While trade tensions may have temporarily eased between the United States, China, and the European Union, the time to think holistically about mitigating tariff cost and risk to profit and cash flow statements and supply chains is now. It’s important to act now to protect against declines in operating margins going forward and to remain competitive.
We recently hosted a webinar for more than 250 participants on the implications of U.S. tariff changes. Many companies have already made moves to re-source, negotiate with customers and suppliers on pass-through, and implement other changes across their businesses. We were surprised to learn that while 29% of participants polled being most affected by Section 232 steel tariffs, 37% identified Section 301 Chinese tariffs as the greatest tariff impact on their business. Regarding their actions in response to these tariffs, 41% are still assessing their supply chain options. And a full 27% aren’t planning on making any changes to their supply chain.
Importantly, none of the companies participating in our webinar said their business has taken a holistic, cross-functional approach to deal with tariff risk.
Political context of the tariff changes
Businesses should expect a fairly contentious period over the next 10 months until the election. The Administration has already stated that Chinese tariffs are likely to continue past that point. And negotiation with the European Union and the United Kingdom post-Brexit will be shaped by the Administration’s use of tariffs as a primary negotiation tool. While the Administration’s trade strategy may seem disjointed, and you may legitimately disagree with its base assumptions, it’s rational based on the Trump administration assumptions:
- Trade deficits are inherently bad — they reflect a national security risk.
- Reshoring foreign-based jobs are the priority — short-term collateral damage (such as farm jobs) is worth reclaiming manufacturing and technology jobs.
- Tariffs are absorbed by the exporting country — and those that aren’t are revenue for the U.S. Treasury without harm to U.S. citizens.
- Tariffs may be used to enact policy beyond commerce — tariffs are effective leverage to achieve everything from immigration to defense policy.
Immediate actions to mitigate tariff risk
In this context, companies should be thinking about taking several effective steps to start their tariff risk mitigation journey. Inaction creates risk no matter what occurs in the U.S. elections. If President Trump is reelected, the assumptions listed above will continue. If a new administration takes office, the current tariff regime will take time to unwind and, it’s likely a harder stance on international trading partners will continue.
Companies need to assess the various strategies they can implement immediately. These include negotiating with customers and suppliers to manage pass-through of tariff costs. Transfer pricing studies need to be updated to reflect new potential cost structure of benchmark companies and performing comparability adjustments. Strategies such as the first-sale rule are viable methods to reduce customs valuations when the U.S. importer purchases from a foreign middleman by allowing use of a manufacturer’s sales price instead of the importer’s purchase price.
Among the companies participating in our webinar, 17% noted they’re looking at the first-sale rules to lower custom values, and 28% are looking to update their transfer pricing studies to reflect market changes. It’s clear that studies enacted prior to the new tariff regime won’t be sufficient.
Short- to midterm actions to minimize tariff impact
Companies need to understand market and customer requirements and cost models to make hard decisions about keeping current operations in place or changing their manufacturing and distribution footprint. This is particularly important in the rapidly changing environment, such as the Jan. 24, 2020 announcement that Section 232 steel and aluminum incremental tariffs would be added to select finished goods from specific countries on Feb. 8, 2020. The major factors, although not exhaustive, include:
- Country of origin determination
- Local tax rates
- Government cooperation & incentives
- Supply chain movement & associated transfer pricing planning
- Relocation costs
- Raw material sourcing
- Freight cost
- Labor cost & availability
During the webinar, participants identified various U.S. tariff actions they’re focused on: nearly one-half of webinar participants are reviewing their supply chain value streams, while 32% have relocated segments of their supply chain., Twenty-eight percent stated a driving force is adjusting country-of-origin determinations while undertaking these two actions.
Longer-term actions to plan for tariff cost
While companies may pursue the strategies noted above within their current operations, a comprehensive supply chain strategy requires diligent study along with human and financial commitment for long-term optimization. Many companies are investigating the balance between maintaining and growing their Chinese operations against other Southeast Asian opportunities. Many of our clients, in fact, are considering complex variables such as:
- Capital incentives
- Land concessions
- VAT & other tax-related implications
- Labor skills & costs, including government-required benefits
- Supply chain capabilities & capacities
- Government incentives
- Chinese & other country foreign investment restrictions
Planning for long-term tariff cost and risk mitigation requires a holistic approach. This includes the potential relocation of manufacturing operations, sourcing alternatives, tax planning considerations, and pricing and planning in a new environment. Manufacturing supply chains will be driven by global and regional politics, as well as contingency planning. A holistic approach needs to include functional areas across the company: finance, purchasing and supply chain logistics, manufacturing, and legal ramifications to optimize the business’s readiness.
There’s no one-size-fits-all formula for determining which U.S. tariff actions to take. Companies need to assess a range of possible strategies and tactics, benchmark best practices of peers, and — most importantly — take concrete steps now to avoid future cost pressures.
