United States

Planning for more trade tension and tariffs: What now?

THE REAL ECONOMY  | 

Escalating trade tensions between the United States and China became hot news over the summer. Many in the business community expected the imposition of tariffs by the United States to be a short-term negotiating tactic to right size a trade deficit with the largest U.S. trading partner. When it became clear trade tensions would escalate, fiscal conservatism by middle market businesses followed amid global uncertainty. RSM research shows that a majority of midsize businesses are unwilling to deploy excess cash on their balance sheets for growth investment, despite surpluses due to tax reform and a strong economic cycle. Tariffs, along with additional market volatility caused by unstable global trading partners such as Italy and Venezuela, among others, have left CEOs bracing for negative outcomes resulting from global trade issues.

The White House continues to use wide-ranging tariffs to stimulate renegotiation of multilateral trade agreements and repatriate global supply chains back to the United States. This significant policy shift has both direct and indirect implications for many middle market businesses.

U.S. businesses haven’t dealt with tariffs of this magnitude since the 1920s; few have a blueprint for how to handle them. Meanwhile, new trade agreements such as United States-Mexico-Canada Agreement inked in September to replace NAFTA, have made it even more difficult to discern facts from political posturing.

IMPACT TO DOMESTIC COMPANIES, THE ROLE OF BIG RIVALS

The negative impact of tariffs to middle market business is already apparent. In an interview with the Middle Market Transformative Radio Show, Cindi Bigelow, CEO of the Bigelow Tea Co., a U.S. maker of dried teas, estimated that an aluminum tariff first imposed in March was poised to cost her company nearly $2 million and has already changed the way the business buys and stores supplies from overseas.

“We have been significantly impacted,” she says. “That aluminum tariff was crushing for our little tea company.”

Bigelow is not alone. One middle market business executive whose company distributes to big box acknowledged that the business expects newly placed duties on a broad array of consumer products from China—which took effect in September—could reduce operating margins by as much as 13 percent. Even though retail customers are likely to accept price increases, this executive wasn’t as hopeful that big-box retailers, which represent a significant portion of the company’s customer base, will be on board. Either way, new border taxes are likely to have a significant impact on the company’s bottom line.

An executive at another middle market business was also wary of the role big box stores may play in dictating the sector’s response. The executive at a family owned chain of hardware stores expects wholesale price increases at a level not seen before in the company’s history, and worried about passing them on to customers in his stores in a timely manner. If the market, driven by big-box stores, won’t allow for price hikes, the expected impact on the company’s operating margins could be catastrophic. It would not only hurt earnings, but also curb planned capital expenditures for digital initiatives and IT, leaving the business at a competitive disadvantage. 

FREQUENTLY ASKED QUESTIONS

With the newly signed United States-Mexico-Canada Agreement replacing NAFTA, are the tariffs imposed earlier in 2018 going away?

No.  While the agreement does include some significant wins for the middle market, the aluminum and steel tariffs put in place on both Canada and Mexico earlier in 2018 were not removed.

Who pays the tariff?

Typically, the importer pays the tariff to the taxing country. For example, when a U.S. manufacturer imports steel from China, the tariff is assessed at the U.S. border and paid by the importing company. The additional expense is meant to create an increased incentive to source materials elsewhere and decrease demand for the exporter.

If I have already paid for goods and those goods are still in transit when new tariffs come into effect, do the tariffs apply?

Yes, countries impose the tariffs at the port of entry.

How and where are the tariffs actually assessed and paid?

U.S. tariffs are included in the Customs and Border Patrol payment systems and are paid when goods arrive at the U.S. border.  Similarly, tariffs on exported goods are paid when the goods pass through customs at their destination.

If I purchase a product from abroad, and that product is part of a value-added item such as a car that moves across the border multiple times, do I pay the tax just once or multiple times?

If the good falls under tranches of the steel or aluminum taxes that govern Canadian and Mexican borders, then you will pay the tax multiple times.

Can I apply for an exclusion or seek an exemption?

Yes, exclusions and exemptions are possible. However, the application appears to be a long and laborious process with a low probability of success, based on evidence to date.

Tariffs are temporary, right? Should I stock up on important tariff-affected goods before the next increase and then wait it out?

There is no clear answer. However business leaders should expect a protracted trade dispute. There are numerous options to consider when planning around a global trade road map, including some of the steps we’ve outlined below.

What are my options for dealing with the increased costs?

  • There are five primary approaches, each with benefits and drawbacks, and not all will be available to every business. In general, however, a company may do the following:
  • Source material from countries with a lower tariff
  • Modify an item so that it falls under a code not impacted by tariffs. A pre-assembled product may fall into one category covered by tariffs while the subcomponents may not, or vice versa
  • Legally challenge tariff codes for certain materials and components
  • Request an exemption
  • Pass costs on to consumers through price increases

NEXT STEPS

The impact of the tariffs goes beyond the direct cost increases from the import taxes. Retailers, for instance, must prepare for inventory price adjustments by having sufficient bin tickets and price tags. They must also ensure to budget enough payroll hours for employees in stores to update stock and change signage, steps that may seem trivial, but can quickly drive up expenses. All consumer products firms, including retail, manufacturers and distributers, should also speak to vendors throughout their supply chain, attempt to quantify the impact rising prices might have and consider whether the additional costs can be passed on to customers. Financial performance and share valuation for both private and publicly traded firms could be significantly impacted if appropriate steps aren’t taken to plan and prepare.

Consider the following:

  • Impact assessment: understand which components and materials are affected by tariff code.
  • Cost impact assessment: Gain visibility into the cost impact of increased tariffs by analyzing actual costs to current or planned costs and their timing.
  • Cost modeling: Develop a “what if?” scenario and analysis for increased material costs at the product level.
  • Supply chain repatriation: Repatriating goods back to the United States may be an option. Moving to other countries outside the tariff zones could be a solution.
  • A merger or acquisition:  Some businesses with thin operating margins or lack of interest in continuing in lines of business may consider M&A a realistic option.
  • Private equity financing: A cash infusion from PE may be an option for firms that cannot find bridge financing.

Tariffs and trade tension make finding the best path forward difficult, but not impossible. Visit RSM’s tariffs resource center for continued coverage of how the middle market can both react confidently and plan decisively.

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