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Crunching the Numbers: In-depth Cost/Benefit Analysis

10/16/2002

By Greg Jones

  

An in-depth analysis of FTZ savings and costs should be conducted by any prospective Zone user before it invests significant time, effort, or money in obtaining FTZ status and/or engaging in the activation process. After all, why do companies use FTZ’s? … Money. This essay discusses in brief the issues and methodology that should be included in any company’s cost/benefit analysis of the FTZ program.

 

 

ANTICIPATED OR POTENTIAL BENEFITS

 

As a general rule a company will not pursue any action unless some threshold of anticipated benefit is reached. The first step in investigating anticipated or potential benefits is to identify the potential benefits of the FTZ program, and to determine which among those may be quantifiable. Following is a list of benefits common to the FTZ program[1]:

 

 

1. Relief from "Inverted Tariff" Rates

 

In many manufacturing situations, the Zone User may be granted relief from inverted duty rates and thereby have the choice of paying the lower finished product rate on foreign components or materials incorporated into that product. For example, a U.S.-based chemical manufacturer imports certain chemicals as raw materials. Normally, the U.S.-based manufacturer would pay a 3% duty rate on its imported raw materials, whereas its foreign competitor who imports the same finished product pays only 2% on the value of any non-U.S. value in its product. However, if the U.S.-based chemical manufacturer is in a Foreign-Trade Zone or Subzone, and its operation has been approved for relief from inverted tariff rates by the Foreign-Trade Zones Board, it pays the same 2% finished product rate on the value of its foreign raw materials when its finished product leaves the Zone for U.S. consumption. This levels the competitive playing field for the U.S.-based manufacturer versus its foreign-based counterparts.

 

 

 

 

2. Cash Flow

 

Unless and until the goods are imported into the United States, no duty payment is required on merchandise brought into a Foreign-Trade Zone. This allows these funds to be used as working capital for the Zone user to earn interest or be invested.

 

 

3. Damaged or Nonconforming Items

 

No duty payment is required if merchandise is not brought into the United States. If merchandise is defective, damaged, or not in conformance with U.S. standards, no duty payment is owed while it is being manipulated, repaired, or stored in the FTZ. (The actual importation does not occur until merchandise leaves the Zone and is entered for consumption in the United States). Merchandise may be altered, repackaged and/or relabeled to meet U.S. requirements. Zones are often used for the purpose of properly marking the Country of Origin on goods prior to their entry into the United States.

 

 

4. No Duty on Value Added

 

Due to the previously mentioned 1980 Amendment to Customs regulations, the "value added" to a product in a  Foreign-Trade Zone (cost of labor, overhead, facilities and profit) is not included in its dutiable value (19 CFR 146.48e), which means the duty on the final product shipped from the Zone is computed on its market value minus the value added. No duty is assessed on domestic parts or materials, OR on domestic labor, overhead, or profit.

 

 

5. No Duty on Re-exports[2]

 

If merchandise is re-exported from a Foreign-Trade Zone, no duty is paid. This is a savings to exporters who would otherwise be required to pay duty on merchandise brought into the United States. If merchandise, on which duty has previously been paid, is re-exported from the United States, the exporter must normally engage in the time-consuming process of filing for "drawback" from U.S. Customs. The FTZ user never pays duty on the merchandise – thus saving administrative burdens and cash.

6. Quota Items

 

No quota is applied to foreign goods in a Foreign-Trade Zone. Therefore, Zone Users may take advantage of bulk shipments and store quota items in a  Zone until the next quota period allows importation of the items into the U.S., again deferring duty payment until the goods are actually imported and effecting cost savings through fully-loaded shipments. This also gives the Zone User the advantage of being one of the first in the market with its merchandise when the next quota period begins.

 

 

7. Indefinite Storage

 

Large or small quantities of merchandise may be placed in a Foreign-Trade Zone and stored (with duty payment being deferred) until the U.S. market can absorb them. They are therefore available for the market, but a cash deferral results for the Zone User until the goods are brought into the United States. Also, if the goods are not needed in the U.S. market, they may be re-exported with no duty incurred. There is no limit to the period of time goods may be stored in a Zone.

 

 

8. Zone-To-Zone Transfers

 

A vendor located at one Foreign-Trade Zone, may sell goods to a buyer  in  another  Zone or Subzone anywhere in the U.S. and  transfer  those goods to the buyer's FTZ with no  duty  paid on the goods. Thus, the vendor located in a Foreign-Trade Zone can price sales to the buyer located in another FTZ based on a cost which excludes duty. As a result, the buyer obtains a discount from the vendor and takes further advantage of FTZ cost-saving strategies. The vendor benefits by becoming more cost-competitive through up-front cost savings, and the buyer benefits through the vendor discount.

 

 

9. Government and Military Sales

 

Sales of foreign merchandise may be entered into the United States duty free if the vendor has a government contract in place. This benefit is particularly important to U.S.-based manufacturers who manufacture products for both commercial and government sales. Often, the companies must bring in foreign parts before they know which parts will be incorporated into products for sale to the government, and which parts will be incorporated into products sold in commercial markets. Because no Customs Entry is made until product leaves the Zone, Zone status affords these companies the opportunity to defer the importation of the parts until the government contract is in place.

 

 

 

10. Improved Logistics

 

Two Zone procedures can be used in concert to improve an operation’s logistics.

 

The Direct Delivery procedure allows foreign merchandise to be transported in-bond directly to the Zone user’s facility without clearing Customs at the first port of unlading, and without the necessity of the in-bond carrier reporting to the local Customs office prior to the delivery of the merchandise to the Zone site. Direct delivery procedures often save one to two days in delivery of foreign merchandise to the Zone user. This shortens the Zone user’s international pipeline, thereby eliminating inventory within that pipeline.

 

Since the formal Customs entry takes place when merchandise leaves the Zone for domestic commerce, Zone users often use the so-called Weekly Entry procedure to streamline shipments and Customs paperwork. Under the Weekly Entry procedure the Zone user files one Customs Entry per week, rather than filing one Customs Entry per shipment. This allows the Zone user to serve the domestic market without paperwork delays. Pursuant to the provisions of the Trade Development Act of 2000, the Weekly Entry procedure has been made available to all kinds of FTZ operations, including manufacturing and distribution operations.

 

The FTZ Weekly Entry procedure often provides significant benefits to both the Zone user and the U.S. government. For Zone users operating in today’s Just-In-Time environment, use of the FTZ Weekly Entry procedure means that hundreds, or even thousands, of import receipts over the course of a year are entered into the domestic commerce on only 52 Customs entries per year. In addition to saving the Zone user lots of paperwork, the company can reduce its payments of so-called “Merchandise Processing Fees’ that are associated with the filing of a Customs Entry[3].  The U.S. government saves by the corresponding reduction in the number of entry filings and the reduction of the costs associated with processing each entry[4].

 

 

ANTICIPATED OR POTENTIAL COSTS

 

A number of costs may be associated with obtaining Zone status and operating under Zone procedures. The first step in investigating anticipated or potential costs is to identify the potential costs of the FTZ program, and to determine which among those may be quantifiable. Following is a list of costs common to the FTZ program:

 

1. Application and Activation Costs

 

If the company is not located within an existing General-Purpose Zone area, or if the company plans to use Zone procedures for a manufacturing or processing operation, then an application on its behalf must be submitted on to the Foreign-Trade Zones Board. (If the company’s operation is outside the existing General-Purpose Zone area, it may be designated as a so-called “Subzone.” If the company plans to use Zone procedures for a manufacturing or processing operation, then – even if it is located within an existing General-Purpose Zone area – its use of Zone procedures will require the approval of a request for FTZ manufacturing authority[5] by the Foreign-Trade Zones Board. Often, companies engage the services of third parties to assist in the preparation of Subzone applications or requests for FTZ manufacturing authority. In some cases, Zone Grantees may charge certain fees in association with the submission of such applications.

 

Whether in an existing General-Purpose Zone environment, or in a designated Subzone area, the company must be approved by Customs  - that is, “activated” – before it can enjoy the benefits of Zone status.  The activation process is often overlooked in terms of effort, cost, and strategic importance. Because the company must live with procedures and systems established during the activation process, the manner in which it is approved often has cost/benefit ramifications that extend for years[6].  Often, companies engage the services of third parties to assist in the activation process. In some cases, Zone Grantees may charge certain fees in association with the activation process.

 

Some Zone users purchase packaged FTZ inventory and management systems that work in conjunction with their existing inventory and management systems.  The licensing and implementation of such systems must be compared with the direct and time-related[7] costs of making internal systems enhancements that may be required for regulatory compliance. 

 

Depending upon individual circumstances, additional security measures may be required. Such measures are usually the result of requests by Customs during the activation process. These can vary in nature and cost. Typically, signs denoting Zone status – which can be had at nominal cost – are involved. Occasionally, additional fencing or other measures that are more significant in cost and/or sophistication  may be required.[8]

 

 

2. Ongoing External Costs

 

A number of ongoing external costs can be associated with the use of the FTZ program.

 

Zone Grantees are required to maintain a Zone Schedule that sets forth the rules and regulations of operating under its grant of authority, and a schedule of Zone User Fees. Typically, Zone User Fees are payable on some sort of regular (e.g. monthly, quarterly, annual) basis. Any company considering the use of the FTZ program should first inquire about the Grantee’s schedule of Zone User Fees.

 

The use of Zone procedures may often involve the preparation of additional Customs documentation (e.g. CF 7512’s for in-bond movements). In anticipation of this, the additional (if any) costs of third-party Customshouse brokerage services should be considered.

 

If the company is going to be its own “Zone operator,” then it must maintain a continuous FTZ Operator’s Bond[9] with Customs. The ongoing cost of maintaining the bond is usually nominal.

3. Ongoing Internal Costs

 

The most significant ongoing internal costs involve the level of staffing necessary to manage the company’s use of Zone procedures. Some of these costs are more easily quantifiable than others.  Obviously, the company will choose or hire an employee who has the primary responsibility for managing the company’s use of FTZ procedures. Depending on the nature and level of Zone-related activity, the degree to which Zone-related processes may or may not be automated and/or may or may not be outsourced, management of the company’s FTZ processes may require less than the effort of one[10] full-time employee, or, conversely may require the efforts of several full-time employees.  Additionally, pursuit of FTZ savings may require additional efforts on the part of a number of employees within the company (e.g. personnel in Logistics, Purchasing, Contracts, Finance, Shipping/Receiving, Production, etc.), however, the extent of effort (and relative labor costs) are often difficult to measure. Usually, the threshold of savings over costs that drives the company to use the FTZ program makes these costs negligible.

 

 

 

 

Another Word About Maximizing Cost Savings

 

Walk before you try to run.  In implementing Zone procedures, smart companies realize that maximizing Zone savings means protecting those savings. How are Zone savings “protected?” … Through sound compliance measures. Smart companies often walk before they try to run by admitting just a few – sometimes even just one – kind(s) of merchandise in Zone status as they commence Zone operations. If there are any compliance issues, they tend to be smaller, more readily identified, and more easily remedied. Companies who try to start their Zone operations in a “full blast” mode often learn a lesson that one shouldn’t have to be a rocket scientist to know: Full blast start-ups more often involve blow-ups than they involve trips to the moon.

 

Maximizing Zone benefits isn’t rocket science. You can take it step by step as if traveling on foot, or, even if you’re a racier type, you can gear up in a proper, coordinated sequence.

 

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