Correct accounting for duty drawbacks with outward and inward processing in global production networks $ Marius Häntsch a , Arnd Huchzermeier b a Daimler AG – Production Strategy Locations, Mercedesstraße 138, 70327 Stuttgart, Germany b WHU – Otto Beisheim School of Management, Burgplatz 2, 56179 Vallendar, Germany article info Article history: Received 20 March 2014 Accepted 15 April 2015 Available online 28 April 2015 Keywords: Duty drawbacks Production networks Automotive Strategic planning abstract We develop a new model for the correct accounting of customs duties levied on a product. We examine inward and outward processing – that is, processed components can be either imported or produced in a foreign country – in the strategic planning of a global production network. This complex modeling problem is structured with path variables, and the duty drawbacks can be simultaneously and correctly entered for n production stages in m market regions (with corresponding duty regions) for all products with a maximum n-level bill of materials. We present a case study from the automotive industry to examine whether or not the possibility of future duty rate changes or free trade agreements, such as one between the United States and the European Union, could affect the design of a production network and hence should be considered in strategic planning. We show that correctly accounting for duty drawbacks can lead to changes in the global footprint of production. We also demonstrate that intercontinental trade barriers (in the form of duties) diminish working capital and entail longer delivery routes. Eliminating these political trade barriers could increase the returns to capital while reducing both delivery lead times and environmental costs. & 2015 Elsevier Ltd. All rights reserved. 1. Introduction The production networks in many industries have become more internationally linked than ever. Especially in the automotive indus- try, global added-value activities are critical for success – as we can see with such market leaders as VW, Toyota, BMW, and Mercedes- Benz. Yet the establishment of production networks involves more than following market developments; relationships, restrictions, and promotions in international trade play a key role in selecting future production locations [26]. For many industrialized nations and emerging markets, the automotive industry is an important one. It symbolizes the highest technological progress of a nation's economy, and its high job multiplier (7.5 per job; [23]) creates steady employ- ment in automotive manufacturing. Trade restrictions, such as high duties on vehicles or trade agreements with selected partners, help governments to enhance the appeal of their own production location and flow of goods. For instance, China has high import duties on finished vehicles even though upstream products can usually be imported with much lower duties; moreover, if upstream products are re-exported then duties may be waived or refunded in order to ensure the international competitiveness of local companies. There are also lower duties upon re-import of goods that were further processed by “extended workbenches” in other countries as part of an intermediate process. Western European original equipment manufacturers (OEMs) use such a cost advantage (e.g., from Eastern Europe) to improve their global competitiveness [21]. The latter measures can significantly affect the appeal of production locations and so, in general, should be considered in the strategic planning of such networks. Duty drawbacks are rarely addressed by optimization models found in the literature. We know of no other research publications about the proper accounting of duty drawbacks for globally produced products, as when their components are (repeat- edly) manufactured or assembled in foreign countries. Section 2 reviews the literature on accounting for duty draw- backs in optimization models. In the next section we discuss the relevant fundamentals of duties and duty drawbacks. In Section 4 we develop a new model that performs that accounting in full. A case study is presented in Section 5, where the effects of a free trade agreement between the United States and Europe are analyzed and we present results of a study on the ideal production footprint. In Section 6 we summarize the results, discuss some managerial insights, and suggest future avenues of research. 2. Survey of the literature In this section we review previous optimization models for global supply chains that incorporate duties and duty drawbacks. Contents lists available at ScienceDirect journal homepage: www.elsevier.com/locate/omega Omega http://dx.doi.org/10.1016/j.omega.2015.04.007 0305-0483/& 2015 Elsevier Ltd. All rights reserved. ☆ This manuscript was processed by Associate Editor Kuhn. E-mail addresses: marius.haentsch@daimler.com (M. Häntsch), arnd.huchzermeier@whu.edu (A. Huchzermeier). Omega 58 (2016) 111–127