Dr. Raymon Krishnan: Restructuring global value chains

The trade war is now part of the “new normal,” and this has created a global ripple effect. Seen optimistically, this challenging trade environment is a catalyst for a slew of innovative measures and creative tactics to mitigate tariff costs – although one could argue that supply chain optimization from a cost and performance perspective is something that firms should already be doing on an ongoing basis.

Some companies look for legal loopholes to help avoid or reduce duties without shifting production to other countries. For instance, law firms and consultants in the U.S. are reporting that they are being inundated with requests from importers seeking to use provisions such as the “321 de minimis” rule, which allows goods worth less than $800 to be shipped to the U.S. without being subject to tariffs.

Any of these creative ways to reduce tariffs payable by companies should be used carefully. Money can be clawed back if authorities clamp down on a particular tariff avoidance method.

Authorities in the U.S. have recently started cracking down on firms that use “origin engineering” as a technique to avoid tariffs altogether. Goods are typically considered to have come from a country if they have been “substantially transformed” there. In extreme cases, firms simply state that a product comes from one country when, in actual fact, it was manufactured in a country that is impacted by the higher tariff being imposed. This practice is illegal.

Ensuring that any approach is fully compliant in order to avoid having to relocate production or supply sources often takes up a lot of internal resources. This article looks at how a company could seek to reduce the impact of and capitalize on the opportunities the “new normal” has created.

1. Reclassification

All products are classified with a specific code according to the Harmonized System (HS). The HS code determines the tariff a product will incur at the time of import. Often there is a degree of flexibility in assigning an HS code for products. It is not unheard of for a firm to classify products under different HS Codes in different countries. Reclassification is one way to pay lower or no tariffs at the time of import.

2. Product redesign

Changing a product design by replacing tariffed elements with non-tariffed equivalents may be a way to avoid or reduce tariffs. This can, in turn, alter the product origin and transform your product into a non-tariffed product.

Alternatively, you may want to relocate – totally or in part – where your product is manufactured. One way to ascertain whether a product transformation is enough to classify as a change of origin is its added-value criteria.

3. Free trade agreements (FTAs)

FTAs provide various benefits for businesses. By exploiting the use of FTAs, firms can identify the best accessible markets for their products – with regard not just to tariff reductions but also to other benefits beyond tariff cuts, such as better customs procedures and IP rights.

Most trade regulations also include a “de minimis” rule that allows the duty-free importation of non-originating goods. Countries may also allow duty drawback or postponement schemes, which allow for a refund of paid customs duty or taxes on unused imported goods or goods that will be treated, processed or incorporated into other goods for export.

4. Buying forward

Many companies buy forward inventory ahead of tariffs being implemented. This strategy, however, may incur additional warehousing and storage costs, and firms may experience accounting challenges where an inventory is considered an asset, which could affect cash flow. Buying forward may distort demand and induce a “bullwhip effect.”

5. Postponement

Postponement is the delaying of a process, usually a manufacturing process, to as close to the actual time it will be needed as possible. Firms could store products that attract tariffs in bonded warehouses until they are required.

For compound goods, there might be a cost-unbundling option that helps to decrease its dutiable value and is another form of postponement.

6. Insourcing

Firms could choose to insource certain manufacturing processes, such as product assembly. Although this does not help to avoid tariffs for the components of your product, companies may benefit from decreasing transportation costs as they move final transportation closer to their customers.

7. The “first-sale” rule

If a firm is multi-tiered, i.e. if your transaction includes an intermediary vendor or subsidiary use, the first-sale rule could be allowed. The first-sale, or First Sale for Export (FSFE), duty reduction program allows for significant cost savings for multi-tiered importers.

8. Share tariff with a supplier

A supplier could be asked to bear the tariff increase or some part thereof, and they may be willing to do so in order to keep your business. Joint tariff payment is a better strategy for both partners when compared with looking for a totally new supplier or sourcing from a different country altogether.

9. Relocating production from China

The U.S.-China trade war is causing what has been described as the biggest cross-border supply chain shift since China joined the WTO in 2001. The ABC (Anywhere But China) phenomenon has companies relocating or stepping up plans to relocate their manufacturing outside China. Southeast Asian countries, Taiwan and India have become alternative manufacturing locales or sources of supply. While simple in theory, relocation may be challenging for firms. Relocation, coupled with the exploration of plausible options such as reshoring and nearshoring, must be considered in any supply chain network optimization exercise.

10. Restructure or pivoting a business

Business structure is of critical importance in building resilience to disruptions in supply chains. Firms should remain alert to new regulatory changes in international trade that may threaten their structure. For example, the EU’s tightening rules on palm oil imported from Southeast Asia places Malaysia and Indonesia in a difficult position, as they account for 85% of the world’s total palm oil supply.

Firms must constantly evaluate and evolve their supply chains and leverage opportunities. As the dynamics of tariff policies may take a 180-degree turn overnight, it is necessary to model and forecast the scenarios in which a firm operates. Owning sound data is crucial to planning optimal shipping routes, locating distribution centers and warehouses, and forecasting revenue volumes and other trends.

Ingraining new approaches to business development would help restructure supply chains effectively. Some of the strategies discussed above cover collaboration with new and existing partners. However, we could also consider collaboration with competitors across different markets. The concept of combined distribution networks (CDNs) is applied when competing companies in a supply chain work together. Restructuring business development models may occur in other ways, but the focus should be on solutions that entail innovative, non-traditional measures.

Ensuring continued resilience and, in turn, commercial success in situations in which firms have little or no control means that companies need to constantly evolve to stay ahead. Those that are able to do so will not just survive but come out ahead in these turbulent times.

www.raymonkrishnan.com

Published: January 2020

Image: Nina Tiefenbach for Delivered.