Tariff Risks Part II – Mitigation Strategy Analysis

As we saw in our last blog (Tariff Risks – Part I), trade/tariff risks can be a major geopolitical uncertainty for the manufacturing and retail sectors.  How can companies prepare for this besides relying on insurance products?

Price Increases

The first and most direct mitigation strategy is to pass the associated cost increases to customers.  However, this is largely a theoretical option as it may not be feasible in segments with a high number of competitors, for upstream producers or in price-sensitive product areas.  Companies have traditionally found ways to mitigate via long-term contracts or good supplier relationships.

Cost Absorption 

The second mitigation strategy would be to absorb these costs in the short term, with the hope that this period would be temporary.  Big-box retailer Costco has been able to sustain sales and profit margins utilizing their scale and operational excellence.  This exemplifies the need for stronger cash flow positions, and the superior supplier bargaining power of larger firms. Obviously, this mitigation strategy can cause problems for small-medium size companies.

Alternate Suppliers and Locations

Sacrificing profit margins hasn’t been the only solution employed by companies finding themselves in this position.  A third strategic option is to identify and mobilize alternate suppliers located in regions unaffected by these tariffs.  Alternate locations include other Asian hubs such as Vietnam, Taiwan, Bangladesh and India. As an example, Taiwan has recently seen 169 companies shifting some production to its shores, including key suppliers to Apple, Dell, and HP.  We will probably see more companies evaluating alternate locations for new expansion, and in some cases, moving existing production out closer to customers. The latter is a difficult choice for manufacturing, considering the associated infrastructure requirements, assets on-the-ground and even the costs of mothballing existing assets.

Shifting the Logistics Footprint

As a fourth strategy, some companies are reported to evaluate exporting unfinished goods to other countries to complete the processing for finished goods.  Companies are also looking to ship directly to U.S. homes from warehouses in Mexico, Hong Kong, and Canada. According to AP News, Federal regulations allow U.S. based companies to send packages worth less than $800 to American homes from countries like Mexico and pay no tariffs.

Producing for Local Consumption

One should also consider beyond the export aspect, to manufacturing for growing local consumption.  As The Economist noted on January 2nd, 2020, many large companies including ABInbev and Procter & Gamble saw high sales growth and larger share of sales in China compared to previous years. In these cases, the challenge for the manufacturing supply chain would be to beat competition rather than shipping abroad.

How can companies prepare?  

While companies cannot prevent external risks such as tariffs, they can take steps towards monitoring the risk landscape and assessing impact on their market segments and more specifically supplier-tier organizations.  This can also better prepare them to develop a competitive advantage. But, this is complicated considering the multitude of facilities each company has via its own and via JV partners. 

This footprint challenge is compounded when one starts looking beyond the organization to the globally interconnected supply chains.  Identifying potential vulnerabilities, assessing contingency plans for business continuity, having up-to-date information on unfolding new events, and prioritizing geopolitical risks, can help mitigate the impact effectively.  Scanning for signals and preparing for multiple futures or scenario planning will be essential for long-term planning whether it’s for supply, manufacturing, distribution or delivery. 

Once-a-year risk reviews or siloed, region-level strategies cannot accomplish this.  Fortunately, advances in machine learning and analytics combined with cloud computing can address this dynamically and globally.  A software tool from a current IT vendor may not be enough, but strong expertise in global operations and risk management will have to be combined with the tool, to address any upcoming vulnerabilities and to sift conclusions from noise.

Author: Rekha Menon-Varma, Co-Founder & Managing Partner, Vertaeon LLC

Research Input: Brandon McKay Crooks