Chapter 34 The Value Chain: A Study of the Durable Medical Equipment Industry

9 Pages Posted: 16 Nov 2018

Date Written: February 19, 2018


When reviewing transfer pricing cases from the U.S. Tax Court (or other judiciary or tax administrations around the world), the analyses usually begin with a study of the industry. This is often analogous to an MBA style analysis.

The industry analysis helps in the comparability analysis – that is mandated by US regulations. This aims for having an uncontrolled transaction be priced sufficiently similarly as a controlled transaction. If the transactions are not within a certain margin, then the relevant tax administrations will perform adjustments. Comparability factors include: functions, contractual terms, risks, economic conditions, and the type of property or services in question. These economic conditions are brought out in the industry analysis.

After the comparability analysis, the functional analysis occurs. This functional analysis involves, identification of the activities undertaken or to be undertaken, resources employed or to be employed, use of plant and equipment, intangible assets, work force in place, etc. This analysis depends on the transaction and industry, the functional analysis should focus on understanding critical activities that may have an impact on prices or profits: product design and development; product manufacturing; branding and the importance of marks; and supply chain of inputs and outputs.

Often, contractual terms are important because they can have significant impact on prices. Contractual terms may be stated or implied. If they are not stated, it does not mean they should not be adjusted if identified. Contractual terms may include collateral transaction where, for example, services may be embedded in a tangible goods transaction. Economic substance must exist within the contracts. Economic substance means if there is no written contract, the actual conduct of the parties will be given greater weight. Written contracts where risks have been shifted to a party that has no capacity to bear risk would likely not be respected. This could trigger a substance over form analysis by the tax authorities.

Economic conditions are often a matter of identifying risks in the market. These risks can include market risks (input costs, demand, pricing, inventory, etc.); and they can include financial risks (capital, foreign currency, and interest rates, etc.).

Economic conditions for the firm and/or the industry may have significant impact on prices or profits. Moreover, economic conditions are relevant primarily in evaluating the firm in the context of: market for the firm’s products; market structure (whether perfectly competitive, monopolistic, or somewhere in between); market size and market share; market conditions related to contraction or expansion; location-specific costs – relevant especially for manufacturers, high-inflation countries, non-business friendly locations; and alternatives realistically available to the buyer and seller. Much of this information is often presented to the tax authorities required by regulations.

One way to conduct an industry analysis is through a Porter analysis. This sets up a framework for visualizing the bargaining power of suppliers, threats of new entrants, threat of substitutes, bargaining power, and how this all affects industry rivalry. This can be further informed by Porter’s four corners model that helps predict the action of market players.

Suggested Citation

Lincoln IV, Charles Edward Andrew, Chapter 34 The Value Chain: A Study of the Durable Medical Equipment Industry (February 19, 2018). Available at SSRN: or

Charles Edward Andrew Lincoln IV (Contact Author)

University of Groningen, Faculty of Law ( email )


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