Supply Chain Strategies to Minimize the Impact of Tariffs

This article first appeared on Chainalytics Blog here. Karun Alaganan also contributed to this story.

The Mandarin word for “crisis” is Weiji or 危机 and it has two interesting characters, with the first meaning “danger” while the second represents “opportunity.”

Despite the fact that this translation has been disputed by some Chinese linguists, a similar interpretation can be applied to the ongoing tariff saga between the U.S. and China. While bureaucrats and politicians are busy negotiating to resolve trade tensions, for supply chain managers, the tariff situation can be seen as a crisis — one filled with both dangers and opportunities.

Over the past 15 months, the media has constantly discussed the impact of tariffs on trade between the U.S. and China. At midnight on Friday, 5 May 2019, the U.S. filed paperwork to raise tariff rates, from 10% to 25%, on $200 billion of goods imported from China. While the 10% tariff has been in effect for months now, companies in the U.S. have mostly been able to pass on the cost to the consumer, thanks to historically low unemployment and all-time highs of domestic consumer sentiments. However, the additional 15% in tariffs, along with the risk of further increases, now requires companies more than ever to assess options to change their supply chains in a manner that lets them avoid the tariffs and future uncertainties.

Our recent experiences of working with a few global supply chains impacted by the tariffs show that supply chain managers should immediately focus on some “here-and-now” decisions. Because tariffs may continue into the future with new flavors, they also have to evaluate “wait-and-see” scenarios.

Our recent experiences of working with a few global supply chains impacted by the tariffs show that supply chain managers should immediately focus on some “here-and-now” decisions. Because tariffs may continue into the future with new flavors, they also have to evaluate “wait-and-see” scenarios. Loosely speaking, the here-and-now approach is designed to avoid creating a new crisis (i.e., the danger part) and wait-and-see is for evaluating new opportunities.

Here-and-now decisions

There are three steps for supply chain managers to follow regarding here-and-now decisions. Since there has been speculation of a 25% tariff for some time now, most companies have probably built up inventory reserves (as shown by U.S. Q1 GDP expansion of 3.2%, thanks largely to an inventory build). A part or all of this additional inventory might be in various types of overflow storage (including those in Free Trade Zones, or FTZ). Since these are not standard storage areas (hence not integrated with current systems), we are finding that this inventory exists in regular reporting simply as an additional row. This could be a potential crisis in near-term.

First, a bridge process must exist to treat this inventory as a regular inventory as much as possible. Tracking all attributes, including batch numbers, expiry dates, current quality, and consumed or allocated quantities is important. Since the same overflow storage facilities are being used by many others, you might need to increase the frequency of physical counting and quality inspections. This one-time inventory build, often outside the normal metric tracking, cannot be a scapegoat for operational inefficiencies (No, extra hiring is not required. New system features are not needed. Cost increases still need detailed explanations.) When conducting an assessment of a luxury lifestyle product distributor recently, we noticed that the insurance did not cover extra stock, and purchasing teams had no process to update new post-tariff POs to avoid more inventory build. While there is a need for a “war room” to design quick process changes, there must not be a war room for ongoing tracking. Your process changes should be such that all the pre-tariff one-time buying is integrated into the standard process.

The second aspect of the here-and-now work is to update net landed costs considering the new tariffs, and all the steps taken before the tariff announcement. (If your company does not have a network model to facilitate these cost decisions, we recommend you look into building one.) It includes not only additional working capital costs, but also overflow storage, extra transportation costs, additional insurance premiums, etc. Working closely with Finance & Accounting, as well as the Sales teams, this updated landed cost will guide conversations of price increase, impact to bottom-line, and the need to look for options.

That brings us to the last here-and-now activity: Look for alternate sources for commoditized products. In our engagement with a specialty chemical buyer, the supply chain manager was surprised at how much commoditization has happened in their buying. The “specialty,” often thought to be unique to a few suppliers, has spread to many countries. The landed cost calculation also helps while looking for alternate sources. Such searching avoids immediate dangers occurring from new tariffs, and also retaliatory measures from either country or one of its allies.

Wait-and-see opportunities

Once the danger part of the crisis is taken care of, it is vital to turn to the strategic opportunities presented in the situation. We suggest three initiatives:

• Thorough cost-to-serve analysis
• Full-blown alternate sourcing exercise
• Evaluation of FTZ options

As a first step, the cost-to-serve analysis gives you the updated total costs for various segments of your supply chain. It enables you to segment your supply, demand, and overall product portfolio to understand contribution margins clearly. This analysis prepares you with all the facts for a successful alternate sourcing, overflow storage costs, and the net benefits of FTZs.

While alternate sourcing seems to be the most obvious step, it turns out to be the most complex one as well. That is the reason only commoditized products are part of here-and-now strategy. Searching for new sources for all your products impacted by tariffs is a big exercise. You need to look at the ability to produce the same quality and specifications, regulatory and compliance aspects, working capital needs with new lead times, knowledge transfer costs, risks with existing supplier relationships, long-term business strategy, etc.

Since the “tariff war” started, we have seen a growing shift towards the use of FTZs since it negates the risk of tariffs on not just Chinese imports, but imports from all across the globe. An FTZ allows companies to postpone import duties on raw and component materials imported until they leave the FTZ zone. In some cases, if your plant is qualified as an FTZ and your raw and component material is moved only between FTZs (i.e., customs to warehouse and warehouse to plant) using bonded transportation, you may be able to avoid import duties completely. However, the availability of FTZ warehousing is tight and getting a new FTZ approval can take 6-9 months. Additionally, there are special reporting requirements for all movements in and out of an FTZ, and tool and process changes must also be considered in order to meet these requirements. The net benefit of all this work might not result in bottom-line impact too. Hence, our recommendation is to start with the cost-to-serve analysis to equip the manager with the insight needed to avoid “in-silo” scenario comparisons.

At Chainalytics, we work on similar supply chain solutions for our clients regularly, within the U.S. and around the globe. Our total-cost approach helps leadership mitigate dangers while not missing any opportunities. If your organization is seeking strategies to mitigate tariff impacts, seek the expertise of experienced supply chain professionals who possess the skills and methodology to keep your operations running smoothly.