The art of product classification

For many businesses, classifying their products is a tedious and time-consuming, manual process involving lengthy internal discussions, Excel spreadsheets, and a lot of head-scratching.

The result is often frustrating: poor record keeping, a lack of transparency, and a high error margin. 

But commodity codes are the key classifier in international trade, determining the customs duties for imports, for example. They also define import and export restrictions, as well as documentation requirements. Businesses dealing with controlled goods use an additional export control number to check whether goods require an export license, if they are subject to export controls, and whether they can be exported in the first place. Benefiting from preferential trade agreements is also linked to classification as it refers to products with certain commodity codes.

This also means that assigning the wrong commodity code can bring about far-reaching consequences. This code doesn’t just affect fiscal matters (e.g. customs duties, VAT on imports and excise duties), but also import/export licensing and permit requirements, bans and restrictions, documentation requirements, special foreign trade statistics (supplementary unit), and the obligation to report certain measures. And as with any customs matter, official authorities across the globe impose strict penalties for non-compliance – ignorance is no excuse.

Keeping all applicable regulations on screen to ensure both regulatory compliance and leveraging business benefits can be a great challenge. Identifying commodity codes and export control numbers is such a complex task that it’s almost an art in itself. As such, some companies don’t give it the necessary attention. Many have no established process for product classification at all, or have only a few, if any, employees with the right subject matter expertise.

An example of what can happen when classification is inaccurate was reported by Reuters recently: Solar modules worth more than $150 million that are stuck at various Indian ports due to a dispute over their classification and the import tax applicable to them. Several consignments are held up because customs officials have demanded that some of them be classified as “electric motors and generators”, subject to 7.5% duty, not as “diodes, transistors and similar semi-conductor devices” with no duty at all.

Many companies that I have visited are quite surprised when I tell them that product classification doesn’t have to be a slow, cumbersome, and risk-prone, manual process. They’re not aware that the IT support they expect for many other aspects of global trade and logistics is also available to automate much of the product classification process.

How does it work?
In a nutshell, as soon as a new product is created in the ERP master data, it is automatically downloaded into the software for classification. The key methods these powerful tools then use to determine the classification are:

Rulebase foundation:
The product data defined in the ERP system is used to define a rulebase that is referenced to suggest the appropriate commodity codes and/or export control numbers. And once rulebases are defined, this can lead to a high degree of automation.

Self-learning algorithm:
When a new material is defined and its attributes (e.g. product group, size, or application) are assigned, the software compares the new data against materials that have already been defined and classified. Commodity codes and/or export control numbers are then proposed based on statistical probability – if the new material has similar characteristics to, let’s say, 100 other materials that are all classified with a single commodity code, then there is a high likelihood that the new material should be classified with the same code. A sophisticated algorithm helps the software “remember” classifications already accepted as correct. Over time, the software gets “smarter,” leading to a higher accuracy rate of commodity code suggestions.

With the right software, product classification can largely be automated, leading to an accelerated global flow of goods. It also helps to save customs duties and tap potential benefits of trade agreements, secure supply chains, and achieve a competitive edge by eliminating errors in the execution.