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Eric Bloch Column

The stimulus of toll manufacturing

By Eric Bloch

WHEN Reserve Bank of Zimbabwe (RBZ) governor Gideon Gono presented his third quarter monetary policy statement on October 20, he used the occasion as an opportunity to urge Zimbabwe’s industria

lists to embark upon toll manufacturing.

He said: “As monetary authorities, we are aware that most manufacturing firms are operating well below their normal capacity utilisation levels due to input shortages and the current severe contraction of aggregate demand.

“In order to forestall job losses, as well as promote foreign exchange generation, we call upon relevant authorities in government to consider giving dispensation to manufacturers who are able to toll manufacture for regional customers to do so on the basis that such customers would supply raw materials, take the output and pay a toll manufacturing fee in hard currency.”

Toll manufacturing is far from being a new methodology of transacting business.

More than 150 years ago, a significant characteristic of the industrial revolution was the provision of wool to manufacturers of woven products and garments on the basis that the wool was not sold to them, but was supplied to the manufacturers to produce woolen cloth and garments to the specification of the wool suppliers, and for and on their behalf. In consideration for that production, the manufacturers would be paid manufacturing fees which would fund the wages and other operating costs payable by them, and yield them a profit.

In the 20th century, these practices became increasingly pronounced, and especially so within the clothing industry where they became known as cut, make and trim.

At the present time, the concepts of toll manufacturing have very great potential benefits for much of Zimbabwean industry, inclusive of the manufacturers of clothing and textiles, furniture, engineering products, pharmaceuticals, foodstuffs and much else.

Almost all of industry has been very severely affected by the minimal availability of foreign currency required for the importation of raw materials and other manufacturing inputs, including consumables, spares and packaging.

In consequence, a very great number of industries that were operating multiple shifts had no alternative but to reduce operations to single shifts. Others had to reduce production hours from eight or nine per day to six, and yet others cut back their operations to only two or three days a week.

But the ramifications of the massively decreased production were far-reaching. With production often at levels of less than 30% of capacity, operating losses were inevitable. Few, if any, overheads could be reduced in tandem with the reductions in production, for most of such costs are fixed in nature. Rentals, salaries, insurances and the like do not diminish because of contractions in production volumes.

In contra distinction, some costs increase. In particular, the losses sustained eroded the capital base of the enterprises, already radically impacted upon by the ravages of inflation, which necessitated greater application of capital to fund stocks and debtors. As a result, there was increased recourse to borrowings, with consequential increases in finance costs.

Not only have the manufacturing enterprises suffered horrendously, but their negative, and usually appalling, circumstances have had unavoidable, very major, downstream economic repercussions. The services of contract labour have been terminated, other labourers have been retrenched, domestic purchasing power has been increasingly constricted, there has been lesser spending to downstream suppliers of goods and services, and revenue flows to a ravenous fiscus have markedly diminished.

However, toll manufacturing for export customers can dramatically reverse many of these ills. A few manufacturers have already established positive toll manufacturing arrangements, but they are the exceptions, rather than the rule. Most have, as yet, been oblivious of the opportunities.

Undoubtedly that was the motivation for Gono’s reference to toll manufacturing. As stated by him, the fundamentals of a toll manufacturing arrangement are that the customer provides certain agreed manufacturing inputs, the manufacturer undertaking to apply those inputs to production of mutually agreed goods. Instead of selling product, the manufacturer receives a toll-manufacturing fee which is calculated to cover any inputs supplied by the manufacturer, all costs of production, an attributable proportion of overheads and a fair profit.

The direct advantages to the manufacturer are that he does not have to find foreign currency to pay for imported inputs, and does not sustain the financing costs attendant to those inputs. At the same time, he is enabled to have increased productivity, restoring prospects of price stability and of profitability.

The economy as a whole benefits with the continuance (and possible growth) of employment, the downstream economic flows, and the reduced pressures upon the foreign exchange resources.

There are also benefits to the customer. First of all is the greater assurance of continuity of supply and, secondly, the customer can usually command a more favourable price than otherwise.

Moreover, if the source of the inputs supplied by the customer is the same country as the ultimate destination of the manufactured products, the customer only sustains liability to Customs duties, other import taxes, and value-added tax on the value added to the supplied inputs, instead of upon the total value of the manufactured products.

The RBZ has only one reservation insofar as toll manufacturing contracts are concerned, and that is they should not be structured so as to circumvent exchange control regulations with especial reference to “transfer pricing”.

The RBZ does require compliance with its normal export regulations, insofar as they are relevant, including requisite CD1 export authorisation, based upon the toll manufacturing fee volume, and the timeous acquittal thereof. And 30% of that fee must be sold to the RBZ at the official exchange rates, while the other 70% remains available to the manufacturer in terms of the normal 45-day retention protocols.

But at least the manufacturer is mandatorily disposing of 30% of the toll-manufacturing fee only, and not 30% of gross product value, because, to all intents and purposes, the toll-manufacturing fee equates to a normal selling price for goods of like nature, quality and quantity, net of the value of the customer-supplied inputs.

It is little wonder, therefore, that Gono sought to promote toll manufacturing, and the private sector should respond positively in its own best interests.

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