When ‘Business Strategy’ Gets Written Out of the Story

In many transfer pricing reports, the ‘Business Strategy’ section—if there even is one—is barely more than a narartive speed bump. Within the broad spectrum of related parties defined as ‘limited risk’ entities, the narrative often boils down to: “Um, whatever the local strategy is, it comes from the parent (or principal) company.”

Sure, corporate strategy is commonly set centrally. But should that really be the end of that storyline in your Local File? In a functional analysis, the OECD insists that, “Business strategies must be examined to determine whether they influence the level of comparability between the controlled and uncontrolled transactions.” (OECD Guidelines, ¶1.29) Thus, a business strategy isn’t just filler…a box to check. Rather, it is a factor envisioned to have the potential to transform the functions performed, the risks assumed, etc., and by association, may also impact transactional profits. So, why is it overlooked?

The Business Strategy – More Than Just an Emergency Gambit

As a practical matter, the business strategy narrative tends to get the most attention and diligent polish when a controlled transaction’s profitability deviates markedly from—and usually uncomfortably below—the policy target or an interquartile range. Whether attempting to explain the impact of exogenous market shocks or a market penetration plan, these discussions ironically often seek to justify why the standard comparables profitability range—that same one that has worked every year prior—would no longer be the most reliable benchmark for testing purposes. This leads one to conclude that transfer pricers tend to reserve full deployment of an elaborate business strategy narrative for ‘Break Glass’ moments.

How would the Business Strategy write-up impact an analysis during ‘normal times’? Consider your latest ‘limited risk’ benchmark set. Then peruse the business descriptions. (These ought to be in the appendix). Now reflect on OECD guidance that, “Differences in business strategies should be taken into account when evaluating the comparability of controlled and uncontrolled transactions.” (OECD Guidelines, ¶1.35) Do the final selected comparables deploy business strategies that are remotely similar to that of your tested function?

This may prompt some questions: How does one bridge such differences in strategy? If this were now to be taken into account during the comparables screening process, what would change? It depends, of course, but let’s further consider a benchmark for a generic shared services center function. In one example, let’s envision an administrative support services outsourcing provider whose strategy is to manage its own team, resources, and delivery process. This may be quite different from a company whose primary strategy is to recruit or supply human capital that can drop in and execute a client company’s playbook. The impact of this difference may readily be seen in margins and expense ratios, which then can move your interquartile range.

While the above example is a fairly common one, differences in strategy may be far more profound when considering gross margin-level testing, and especially if benchmarking is based on contracts or product prices.

“Limited Risk” ≠ Strategic Context

Even if “all material strategic decisions” are decided elsewhere, local entities still operate within those strategic parameters and can even shape them in subtle ways. Working within a pricing and discount schedule is probably not the sole function of a sales team with strategic relevance to the business. Rather, they make day-to-day calls as they adapt to local conditions and unique client needs, and resolve real issues that are too granular for leadership to anticipate.

And for a ‘real-life’ comparison, when is the last time your boss’s boss told you exactly how to do literally everything important on your to-do list?

Simply ascribing a ‘Limited Risk’ label to an entity’s functional character may fall short of defining how it exists within corporate strategy. Somewhere in that org chart, there is a business unit leader who will be held accountable for executing a strategy and meeting certain associated goals. Does that strategy align with your narrative, and would describing it influence comparability assertions?

A Picture Can Tell a Thousand Words 

Take a peek at the company’s personnel org chart and the associated reporting structures. (While documentation of functional personnel and reporting lines is probably best reserved for its own Margin Note, it’s fitting here to flag another an oft-underserved OECD Local File requirement found in the very first bullet of Annex II to Chapter V, “…description of the individuals to whom local management reports and the jurisdiction(s) in which such individuals maintain their principal offices.”) If the functional analysis insists that “Everything (important) comes directly from the Parent/Principal,” but the org chart suggests this chain of relationships is anything but direct, will the narrative stand up? What does the reporting structure and ‘span of control’ that management maintains inform the reader about how closely connected or directly managed the team within the controlled function actually is? It’s obviously more helpful if the narrative and exhibits depicting the structural hierarchy align with assertions about strategic direction and oversight.

Alternatively, it may be the case that there indeed is a detailed, global manual with a standard operating procedure for countless exigencies (and low materiality thresholds). If so, document this instead.

Why It Matters

The Business Strategy section is where commercial context meets and frames the economic analysis. By reducing it to a throwaway line, one not only weakens the narrative, but economically significant factors in the comparability analysis may also be missed. This, in turn, may also reduce the impact or persuasiveness of a future highlight on a sudden change in the business strategy.

Business strategy deserves more than a sentence. It’s part of a cohesive economic story, which when told well, can make the difference between a controlled transaction that’s merely documented and one that’s robustly defended.