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Before this year, the average business owner may not have known much about tariffs or the impact they could have on their business. Now, entire businesses are at the mercy of potentially high costs to import products and raw materials from certain countries.
What is a Tariff?
A tariff is a government-imposed tax on items entering a country. For example, if a sneaker company has all its sneakers manufactured in China and the U.S. imposes a tariff on Chinese imports, the importer—typically the U.S.-based company—must pay the tariff when goods enter the country. It is then up to the sneaker company to increase its price to cover the increased cost of doing business due to the tariff that must be paid. The driving force behind tariffs is to strengthen U.S.-based manufacturing.
Contrary to popular belief, it’s NOT the exporting country (like China) that pays the tariff but the importing business in the U.S., which may pass the cost on to consumers since the required payment of the tariff increases the importer's operation cost.
- A tariff can best be looked at as a tax or a strategic tool meant to discourage a U.S. based company (or wherever a company’s HQ is based) from conducting business or manufacturing in a country outside of the Company’s HQ. Most governments like the U.S. want to stimulate domestic manufacturing jobs and instill greater pride in “Made in the USA” labels.
- It is often assumed that tariffs cause inflation, and in some ways, they do. They can contribute to a total economic downturn, as both consumers and companies must change strategies and behaviors, which can lead to scaling back on expansion and travel, and it could mean layoffs. Higher unemployment means consumers are less likely to spend on non-essential items, instead focusing on lower-cost substitute products.
- A tariff can best be looked at as a tax or a strategic tool meant to discourage a U.S. based company (or wherever a company’s HQ is based) from conducting business or manufacturing in a country outside of the Company’s HQ. Most governments like the U.S. want to stimulate domestic manufacturing jobs and instill greater pride in “Made in the USA” labels.
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How Do Tariffs Work?
Tariffs are generally implemented for two main reasons: They help to increase government revenue, and they can also protect domestic industries from foreign competition. There are both positive and negative impacts to using tariffs. Let’s discuss the two perspectives below.
Positive Impact
The use of tariffs could protect the public from cheaper, lower-quality goods that could hurt citizens, for example, lower-quality toys made with lead. Another example is products that could be made with questionable labor practices or processes that don't meet U.S. safety standards. An example of this is the growing number of Chinese EVs available within China.
While there are quite a few impressive Chinese EV models being produced, a U.S.-imposed 100% tariff on Chinese EVs protects the domestic, European, and Asian auto industries that have invested heavily in the U.S. for decades. Chinese EVs can cost as little as $10,000 USD in China. The 100% tariff offers protection to other companies by making the added costs of importing Chinese cars unattractive.
In 1994, German automotive manufacturer BMW started their first U.S. production in South Carolina. That investment helped to create 11,000 U.S. jobs. BMW focused on building their most-imported cars in the U.S. to reduce their operating costs. As U.S. operations grew, this strategic move allowed BMW to hire more U.S. engineers and designers.
For BMW, opening in South Carolina reduced their operating costs in the U.S. market. When used properly, a tariff can be beneficial to job growth and business. In this case, tariffs prevent cheap and uncompetitive auto imports. A tariff on heavily discounted foreign cars protects the U.S. workers at BMW in Spartanburg, South Carolina.
Negative Impact
We mentioned that tariffs are a tool that can be used negatively or positively. Sticking with the auto industry examples let's discuss some other impacts. The ongoing announcements around automotive tariffs from the Trump Administration are already impacting the importation of parts and automobiles.The overall purpose of the Trump tariffs is to increase U.S. investment and manufacturing.
Since even U.S. domestic cars (Ford, Chevy, etc.) rely on imported parts, car prices across the board could increase. Tariffs can create challenges for companies operating in the U.S. Let's look at Honda of Japan who has produced over 30 million cars in the US since 1982. Honda has several plants across North America with some dedicated just to parts like transmissions.
Honda produces it’s US market Honda Civics in several countries; it’s sportiest low production variant, the Type-R in England, it’s hybrid model in Canada and its base and SI model in the U.S. With this tariff in effect, production costs will increase and the overall cost to customers will increase by thousands.
Without US based factories, some companies may find that the higher cost of tariffs, along with import fees make it too difficult to operate in the U.S. market.
Expert Opinions
There are many conflicting opinions on the value of implementing high tariffs. Economist Oren Cass believes that if the tariff policy is done right, then there is the possibility of seeing more investment in making products in America.
From an opposing point of view, economist Jason Furman, the former chair of the White House Council of Economic Advisors, believes that the addition of tariffs is not a stable financial plan due to the constant shifting of policies that are ever changing. He also believes tariffs may be may be harming people who work in the export industry and be detrimental for consumers who are buying imported goods.
Yet, these two economists do agree that the CHIPS program, which sets out to favor U.S. production of semiconductor chips over foreign chips, is a great initiative for national security. Reducing this reliance ensures that critical chips for AI, defense, and advanced computing needs are available domestically.
Impact on Large and Small Businesses
Tariffs are likely to take a greater toll on smaller businesses, affecting local economies and communities. Tariffs are a direct threat to margins; many large companies have more room in their margin to eat up some of the tariff costs. Larger companies have the advantage and can more easily make adjustments in their supply chains, capacity, and manufacturing.
Small businesses are beginning to experience not only supply chain disruptions but also issues with their pricing strategy and profitability. As prices of goods increase, small businesses will be forced to increase the price of their niche products. If there is a decrease in consumer spending, then it is likely that the company may not reach their projected targets for the year. Small business owners may be forced to close their doors if they don't adjust their strategies.
Large businesses may also experience not only supply chain issues but also reduced profit margins and hesitancy to invest in new projects since the financial risk is higher. Tariffs not only make it harder to get products from foreign countries but they can also negatively impact the financial health of the company.
As mentioned, if a business cannot transfer the increased costs of goods to the consumer, it may choose to absorb them, which lowers their overall profit margin. The uncertainty of tariff policy and the potential inability to reach quarterly goals may also delay the hiring of new talent.
Continue reading below to learn more about alternatives that may be beneficial for your business.
Finding Alternative Solutions and Offsetting Tariffs
In the wake of increased tariffs, business owners are interested in finding ways to navigate the ever-changing economic climate. The strategies listed below are ones that range in difficulty depending on the size and type of business being run. Read below to learn more.
Front-Loading
One strategy is front-loading your products, which consists of speeding up the delivery of products in anticipation of events that may be disruptive. Essentially, stockpiling goods before a supply shock. Although front-loading sounds easy, this maneuver costs more money and decreases storage space due to the massive increase in products in one place. This may be a strategy that is better suited for larger retailers or businesses like Walmart or Columbia Sportswear.
This strategy can be risky because it involves greater financial investment into inventory. It also makes several assumptions past the standard practices of Inventory Management.
Package Cost Reduction
Another strategy is reducing costs rather than increasing the price of the product. Although increasing the price of the product may be the “go-to solution,” it may reduce the amount of business your company receives.
By finding more cost-effective components of the product or using more affordable, sustainable, and sleek packaging, you can cut costs and attract customers.
Learn more about how to select smarter and more sustainable packaging that engages with your customers.
Supplier Diversification
A strategy that may also be helpful is to diversify suppliers. Whether you are a small or large business, finding suppliers in an economically turbulent situation is tough. A potential solution is to transition from a foreign supplier to a local U.S.-based one for some of your product lines.
Switching to domestic suppliers could help offset costs with tariffs. A potential drawback is limited product options, and it may become difficult to meet demand with smaller manufacturers.
Learn more about GS1® US and Alibaba’s jointly released guide “Mastering E-Commerce: A Guide for U.S. Companies,” which helps businesses understand why a foundation of data based on GS1 Standards is helpful when sourcing and selling products internationally.
Use Free Trade Zones
A free trade zone is a designated area in a country that businesses can operate in with reduced or no tariffs, no import/export duties, and no other trade restrictions.
Free trade zones are often near ports, airports, or borders, so the goods move easily. This is an attractive option for many businesses, but gaining access to these zones is limited and competitive. This may be a good option for a company that imports and exports products in a given zone. Take, for example, an Italian food importer working with Italian cheese makers in a designated economic zone for trade.
Combining these strategies may help you to navigate the economic turbulence impacting your business.
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