Nov 30, 2009 0:00 AM AWST

Planning for Economic Recovery: Establishing a Regional Distribution Centre in China

The luxury retail industry is one sector that has weathered the economic downturn well and is now planning to grow from strength to strength. This article summarizes the experiences of a US luxury retailer as they evaluated options for establishing a Regional Distribution Centre (RDC) on Mainland China.

What was the regional footprint of the business in Asia?

Well-established third party manufacturers (services providers) were located in China, Vietnam and India. Related party distributors existed in Japan, China, Hong Kong, and Macau whilst third party distributors supported the remaining markets in Asia. The third party manufacturers sold and shipped products to headquarters in the US, where a global RDC existed. Headquarters then sold and shipped products to the respective related and related party distributors in Asia. With markets in the West suffering and all markets in Asia yielding revenue growth for the company, particularly Mainland China, it become imperative to reduce logistics costs and lead times by locating inventory destined for consumption in Asia nearer to distributors.

What location options were considered?

An internal study identified a short-list of potential locations on the Mainland, namely Futian, Yantian, and Shanghai. Hong Kong was also included in the short-list due to the presence of a mature logistics infrastructure and well established international service provides. The internal study confirmed that Hong Kong was comparatively more expensive – up to three times in storage costs – which forced further study in respect of options on the Mainland.

What were the key considerations when evaluating Mainland China?

We recognized that the range of bonded zones available has rapidly evolved, so deciphering which zone(s) was best placed to support our business needs was the primary obstacle to overcome. Thereafter, we aimed to focus on more specific issues of comparison, such as the ease of customs clearance and management, exemption from quarantine and inspection and other nontariff barriers, relaxed foreign exchange controls, and use of Free Trade Agreements.

Last but not least, we did not want to adversely disrupt or create additional costs for our third party manufacturers regarding export VAT refund and logistics costs.

How was evaluation of the bonded zones in Mainland China approached?

As noted above, we firstly acknowledged that the landscape in China has rapidly changed from having very few, if any, bonded zone options that may support an Asia RDC, to having several. We saw this as a risk to manage as well as an opportunity for our business. Firstly, we methodically evaluated the various bonded zones, focusing on the following:
- Bonded Logistic Park (BLP)
- Bonded Logistics Centre (BLC)
- Bonded Port Area (BPA)
- Bonded Warehouse (BW)
- Export Processing Zone (EPZ)
- Free Trade Zone (FTZ)
- Integrated Bonded Zones (IBZ)

We quickly sought to evaluate the pros and cons of the different types of bonded zones, as related to the needs of our business, experience and resources. Some key issues identified are for certain zones were as follows:

EPZ
- Logistics function is only newly established and underdeveloped.
- Location is slightly inland, therefore requiring bonded transport and increased lead-times and cost for certain product flow movements.

BLP / BLC
- Specifically designed to support RDC operations
- So-called "inbound China originating goods" qualify for export VAT refund.
- Warehousing costs may be comparatively high and re-imported goods of Chinese origin will be assessed customs duty and import VAT.

We also compared the bonded zone options in a number of areas, including:
- Storage period
- Maturity of rules
- Administration of the actual bonded zone
- Sea freight options in terms of frequency and coverage for intra-Asia trade
- The distance from the sea/airport for bonded transfer costs and delivery times
- Export VAT refund for third party manufacturers, which is particularly sensitive for the apparel and textile sector

We were therefore able to narrow the list of potential zones to a BLP. The question was whether to be based in Futian, Yantian or Shanghai.

How was 'ease of Customs clearance and management'measured?

As we all know, many statistics and reports address the question of how easy it is to clear products in and out of a country. Key indicators include declaration time, inspection rate as well as authorisation and documentation requirements. All of these need to be built into the decision making process so that no unnecessary or unexpected barriers crop up at implementation. To the greatest extent possible we benchmarked these across the different bonded zones. At the same, we also noted that an individual Customs Officer may still impact on processes, but planned for this to be the exception, rather than the rule.

What concerns existed about the declared dutiable value of goods?

We noted that customs valuation issues when moving goods into and out of a bonded zone can be sensitive. Depending on which entity is responsible for import declarations and regardless of whether any import taxes are due, determination of the appropriate import value can be complex. We mapped out our transaction scenarios and based on the customs valuation rules in China developed a standard operating procedure for determining the dutiable value declared to Customs and appearing on invoices.

What concerns existed about quarantine and inspection and other non-tariff barriers?

One the attractions for considering locating in Hong Kong were the certainties surrounding quarantine and inspection and other non-tariff barriers. However, the operating cost of being located in Hong Kong was prohibitive, hence the necessity to turn towards the Mainland. We all know that quarantine and inspection requirements are another main element to impact the efficiency and effectiveness of an RDC. Based on the HS Codes of products and the bonded zone in question we evaluated just how complex the requirements are to apparel and textile products and related accessories. We sought to establish standard operating procedures so as to ensure compliance, without putting in place too much headcount to support the operation.

What concerns existed in terms of foreign exchange controls?

Similar to the quarantine and non-tariff barriers, this was a concern relative to Hong Kong, but just another issue that we methodically approached. However, to enhance the privilege of bonded zones and support the development of RDC business in Mainland China, there are relaxed controls and management of foreign exchange in certain bonded zones.

Were Free Trade Agreements a consideration?

Absolutely. Apparel, textile and related accessories are still subject to high tariffs, so taking advantage of Free Trade Agreements was important. Asia is one of the most mature regions in terms of Free Trade Agreements implemented. We noted that shipping products through an RDC in China may cause them to lose their eligibility for reduced duty rates when imported into the ultimate destination market. If so, the additional expense of such duties may be prohibitive.

We worked to identify what products and markets were key 'beneficiaries' of Free Trade Agreements and validated with authorities to understand what Certificates of Origin could be granted, to whom and under what circumstances. Based on the outcome of this study, we felt that Free Trade Agreements could still be used, but subject to certain criteria being fulfilled and some administrative effort.

Damon R. Paling is a partner at PricewaterhouseCoopers. Based in Shanghai, he consults on customs, trade and supply chain issues.