Publication: IIE Transactions
Publication Date: 01-MAY-07
Delivery: Immediate Online Access
Author: Li, Yanzhi ; Lim, Andrew ; Rodrigues, Brian
Article Excerpt
1. Introduction
The global economy has recently seen a surge in Free Trade Agreements (FTAs) (Ju and Krishna, 2005), which have reduced or eliminated trade barriers and transformed the way products are procured, manufactured and distributed. These include the European Union (EU), the North American Free Trade Agreement (NAFTA), the Central European Free Trade Agreement (CEFTA), the Singapore-Australia Free Trade Agreement (SAFTA), and the United States-Singapore Free Trade Agreement (USSFTA).
This work is motivated by sourcing decisions faced by firms, especially by multinationals, who manufacture in Singapore and sell in the Japanese market since the Japan-Singapore Economic Partnership Agreement (JSEPA) came into effect in 2000. In the broader context, the sourcing problem we study is experienced by firms who manufacture and export within free trade regimes and import material from FTA partners and others.
Under JSEPA, 94% of Singapore's exports and an additional 4000 products enjoy a zero-tariff rate, with the major benefactors being in the electronics, pharmaceuticals and instrumentation sectors. The annual savings to exporters has been estimated to be S$330 million by the Singapore government. (1) Companies in Singapore with global manufacturing and distribution networks decide on material (2) sourcing strategies to exploit tariff concessions from JSEPA (or any other applicable FTA) to reduce costs and increase profit margins.
As with any FTA, JSEPA partners enjoy zero-tariff rates for originating goods, although external rates set by members against nonmembers need not be equalized. Given this imbalance, Rules Of Origin (ROO) are implemented to prevent trade from going through the country with the lowest tariff before for transshipment to other partner countries. For example, ROO prevent electronic products originating in Indonesia and shipped to Japan through Singapore from benefitting from the JSEPA. ROO specify conditions under which a good becomes eligible for a zero-tariff rule so that only goods originating from partner countries can benefit from the FTA. In effect, ROO determine the "nationality" of goods. (3)
Although details vary among FTAs and for different goods, ROO determine if the country of origin is the last country where substantial transformation has taken place. Criteria used to establish transformation are specified in Value-Added (VA) rules, Change in Tariff Classification (CTC) and Process Rules (PRs). Each can be applied in isolation or together. CTC and PRs are relatively easier to implement when compared with VA rules. For example, in a PR, the product of a chemical process is deemed an originating good of a country if the process occurred in that country. Product-specific rules in JSEPA use the VA method and require that the local (or "originating") content of a good be no less than a percentage qualifying value determined by the formula:
QVC = [[FOB - NQM]/FOB] x 100%,
where FOB is the free-on-board price payable by the buyer, regardless of the mode of shipment, and NQM is the non-qualifying value of materials used by the manufacturer in the production of the good. This is computed taking NQM = TVM - QVM, where TVM is the total value of materials and QVM is the qualifying value of materials, and is a method common to most ROO: see, for example, US Customs and Border Protection--NAFTA Rules Chapter 4. (4)
Firms within FTA countries source from non-FTA partners, the so-called "Rest-Of-the-World" (ROW) countries, for a number of reasons besides costs. For example, a long-term and stable supplier may be preferred. In other scenarios, tariff incentives arising from multiple FTAs may be in place. For example, Singapore and the United States have a bilateral FTA (USSFTA) although the US is ROW vis-a-vis the JSEPA FTA. These considerations underscore a need for detailed planning tools for firms who source material and export within FTA regimes.
2. Literature review
FTAs have been studied extensively from national, welfare and economic perspectives (e.g., Krueger (1997), Chase (2003), Mann (2003)) together with their macro influences on industries (e.g., Krueger (1997), Bair and Gereffi (2003), Stordal (2004)). In the economics literature, work on ROO and content value rules include Hollander (1987), Vousden (1987), Krishna and Itoh (1988), Richardson (1991), Krueger (1997), Duttagupta and Panagariya (2003), Estevadeordal and Suominen (2003), and Ju and Krishna (2005). In operations management, early empirical work on international procurement is found in Davis et al. (1974), Monczka and Giunipero (1984), Vickery (1989), Carter and Narasimhan (1990), Min and Galle (1991), and Monczka and Trent (1991), although these include little mathematical modeling. The general supplier selection problem has been studied by Moore and Fearon (1973), Gaballa (1974), Bender et al. (1985), Kingsman (1986), Turner (1988), Chaudhry et al. (1993), and Weber and Current (1993). Other work on sourcing include Minner (2002), who reviewed inventory models in a global sourcing environment and analyzed the effects of different models, and Chung et al. (2004) who proposed a business model for global sourcing.
There has been little work in the operations management literature on the impact of ROO on material sourcing decisions at the firm level. Munson and Rosenblatt (1997) study models where local content rules compel firms to purchase components from suppliers located in the single country of manufacture. In this work, the classical plant location model is extended and derivations given for local added value. In a recent study, Kouvelis et al. (2004) proposed a model used to design global facility networks which incorporates government subsidies, trade tariffs and taxation issues. While the mixed-integer model provided is difficult to solve for realistic problem sizes, the work focuses on modeling special cases and provides useful insights and analysis for these situations. In this study, we extend the work of Munson and Rosenblatt (1997) by: (i) allowing the manufacturer a choice of whether or not to satisfy the local content requirement for each unit of a product; (ii) explicitly incorporating different transportation costs depending on the country of shipment; and (iii) developing and incorporating a solution method for the case of supplier capacity constraints.
In this paper, we focus on sourcing strategies which can be used at the firm level by taking into account tariff concessions offered by ROO through product-specific local content rules provided by the JSEPA FTA. Since we aim to provide solutions for realistic problem sizes, an algorithmic approach has been adopted. The model studied is generic and can be applied to material sourcing planning wherever tariff concessions are available through local content ROO.
The paper is organized as follows. In the next section, a model for the sourcing problem is provided. In Section 4, a dynamic programming approach is given for the uncapacitated supplier case and in Section 5, a column generation technique is developed to solve the capacitated case. Numerical experiments which test the algorithm are given in Section 6; these are analyses and used to provide useful insights into sourcing strategies. Conclusions are drawn in Section 7.
3. The sourcing problem
3.1. Assumptions
A firm manufactures a single product which requires multiple components/subassemblies, and possibly multiple units of each component in a two-level product tree. The product is manufactured in country A and sold to customers in country B. Assume that m components are required which can be sourced from A or B or from suppliers in any of n other ROW countries. We assume the price of a component from any one country can be represented by an aggregate price even though vendors in the country sell at different prices, and only price differentiation between countries is relevant. If A and B are FTA partners, a tariff imposed by B is eliminated if the goods from A satisfy the ROO VA rule if local content is above a specified QVC.
In the analysis, we differentiate imported components from FTA partners, e.g., country B, with those from the ROW. For imports from B, transportation costs incurred from B to A are deemed to be inland transportation costs which are included as local content costs and added to ex factory costs, in an FOB price formula. Transportation costs incurred from any non-FTA country to country A cannot be used in local content calculations and in the total FOB price formula. This is standard practice in agreements where transportation costs are a consideration, as for example in JSEPA, and is a liberal formula since it allows companies to add up costs to meet the QVC threshold.
Apart from transportation costs, local content includes costs incurred during production, such as wages, factory rental fees,...
NOTE: All illustrations and photos have been removed from this article.
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