Total Landed Cost (TLC) is the sum of all the costs of an item to get it landed domestically. While it is a simple concept, it is reasonably difficult for organizations to calculate. This article will discuss why it is a challenge for companies to calculate, and how companies tend to operate in absence of an ability to calculate total landed cost.Let's first start with an example. ACME Apparel is an apparel company. They are looking to have shirts made. Where should they have their shirts made, and by whom? In today's global world, that is not an easy question to answer. There are nearly an infinite number of options, ranging from having the shirts made domestically, to near-shoring them from Mexico, to having them off-shored to China, Vietnam, of Bangladesh.Let's assume that ACME has decided not to have the shirts made domestically. How could ACME determine whether or not to make the shirts in Mexico, or China? If cost were the only dimension, (let's assume quality would be equivalent from all locations and that time is not a factor), then ACME should figure out how much it would cost to get the shirts landed in the US. As it turns out, this is not an easy task.
What Cost Elements Go into Total Landed Cost?
There are many cost elements that go into determining the total landed cost of an item. The product cost, which is obvious, is only one element. While it is easy to get costing from different vendors as to how much a shirt would cost to make in China ($3/shirt) or in Mexico ($7/shirt), it is not simply a matter of looking at those two prices and saying that we should have shirts made in China because it is cheaper. There are other costs that need to be factored in.The shirts made in Mexico could be coming from a factory just on the other side of the border. To get them into the US would be simply a truck drive, which is reasonably inexpensive. The shirts made in Chain require transportation from China to the US. This transportation is expensive and complicated, and as such, requires additional services to execute. Let's take a look at some of the costs that will be incurred:
- Freight - This is the cost of the transportation from the origination point to the destination point. This is often done by a freight forwarder who coordinates the movement of the container from the foreign port to the domestic port.
- Insurance - Most companies insure their goods during transportation.
- Drayage - Drayage is the movement of the container from the port to the warehouse.
- Commissions - Since you often don't know the foreign countries, you may use agents to help you navigate the landscape. They would be paid a commission on the goods that you purchase.
- Duties, Fees, and Taxes - When importing goods, you are required to pay duties, fees, and taxes on the goods being imported. The duties are somewhat dependent on where the goods are originating. Certain fees are dependent on the mode of transportation. For instance, if you are bringing in the goods at an ocean port, there is a Harbor Maintenance Fee (HMF) that is required to be paid, while bring in goods by truck do not require that fee.
- Customs Brokerage - The customs brokers are expert in the customs filing process, and most companies use them.
- Warehousing - Most product that you purchase will need to be stored. When buying product from overseas, you will likely need to carry more inventory and therefore store the inventory in a domestic warehouse. Since Mexico is much closer to the US, it is possible that your vendor in Mexico would absorb the storage cost and maintain inventory in Mexico.
Now, when we look at this non-exhaustive list of costs that would be applied to the shirt that we want made, it becomes clear that many of these costs elements will be higher when buying overseas, and lower as you get closer to home. However, what is not clear is how much the total landed cost is for each destination.
When to Calculate Total Landed Cost?
There are two point in time when the calculation of total landed cost could be useful. The first, and most likely point that companies would calculate total landed cost would be once the goods have been received, and the various invoices have been collected for that shipment. At this point, a financial analyst would be able to aggregate the various costs, allocate them to the shirts, and determine exactly how much it has cost to have them landed.Understanding total landed cost is important, even if it is being calculated after the fact. It will allow the company to make better decisions in the future, hopefully. Were these shirts profitable? (Assuming we know how much they are being sold for.) Do we need to raise the price? Do we need to investigate alternatives for manufacturing?
The second (and more useful point in time) to calculate total landed cost is on a pro forma basis. Being able to, in advance, calculate the total landed cost from a variety of locations, enables you to make real-time buying decisions. These real-time decisions could save you hundreds of thousands, or millions of dollars each year.