Getting to Total Landed Cost

Comprehensive and accurate landed cost research can make or break a product's entry or success in a market

Anne van de Heetkamp with TradeBeam
Anne van de Heetkamp with TradeBeam
By Anne van de Heetkamp

Decision making with regard to total landed costs is no longer a matter of finding the cheapest manufacturing location. At best, the manufacturer knows two things before manufacturing commitments are made: what product will be sold and where it will be sold. A wide variety of cost factors are then considered before final decisions and commitment towards factory space, suppliers, labor and financial resources are made. Even before the commitment to a production location, the manufacturer has to realize that costs incurred after production have an effect on the manufacturing decision. Two crucial elements of total landed costs are incurred only after the product leaves the plant: transportation costs and import duties.

Historically, the customs duties element has been a necessary evil in the landed costs equation. But with global business paying closer attention to all landed costs components, and the import duties representing an opportunity to save costs, the insight into total landed costs serves multiple purposes. By gaining insight into the applicable customs duties, the manufacturer/seller can improve resource allocations; if the customs duty analysis is executed properly, the benefits include more competitive pricing. Also, the buyer will ultimately benefit from the enhanced transparency. In a less traditional setting such as B2C Web-based commerce, the buyer used to be surprised when requested to pay for customs duties. With new checkout tools available, the buyer is informed prior to purchase on total landed costs, which results in fewer abandoned shipments and higher customer satisfaction.

Components of Customs Duties

Where transportation costs are typically based on a combination of mode of transportation, volume, weight, trade lane and negotiation skills, the import duties are the result of more complex and sometimes unknown variables. Import duties are in most cases based on the formula "duty rate x customs value."

The basis for the customs value in most cases is the transaction value or another "at arm's length" price (this can be the transfer price, for example). In addition, most countries require freight and insurance to be included in the customs value, as well as any other conditions for the sale (like royalties) or provisions that were made in order to manufacture the goods. For example, the value of raw materials or moulds needed for production that were furbished to the manufacturer but are not accounted for in the transaction value will have to be added to get to the customs value.

With regular import duty rates ranging between 0 percent and 50 percent (averaging 9 percent), and preferential rates being significantly lower (usually between 50 percent and 100 percent reduction after a free trade agreement, or FTA, is in full force), it is vital to determine prior to shipment — and, where possible, prior to production — what these rates are going to be, since they can ruin or define market success. The applied duty rate is associated with:

  • The Harmonized System (HS) code;
  • The trade lane;
  • The determination whether or not the product qualifies for preferential treatment.

HS Code

Based on the imported product's characteristics, the item is classified under a specific Harmonized System code. Each country's HS code is different and usually consists of eight to 13 digits/characters, but codes are harmonized across countries to the sixth digit level. The HS code defines what possible duty rate can apply. It is possible that, for a particular product, multiple duty rates can apply. Usually, this is the case when the product qualifies for preferential treatment.

Trade Lane

Whether lower duty rates may apply depends on the trade lane on which the product is shipped. The question is: Is the product shipped on a preferential trade lane? A preferential trade lane can be associated with a bi- or multilateral agreement, based on which the importing country grants duty reduction upon import, or it can be a unilateral measure taken by the importing country. For example, the free trade agreement between the U.S. and Australia and NAFTA are respectively bi- and multilateral preferential agreements. The General System of Preferences and the African Growth Opportunity Act are ways for importing countries to stimulate exports in developing economies.

When the potential trade lanes are known, the manufacturer can identify the related duty rates and duty rate consequences. Both the FTA text and unilateral initiatives will provide the reduction rates on an "HS code by HS code" basis. For example, the duty rates for microwave ovens imported into Malaysia coming in from Japan under the ASEAN-Japan FTA will decline to 0 percent in the coming years, where the regular rate will remain much higher (see chart below).

Getting to Total Landed Cost Illustration 1












Qualification

The final checkpoint concerns the determination whether or not the product qualifies for preferential treatment. The eligibility criteria are usually a combination of regional value content (or added value), tariff shift, product-specific handling and other treatments, and a direct shipping requirement.

The regional value content (RVC) rules specify that the product has to have a certain percentage of the value originating in the FTA countries. Usually, a general rule is applied, with exceptions or more specific percentages that can be applied on particular HS codes. For example, the general threshold for RVC in the Japan-Mexico FTA is 50 percent, but for automobiles of header 8703 the threshold is 65 percent (and includes a tariff shift rule).

The tariff shift rule stipulates that the subcomponents of the finished product cannot have the same 2/4/6 digit HS code as the finished product itself. In addition, exclusions may also apply. For example, the ASEAN-Japan FTA identifies a general RVC component of 40 percent or a tariff shift at the four-digit level. However, in the HS-based rules for HS 8473.30 (computer parts), a shift of heading of products from heading 8542 would disqualify the product for preferential treatment.

The product-specific handling and treatment requirements specify that certain handling (for example: painting, repackaging, cleaning) will never be sufficient for a product to qualify for preferential treatment, even if the handling or treatment would meet the RVC and/or tariff shift requirement.

The direct-shipping requirement defines that the product can only be eligible for preferential treatment if it is clearly destined for the importing countries' market. This requirement can be met for example by directly shipping the product from the manufacturing country to the importing country, by marking and labeling according to the importing countries' requirement at manufacturing, or by a clearly laid out made-to-order paper trail.

Conclusion

When conducting landed cost research, the inclusion of a detailed analysis on duty rate implications is crucial. The manufacturer has to ensure that not only the current duty rates but also the preferential rates, future duty rates and preferential criteria are part of the analysis. This gathered intelligence can be the difference between the making or breaking a product's entry or success in a particular market. ¦

About the Author: Anne van de Heetkamp is director of global trade and compliance at TradeBeam, Inc. He has 15 years management experience in trade consultancy, global trade software and global trade product development, with both public and venture-backed technology companies. His experience spans multiple countries and continents. At TradeBeam, he is responsible for all trade compliance-related consultancy, data collection and managed services. In addition, he qualifies and assists product improvement and development.