Introduction
The accurate analysis and calculation of total landed costs is imperative for organizations with global supply chain operations. However, many companies overlook common cost elements including duties, tariffs, taxes, harbor fees and handling fees, to name a few. Companies also employ tactics that theoretically reduce costs but, in many cases, generate cost savings in one area while increasing the total landed cost. For example, it is common to incentivize procurement organizations to lower a product’s purchase price variance. While this lowers the actual product cost, it may result in increasing transportation, inventory, warehousing and Customs costs.
To find the lowest total landed cost, your organization must think strategically across the design-to-deliver process. Rather than view supply chain operations as a series of discrete business functions, it must be viewed in its entirety with the goal of reducing total landed costs.
Many companies use disparate processes and systems as well as outdated information, resulting in lower margins and higher costs. By adopting management systems to accurately calculate total landed costs, companies can better manage and understand the impact of costing decisions that include offshoring or near-shoring. This leads to greater predictability and control of costs and profitability while driving improved global supply chain control and visibility.
Landed Cost Explained
Landed cost, or total landed cost, considers all the financial elements that materials and products encounter before reaching their final destination, be it by land, sea, or air. It is an all-encompassing figure that accounts for every expense incurred along the way.
This cost includes the per-unit price of the product itself, freight charges, taxes, import and export duties, insurance premiums, payment processing fees, currency exchange rates and other expenses. The expenses can fluctuate based on factors such as the destination country, seasonal variations, shipment volume and other variables.
It’s important to note that landed cost exclusively reflects the direct costs associated with delivering the product to its intended location. It does not factor into the cost of goods sold (COGS), which is a separate calculation.
The Pivotal Role of Landed Costs
Landed cost analysis plays a crucial role in various aspects of your business operations, impacting several key areas:
Product Pricing Precision – Failing to account for landed cost can lead to inaccurate product pricing, resulting in insufficient revenue to cover all shipping expenses. This oversight can undermine your business’s financial stability.
Profitability Preservation – Incorrect product pricing, stemming from a disregard for landed cost, can erode profit margins as the business is forced to absorb these unanticipated expenses, ultimately reducing its bottom line.
Sourcing Insights – From a buyer’s perspective, understanding landed cost is essential when evaluating competitive offerings and selecting suppliers. A product with a lower per-unit cost from an overseas supplier may initially seem like a better deal, but once international freight fees, customs charges, cross-border taxes and insurance are factored in, the total cost could surpass that of a domestic supplier, potentially straining the business’s budget.
Shipping Strategy Optimization – Monitoring landed cost over time can help identify opportunities to reduce shipping expenses. This involves exploring alternative shipping companies, modes of transportation, or renegotiating volume shipping deals and discounts with carriers, ultimately leading to cost savings.
Landed Cost Elements
So, what are the various fees involved in determining landed cost? Note that not all of the indicated expenses may apply to your business or to every order shipped or received. The costs and fees to consider include:
Insurance: Insurance is essential. It protects you against lost, stolen or damaged goods.
Customs: Each country has specific import and export fees and regulations. Shippers should expect to pay custom-related costs like duties and tariffs.
Exchange rates: Do not overlook exchange rates when establishing your product prices. Small businesses, especially, are at the mercy of currency exchange rates.
Demurrage fees: Shipping lines frequently charge demurrage fees for containers sitting beyond the free time allotted inside a port or terminal.
Free on board (FOB): FOB is used to describe who is liable for products damaged during transit. It can affect your purchasing and shipping expenses.
Port charges: There are various port charges that can include early or late port charges, demurrage fees, or even cancellation costs.
Calculating Landed Cost
The basic formula looks like this:
Product + shipping + customs + risk + overhead = landed cost
You account for product and shipping costs, and then add all tariffs, taxes and duties required by the country’s regulations. Risk is the cost of protecting your investment, which might be insurance and any compliance costs. Finally, overhead charges cover fees like currency conversion, payment processing and any bank charges.
Landed cost calculation example:
As a simple example, let’s assume a purchase of 500 items from a supplier at $10 per unit. The duty is 2%, or $.20 per item ($10 x. 0.02). Shipping is $1,000, or $2 per item ($1000/500 items). Insurance is $200 resulting in a cost per unit of $200/500, or $.40. There’s also a $2 payment processing fee per unit.
Total landed cost = $10 (product) + $2 (shipping per item) + $.20 (duties) + $.40 (insurance) + $2 (processing fee) = $14.60 per unit
Landed Cost Accuracy is an Imperative for Supplier Selection
While many companies continue to base their sourcing decisions heavily on the purchase price, a more accurate approach is to consider comprehensive landed costs — especially when comparing suppliers from various countries.
Over the years, the allure of low wage rates in certain countries has led many companies to offshore production without fully accounting for the total costs involved. The wage gap with other manufacturing locations was so large that additional expenses were often overlooked. However, by only comparing prices instead of the overall cost of sourcing from different countries, the expected profitability may have been overestimated.
In light of the shifting competitiveness of low-labor-cost countries, objectively reevaluating sourcing decisions through the lens of accurate and total landed cost is an effective strategy. When the full costs are considered, your company will gain more insight when deciding to source from Vietnam vs. China vs. Mexico vs. other geos you are considering. This approach not only reduces costs but also enables greater flexibility in innovation and product strategies while minimizing risk exposure to localized disruptions around the globe.
Visit our website to find out more about how QAD Supplier Management and Sourcing can help you mitigate supply risks and cut costs. Or, access our Importance of Direct Spend Management eBook providing details on how you can more efficiently and accurately select the optimal source of direct raw materials, products and services.
