Tariffs and manufacturing: How to prepare for uncertainty
INSIGHT ARTICLE |
A global supply chain is only as strong as its weakest link, and when it becomes unprofitable to work with a specific country, a company needs to explore alternative solutions. Justin Spillers, a partner at Ohio-based Mark One Manufacturing, learned this lesson when the tariffs his company was paying for products imported from China were unexpectedly increased. He recently spoke with members of the RSM manufacturing team about tariffs, diversification and the importance of not relying on third parties. The following highlights of that conversation have been edited for clarity.
RSM: What does your company do?
Justin Spillers: In a nutshell, Mark One Manufacturing has a couple of different core subsidiary businesses that all focus around manufacturing engineered metal and plastic components and full assemblies. We do that in a variety of different industries, including automotive, appliance, industrial aerospace, medical and military-government. Mark One’s primary focus is providing its customers with unique custom solutions based upon a well-diversified global supply chain that can provide A to Z service solutions. This includes taking different types of manufactured components and assemblies that are no longer well suited for domestic manufacturing and bringing them to our established core supplier base around the world.
RSM: When you say that some things may not be well suited for domestic manufacturing, what do you mean by that?
JS: A lot of the more grueling and labor-intensive manufacturing work can no longer be competitively made stateside and the U.S. labor force has simply been depleted of many types of laborers who have the necessary skill sets to manufacture the products cost effectively and on a timely basis. For example, one of our big customers sells very large, deep-draw stainless steel bowls. Well, there are only a handful of companies in the world that can do the deep-draw process necessary to make an 80- or 100-quart bowl to fit commercial mixers. There are no longer any manufacturers who can complete this process left in the United States. This has required us to locate and develop specific suppliers that are very good and very niched down in to a specific segment to meet the diverse requirements of our customers.
RSM: How long does it take to develop a relationship with suppliers, especially when you’re looking outside the United States?
JS: That’s really one of the most important aspects of our company that has allowed us to be successful. My partner and founder Doug Larger has been in this business since 1994. He started out as just an independent sales rep matching up domestic OEMs with domestic manufacturers. He was essentially the broker in the relationship.
When the free trade zones opened up and became functional in the early 2000s in China, a lot of that work started shifting from domestic manufacturers to all sorts of China-based manufacturers for a variety of reasons. Doug literally got on a plane and flew to China without knowing anyone at all and went through hundreds and hundreds of suppliers to find the best ones. A lot of these suppliers we’ve had for over 10 years and they’re now much more than suppliers, they’re partners and friends and extensions of our company. The general managers and owners of these factories visit our families and us and stay at our houses during holidays. Developing this trust and business relationship is the most important component of having a successful global manufacturing operation.
RSM: What impact have tariffs had on your company? How have things changed in the last few months since these new tariffs were implemented?
JS: It literally caught every single person off guard. The only people I’ve ever spoken to that had any real understanding of the tariffs and how to navigate them are people in the clothing industry, because their standard-rate tariffs are significantly higher than what the standard rates are for a company like ours.
Everybody was really scrambling to try to get up to speed on this subject because no one ever really knew how the tariff system worked. Most people relied upon their freight forwarder to tell them the tariff code to use and simply accepted that as gospel because the percentages were pretty low and had minimal impact on margin. No one at our company had ever systematically vetted how each of our products should be classified and what tariffs should apply. Our freight forwarders would generally discuss the type of product and apply the code they thought was most applicable.
When this started to come about, we literally went product by product. Our team looked up every single tariff code and really read through each code section extensively to make sure all of our classifications were the best suited for the products we were importing.
There is certainly some subjectivity in deciding what tariff code to use as only a proactive ruling from the customs agency is binding. Most of the time, people classify their own products without requesting an advance ruling from customs. In some instances, we identified what we believe was the correct or better code which had a reduced tariff rate.
RSM: Did the new tariffs serve as a kind of forcing mechanism for you to audit those you were paying?
JS: There were a number of instances where we have been able to save a sizeable amount of money by classifying parts the way they should have been instead of relying on our freight forwarder. We’ve been filing refund claims that you can use to claw back over payments you’ve made to customs, depending on what type of part it is.
But as the tariff war started to ramp up and the original Trump tariff list added 10% to some of our aluminum parts and 25% on some steel parts, we had to get in front of our customers and figure out global resolutions that our suppliers and customers would accept.
In most cases, it was a combination of us working with our suppliers to see if there was a way to manufacture at a more competitive rate. If they had any partner suppliers that we could shift the work to in a country other than China, then we could be importing from Taiwan instead of China and completely avoid the additional tariffs. We had to figure out as many solutions as possible to keep our customers happy.
RSM: Were you happy with what you were able to do?
JS: Overall, yes. We now have a much better understanding of how the tariff code system works and how we should be classifying our parts. Also, ways to mitigate and avoid certain tariffs based upon complex situations, such as instances where we ship U.S.-made components to China to get integrated into our Chinese parts so that the value of the U.S. components is exempt from tariffs when it re-enters the United States. We can explain to our customers and educate them on understanding how this works, even with our very large customers.
We established much better relationships with a lot of our customers and our buyers, just because we’re able to talk intelligently about an issue that is very important to them. We worked collectively to come up with solutions that helped everyone.
RSM: What was the biggest change you had to make?
JS: What caught me by surprise were the unintended consequences that actually enabled us to win more business for our offshore operations. For example, we build these great big stamping dies that cost a couple hundred thousand dollars each. Well, shipping them here and paying 10% or 25% on these massive, very expensive dies was cost-prohibitive. In a lot of instances, we had these product orders in place well before the tariffs were announced. Our customers didn’t care about the tariffs because the order was already placed with Mark One and accepted by us. So, we’ll build the stamping die in China, at the cheaper China prices, and we’ll ship it to our supplier in a location other than the United States. Our supplier will run the stamping parts and they’ll ship the parts to our U.S. customer. They won’t have to pay the increased tariff because the die doesn’t return to the United States and the parts come from a non-Chinese supplier to the United States.
But what our domestic customer lost is all the production work that would otherwise been done in the United States. In cases such as this, the United States is actually losing work. The tariffs forced the stamping dies to be shipped outside of the country; the domestic customer decided to not run the parts on their own U.S. presses.
A lot of our customers decided to do production work offshore instead of domestically because they had millions of dollars committed in new die programs that they couldn’t stop. No one received warning of the tariffs and there was no grandfather clause to avoid them. We have customers that had literally tens of millions of dollars in dies already being made in China that they planned on shipping back to the United States to run the parts in their U.S. facilities. If they shipped the parts back to the United States, they would have paid millions of dollars just in tariffs at the additional 10% or 25% rates. They couldn’t do that; it would have put some of them out of business.
They had to shift them to offshore companies outside of China to run the parts and then ship the completed parts back to the United States. They couldn’t run the parts in their own U.S. facilities, which is what they planned on doing. It certainly had an impact on their domestic labor force.
We have a local customer who was buying parts for $100 from their domestic supplier. I could have supplied it for $80 using my China supplier, but he wanted to keep it domestic.
Well, when the 25% tariff hit, all the domestic suppliers just raised their prices 25% because they could, because their competition had to raise their price unwillingly by 25%. In return, a lot of the domestic factories are raising their prices to make more money in this new competitive landscape.
My customer’s $100 part is now a $125 domestic part; my $80 part in China is now a $100 part when you add the 25% tariff to it. My domestic customer actually had to move offshore to get back to the $100 price point he was buying it at originally before the trade war started.
This is ironic because the United States imposed these tariffs to try to get more work in the United States and, in a number of instances, it’s actually shifting the work offshore.
RSM: How do you plan for this kind of uncertainty?
JS: I thought we had good contracts in place that planned for remote, unforeseen issues with detailed force majeure clauses. But, unfortunately, we didn’t have the language to cover a change like this that would require our customer to pay the full tariff increase because something like this has never really happened before; it was so unprecedented. We had to quickly update and modify our contracts and our purchase order forms to make sure we were covered in any scenario like this. That was on the front end.
One of the biggest things is we’re very diverse in the industries we service and we really do a wide variety of work for a unique diverse base of customers. That’s by design and helps protect us from certain industry-specific unforeseen changes. But this change was not industry-specific and affected essentially all of our customers and their industries.
But what we really needed to do was to diversify our supplier base geographically. We had a lot of our eggs in one basket with China, thinking something like this couldn’t happen. China over the last decade has been by far the country of choice for U.S. manufacturing needs. But obviously we realized that, depending on the political landscape, one country can be isolated very quickly. We are expanding our supplier base right now heavily. We’re looking at additional options in Mexico, India, Portugal and other Asian nations we’ve already been manufacturing in.
RSM: Based on your experience, what advice do you have for other manufacturers?
JS: I think the biggest thing is just education. I think people rely upon third parties too much, like we did.
I think it’s smart for any business owner or any key person in a business to know why something is being done the way it’s being done. It took a lot of time, energy and effort to get up to speed on it but, now that I have, it’s actually been good for us more than anything. Now we can use that knowledge in our marketing and sales efforts. We confidently state that we know how to navigate the current tariff landscape. We are trying to use the tariffs as a positive to help distinguish our company from some of our competitors.
We also are fortunate to have a U.S. congressman representing our district who greatly aided this education process. He helped us successfully apply for tariff exemptions and understand different tariff strategies that could help us reduce our overall tariff exposure for our customers. Based on the success we had, I would encourage other business owners to reach out to their state and U.S. government representatives and see if they can help them in any way. I mean, that’s what they’re there for.
There are challenges manufacturers face when operating globally, but upfront planning can save companies time, money and headaches.