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In our fourth annual top executive interview, KPMG’s relocation and expansion expert, Hartley Powell, reveals site selection trends and the truth about financial incentives.
For an executive in charge of a corporate relocation or expansion project, the site selection process can feel overwhelming. A long list of factors must be considered when searching for the ideal site: Accessible facility space, a skilled workforce, proximity to distribution points or research centers, local tax climates, and available financial incentives are just a smattering of the innumerable factors that affect the decision-making process. Furthermore, staying on top of relocation trends can be difficult in the sprawling, fast-paced, and evolving global marketplace. With increasing frequency, foreign companies are breaking ground on U.S. soil and, reciprocally, American companies are crossing international borders to expand their business ventures. As such, it’s integral for site selectors to understand not only how relocations and expansions work stateside, but also how foreign countries and companies approach the process.
To help you anticipate future trends and to shed light on the complexities of site selection, we conducted an in-depth interview with Hartley Powell, the national leader of KPMG’s Strategic Relocation & Expansion Services practice, which operates both domestically and globally as part of the firm’s Global Location and Expansion Services group. KPMG LLP, an audit, tax, and advisory firm, is the U.S. member firm of KPMG International, which employs 123,000 professionals with more than 7,100 partners in 145 countries.
(The views and opinions are those of the interviewee and do not necessarily represent the views and opinions of KPMG LLP. The information contained herein is general in nature and based on authorities that are subject to change. Applicability to specific situations should be determined by consulting your tax adviser.)
BUSINESS FACILITIES: What industries do you see staying and growing in the United States over the next few years, and why?
Hartley Powell: While I’m not in the business of making predictions, from my vantage point—based on open market data and what we see in the marketplace—industries such as advanced manufacturing, pharmaceuticals, health care, and automotive should be among those continuing to lead the way in growth in the United States. We should expect these and other industries to continue to flourish because of our country’s market depth, strong talent base, advanced technology, and research facilities.
BF: Can you talk about any U.S. location trends you see developing in 2008 and the next few years? Are certain states luring in businesses at an unusually high rate? If so, what are their secrets to success?
Powell: There are various key factors that continuously drive the location process. They typically include labor costs, availability of skilled labor, taxes, highway accessibility, and, of course, incentives. While all locations have to meet the basic business needs of the company, one particular trend we’ve seen lately is that companies are looking much more closely at incentives and zeroing in on when they can expect to realize their “true” benefits. As more states streamline and simplify their tax structures (e.g., single sales factor, exemptions, etc.), the value of the traditional tax credits has been significantly reduced. Therefore, companies are focusing on monetary or cash-based incentives for economic development, which can be more easily utilized and applied to a variety of company investment needs, unlike typical training and infrastructure grants. Our clients are attracted to the fact that cash incentives go immediately to their bottom lines, instead of waiting 10 to 15 years to utilize all of their earned tax credits.
Another trend involves “on-shoring” certain call center functions to improve customer service. In addition, companies are consolidating their data center functions to create efficiencies and cost savings. Today’s economy, more than ever, is pressuring companies to reduce costs and optimize their global footprint. Clearly, consolidation, mergers, and select acquisitions will continue to drive business trends.
Also, it’s no secret that some U.S. companies are choosing to move south to take advantage of the milder climates, lower costs of living, favorable tax environments, and reasonable labor costs. Texas, in particular, is becoming one of the fastest growing job markets. The Southeastern states, particularly Alabama, Mississippi, and Georgia, with new automotive plants and suppliers, are also experiencing tremendous growth.
BF: Which states have reputations for being the most business-friendly? Are they deserved? Which states get unfairly overlooked?
Powell: That’s not an easy question to answer because every state has unique qualities and incentive programs that make them a good fit for specific business operations. For example, many of our service-related clients say they find that Oklahoma has become highly responsive to business needs in recent years. They find the state’s business costs to be reasonable and the state’s incentive structure helpful in offsetting short- and long-term business costs. In the Southeast, our clients in the automotive industry have found that Georgia, Mississippi, Alabama, Arkansas, Tennessee, North Carolina, and South Carolina offer the combination of facilities, personnel, and tax and incentive structures that they are looking for.
Upstate New York is one area that is often overlooked. Our clients find that many of the municipalities provide environmental, educational, and economic benefits that meet their needs. Utah also actively recruits businesses and can be a good fit for companies seeking to set up operations.
BF: What foreign countries are U.S. companies currently finding to be good choices for business locations, and why? Do you see this changing over the next 10 to 15 years?
Powell: As U.S. companies continue to expand their operations globally, India, China, Vietnam, the Philippines, and Eastern Europe remain solid choices. The cost of doing business is generally highly competitive and they each have a plentiful employee base. India’s government is continuing to develop its infrastructure and ports, and it places a high emphasis on educating and developing its workforce. Vietnam and the Philippines are developing their workforces and we’ve seen several companies setting up operations there. In the future, as the world economy continues to expand and supply chain needs develop, we expect South America, Mexico, and Africa to become increasingly attractive locations for companies.
In fact, the results of KPMG’s 2008 Competitive Alternatives Study, which compares business costs in 136 cities in 10 countries in North America, Europe, and Asia Pacific, bears that out. Of the countries studied, Mexico is currently the most cost-effective place to conduct business, with costs approximately 20.5% below the U.S. baseline. As an emerging industrialized country, it is well-positioned to experience strong growth in the years ahead. Other countries that rank high in the study across a range of factors include Canada and the United States, partly reflecting the weaker U.S. dollar.
BF: Companies expanding in the United States have grown to expect a bevy of financial incentive offers, even competing offers. Do locations in other countries play the incentives game differently? Do you see a substantial difference in the quantity and quality of financial incentives offered by locations outside the United States, and does a U.S. company looking abroad need to adjust its expectations?
Powell: In the United States, the states have control of credits and incentives. In other countries, incentives are administered differently. And so, the political structure and the financial flexibility of each country’s government play a huge role in how incentives are handled.
In Europe and other parts of the world, incentives are very specific to a country or region. Understanding the process in each country can provide opportunities for incentive solutions for site selection projects.
Within the 25 member countries of the European Union (EU), the use of incentives is governed by the European Commission (EC) in Brussels, Belgium. The EC sets ceilings for the amount of incentives that can be provided in any location within the EU based on the location’s per capita income relative to the EU average. This means that the level of incentives allowed is higher in the less affluent regions of the EU, which include the central and eastern European countries that joined in 2004. The ceilings are expressed in percentage terms, and incentives may usually not exceed a certain proportion of a project’s capital expenditure or of the payroll for newly created jobs within a certain period.
This system may seem simple and appears to leave little room for variation, but that is not necessarily the case. Many companies make unwise choices by taking regulations at face value, believing that “if we invest in Poland or Hungary, we will get 35% or more back in cash grants.”
Two important points need to be understood, though, to make sense of incentives in the EU. First, the ceilings are limits intended to level the playing field among regions in the EU. However, no company or investment project is guaranteed any amount of incentives. Even in locations where the incentive ceiling is high, a project may not qualify for incentives or may receive an amount well below the maximum allowed.
Some countries, such as Estonia, hardly provide any incentives at all, even though under EC regulations they are allowed to do so. Additionally, each country has a large variety of incentive programs, both nationally and regionally, which need to be negotiated and applied for separately. In other words, there may be just as much scope to craft an incentives package in the EU, provided that the total value of the package does not exceed the ceiling set by the EC.
Outside the EU, the nature of available incentives often depends on a combination of two factors: the political structure of the country and the financial ability of the government to support companies. In India, for example, the individual states have a high degree of political autonomy and are increasingly competing for foreign direct investment internationally and between one another. While they are free to offer their own incentives packages, few of the states have the budgetary means to provide much in the way of direct support such as grants.
In Russia, which has a similar federal structure, economic policy is highly centralized and even the wealthier regions are prohibited by law from providing anything to potential investors beyond some limited regional tax abatements. However, investment in these countries makes sense for the right companies that need access to markets or natural resources.
In smaller, highly centralized, and wealthy states such as Singapore, or some of the Persian Gulf states, decisions can often be made quickly and financial support for the right projects may sometimes be significant. Because these countries are keen to diversify their economies, they may even take a direct financial interest in projects that reflect their economic development priorities. However, many developing countries lack the financial means to provide such support and their incentives programs often center on tax abatements or duty reductions. But opportunities for favorable business arrangements still exist. For example, in countries such as Egypt or Malaysia that still regulate industries through import duties or local content requirements, there is the potential for crafting incentives arrangements that can reduce the costs of these regulations to an investor.
BF: Can you identify some types of financial incentives that companies should be cautious of, ones that might seem beneficial on paper, but don’t always prove to be in practice? Do any specific examples you have dealt with come to mind?
Powell: To begin, companies need to be realistic in their expectations of the gains they may receive from business incentive programs. That said, there are two types of incentives that our clients sometimes say they approach with caution: tax credits and cash rebates.
Traditional tax credits based on job creation and/or capital investments are often not applicable in all business tax circumstances; therefore, tax credits may not be fully utilized by many companies. Even though companies may be entitled to large tax credit incentives, the actual value and impact of a tax credit on a project will depend on whether a company can utilize the benefits. Utilization of tax credits depends on a company’s annual state tax liability.
Currently, 29 states offer some form of cash rebates based on new job creation. While these programs can sometimes be extremely beneficial for a company, they can also be complex from a compliance standpoint. Cash rebates often come with significant implementation challenges related to annual auditing, potential recapture benefits, stringent deadlines, extensive paperwork, and company processing errors. Any company that is involved with such cash rebates should be sure to read the fine print, so there are no surprises from a compliance standpoint. One approach we sometimes suggest is for the company to designate an incentive manager to oversee the incentive program and manage receipt of the business cash benefits.
BF: What is the most important piece of advice you can give to executives undertaking their first relocation or expansion project?
Powell: We always underscore to our clients that incentives should not drive the site selection decision process. Only when viable sites have been identified based on a company’s business needs should incentives play a role in the decision process. Bottom line: incentives never make a bad site good, they only make a good site better.