On Supply Chain Integration to Free Trade Zones: The Case of the United States of America

Abstract

The interdependence of resources in a global marketplace, the advancement of technology and rising national economic constraints have compelled companies to excel in their supply chain performance. To that end, Free Trade Zones (FTZs) may help supply chains improve their bottom line while generating economic development to their geographical regions. The shift of manufacturing to overseas and recent changes in global trends, regulations and procedures call for a renewed understanding of FTZs from the perspective of the extended enterprise. Although having significant potential impact on the efficiencies of global supply chains, FTZs in such a context have not been studied in depth in academic literature. With this paper, we aim to modestly draw attention to that gap while providing an overview of the contemporary state of FTZs with a special focus on the USA and the application process therein. We propose a practical decision framework that considers the cost of imported goods and the level of business maturity to help companies make better decisions when they want to integrate with a FTZ.

Keywords

Trade zones global logistics supply chains decision making economic development

Introduction

A Free Trade Zone (FTZ), also called Foreign Trade Zone, Duty Free Zone or Special Economic Zone, is a designated physical site that is considered to be outside formal customs authority and, therefore, allows for free trade with countries across the world. In FTZs, which are generally located at or near water ports or airports, ‘nondomestic merchandise may be stored, exhibited, processed, or used in manufacturing operations without being subjected to duties and quotas until the goods or their products enter the customs territory of the zone country’ (Murphy & Knemeyer, 2015, p. 252).

The intent of these zones is to offer duty savings mainly by reducing importation costs for parts, eliminating those costs for items that may never contribute to a finished good and deferring those costs until a finished product is able to be assembled within a zone. FTZs may provide efficient logistics with lowered transaction costs and thus increased economic development (cf. Tongzon, 2011). They benefit individual domestic corporations but also allow for the country as a whole to gain a competitive advantage compared to other nations (e.g., Yilmaz, Cooke & Dellios, 2008). Benefits include the creation and retention of jobs within the designated country as well as capital investment from corporations using the FTZs. The role of FTZs differs between countries: while FTZs are tools for global sourcing in developed countries like the USA; they are primarily tools for export promotion in emerging countries like China, India, Mexico and Turkey.

FTZs, internationally, date back much farther than the creation of those in the USA. There were free ports for trade during the Middle Ages in the Far East that provided a similar service and advantage. Singapore, Gibraltar and Hong Kong were the first known FTZs from this time period and all fell under the British Empire at the time. Europe began utilizing FTZs in 1888, hundreds of years after they were first created. Free Trade Zones have grown in popularity through the years; in 1999, there were 3000 FTZs in 116 countries aside from USA (see IFTZ, 2010).

Some of the most aggressive actions around FTZs and their development are happening in the Middle and Far East. The United Arab Emirates (UAE) was one of the more recent adopters of FTZs with the first one formed in the mid-1980s. Despite its slow start, the UAE’s utilization has grown significantly in the last few years with the number of companies utilizing FTZs increasing more than 25 per cent in 2012, to nearly 7000 in total. Additionally, FTZs account for 27 per cent of Dubai’s non-oil trade alone (Ford, 2013). In Shanghai, a zone was established as recently as September of 2013. China had Bonded Trade Zones since the early 1990s but established its first FTZ in 2013, with regulations outside the country’s customs authority. A concept known as a Qualifying Industrial Zone allows for similar benefits between Egypt and the USA under certain conditions. Since 2005, India has approved over 575 new FTZs (SEZIN, 2014). Clearly, FTZs have become extremely popular in recent years and will continue to be an important aspect of business.

Figure 1.

Source: http://www.inboundlogistics.com/cms/article/trends-october-2013

The US has been progressively more active in the FTZ space in the last few years. As displayed in Figure 1, the value of exports from facilities using FTZs in the US increased from around $40 billion to about $70 billion over a five-year period.

Although there has been extensive research and discussion on the use of FTZs at the macroeconomic level (e.g., Gereffi & Lee, 2012; Hamada, 1974; Johansson & Nilsson, 1997; Miyagiwa, 1986; Ok, 2011; Rodriguez, 1976; Wan, Zhang, Wang & Chen, 2014), literature is scant on how, particularly, to integrate a supply chain to a FTZ in the face of global sourcing and competition. Considering the costs and the business maturity of the focal company in a supply chain, this paper proposes an easy-to-use decision framework at a micro level.

This study, besides aiming to shed light on current decisions related to supply chain integration to FTZs, is designed to aid logistics, purchasing and supply chain professionals in increasing cost performance. The need for this research emanated from a real problem a US-based company faced when it wanted to integrate its supply chain to one of the FTZs in Ohio, USA. However, we observe increasing interest by enterprises in the world for FTZs. Although the focus of this paper is on companies based in USA, a similar break-even approach, depending on the trade regulations of the country at hand, may be utilized. It is our hope that this study will encourage academics to conduct much needed scholarly research in the area of FTZ decisions.

In the remainder of this paper, we first look at the FTZ in the USA. This develops a case for us to get into the some specifics of application procedures. Then, we investigate the implications of integrating and FTZ to a supply chain and develop a practical decision framework based on a case in Ohio, USA. Finally, we conclude with an emphasis for future research.

A Closer Look at FTZs in the USA

FTZs in the USA were established in 1934 under the Foreign-Trade Zones Board to promote competition and enable companies to expand easily within the country. The intention was to remove disincentives for manufacturing in the USA so that companies would continue to invest and build, subsequently helping the economy. The FTZs are regulated by the FTZ regulations and US Customs and Border Protection (CBP). Figure 2 is a map showing the locations of US FTZs.

The programme initially saw very slow growth. In 1970, 36 years after the introduction of FTZs, there were only eight general-purpose zones and three subzones in USA (Wirtz, 2007). Over the next 40 years, though, the concept of FTZs became more and more popular. States began to see the value and savings they could accumulate, and applied for FTZ around major ports, air hubs and even state borders. According to the 2012 Annual Report of the Foreign-Trade Zones Board to the US Congress, the value of shipments into the established zones topped $730 billion. These zones were used by 3200 companies and employed nearly 370,000 people (see also ECON, 2013). Today, there are roughly 250 general-purpose zones and over 500 subzones, with some form of FTZ in each of the 50 states. Schwartz (1998, p. 79), by noting ‘Many manufacturers benefit from FTZ use. But be prepared for the application process’, emphasizes the importance and sometimes overlooked step in integrating FTZ to the company’s chain operations. Therefore, knowing how application is made to establish an FTZ in the USA is in order.

Figure 2.

Source: http://www.channelingreality.com/CORE/FTZ_Map_Page.htm

Application Requirements and Regulations of FTZs in the USA

The application process for establishing an FTZ can be time consuming with various stages to ensure all requirements are met. There are four major steps in applying for a foreign trade zone:

Pre-docketing: The corporation works on a paper application with assistance from an FTZ analyst to ensure all information is accurate and comprehensive. The original is submitted only after the FTZ analyst clears the application.

Docketing: When the application is docketed, it is published and open for public comment for 60 days (40 days for subzones). The notice is published in the Federal Register by FTZ staff.

Review: FTZ staff review the application and determine approval or non-approval.

Interagency clearance: Once FTZ staff approves, the application is sent to CBP headquarters and the Department of Treasury, which must also approve. If they do, it is sent to the Department of Commerce for final review. The final stage ends with publication in the Federal Register.

The application itself must include an in-depth analysis of everything potentially involved with the FTZ. Title 19 of the US Code details all necessary components for submitting the physical application at the pre-docketing stage. The requirements include (19 US Code):

Location and qualifications of proposed area

Land and water or land or water area or land area alone if the application is for its establishment in or adjacent to an interior port;

Means of segregation from customs territory;

The fitness of the area for a zone; and

The possibilities of expansion of the zone area;

The facilities and appurtenances which it is proposed to provide and the preliminary plans and estimate of the cost thereof, and the existing facilities and appurtenances which it is proposed to utilize;

The time within which the applicant proposes to commence and complete the construction of the zone and facilities and appurtenances;

The methods proposed to finance and undertaking;

Such other information as the Board may require;

The board may upon its own initiative or upon request permit the amendment of the application. Any expansion of the area of an established zone shall be made and approved in the same manner as an original application.

Regulations for FTZs comprise two parts: FTZ regulations (15 CFR Part 400) and CBP regulations (19 CFR Part 146). Table 1 shows some of these specific regulations.

Worldwide, requirements and regulations of FTZs differ based on the country where the FTZ is located. International trade is an important concern when developing any corporation or entity and is encompassing new regions every year. While FTZ regulations differ based on the country, there are some important guidelines and agreements in use by countries today that will also impact FTZ decisions. Some of the most notable international agreements are listed in Table 2 (see also Long, 2003).

Table 1.

Application for Establishment and Expansion of Zone in the USA

Who can grant zones?
The Board (including Secretary of Commerce and Secretary of Treasury) is authorized to grant zones.

How many zones can be granted?
Each port of entry can be granted at least one zone; however, if a port of entry is located within two states, it may be entitled to one zone in each state. All exceptions to this regulation must be granted by the Board.

What purposes can a foreign trade zone be used for?
Any operational purpose including exhibition, assembly, manufacturing and processing.

What can be imported/exported from foreign trade zones (FTZs)?
Anything can be imported/exported from FTZs as long as it follows US law. Any foreign items are subject to US law while waiting within in the US borders.

Are there consequences to violations of FTZs?
Yes. The Board will assess penalties of up to $1000 for every day a regulation is not followed.

How are FTZs regulated?
FTZs are regulated by the Board and any person the Board deems a ‘supervisor’ of each foreign trade zone. The corporation is also responsible for which materials are used and which operations occur within foreign trade zone. Corporations can oversee this or contract to an Operations Sponsor. FTZs are treated as public utilities, which states, cities and municipalities are responsible for regulating.

Source: TITLE 19 (2013).

Table 2.

Major International Trade Agreements

International Agreement	Countries/Entities Involved
World Trade Organization (preceded by General Agreement on Tariffs and Trade)	All countries except Somalia, Greenland, Eritrea, Korea and multiple islands surrounding South America, Europe, Asia and Australia
North American Free Trade Agreement	USA, Mexico and Canada
Hong Kong Special Administration Region	China and United Nations

Source: Long (2003, pp. 78–80).

Implications for Designing Supply Chains

Excellence in supply chain management has increasingly been the linchpin in the success and viability of the parties to it. In the ever-changing global marketplace, supply chain management has received tremendous attention both from researchers and practitioners. As the boundaries of chain extend to other countries, the required modification and alignments may be complex and challenging, due not only to cultural and communication differences, but also economical and risk constraints. Numerous studies have been conducted in global supply chain management wherein exchange rates and a multitude of regulations are incorporated in decision models (e.g., Arntzen, Brown, Harrison & Trafton, 1995; Beamon, 1998; Bookbinder, 2013; Meixell & Gargeya, 2005). A more sophisticated and hence realistic integration of a FTZ decision into supply chain management calls for further research.

There are several ways to establish FTZs for organizations. The two main types of zones are magnet sites and subzones. Magnet sites are located in places like sea ports, industrial parks or airports/airfields. Subzones are a portion of that magnet site that is granted to a specific company or for a special use. Application for this type of zone comes through an Alternative Site Framework, which is an expedited and less costly way to establish. Within the zone, a company can also apply for production authority, which allows it to alter fit, form, or function of a product, as opposed to just passing it through for trade purposes. Any kind of good is eligible for duty deferment within the zone. A company should look at many factors when determining if an FTZ is right. Costs and benefits exist for both new and mature supply chains.

In general, once an FTZ is established, many benefits apply. Clearly, the duty saved by establishing this type of zone is the biggest and most attractive benefit. Also, this zone helps to expedite international importation and exportation. As mentioned earlier, it incentivizes domestic production and manufacturing. This leads to employment opportunities and economic development. Costs incurred in the application, regardless of the maturity of the zone, range from $3,200 to at least $8,000. The paperwork can take up to a year and requires site visits and coordination with authorities.

Designing a new supply chain around the concept of FTZ can be very advantageous. Physically, the site and product security can be set up in a way that meets all the guidelines set forth by the FTZ Boards. Also, site selection should take into account any existing magnet FTZs. The Alternative Site Framework allows for quicker and easier establishment of a zone. Instead of creating a new zone, the FTZ can be part of an existing magnet. If no magnet zone is available, the company would need to apply to be a new zone. An Enterprise Resource Planning (ERP) system can be established that allows for traceability and serialization, which helps track specific parts from import to export. If the application process is done in tandem with the formation of a supply chain, the FTZ could be ready when the business opens. This is the most cost-effective way to establish an FTZ and take advantage of the duty deferment.

An FTZ can be costly and time consuming to deploy in a well-established, mature supply chain organization. First, the security of the perimeter and the goods must be in place, or it will need to be established. The application process will vary, depending on the availability of a magnet zone in the area. Also, if parts are not tracked properly, additional systems and capabilities will need to be established with the ERP system. The costs and time will vary greatly, depending on what has already been established at the site of the supply chain organization.

Aside from Foreign Trade Zones, other options exist to reclaim duties on imported and exported materials. Options presented in this section are available in the USA, and represent a few of the commonly used methods. Both duty drawback and temporary import bonds are alternative ways to deal with duties. As with FTZs, each method has pros and cons. Each form has limitations on eligibility and takes planning and evidence to gain the full benefit.

Temporary Importation under Bond, or TIB, is

a procedure whereby, under certain conditions, merchandise may be entered—for a limited time—into U.S. Customs territory free of duty. Instead of duty, the importer posts a bond for twice the amount of duty, taxes, etc. that would otherwise be owed on the importation. Under this procedure, the importer agrees to export or destroy the merchandise within a specified time or pay liquidated damages, which are twice the normal duty. Only certain items … may be entered as a TIB. (www.cbp.gov)

This special type of duty deferment carries with it many rules and regulations. The types of products that qualify for TIB vary from showcase automobiles to animals, fashion samples and art. These goods all qualify for use of a TIB if they are here for showcase, repair, examination, sampling or temporary use, but not if they are for sale. In total, there are 14 subheadings that outline imports eligible for TIB. Timing of the transactions is also outlined in the regulations and is important. Goods imported using this type of bond must be exported within one year of arrival at the port. This time can be extended to a maximum of three years total. Once the bond time has expired, the items must be exported or destroyed, or the importing company is liable for liquidated damages (double duty plus fines). TIBs take planning and coordination with US Customs and the port authority. Paperwork must be submitted showing proof of both arrival and departure. Failure to provide the correct documentation results in the organization being assessed the posted bond plus fees. If the imported good falls into one of the 14 subcategories, this can be a way to avoid duty payments.

Duty Drawback (DD) is another form of duty repayment that puts 99 per cent of the duty paid back into the hands of the company. The US government holds on to the 1 per cent as a fee.

Drawback is a refund of duties paid on imported goods when the goods—or other items manufactured from the goods—are subsequently exported or destroyed. The government provides drawback refunds as a way to help U.S. companies compete in foreign markets by eliminating some of the costs associated with importing goods into the U.S. (Wilson & Arends, 2012)

Many types of drawbacks exist, but manufacturing and unused merchandize are the most commonly used. Manufacturing drawbacks are used when a good is imported, used as part of a wider assembly, and then exported. This type of drawback requires a ruling from Customs. The unused drawback is applicable for products that are cross-docked, or brought into the US and sent out in the same condition. There are also drawbacks available for products imported and exported between North American countries as outlined in the North American Free Trade Agreement. Time constraints exist around this programme; exports must occur within three to five years of importing (depending on type) and paperwork must be submitted within three years. If the imported and exported products fit into one of the drawback categories, this is another fairly simple option to reclaim paid duty.

A Decision Framework for Integrating to FTZ

As expected, many requirements exist regarding integration to and working in a FTZ and a company or organization must be ready and able, legally and physically, to comply with these rules. The decision framework proposed (see Figure 3) attempts to organize some of those decisions and assess the readiness of a logistics organization. It also offers some suggestions of other ways to deal with duties on imports and exports when systems are not mature. Suggestions are applicable only for US-based organizations and it is important to note that only certain subsets of goods and materials will qualify for each of these duty paybacks or deferments.

Figure 3.

Source: Prepared by the authors.

Figure 3 depicts a decision framework for ways in which ERP integration is viable for FTZ. The dollar values on the vertical axis represent the duties paid on eligible imports; they are approximated for the year 2014 for those costs in the state of Ohio, USA. These cost segmentations can also be seen as small, medium and large (i.e., more than $100,000/year). Nevertheless, these cost figures should be calibrated in context with respect to the region/country in which FTZ integration is being considered. We also note that the crossover numbers may be lower for products with inverted tariff.

As seen in Figure 3, if an organization has no ERP system, and little duty is paid, it will be most cost effective to simply pay the duties owed. The implementation costs of an ERP system and site security will outweigh the benefits of reclaiming a small amount of duty. If there is no ERP system, but the duties paid are substantial, it would be worth the cost to implement some form of material tracking system. Reclaiming duties would be easiest using a drawback once the system is established. This would allow the organization to reclaim duties from previous years, and set up the channels to collect the drawback in the future. Duty drawback is also a good option if the duties paid are low, and there is an established ERP system. TIBs are best suited for a company with an ERP system and duties less than $100,000 per year or a mature system with less than $50,000 in duties per year. As mentioned previously, only a subset of imported goods will qualify for TIB. If products cannot be brought in under bond, due to their type, a DD would be best used in these cases. Foreign Trade Zones typically are best suited for companies with large yearly duty payments and mature ERP systems. This speaks about the costs to implement and sustain the tracking, auditing and security of these parts. Once established, the FTZ will be the least cumbersome to maintain, but takes a significant amount of upfront capital to establish.

Each form of duty reclamation will cost the company money in time, administration and data tracking. It is important to note that a basic ERP system implementation ranges from $200,000 to $1 million dollars. If the company is using no formal ERP system, Foreign Trade Zones become very difficult. An FTZ requires part tracking, which is facilitated by the incoming and outgoing signals in an ERP system. If the parts are being tracked manually, and are of low value, it is assumed it is not worth the cost to file any drawback paperwork. As an ERP system matures, the type of duty payback is determined by the worth of the material being received and shipped from the plant. Only high-value imports and exports justify the use of an FTZ. As mentioned, an FTZ requires site security, application costs, and a fair amount of administration cost. Although it is the most sophisticated and automated choice, it requires the most investment.

Concluding Remarks

Laws establishing FTZs in the US were passed in the 1930s. The government wanted to promote trade and domestic manufacturing while making the economic environment competitive for global companies. Although the concept was adopted slowly, today in the USA hundreds of zones and subzones exist. Combined, they see hundreds of billions of dollars pass through each year. Internationally, FTZs have been in use for hundreds of years. When last measured, there were over 3,000 international zones in 116 countries. Whether in the West, Middle East or Far East, the benefits of FTZs have outweighed the costs. FTZs may be leveraged more in order to maintain a competitive supply chain.

The process for FTZ application is dependent upon the guidelines set forth by the governing country. In USA, the process has several steps and can cost thousands of dollars and take a year or more to complete. That time does not include any technical or physical infrastructure improvements required at the site. The current supply chain structure will also have an impact on the success of implementing an FTZ. The zone requirements can be built into a forming supply chain. More mature supply chains will need to find ways to integrate the requirements into the current system. Several examples of general zones and subzones existing in a state or region (e.g., Ohio, references FTZ1, FTZ2 and FTZ3) can be used as cases to gather best practices. An organization must also keep in mind that other types of duty deferment exist, and there are restrictions based on the types of imports and exports.

An organization must decide if integrating to a FTZ is right for them. Oftentimes, this depends on the sector in which it is operating and what types of materials it imports and exports. It is also important to look at the maturity of the supply chain and the current duty payments. FTZs are a useful designation, but are not right in every case. Thoroughly understanding the costs, benefits, restrictions and regulations can help a company make better decisions.

More research on FTZs, particularly those that use empirical and formal modelling, is required. One extension to this paper might ask, for example, what other types of incentives, aside from import duty, influence a business to choose the location of its operations and the suppliers for needed materials? As noted in Christopher and Holweg (2011), in light of increasing turbulence and volatility, supply chains should be more adaptable and flexible, to the point that the validity of stability condition in traditional thinking is now being probed. Therefore, in this era of new and innovative thinking, the impact of FTZs on the flexibility and sustainability of supply chains (e.g., Reefke, Ahmed & Sundaram, 2014) calls for further scholarly research.

Footnotes

Acknowledgements

The authors are grateful to the anonymous referees of the journal for their extremely useful suggestions to improve the quality of the article. Usual disclaimers apply.

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