Preferential trade agreements can provide significant cost savings and affect many sourcing, production, and logistics decisions. But taking advantage of Free Trade Agreements (FTA) is not as easy as it may seem. Companies need to comply with the various requirements set forth in the FTA and without the necessary internal coordination and proper communication with other supply chain parties, the benefits may be lost and the competitive outlook will be adversely affected. As preferential treatment may result in duty rate savings of over 15%, it is vital that where possible the manufacturer does take advantage of the available FTAs.

Origin Management is the holistic approach towards taking benefit of FTAs, and is the cross-functional program that informs and involves people throughout the company and supply chain regarding origin issues. Origin Management is geared towards 1) taking as much benefit as possible of all available FTAs or other preferential programs, and 2) ensuring that all preferential claims that are filed can be sustained and will not be rejected upon importation or at a later stage (for example during a customs audit).

However, before launching into setting up a program that commits resources to the management of Free Trade Agreements, manufacturers have to analyze whether Origin Management is ‘worth it.’ A series of analytical issues needs to be dealt with. Based on a review of the below items the manufacturer will be able to assess whether there is sufficient financial incentive to set up an Origin Management program.

What products do you sell and what markets are you selling into?

After the general tariff reductions agreed on during GATT (currently WTO) round of 1994 and the Singapore Agreement of 1996 (an agreement on the reduction/abolishment of duties on high tech/electronics), not all products stand to benefit from Free Trade Agreements: for a high number of products the difference in regular or Most Favored Nation (MFN) duty rate and preferential rate is minimal or zero. In other cases, products may be (temporarily) excluded from duty reduction as they are considered sensitive goods and home industries need to be protected.

Clearly, the markets you are selling into and the available manufacturing locations define whether or not there is even a Free Trade Agreement available to leverage (i.e. is there a FTA concluded for products manufactured/shipped on the specific trade lane?). It will pay of to 1) look into the future where available FTAs are concerned—they are recorded at record pace and fixation on only current FTAs can be costly down the line, and 2) review whether there are alternative manufacturing locations available to create trade lanes that result in more beneficial duty rate.

Examples:

-    Regular duty rates for cars and bicycles imported into Mexico are 50% and 20% respectively. Under NAFTA, 0% rates apply.

-    The South Korea—U.S. FTA has been signed, but not yet implemented. Not taking into account the duty reduction that will take effect the moment the FTA is effective, can lead to significant competitive disadvantage.

-    The U.S. has always been very active when it comes to FTAs. Current negotiations include for example Latin American countries such as Argentina and Brazil, the South African Customs Union, and, perhaps, even a European Union—U.S. FTA may happen.

Complete analysis of duty rate implications

Once the potential trade lanes are identified, the seller can finalize the analysis regarding the exact duty rate implications. It is of vital importance to include in this analysis the future (preferential) duty rates as well as to gain insight into what FTAs could be signed on short notice. Either may turn the best solution from a duty rate/FTA perspective today to a bad decision tomorrow. The duty reduction schemas (tables) can be found in each Free Trade Agreement as a schedule that will allow the seller to identify duty rate reduction for an extensive period of time is included typically in the main agreement.

Review Bill of Materials

The last component is the review of the Bill of Materials (BOM). Each Free Trade Agreement includes Rules of Origin, which most importantly, specify what percentage Regional Value Content (RVC) needs to be met in order for a good to qualify for preferential treatment. The manufacturer can now calculate whether a particular BOM qualifies for preferential treatment. If it doesn’t, the manufacturer can review sourcing alternatives that would make the BOM eligible.

Example and other considerations:

The impact of FTAs is felt globally. Selecting the right manufacturing location for automotive parts shipped to Indonesia can result in 15% duty savings. With the recently implemented Indonesia (ASEAN)—Japan FTAs, shipping from Japan seems a solid option today, but even more so in the future:

Indonesia Automotive Parts

Duty Rates    2008    2009    2011    2012

MFN Rates    15%    15%    ?    ?

Indonesia - Japan     0%-13.6%    0%-12.3%    0%-9.5%    0%-8.2%



In similar fashion, the import of bicycles into China be reviewed. The China—ASEAN agreement has not been effective for long, but shipping from an ASEAN country will result in significant savings today, and even higher savings in the coming years:

China duty rate    2008    2009    2011    2012

MFN Rate    13%    13%    ?    ?

CN – ASEAN (Malaysia)    8%    5%    0%    0%



Clearly, duty rates are not the only deciding factor. For an informed decision, all cost components need to be considered, including the cost of complying with the FTA. These costs vary and can be as high as 15% of the costs of good sold (a recent survey pointed out the likely costs are between 2% and 5%). But even if the program costs are less than 2%, they still need to be considered in order to identify the net benefits from FTAs.

However fashionable using Free Trade Agreements may appear, common sense and financial benefits must supersede the urge to go with the latest craze. If the benefits are too low, duty rate benefits cannot be a leading argument to base manufacturing location decisions on. If the benefits are significant (for example over 10%), there is likely no other supply chain cost element that can reduce net cost as drastically as selecting the right location from a duty rate perspective.



Anne van de Heetkamp is Director of Global Trade Compliance for TradeBeam.