Navigating Tariffs: A Multipronged Approach
Many companies didn’t foresee the duties levied on imports from China lasting as long—or expanding as much—as they have. As a result, we’ve seen a lot of firms finding themselves in a reactive, rather than proactive, position. But there are ways to change that.
As with any major challenge, tackling it requires a problem resolution process. First, assess what happened and the nature and significance of its impact with your internal team. Second, consider what internal and external resources may be required to respond. Finally, triage the priorities. We discuss each of these elements below.
For this piece, we spoke to experts from four different organizations: an international business development consultancy; two law firms; and a certified public accounting and business advisory firm. They offered their insights on how to approach an issue that’s fraught with complexity.
Assemble Your Tariff Team
To navigate an issue this complex and with so many moving parts, it’s essential to have a team of experts who can help you manage your short- and long-term needs.
1. Your internal team
Tariffs represent a major impact to a company, so it requires the involvement of the entire leadership team, including the CEO or president, the CFO, COO, the import-export manager, supply chain leader, and in-house legal counsel. With tariffs continuing to linger and loom over new jurisdictions in 2020, this is the time to come together to address the current tariff situation if you have not already.
2. Attorneys specializing in international trade
One of the first steps you can take is to review your existing contracts with suppliers. That starts with determining whether your agreements address tariffs.
“Typically if you have a long-term supplier arrangement, your agreement is going to address who pays tariffs, taxes, etc.,” says Matthew Jackson, a partner at Barack Ferrazzano Kirschbaum & Nagelberg, a law firm with expertise in representing manufacturers and distributors. “You need to know what agreements you have in place and what they say about your responsibility for an increase in tariffs. If the agreement does not directly address tariffs, carefully review the pricing language and other terms of the agreement and consider whether there is any language that may impact which side shoulders the responsibility for an increase in tariffs. It’s a good opportunity for businesses to think about this issue. You shouldn’t wave it away when you’re negotiating contracts, particularly long-term contracts.”
If you have a contract coming up for renewal, use this time to negotiate and incorporate for tariff protections. If your existing long-term contracts are not working for you and are not due to be renewed, work with your attorneys to see if there is an angle to renegotiate the documents ahead of maturity.
3. Import-export consultants
They can help fill in the knowledge gaps and provide ideas for strategic planning options.
When you’re getting into the nitty-gritty of tariffs, these consultants can make all the difference. Although you’re an expert in your business, working through international best practices is literally their trade.
“Search out the help you need to tell you what you don’t know and to give ideas and options for strategic planning,” says Derek Begue, global vice president of business development at PRA Global, an international business development firm.
4. Bankers with corporate finance and international trade expertise, and who appreciate how tariffs can affect your cash flow
“In terms of the cost structure, that’s more than just a near-term issue,” says Dave Andrea, principal in Plante Moran’s strategy and automotive-mobility consulting practice. “There are going to be flare-ups in capital flow.”
At BMO, our clients in a wide variety industries have been affected by tariffs. To help them, we’ve revisited advance rates and availability limits, looked into providing seasonal or bridge financing, and provided debt to help support efforts to diversify and expand supply chains.
Each situation will differ depending on the nature and extent of the impact tariffs have on your business. Some may be able to readily pass costs through to customers, while others have already found the impact to their businesses to be unsustainable. You may need to reconsider your entire supply chain, take strong actions based on your customer and supplier contracts, or materially restructure your lending arrangements. Or you may be fortunate and simply need to capture and pass the higher costs along.
Assess Your Current Contracts
Now is when relationships begin to matter. Your ability to work with your suppliers and customers to limit the financial impact on your business may depend on the strength of your working relationship with these key partners. However, you need to understand the language of the contracts and what they say.
Jackson recommends taking a proactive approach to examining your contracts. For example, whether the contract’s force majeure clause—which permits a company to depart from the terms because of an uncontrollable event—covers tariffs.
While there are opportunities to renegotiate certain contract terms, that may only apply if you have a certain amount of leverage over your suppliers.
“If you’ve been allocated responsibility for new tariffs, you’re looking for a discussion with the other party to shift the load, but you need leverage to do that,” Jackson says. “One point of leverage is that you have a good relationship with your supplier, allowing you to reopen negotiations. If you don’t have that type of relationship with your supplier, force majeure is a card you can play to renegotiate.”
Even if your contracts with suppliers stipulate that they carry the burden of tariffs, you may need to work with them on some kind of compromise since paying an additional 25% that can’t be passed through may mean a hit to their balance sheet from which they can’t recover.
While it is important to minimize your tariff risk, it is equally important to understand that your supply chain is an ecosystem and a business failure at one point of that ecosystem can be detrimental to the entire chain.
Assess Your Working Capital
The dollar impact is important, but the timing of cash changing hands may be as well. For companies that were used to paying about a 3% tariff for imports, the jump to 25% in some cases could be enough to erase profitability. And with tariffs due when the product enters the country, cash is consumed early and often.
This could be a great time to revisit supply chain financing solutions as well as revolving line of credit terms with your banker. At BMO, we’ve increased commitments as well as limits on inventory to accommodate the growing cost of inventory due to tariffs.
Consider Filing for Exemptions
Since the trade war with China began in January 2018, it has expanded in scope from solar panels and washing machines to include a wide range of products, including apparel, sporting goods and consumer electronics. Once you know which of your products are impacted by the tariffs, you can start to look for possible exemptions. The Office of the United States Trade Representative manages a process for interested parties to request exclusions from the China-specific tariffs. The Commerce Department runs a separate process covering the tariffs on steel and aluminum products.
More generally, the Miscellaneous Tariff Bill temporarily reduces or suspends the import tariffs paid on particular products. Companies can submit a petition for each product.
“Companies should be aware there’s an opportunity to reduce the duty they pay,” says Lawrence Friedman, a partner at Barnes, Richardson & Colburn, a law firm specializing in international trade regulations and customs law. “It’s another way to mitigate some of the costs to your supply chain.”
Minimize Your Losses
Until recently, tariffs hadn’t been top of mind for many business leaders. That often led to a lax approach in contract agreements between manufacturers and suppliers, Begue says. Given the current situation, he recommends rewriting contracts where appropriate.
“There was a lot of room to not do effective contracting because there wasn’t the need for hypervigilance to pinch pennies,” he says. “Now you need to make sure you’re following best practices in contracting. That could include shortening your terms and asking your suppliers for itemized commercial invoices. Tariffs only apply to the goods not the services or fees, so having your procurement department understand what’s going into what you’re paying can save money, by itemizing the dutiable and non-dutiable parts of the purchase.”.”
Taking advantage of exemptions can also help minimize your losses. Dave Andrea of Plante Moran notes that some companies are looking into what’s called a duty drawback, which is a 99% refund on the duties paid on imported goods that are subsequently exported.
“When tariffs were 2% to 3% it may not have been worthwhile to make that effort,” Andrea says. “But now at 25%, we’re seeing more companies apply for duty drawbacks.”
Andrea also recommends monitoring the latest Section 301 exclusions1 to China import tariffs. “Even though the application procedure is closed for Lists 1, 2 and 3, you still have to monitor those because the government is issuing block exemptions, so there could still be opportunity for assistance there,” he says. And with List 4, there is to be an exclusion process that’s yet to be announced, so you have to keep on top of that.”
(The deadline for submitting exclusion requests for List 4A items closes on Jan. 31.)
Along with applying for exclusions, reclassifying products is a potential option. Changes to your sourcing could change a product’s country of origin, but the U.S. Customs and Border Protection’s law on “substantial transformation”3 can make it difficult to pull this off.
“Everyone is looking at the supply chain and seeing if they can get the product out of China in a way that produces a country of origin other than China,” Friedman says. “People are asking if we take the parts but ship them to Thailand and assemble it there, is it a product of Thailand?”
(Read the related article, “The Don’ts and Don’ts of Managing Tariffs,” about the pitfalls of trying to work around tariff enforcement.)
Optimize Your Supply Chain
Some companies are exploring ways to diversify their supply chains. But it’s a lengthy, complex process, and not every company has the resources to do it.
“The big problem right now is we have no idea how long this is going to last,” Friedman says. “It can take a considerable amount of effort and money to move production. The calculation of when you’re going to move to Vietnam or India or somewhere else is complicated because you’re in that investment for the long haul. You’re not going to move back to China when a deal is struck.”
Begue says diversification goes beyond multiple suppliers to include how you go to market, noting that PRA’s clients with operations in Europe have benefitted from the U.S-China trade war. “You can still keep your supplier. And if it’s a homogenous product, you’re getting a cost savings from your supplier because they want to continue getting the volume they need. So you just shift the market to Europe and put more marketing dollars and effort into other markets.”
But Begue notes that companies without a global supply chain or global go-to-market strategy don’t have that flexibility. “You’re basically stuck in a mitigation framework where you’re relying on exemption processes, which are very slow, or you rely on your customers’ good will, which is spotty,” he says. “You’re looking at your operating margin and you’re cutting 10% to 15% on your annual forecast and you’re looking at next year thinking what you have to cut, which is never a good feeling going into strategic planning.”
Dual sourcing is another option, but this also requires extensive resources and long-term planning. Moving forward, however, Begue says companies can be proactive about establishing primary and backup suppliers for new products.
“We’ve been a bit spoiled because of how good China’s approach to manufacturing has been,” he says. “It’s been a one-stop shop for many industries. Within the supply chain there are a number of different services needed, so you have to have industrial clusters in order for it to be efficient. In Southeast Asian countries there are pockets of that, but it’s not as robust.”
Along with Vietnam and other Southeast Asian countries, Mexico and certain South American countries are attracting interest as possible supply chain sources. But as Begue points out, “We’re seeing risk everywhere. There are issues related to trade with Mexico. Even with Canada there’s been tensions. Those are our top two trading partners by a long shot. No place is safe at the moment.”
Begue also says some companies are redesigning certain products to take advantage of alternative supply chains. “They’re not trying to fix something that can’t be fixed, but going forward they’re trying to create completely brand new supply chains for new product lines, so it effectively diversifies the company’s future product situation.”
Ultimately, any changes to your supply chain need to be more cost effective than simply paying the tariffs. Friedman says you have to calculate your total landed cost—what it takes to get the entire product to the U.S.
“If you get it right, you pay duty as if it came from a non-China country,” Friedman says. “But you’ll have additional costs related to logistics and potential customs duties into other countries. If that change from China to another country is less expensive than the 25% duty, it may make economic sense.”
Determine Your Tariff Strategy
There’s no one way to handle the tariff situation. There’s no telling how long they will last, there’s no way to predict future actions against other countries or products, and no two companies are alike.
“Some are waiting it out, others have made the decision no matter what happens, they want to have a more diverse supply chain so they’re not stuck on the political horns of future changes in trade relations,” Friedman says.
One thing does seem clear—doing business in a global economy will always involve navigating risk, and a strategy for dealing with the impact of tariffs should be an essential part of that risk management plan.
“Our clients are not completely pulling back and becoming completely regional based,” Andrea says. “You’re probably still going to have to have global operations. You’re going to have to be able to manage that risk accordingly.”
BMO Commercial Bank’s Jaime Freeman, Mea Konopasek and Carl Skoog contributed to this article.
1 Office of the United States Trade Representative
Head of Specialty Markets, BMO Commercial Banking
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