Restructuring Global Value Chains – Leveraging the New Normal – LogiSYM August 2019
Given the turbulent and challenging economic outlook, firms are now, more than ever, looking at ways to mitigate the effects and pressures being imposed on their supply chains. The trade war and other disruptive effects such as slowing economic conditions, legislative changes and increased compliance requirements are impacting global value chains (GVCs).
It is somewhat surprising that many firms do not have contingencies in place for disruptions to their GVCs. Anyone who works in supply chain or business would be aware that disruptive challenges, be it naturally occurring ones (like tsunamis for example) or disruptions due to the imposition of trade tariffs occur all the time. A supply chain that has not been designed to overcome or counteract disruptive challenges is a poorly designed one. Given the attention and focus many companies are just now giving to their supply chains, it also means that many companies have poorly designed supply chains.
The trade war is now part of the ‘new normal’ and this has created a ripple effect globally beyond just the US and China. Optimistically though, this challenging trade environment is a catalyst for a slew of innovative measures and creative tactics to mitigate tariff costs – although one would argue that supply chain optimization from a cost and performance perspective is something that firms should already be doing on an ongoing basis.
More and more companies are looking at how their supply chains are structured and are either turning to their customs brokers, 3PL’s or even their lawyers for help in containing the increased costs and impact.
Some companies have taken to looking for legal loopholes to help avoid or reduce duties without shifting production to other countries. For instance, law firms and consultants in the US 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 US 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 — and top executives held accountable — if authorities clamp down on a particular tariff avoidance method.
Authorities, especially in the US for example, 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 origin engineering, firms try to adjust parts of their supply chain to claim that production of the a particular product originated outside of a particular jurisdiction to avoid being impacted by the tariffs being imposed. 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.
To exploit and ensure that any approach is fully compliant to avoid having to relocate production or supply sources often takes up a lot of internal resources. This paper looks at the ‘tool-chest’ of avenues a firm could look at to reduce the impact of and capitalise on the opportunities the “new normal” has created.
Each product is classified with a specific code according to the Harmonised 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 a HS code for products. It is not unheard of for a firm to classify products under different HS Codes in different countries. This happens for a number of reasons.
Reclassification is one way to pay lower or no tariffs at the time of import.
2. Product Re-Design
Changing a product design by replacing tariffed elements with non-tariffed equivalents may be another way to avoid or reduce tariffs. For example, you may choose to ship some components of your product from places that are eligible for preferential treatment. This can, in turn, alter the product origin and transform your product into a non-tariffed product. However, it is a fairly big undertaking and will require engineering teams to rework product designs.
Alternatively, you may want to totally relocate or relocate part of where your product is manufactured. One way to measure if a product transformation is enough to classify as originating is its added-value criteria. The product is considered originating only if certain percentage of the good’s value originates from a country where you are attempting to derive preferential treatment for your product.
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 – not just in tariff reductions but also other benefits beyond tariff cuts. Some FTAs also offer better customs procedures, IP rights and technical measures.
Most trade regulations also include a de minimis rule that allows the importation of non-originating goods duty free. Countries may also allow duty drawback or postponement schemes which allow you to get a refund of customs duty paid or taxes (GST, VAT) on unused imported goods, or goods that will be treated, processed or incorporated into other goods for export.
4. Forward Buying
Many companies forward buy inventory ahead of tariffs being implemented. This strategy, however, may incur additional warehousing and storage costs. In addition, goods and storage availability may be unpredictable and tight.
Firms may also experience accounting challenges where an inventory is considered an asset and this could affect cash flow. Furthermore, forward buying may also distort demand and induce a bullwhip effect, which is a distortion of information in a supply chain caused by one-off spikes in demand.
Postponement is the delay of as much of a process, usually a manufacturing process, to as close to the actual time needed. A simple form of postponement firms could adopt in their supply chains is to store products that attract tariffs in bonded warehouses until they are needed. When used this way, postponement will not eliminate the need to pay a tariff on a product – unless a tariff is eliminated or reduced whilst held in bond – but it will free up cash flow.
For compound goods, there might be a cost unbundling option that helps to decrease its dutiable value. This mechanism allows for the reduction of tariffs by unbundling the product and counting dutiable components only and is another form of postponement.
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 stage closer to their customers. Reanalysis of customer geography might also be useful and products can be market positioned to reduce transport costs.
7. The ‘first sale’ ruleg
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 sales or First Sales for Export (FSFE) duty reduction programme allows for significant cost-savings for multi-tiered importers.
8. Share tariff with a supplier
Another way to reduce immediate tariff-related costs is through renegotiating terms with your supplier. A supplier could be asked to bear the tariff increase or part of the tariff increase and they may be willing to do so in order to keep your business.
This could be a strategic win-win approach for both parties and joint tariff payment is a better strategy for both partners when compared to looking for a totally new supplier or sourcing from a different country altogether.
9. Relocating Production from China
The US-China Trade war is causing what has been described as the biggest cross-border supply chain shift since China joined the WTO in 2001. Many firms have either relocated their manufacturing facilities, are planning to relocate, or are looking for alternative suppliers from outside China. Southeast Asian countries, Taiwan and even India have become alternative manufacturing locales or sources of supply. With an influx of manufacturers and investors in the region, destinations such as Vietnam and Thailand have benefited from “the trade war refugee effect”.
Whilst this option may be simple to understand in theory, firms may find relocation challenging for various reasons. Some may not own sufficient financial and human resources to afford such rearrangements. Even if they successfully relocate, they may be unsure whether they can survive a competitive surge for safe havens. Others may not be familiar with the legal, accounting, trade and customs climate of the alternative countries in which they choose to do business with.
Relocation coupled with the exploration of re-shoring and near-shoring are all plausible options that must be considered In any supply chain network optimization exercise.
Business Model Strategies
10. Restructure or pivoting a business
Business structure is of critical importance in building resilience disruptions in supply chains. Thus, companies have to be creative in this global trade battlefield. Aside from the effects of the US-China Trade War, 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 percent of the total supply of the world’s palm oil supply. There are two possible scenarios under this example:
Scenario 1: Firms stick with palm oil and find new markets.
Since the EU palm oil ban will reduce demand of this commodity in Europe, discovering new markets of palm oil consumers is one immediate solution.
Scenario 2: Firms develop a new product for new markets.
Firms may need to discover both new goods and markets to pivot their businesses altogether. In the case of Malaysian and Indonesian plantations, the durian market in China may be a promising alternative. China’s per capita consumption of durian is expected to grow from 0.21 kilograms in 2016 to 1.11 kilograms in 2030 – an increase of more than fivefold. Moreover, both Malaysian and Indonesian agriculture enterprises can take advantage of the benefits provided under ASEAN-China Free Trade Area, which has put durian product tariffs at zero since 2015.
In most circumstances, there is no such thing as a tariff-proof supply chain or a resilient supply chain. Firms have to constantly evaluate and evolve their supply chains and leverage opportunities. This will help them to achieve multi-sourcing date-visibility and automate supplier solicitation process and qualification for multiple FTAs. As dynamics of tariff policies may take a 180-degree turn overnight, modeling and forecasting scenarios under which a firm operates is necessary. It is crucial to own sound data to plan optimal shipping routes, locate distribution centers and warehousing, and forecast revenue volumes and other trends.
Ingraining new approaches to business development would help effectively restructure supply chains. Some of the strategies discussed above covers 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. CDNs could result in up to 70 percent reduction in supply chain costs for companies whilst also supporting green initiatives. The key paradigm here is prioritising collaborative advantage over competitive advantage. Restructuring business development model may occur in other ways, but the focus should be on solutions that entail innovative non-traditional measures.
Trade will affect companies in different ways, depending on the complexity of GVCs, their industry sector, size, capacity, and business model. The trade environment has become more unpredictable than before. To ensure continued resilience and in turn, commercial success in situations in which firms have little or no control means that they firms 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.