Lessons · Lesson 5 of 6
What a preference is worth paying for
Calculate how much more a qualifying fabric may cost before the preference stops paying for itself, and see why the obvious way of working it out is wrong in a predictable direction.
Lesson 5 of 6 · 17 min
The question the sourcing sheet actually asks
A preference is not free in three of Bruinsma's four routes. In Egypt, Vietnam and Morocco the rule requires cloth from a restricted set of places, and cloth from a restricted set of places costs more than cloth from anywhere. So the real question is never do we have a preference. It is:
How much more may the qualifying cloth cost before we would be better off buying the cheap cloth and paying the duty?
That number exists. It is different for every origin. And almost nobody calculates it. What people do instead is compare the fabric quotes and notice that the qualifying one is dearer. Then they either pay it without knowing whether it is worth paying, or refuse it without knowing what refusing costs.
This lesson is only about that one calculation. Choosing where to place an order in the round — capacity, lead time, risk, minimums, the relationship — is course 26.1's subject, and this lesson does not attempt it.
The shortcut, and why it is wrong
The intuitive answer is easy, and it is what every cost sheet does. The preference is worth the duty. The duty on the Egyptian route is EUR 0.85608 a shirt. The shirt takes 1.62 metres. So the qualifying cloth may cost up to
0.85608 divided by 1.62 = EUR 0.5284 a metre more, and the preference still pays.
That is wrong, and it is wrong in the same direction every time. It always says you can afford more than you can.
The reason is that the duty is charged on the customs value, and the fabric price is inside the customs value. Buy dearer cloth and you raise the value the duty would have been charged on. So the money you save by not paying duty is not fixed. It grows as the cloth gets dearer, but it grows more slowly than the extra cloth costs you.
Set it out properly. Write the extra cost of the qualifying cloth as a premium per metre. The qualifying route lands at the customs value with no duty on it. The cheap route lands at a lower customs value, with duty added on top. They break even when
the premium a metre equals the duty a shirt, divided by the metres a shirt, divided by one plus the duty rate.
On the Egyptian route: 0.85608 divided by 1.62 divided by 1.116 = EUR 0.4735 a metre.
Notice the shape of the correction. The honest answer is exactly the shortcut answer divided by one plus the rate: EUR 0.5284 divided by 1.116 is EUR 0.4735. That is a rule you can do in your head at a supplier meeting, and it is the whole of the arithmetic content of this lesson.
What the shortcut costs on one order
Suppose Zahran is offered qualifying poplin at a premium of EUR 0.50 a metre over non-qualifying poplin of the same construction. The shortcut says take it: 0.50 is under 0.5284, so the preference still pays.
Work it through instead.
| Qualifying cloth, no duty | Cheap cloth, duty paid | |
|---|---|---|
| Customs value a shirt | 7.38 | 6.57 |
| Duty a shirt | 0.00 | 0.76212 |
| Landed a shirt | 7.38 | 7.33212 |
| Landed on 21,000 shirts | 154,980.00 | 153,974.52 |
The cheap cloth is EUR 0.04788 a shirt cheaper, which is EUR 1,005.48 on the order. A buyer using the shortcut signs the qualifying fabric, believes the preference is paying for it, and is EUR 1,005.48 worse off on one origin of one style. Repeat that across a range and a season, and the shortcut is not a rounding error.
The break-even is different in every country, and one country does not have one
Now run it across the programme. The premium a preference can carry depends on the customs value, and the customs values differ.
| Egypt | Bangladesh | Vietnam | Morocco | |
|---|---|---|---|---|
| Customs value a shirt | 7.38 | 6.60 | 7.12 | 7.64 |
| Duty a shirt if the claim fails | 0.85608 | 0.76560 | 0.82592 | 0.88624 |
| Premium the preference can carry, a metre | 0.4735 | not applicable | 0.4568 | 0.4902 |
Two readings, and both are counter-intuitive.
The cheapest origin has the least room. Vietnam has the lowest customs value of the three constrained routes. So the duty it avoids is the smallest, so it can afford the smallest fabric premium: EUR 0.4568 against Morocco's EUR 0.4902, a spread of EUR 0.0334 a metre. The origin that looked cheapest on the FOB price is the one where a fabric constraint bites soonest.
Bangladesh has no break-even at all, and that is the largest finding on the page. Its rule lets the factory buy cloth anywhere, so there is no qualifying premium to pay. The preference on that route is worth EUR 16,077.60 and costs nothing to earn. On the other three it is worth EUR 17,977.68, EUR 17,344.32 and EUR 18,611.04, and it has to be bought with a fabric premium every season.
Comparing origins on FOB alone therefore gets it wrong in two directions at once. It ignores a duty saving that is real and unconditional in one place, and it ignores a fabric premium that is real and recurring in three others.
Check yourselfA mill offers you qualifying cloth at a premium that is exactly your break-even. Is the preference worth taking?Show the answer
The arithmetic says you are indifferent, and the arithmetic is not the whole answer. At the break-even the preference is worth nothing in money, and it still carries all of its administrative burden and all of the risk in lessons 3 and 4: the declarations to keep current, the statement somebody has to sign, and a retroactive exposure if the chain moves. A preference at its break-even is a cost with no benefit. Take the cheap cloth, declare at the full rate, and spend the attention somewhere it earns.
Prompt · Price the fabric premium my preference can carry
Before you accept or refuse a qualifying fabric that costs more than a non-qualifying one, and before you tell a mill what you are willing to pay for it.
Act as a costing analyst. You know that a fabric premium sits inside the customs value, and therefore changes the duty it is being compared against. Work out the break-even. My order: garment [DESCRIBE], quantity [UNITS], made in [COUNTRY], shipped to [DESTINATION]. Price: FOB [AMOUNT AND CURRENCY] a unit, freight and insurance to the frontier [AMOUNT] a unit. My destination values goods on a [CIF OR FOB] basis. Duty rate if the preferential claim is NOT made [PERCENT — take it from the published tariff, not from memory]. Fabric consumption [METRES OR KILOS] a unit. Qualifying fabric quoted at [PRICE A UNIT OF MEASURE]; non-qualifying fabric of the same construction quoted at [PRICE A UNIT OF MEASURE]. Do the following. First, compute the customs value and the duty a unit if the claim fails. Second, compute the maximum premium the qualifying fabric can carry, per unit of measure, and show the two divisions separately — by consumption, and then by one plus the duty rate — and state plainly how much the second division changed the answer, because it is the one most cost sheets omit. Third, compare that ceiling with the premium actually quoted and tell me, in money per unit and on the whole order, which route is cheaper landed. Fourth, repeat the whole calculation for [ANY OTHER ORIGIN I AM CONSIDERING: COUNTRY, FOB, FREIGHT] and tell me which origin can afford the largest premium and why. Fifth, and separately from the arithmetic: list what the calculation ignores — the administrative cost of holding the preference, and the exposure if the claim fails after the goods are sold — and tell me how much below the ceiling I should aim if my evidence chain depends on a long-term declaration from a mill that could buy cloth in rather than make it.
AI can make mistakes — check anything you act on.
There is one honest caution to leave this lesson with. Every figure here treats the preference as certain. Lesson 3 showed that it is not, and a preference that fails after the goods are sold costs the whole duty on volumes you can no longer price for. If your chain has the shape lesson 3 describes — a long-term declaration, a mill that buys in, no notification clause — then the break-even you have just calculated is an upper bound. You should be paying less than it, not more.