Duty is a percentage of value, and the value is measured in dollars at the time of entry. A shipment invoiced at 100,000 euros is worth a different number of dollars depending on the exchange rate on the entry date, and the duty is a percentage of that number. If the euro strengthens 5 percent against the dollar between the purchase order and the entry, the dollar value rises 5 percent, and the duty rises 5 percent, on goods whose price never changed.
The same applies to the freight. The currency adjustment factor on ocean freight is a 3 to 8 percent add-on on lanes priced in currencies other than the dollar, applied when the carrier's home currency strengthens. The freight bill and the duty bill both move with the currency, and both move in the same direction, which means the landed cost moves by more than either one alone.
A brand that prices on a landed cost model built three months ago is pricing on a currency that no longer exists. The model is not wrong because the arithmetic is wrong. It is wrong because the rate is stale, and a stale rate is a guess that is usually optimistic.
Hedging is agreeing a rate in advance. A forward contract locks the exchange rate for a future payment, so the dollar cost of the shipment is known when the purchase order is placed, not when the goods arrive. The business pays a small premium for the certainty, and the premium is the cost of removing the surprise.
The alternative is a natural hedge: matching the currency of the costs to the currency of the revenue. A brand that sells in euros and buys in euros has no exposure on that pair, because the money comes in and goes out in the same currency. A brand that sells in dollars and buys in euros has the full exposure, and the hedge is the only way to remove it without changing the business.
The decision is the volume. Hedging costs money, in fees and in the spread, and a business importing 10,000 dollars a month does not need it. A business importing 100,000 dollars a month, with a 5 percent currency swing worth 5,000 dollars, does, because the swing is larger than the margin on the shipment. The threshold is not a number. It is the point where the swing is bigger than the business can absorb.
First, build the landed cost model on a current rate, and update it when the rate moves by more than a point or two. A model that is updated monthly is a model that is wrong by at most a month. A model that is updated quarterly is wrong by at most a quarter, and the quarter is when the damage happens.
Second, separate the exposure by currency and by timing. A shipment that is invoiced in euros and paid in 30 days has a 30-day exposure. A shipment invoiced in yuan and paid in 90 days has a 90-day exposure. The longer the gap, the larger the swing, and the more the hedge is worth. Short exposures can be absorbed. Long ones should be hedged.
Third, price the hedge into the landed cost. The cost of the forward contract is a cost of the shipment, and it belongs in the model alongside the freight and the duty. A model that counts the duty but not the hedge is a model that counts the risk but not the insurance, and the insurance is what makes the number reliable.
Related reading on this site: FOB looks cheaper than DDP until the duty lands, Landed cost per unit: the formula that catches the fees your supplier left out, and What does a freight forwarder actually do for your landed cost?.
Duty is ad valorem, a percentage of the value in dollars at entry. If the currency the goods are invoiced in strengthens against the dollar, the dollar value rises, and the duty rises with it, even though the product price never changed.
It is an agreement to exchange currency at a fixed rate on a future date. It locks the dollar cost of a shipment when the purchase order is placed, so the landed cost is known in advance instead of depending on the rate at entry.
It is matching the currency of costs to the currency of revenue, so the money comes in and goes out in the same currency. A brand that sells in euros and buys in euros has no exposure on that pair.
When the currency swing is bigger than the business can absorb. A 5 percent swing on 100,000 dollars of monthly imports is 5,000 dollars, which is larger than the margin on many shipments. A small importer can absorb the swing. A large one should hedge it.