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Import liability buffer zones. (Product Liability Prevention).

Imagine yourself, the CEO, sitting in your corporate boardroom reveling in the fact that your corporate stock price is soaring and your company is now the national leader in smoked fish products. Not content to sit on your laurels, your marketing department is diligently exploring other areas where your company can broaden its product lines. It has been determined that your profits on smoked herring could be higher. After all, your customers are clamoring for "the same kind of herring you can get in Europe."

Marketing has suggested that your company go to a manufacturer in Europe that is well known for its smoked herring. The European manufacturer will make a custom product with your branding. Adding this new product will increase sales significantly. The plan goes ahead, the product is shipped to the United States, and distributors soon have it on retailers' shelves.

Things do not, however, go according to plan. The safety director explains that a pregnant consumer was diagnosed with food poisoning after eating your new herring. Samples of the product have tested positive for Listeria. Twenty-four hours later, she miscarries. Within seventy-two hours, you have reports of deaths and hospitalizations from Listeria poisoning. Your brand name, which has been rock-solid for the past one hundred years, is now on the six o'clock news. Every paper has your company's problem on the front page. And the FDA has notified you that you have a Class I recall on your hands.

Just when you think things could not get worse, your risk manager informs you that your company dropped its product recall coverage last year as a result of increased premiums and the unlikely event of a product recall. It is estimated by your accountants that the company will spend millions of dollars to complete the recall, not including the cost of settling the numerous lawsuits from the families of the deceased and injured.

Managing the Risks of Global Manufacturing

In today's complex regulatory environment, the burden of producing safe and compliant products rests with the manufacturer. Most American industries have best practices that are routinely deployed by internal safety teams, which continuously inspect and test goods before they are sent to distributors and retailers. At the same time, an increasingly competitive global business environment is forcing companies to consider ways to lower product costs while improving product quality and diversity. To meet these demands, many American companies are partnering with foreign manufacturers to produce custom-branded goods--a unique product that is manufactured by a third party.

Most countries do not have--or do not actively enforce--the strict product safety regulations found in the United States. The problem many U.S. manufacturers encounter is that while they may be saving money manufacturing abroad, the products, materials and facilities in which merchandise is produced are substandard. Additionally, many foreign manufacturers do not perform the type of testing required in the United States to ensure that safe, compliant products reach the market. What can manufacturers do to mitigate this risk?

Two Answers: Bonded Warehouses and Foreign Trade Zones

For companies sourcing some or all of their custom-branded products from foreign manufacturers, protecting and preserving brand integrity and thereby preventing a costly product recall crisis is an important concern. One solution may be in the programs administered by the U.S. Customs Service. Increasingly, companies sourcing merchandise abroad are utilizing customs bonded warehouses or foreign trade zones to protect their brand names and product integrity. Many of these companies are also finding that these programs offer additional benefits above and beyond this originally intended purpose.

A bonded warehouse is a secured area located within the United States, which is treated as being outside the customs territory of the country for customs purposes. Merchandise imported into the United States and entered into a bonded warehouse may be stored, or undergo manufacturing operations, without the payment of customs duty. Bonded warehouses are either public (available for use by several parties) or private (available for use only by the owner). Upon entry of goods into the warehouse, the importer and warehouse proprietor incur liability under a bond. This liability is generally cancelled when the goods are (1) exported (or deemed exported); (2) destroyed under customs supervision; or (3) withdrawn for consumption within the United States after payment of duty.

Another program available to companies is the foreign trade zone. For the purpose of the tariff laws and customs entry procedures, these zones are considered outside the customs territory of the United States. In other words, while a zone is physically located on U.S. soil, any merchandise entered into, processed or warehoused in a zone is deemed technically not to have entered into U.S. commerce. Foreign and domestic merchandise may be admitted into these zones for storage, exhibition, inspection, assembly, manufacture and processing, without being subject to formal customs entry procedures, the repayment of duties or the payment of federal excise taxes. Liability in the foreign trade zone is more complicated than in a bonded warehouse and often dictated by the specific situation.

Bonded warehouses and foreign trade zones offer safe havens for companies distributing foreign merchandise in the U.S. market. Both programs permit a beneficiary company to perform on-site inspections, sampling and testing of imported merchandise before it takes ownership and control of the products. Inspection and testing can be done by a company's employees or outside third party testing companies. Either way, these customs and trade programs enable companies to test perishable items for contamination and inspect nonperishable items to ensure that they are manufactured in accordance with contractual obligations, industry specifications and federal regulations.

Properly negotiated and structured, agreements and contracts with foreign suppliers can be written such that title passage (i.e., change of ownership) to the product does not occur until inspection and testing has been completed inside the bonded warehouse or foreign trade zone and the buyer is satisfied with the quality. If it has been determined that the merchandise is substandard or contaminated, the product can be rejected by the company without risk of significant financial loss or legal obligations. In such a case, the responsibility for returning the merchandise to the country of origin or finding another potential buyer falls upon the foreign manufacturer or middleman company. These arrangements provide a protective layer of insulation against a costly product recall and protect product branding and distribution strategies.

Additional Benefits

There are other benefits to a bonded warehouse, in particular, the improvement of cash flow. No duty is collected until merchandise is withdrawn for consumption. An importer, therefore, has control over the use of its money until the duty must be paid. Or, if no domestic buyer is found for the imported articles, the importer can sell merchandise for exportation, thereby eliminating its obligation to pay duty. Another benefit is that inventory can remain in a warehouse for up to five years following entry without the payment of customs duties.

Similar to bonded warehouses, the benefits of a foreign trade zone extend beyond ensuring product quality prior to distribution in the U.S. market. These benefits can include the deferral, reduction and elimination of customs duties as well as improved supply chain efficiencies and more robust inventory controls. As customs duties are paid only when and if merchandise is transferred into U.S. customs territory, a foreign trade zone operation allows companies to keep critical funds accessible for their operating needs while the merchandise remains in the zone. And unlike the five-year limit of a bonded warehouse, there is no maximum length of time that merchandise can remain in a foreign trade zone.

With the permission of the Foreign Trade Zones Board (a government body within the Department of Commerce), users are allowed to elect a "zone status" on merchandise admitted to the zone. This zone status determines the duty rate that will be applied to foreign merchandise if it eventually enters into U.S. commerce. Users can elect the lower duty rate, either that applicable to the foreign products or that applicable to the finished product manufactured in the zone. The result is that a company can improve its margins or lower the price of its product to U.S. customers.

Additionally, no customs duties are paid on merchandise exported from a zone. Duty is eliminated on foreign merchandise admitted to the zone but eventually exported from the zone. Generally, customs duties are also eliminated for merchandise that is scrapped, wasted, destroyed or consumed in a zone. If merchandise is determined to be unsuitable for resale or distribution--either in domestic or international markets--the ability to destroy or consume the merchandise in the zone can help ease the burden of otherwise unrecoverable out-of-pocket expenses for duties and taxes.

Additional intangible benefits have begun to play a greater role in foreign trade zone programs. Many companies in the program find that their inventory control systems run more efficiently and effectively. Zone users also find that in meeting their reporting responsibilities to the U.S. government, they are eligible to take advantage of special customs procedures such as direct delivery and weekly entry.

Indeed, for importers with a high volume of customs entries, the weekly entry procedure can result in significant savings on merchandise processing fees (MPF), an ad valorem surcharge (0.21 percent) levied by U.S. customs on most import entries. Foreign trade zone users are permitted to file one weekly consumption entry for multiple import shipments rather than one entry per shipment. In the zone program, MPF is levied at a maximum of $485 per week, rather than a maximum of $485 per entry. For example, if a company has ten shipments, the MPF on each entry would be $485, or a total of $4,850. Conversely, if the ten shipments were admitted into the foreign trade zone and consolidated under one weekly entry, the MPF on that single entry would be capped at $485, netting the company MPF savings of $4,365.

Noninsurance Solutions

For a risk manager, bonded warehouses and foreign trade zones offer an alternative when product recall insurance premiums are too expensive or coverage is denied altogether. While there are many other issues that need to be considered such as legal and contractual matters, corporate income tax, and rules and regulations of various government agencies, bonded warehouses and foreign trade zones offer companies two potentially cost-efficient, creative and proactive solutions for product recall strategies.

RELATED ARTICLE: FDA Recall Classifications.

According to the U.S. Food and Drug Administration, recalls are classified by the relative health hazard associated with the use of or exposure to the recalled product. There are three possible classifications.

Class I--A situation in which there is a reasonable probability that the use of, or exposure to, a violative product will cause serious adverse health consequences or death.

Class II--A situation in which use of, or exposure to, a violative product may cause temporary or medically reversible adverse health consequences or where the probability of serious adverse health consequences is remote.

Class III--A situation in which use of, or exposure to, a violative product is not likely to cause adverse health consequences.

Katherine Ann Cahill is the director of financial advisory and product recall services and Mark Ludwig is a partner at PricewaterhouseCoopers in New York.
COPYRIGHT 2003 Risk Management Society Publishing, Inc.
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 2003 Gale, Cengage Learning. All rights reserved.

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Comment:Import liability buffer zones. (Product Liability Prevention).
Author:Cahill, Katherine Ann; Ludwig, Mark
Publication:Risk Management
Geographic Code:1USA
Date:May 1, 2003
Previous Article:Managing the human impact of crisis. (Cover Story).
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