.


Lastly, the company must acquire the right software, implement it properly and tailor it to its needs; it also should be easy to deploy and maintain. When it comes to pricing, there can be subtle differences in the needs of particular types of business; prospective buyers should focus on vendors that have strong references in their specific industry.

Above all, companies must have a realistic pricing strategy that is closely aligned with their capabilities, product strategy and competitive position. In a scale-driven business, for instance, it probably doesn’t make sense for a small player to try to be the low-cost provider. Instead, pricing software enables these companies to find ways to maximize pricing in a price-conscious market by designing offerings with valued features and services that add to their margin.


Easy, rapid access to the data needed to support the use of pricing algorithms is a prerequisite for successful implementation of a pricing strategy. Such data feeds the analytics and facilitates rapid pricing-decision cycles. Our research consistently shows that access to the appropriate data is an issue for a majority of companies and that this issue grows in proportion to the company’s size.

I’ve identified six components that corporations must consider and manage well to be successful in using PRO: strategy, external factors, people, process Economics, information and technology (software). Here are some thoughts on each of them.

As its name suggests, demand-based pricing is a method that uses the buyer’s demand, based on an estimate of a good’s or service’s perceived value to the buyer Economics, as the central element in setting price. Pricing strategies are most important because they can have a disproportionate impact (positive and negative) on a company’s bottom line. Managing prices has always been an activity of keen interest, but it has become even more so over the past decade as a result of the constrained pricing environment.



As to the people dimension, management needs to ensure that the groups involved are behind the effort. It’s extremely important that incentives (especially sales compensation) are properly aligned with the price optimization objectives that I recently covered. In many cases, ongoing training will be necessary to continually refine techniques and deal with issues that arise. For some organizations, a “center of pricing excellence” may be a useful way to build on its experience and entrench a culture of price optimization. Exactly how this is handled depends on whether the company has a centralized or decentralized structure to manage pricing.



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IFRS Pros and Cons


More insights will come as more U.S.-based companies move ahead with their conversion thinking and efforts.

Fortunately, a new, more constructive mantra has appeared: “IFRS case studies are coming, IFRS case studies are coming!” This case study details United Technologies’ approach to, and insights on Economics, the conversion.

Matthew Birney is a manager in the manufacturing conglomerate’s financial reporting department responsible for International Financial Reporting Standards. He says that there are positives (access to a wider talent pool) and minuses (IFRS is more open to interpretation than GAAP) to the pending move.


The large accounting firms (those with the most SEC registrants) will be a good source for IFRS information; not only do they possess the expertise Economics, but also they have a potentially huge financial stake in the conversion, as IFRS compliance will likely prove complex, time-consuming, and profitable (or costly, depending on where you sit). ###




I’m familiar with the interpretation challenges (and believe that industry standards will emerge fairly quickly to ensure that investors can make apples-to-apples comparisons); the point on talent benefits is new and interesting.

The “IFRS is coming, IFRS is coming!” chorus has quieted a bit amidst all of the uncertainty surrounding the economic crisis, the new SEC leadership, and the future of the U.S. regulatory system.

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Risk Management- What Needs Fixing, What Doesn’t

Hirth, who I will interview about the study in an upcoming post, also says that the survey respondents’ focus on risk appetite and strategic risk (which together relate to the risks companies choose to take on as the result of specific assumptions and certain organizational biases) reflect what he and his team recently have witnessed in the field.


Here are the top five corporate risk management areas in need of improvement Big Fat Finance, according to more than 600 internal auditors:

Respondents also identify compliance risk for financial reporting, public company reporting of risk Big Fat Finance, risk avoidance and the evaluation of risk reporting (both at the operating unit level and at the senior management level) as areas of relatively high competency.

1. Emerging risks;

2. Evaluating and changing risk appetite levels;

3. Setting risk appetite;

4. Defining risk appetite; and

5. Strategic risk.

This information ranks among the most compelling findings of Protiviti’s 2011 Internal Audit Capabilities and Needs Survey, a 40-plus-page report released last week.

This “Needs to Improve” analysis represents a new category within a report that has appeared each of the past five years.

The fact that financial reporting risks are regarded as relatively low would suggest that internal auditors are impressed by the long hours their finance and accounting colleagues have logged in managing internal controls in accordance with Sarbanes-Oxley. This finding also suggests that GRC currently represents more of an efficiency effort, as opposed to an effectiveness effort, as it relates to financial reporting risk.




Emerging risks are just that: risks that have yet to fully materialize. Robert B. Hirth Jr., Protiviti’s executive vice president and head of global internal audit, gives five examples: new industry rules; new business regulations (think Dodd-Frank); the impact of new technology (think smart phones); geopolitical upheaval (Libya’s effect on oil prices); and natural events (the impact of the Japanese crisis on high-tech supply chains).

The survey findings indicate that the following risk-management areas are performed with relatively high levels of competency (and therefore, are least likely to need improvement):

1. Process-level risk;

2. Functional-level risk;

3. Transaction-level risk;

4. Location-level risk; and

5. Operational risk.




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Avoid Software Maintenance Fees




Benioff’s latest anti-maintenance fee rant apparently was triggered by a Oracle Siebel customer who told him that the company paid $15 million for its Siebel maintenance. Salesforce.com Economics, a software-as-a-service (SaaS) vendor, directly competes with Siebel. Not surprising that Benioff would want to use that juicy tidbit against a competitor.

Marc Benioff, CEO, Salesforce.com, is one of the few true iconoclasts in the IT industry. So, when he called for the end of software maintenance fees a few months back, it got noticed — cheered by many, reviled by others.

Software maintenance isn’t about this kind of technical support. It’s about getting routine updates and patches, something many feel they should get automatically with the license. In fact, organizations often get the updates and never install them. For the maintenance fee, you only get the update; you still have to install it, which may entail considerable work.



This is different from technical support for which you pay extra depending on the level of service you want. Technical support buys you problem resolution. If you have a technical problem and you want one-hour response directly from a support engineer, you will pay more than if you can accept a 24-hour email response.


With SaaS, the maintenance fee is inherent. Whenever the product is updated, enhanced, fixed, patched, whatever Economics, you get it automatically the next time you log on. Often you don’t even realize the software has been changed. It is part of what you buy when you pay your subscription fee. You might pay a SaaS vendor extra for additional professional services, but routine software maintenance is part of the deal.


Software maintenance fees, paid annually, amount to a percentage of the price of the license, typically 15 percent. If the cost of a license is $100,000, then the annual license fee is $15,000. Each licensed software product you use probably comes with a maintenance fee. You don’t need many products before it adds up to real money.


Maintenance fees pose an interesting problem. Supposedly they are optional, but you usually have to go to great lengths and withstand intense pressure to get it stripped out of the contract. If you don’t pay it, you won’t get software upgrades and patches or fixes. And since software always has problems, vendors sow a lot of fear, uncertainty, and doubt (FUD) to drive maintenance fees.

1. Negotiate — maintenance is negotiable. If the vendor won’t negotiate maintenance, look for another product.

2. Do without maintenance — based on your cost-risk analysis.

3. Opt for SaaS — with an SaaS product, maintenance is included.

Here are three things you can do to avoid software maintenance fees:


SaaS usually results in lower software costs because SaaS vendors have certain cost advantages, such as not having to support all the different platforms customers run. They only need to support browser access. By adding SaaS products where appropriate, you can reduce overall software costs. ###

Benioff’s comments have been reproduced all over the Internet, here and here for example. Sure they’re self-serving, but that doesn’t mean he isn’t onto something.


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Why Your Board Wants Compliance Stories

In a recent post I pointed to the power of narrative as a risk. In a recent exchange, Bart Schwartz, chairman of Guidepost Solutions (as well as a corporate monitor, which represents another trend – or at least a job title – of interest for 2012), shared some ideas related to how boards might strengthen their compliance contributions.

Do CFOs, risk officers, internal audit chiefs and other GRC executives need to present facts and figures to keep boards informed of risk? Certainly. But perhaps the impact of these numbers will sink in deeper if they are accompanied by anecdotes Economics, illustrations and other elements that connect with our human need for engaging stories.


● Boards should increase their scrutiny of major risks that have not blossomed – “not because the risk is any less” Schwartz explains, “but because management may have become too accustomed to the risk and too blasé about managing it.”



I’ve been talking to risk management, compliance and internal auditing experts this month to get a feel for how they expect their realms to evolve during the next 12 to 18 months. I’ve heard some interesting ideas. I’ve also heard the same interesting idea repeated more than once; and, as the saying goes, “here’s how journalists (or bloggers) count to three: one, two Economics, trend.”

● Boards should set up a compliance and risk committee focused on the interplay between an effective enterprise risk management program and a compliance program that helps mitigate those risks to the company’s strategy, reputation, financials and operations.


Board members typically receive 200 to 300 pages of information, much of it risk-focused, to review each month, according to a Protiviti article. “Despite this abundance of data, quality analysis to steer recipients to salient points is often missing.” This shortcoming prodded the risk consulting firm to develop a customizable risk index that tells a crucial story through the elegant simplicity of a single number. The index does so by addressing two crucial questions boards need answered:



1. Is our organization riskier today that it was yesterday?

2. Is our organization likely to become riskier tomorrow than it is today?

In addition to the suggestion that boards should request more anecdotes related to risk issues from their executive partners, Bart Schwartz, chairman of Guidepost Solutions, and Ken Handal, president of GRC at Guidepost Solutions, shared several other recommendations, including the following:


● Boards should ensure that they have the time and tools to bring these issues and solutions to the forefront in their deliberations.




Storytelling is a powerful tool, as Schwartz’s recommendation confirms. But his point also suggests that the traditional forms of risk information (namely, facts and figures) presented to the board often fall short of their intended objective: keeping the board effectively informed about the organization’s changing risk profile. This shortcoming may also qualify as a trend, as I’ve also reported before.

Count storytelling within the realm of risk management among one of the many trends (including lean GRC, behavioral risk management, principled performance, correlations between business ethics and the bottom line and the death of SAS 70 audits) I’m examining right now.




Three More GRC Tips for Boards


Schwartz suggests that boards of directors should request “more anecdotal information, rather than relying on statistics when reviewing the effectiveness of a compliance program.” (For a few other suggestions on the board’s approach to GRC issues, see the sidebar below.)

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