Tariffs 101. CONTENTS What are tariffs? The history of American tariffs. Tariffs in the modern age. What the new tariffs aim to achieve

Transcription

1 Are you sitting down? Starting on January 1, 2019, your inventory costs could increase 25 percent because of tariffs. The whole tariff situation has escalated rapidly in less than a year and shows no signs of resolution. Just what are tariffs and what can businesses do to protect their margins? We look at the history of tariffs and how business owners can stay afloat in this new wave of protectionism. CONTENTS What are tariffs? The history of American tariffs Tariffs in the modern age What the new tariffs aim to achieve How tariffs have impacted the washing machine industry Where the trade war is headed How enterprise companies are responding to tariffs How SMB and mid-market companies can respond to tariffs In summary

2 Tariffs are basically a tax on imported goods at the border. This tax allows the government to collect revenue. The other desired outcome of tariffs is the protection of domestic industry and products. What are tariffs? Tariffs are basically a tax on imported goods at the border. This tax allows the government to collect revenue. The other desired outcome of tariffs is the protection of domestic industry and products. Tariffs are used to prevent a trade deficit when a country imports more than it exports. Tariffs restrict imports by increasing the price of goods and services purchased from overseas, driving consumer demand for domestic products. It sounds simple and logical, but the outcome of tariffs is more complicated. Here s why, according to history. The history of American tariffs The first tariff law was passed in 1789, not long after the Constitution was ratified, as a way to generate revenue for the new government of the U.S. Tariffs were the primary source of federal revenue because there were no corporate taxes. Talk about easy quarterly paperwork. The other goal of tariffs was to protect the fledgling industries of the new country. Prior to American independence, Britain imposed limits on what the colonies could manufacture, in effect keeping the colonies primarily agricultural and not industrialized. Not surprisingly, this economic limit helped start the American Revolution. Thee first tariffs were levied at only five percent, but by 1820, tariffs were an average of 40 percent. America was one of the most protectionist nations in the world when it came to trade. Then, two things led to the decline of tariffs: 1. American industry grew and needed to expand to foreign markets. 2. The Federal government created a different revenue source in 1913: income tax. After World War I, tariffs were raised again when the Smoot-Hawley Tariff Act was passed in response to the Great Depression. Canada, Britain, Germany, France and other industrial countries retaliated immediately with their own tariffs and bilateral trade deals. As a result, American imports and exports declined. Post-WWII, protectionist policies shifted to promote the growth of free trade. Use of tariffs declined rapidly. The General Agreement on Tariffs and Trade was established in 1947, becoming the World Trade Organization in The North American Free Trade Agreement (NAFTA), which had bipartisan support, passed in Tariffs in the modern age Tariffs were a simple lever back in While materials, which were not subject to tariffs, may have been imported, most manufacturing was completed in a single country. Supply chains were shorter and the products manufactured were much simpler. Thus, tariffs had a clear cause and effect in this early economy. Today, free trade, as well as technological advances, make products and supply chains radically more complex. For example, if you bought an American-brand vehicle that was one of 1.6 million imported to the U.S. from Mexico in 2016, 40 percent of that vehicle was manufactured in the U.S. In some instances, a single part of that vehicle crossed the border as many as eight times during its manufacture. Imagine the cumulative financial effect if a tariff were levied at each of these border crossings. Given the interdependence of modern supply chains, the value and impact of tariffs is far less clear. In some instances, the same industry can both gain and lose with tariffs. 2

3 The situation for washing machine manufacturers highlights how complex tariffs are now, bringing both benefits and losses to the same industry. One of the few clear winners in this situation? Appliance repair shops. What new tariffs aim to achieve A question most of us are asking right now is why? The rationale for the current wave of tariffs is President Trump s America-first agenda and the administration s stance on the trade deficit. The administration is investigating their stance that China s acts, policies, and practices related to technology transfer, intellectual property, and innovation are unreasonable, unjustifiable, or discriminatory and burden or restrict U.S. commerce. The ability for the president to act without receiving approval from Congress is why we ve seen such rapid escalation on tariffs. And this creates much of the uncertainty for the future. How tariffs have impacted the washing machine industry Citing serious injury to domestic manufacturers the Trump administration imposed its first tariffs on washing machines and solar panels in January of Initially, the CEO of Whirlpool celebrated this new advantage over competitors LG Electronics and Samsung. Whirlpool s stock rose by 10 percent along with hiring, supplier orders, and company expectations. Then, new tariffs on steel and aluminum hit. In the six months since the first washing machine tariff was announced, Whirlpool s share price went down 15 percent. Competitors LG and Samsung have increased investment in their U.S. operations, resulting in some new American jobs. On average, globally, appliance manufacturers have margins of just 3.7 percent. This thin margin left all manufacturers with no option other than a price increase. Prices for washers jumped 20 percent and consumer demand is declining, with an 18 percent drop in shipments in May 2018 alone. Despite a steady rise since the recession ended, U.S. appliance manufacturing industry revenue, employment, and wages are now expected to sink. Ironically, in that same period of months, the overall U.S. trade deficit increased by 7 percent compared to January to July of The situation for washing machine manufacturers highlights how complex tariffs are now, bringing both benefits and losses to the same industry. One of the few clear winners in this situation? Appliance repair shops. Where the trade war is headed Since these first washing machine tariffs, the scale and scope of tariffs have been on a continuous spin cycle. By early July of 2018, the Trump administration had imposed a total of nearly $100 billion in tariffs on China and other trading partners including the EU. The actions set in motion a trade war with retaliatory measures from all impacted trading partners, especially China. U.S. goods initially targeted for tariffs by other countries were both strategic and political in nature; agricultural commodities including soybeans, pork, corn, and wheat, American motorcycles, jeans, and bourbon. As the trade war escalated, a 475-page list of targeted items called the Mega Retaliation Matrix, now numbers into thousands. Industries most impacted by retaliatory (non-u.s.) tariffs: Agriculture Seafood Automobiles and car parts Aluminum, Steel, Iron (exports) 3

4 As a vendor, what do you do if your goods or materials are subject to a tariff? Like the mixed results for washing machines, it depends a lot on your individual situation. On July 11, the trade war went nuclear to a jaw-dropping additional $200 billion in proposed tariffs on Chinese goods, over 6000 line items ranging from nuclear plant parts to sporting goods. U.S. industries that will be most impacted by these tariffs on Chinese imports include: Transportation Construction Manufacturing Agriculture Retail Science and education The Trump administration began levying 10 percent on these targeted Chinese goods on September 24. The rate will increase to 25 percent in January unless China concedes. If China retaliates, the Trump administration is proposing more tariffs on nearly all imports from China other than a few company-specific exceptions. Over $500 billion in Chinese imports could be subject to a tariff. There is no resolution in sight. How enterprise companies are responding A few corporates negotiated exceptions to tariffs, resulting in a significant competitive advantage. The majority, however, are starting to feel the pain of tariffs as a decline in their stock prices. They are taking protective measures. There are four primary responses: Moving production away from China primarily to Southeast Asia Reshoring production to the U.S. Moving production outside the U.S. for the products hit with retaliatory tariffs Increasing costs to consumers These companies, your customers, are looking to their supply chains for collaboration and ways to save costs. How SMB and mid-market companies can respond to tariffs So, as a vendor, what do you do if your goods or materials are subject to a tariff? Like the mixed results for washing machines, it depends a lot on your individual situation. Buy inventory before prices increase The latest tariffs are levied at 10 percent, but this cost will increase to 25 percent January One option is to fund inventory ahead of price increases. If your customers offer an option to request early payment, you can access your own cash at a discount lower than your cost of capital. This provides a smart, debt-free solution to save costs by purchasing inventory before your costs increase. Switch suppliers If your supply chain is in China, you may have to find alternative suppliers, raise prices on future shipments, or reduce your operational costs to navigate these changes. This is easier said than done. Most companies are beginning the process by reviewing their global import and export data and to understand the potential impact of current U.S. and non-u.s. retaliatory tariffs. Once you have a good handle on your situation, you can assess the risks, costs, and savings of making a supply chain move. Be sure to review not only the costs of the inventory but logistics costs, transfer pricing ramifications, and tax implications as well as the time it will take to ramp up production with a new supplier. Stocking up on inventory and assuring you have adequate cash flow now may help you avoid disruption if you need to change suppliers. Look for other cost savings It may not make financial sense to change suppliers or may put your business at too much risk. In this case, you may need to invest in ways to make your business more efficient, streamline operations to save costs, or work with your suppliers to minimize price increases. 4

5 Business owners need to balance concerns like financial stability, cash flow, and the cost of debt which is rising due to interest rate increases and the aspects of the same tax plan that lowered corporate tax rates. Raise prices Your ability to raise prices will depend on your customers and contracts. If you sell to retail or big box customers, many will not accept price increases on confirmed purchase orders. This may not be as painful now with tariffs at 10 percent. But, that pain will increase in January when tariffs go up to 25 percent. Some retailers are collaborating with suppliers in a sharedloss approach, each side absorbing part of the increased cost. As a manufacturer or supplier, you will need to communicate with your customers and weigh the risk of losing business against absorbing increased costs. If you benefit from new orders or supply chain moves Some companies, US steel producers, for example, benefit from the tariffs with increased orders or new contracts. It s a good problem to have, but it comes with a need for increasing cash flow to ramp up production and meet new demands. Accelerating your accounts receivable can give you the cash flow you need without adding debt in this situation, too. Expect and prepare for disruption It s been a turbulent year for businesses. Many celebrated the lower corporate tax rates only to have this boon offset by tariffs and supply chain risks. The uncertainty has a few companies considering delays for expansion plans or purchases of equipment. For some who are impacted by tariffs, the situation requires a balancing act between price and quality of products. Business owners also need to balance concerns like financial stability, cash flow, and the cost of debt which is rising due to interest rate increases and the aspects of the same tax plan that lowered corporate tax rates. The 2017 plan trimmed the deduction on net interest expense for all but the smallest companies. Companies with revenues below $25 million can still deduct their net interest expense, but that deduction is limited for larger companies and gets more restricted beginning in Debt got more expensive. Now is a good time to evaluate your mix of funding options, including your cost of debt versus non-debt sources of cash flow. It is also a good time to find alternative suppliers in case you need to move your supply chain in the future. 5

6 In summary The tariff situation does not show any signs of resolution for the near term. You will need a holistic approach to deal with the current situation and prepare for how it evolves. Depending on your situation, strategies to minimize the impact of tariffs, include: Identifying the products, parts, or materials that are affected by the tariffs and what the financial impact will be. Evaluating your funding options, including your cost of debt which may be rising with interest rates versus non-debt sources of cash flow such as early payment discounts. Accelerating invoice payments to bring in cash flow to fund inventory now at lower costs to minimize financial impact. Deciding if you need to change sourcing or manufacture in the future and plan for how to manage the costs until you can change suppliers. Reviewing your operations to identify costs savings and work with your suppliers to reduce costs in your supply chain if possible. Reviewing your agreements with customers and suppliers for contract dates, hardship exceptions, and terms for price increases related to tariffs. Working with your customers and suppliers to identify any shared-loss options. Ensuring you have the legal mechanisms in place to switch manufacturers; ensure there are no restrictions on switching a manufacturer and that you have rights to intellectual property and technical data you need to provide manufacturing instructions to another source on short notice. Working with your suppliers and customers to prevent supply chain disruption. Even if you are not impacted by tariffs currently, take this opportunity to identify alternate sources in case the trade war escalates in scope. Negotiating price increases if necessary, consider a phased approach. Understanding your full cost of inventory including logistics, transfer pricing, and tax implications. Following the tariff issue closely for how it will impact your business. Diversifying your customer base outside the U.S. to offset the impact of retaliatory tariffs. 6

7 About C2FO C2FO is the largest non-bank provider of funding to businesses. Our technology provides hundreds of thousands of business of all sizes (suppliers) an easy, low-cost way to improve cash flow through early invoice payments, while at the same time helping Fortune 500 companies (buyers) achieve far better returns on short-term cash than any other investment vehicle available. Learn more at c2fo.com. Sources trashed/#2164e66a92fe