Key Concept

Maquiladora is a factory in Mexico run by a foreign company that exports products to its home
country. Contract manufacturing is a form of outsourcing whereby a manufacturer contracts
with a firm for components or products. Toll manufacturing is an arrangement in which a
company processes raw materials or semifinished goods for another company.

Legal Entity Design Considerations in Global

Implementations
Reflecting on my experiences with global SAP implementations, I found a common thread: the
majority of my clients had complex legal entity structures that took significant effort to design in
an SAP system.

To gain competitive advantages in today’s global business environment, corporations often

reorganize into legal entity structures that provide significant tax benefits. These structures
frequently take advantage of legally owning assets, revenue, and expenses in different countries
where tax rates are more advantageous. Accordingly, SAP company code design is driven by tax
and legal requirements, including financial ownership of assets, employee expenses, and
facilities.

Three common legal entity structures include contract manufacturing, toll manufacturing, and
maquiladora. I outline the characteristics of each of these legal entity structures, how the SAP
organizational structure is typically designed for each, and lessons learned from my field
experience.

Definitions

Maquiladora: A maquiladora (or maquila) is a legal entity structure specific to production in

Mexico by a non-Mexican parent company. Through this structure, a US parent company, for
instance, can import input materials duty-free and tariff-free into Mexico and take advantage of
lower cost labor and the devalued peso. The finished goods are then imported back to the US
with a duty on the value added by Mexican assembly. Often cities on opposite sides of the border
will be used as twin plants to minimize transportation costs and be more efficient.

Toll manufacturing: Under a toll manufacturing (or toll processing) model, a parent company
sells input materials to a third party that manufactures the finished goods and sells them back to
the parent company. The advantage in this model is that the parent company makes production a
variable cost by outsourcing the previously fixed costs of labor, equipment, and facilities.

Contract manufacturing: The contract manufacturing structure is very similar to toll

manufacturing, with one main difference: in contract manufacturing, the third party sources the
raw materials for production.

SAP Supporting Design

These legal entity structures are reflected in an SAP system by using one or more company codes
to represent the contracted legal entities as separate from the parent company. If the contract is
with an outside legal entity that is not owned by the parent company, that company code is not
created in the SAP system and it is treated as an external supplier.

The following are key areas to consider in the SAP design:

Raw material inventory: In the case of a maquiladora or in a contract manufacturing model, the
parent company typically provides the inventory of input materials. In these cases, input
materials are extended both to the parent company codes (i.e., where the inventory is originally
sourced from external vendors), and the contract company codes (i.e., where the inventory is
imported). In a toll manufacturing model, the third-party sources the inventory, so it is only
extended to the contract company code. It is important to ensure that raw material inventory is
valued in the correct legal entity, and transferred between companies with the appropriate
transfer price.