On May 5, President Trump tweeted that he would be raising tariffs to 25% on $200 billion worth of Chinese products and that he would eventually impose this same tariff rate on pretty much all products from China. Since then, the media has been all over the map on who will be paying for these tariffs. On the one side, we have President Trump and the media favorable to him stating (or at least implying) that “China will be paying these tariffs.” On the other side, we have the media stating (or at least implying) that the U.S. consumer will be paying these tariffs via increased retail prices
It ain’t that simple. Truth is a many companies and people from all over the world will be paying the tariff. I say this based in large part on what our international lawyers and international trade lawyers have already seen from the last round of US tariffs.
The onslaught of tariffs is subjecting companies that import Chinese products into the United States to overall price increases and our China lawyers are getting an earful about this from clients that sell their products on relatively thin margins to big retailers like Walmart, Target and Home Depot. Our clients with super strong brand names and eye-popping profit margins are — at least for now — remaining much calmer. Some of our clients have flat out told us that they do not really care about the tariffs. We have a client that pays around $60 for the products it has made in China and then sells those products for $1700 to $2100. How much should it care about a $15 price increase? We have another client that pays 20 cents for the product it has made in China and then sells that product for $12. How much should it care about a 5 cent per unit price increase? So yes, the tariffs do not fall equally on all.
But no matter your profit margin (with some exceptions) and no matter to whom you sell your products, now is the best time to be doing two things: 1) looking into the possibility of at some point diversifying or moving your supply chain out of China, and 2) trying to get your China suppliers to lower your product pricing. Our international lawyers are working nearly non-stop to help our clients diversify their manufacturing to countries outside China — so far this has mostly been to other Asian countries, such as Vietnam, Cambodia, the Philippines, Malaysia, Pakistan, India, Thailand and Taiwan, but also to Mexico, Eastern Europe, Portugal, and Spain and even to Canada and the United States — more so after the announcement of the “new NAFTA” agreement, a/k/a the USMC.
This post is going to focus on who actually will pay the China tariffs, yet in doing so it also sets out some steps you should consider taking now to reduce your China product costs.
I will begin by explaining who will pay the 25% Trump tariffs and I will use a widget as my example, with the following assumptions.
1. Assume China Factory was manufacturing its widgets and selling them for $100 each before the tariffs.
2. Assume European Widget Company was buying these widgets from China Factory for $100 each before the tariffs and selling almost all of those widgets in the United States wholesale to Big Box Retailers for $140 which they in turn sell at retail for $280.
3. Assume China Factory/European Widget Company will now have to pay a 25% tariff on its widgets that go to the United States and further assume this means European Widget Company’s total cost for the widgets (as landed in the US) just went up to $125 because of the US tariffs.
What happens next? Does China Factory turn around and say to European Widget Company “we feel your pain and we badly want to alleviate that (and because China the country is now further subsidizing China Factory) we will cut our widget prices to $75 so your landed US costs will remain at $100, resulting in no change to your US pricing? Under this scenario, China will pay the tariffs.” Is this realistic? Of course not.
Does European Widget Company say to China Factory Company, “Hey that’s really too bad about the U.S. tariffs. Because we so love the US and China we will just pay you the same $100 we have always been paying you for the widgets and we will keep selling them to the US Big Box Retailers for $140. We will incur all losses from the tariffs so neither China nor the US will be impacted in the slightest.” This scenario is equally implausible.
Now let’s throw in some more assumptions, based on what happened with previous rounds of US tariffs against Chinese goods and what to a certain extent is already happening in this round of US tariffs against Chinese goods:
1. China reduces its income tax rates for Chinese export manufacturers, thereby reducing their overall costs by 4%.
2. China reduces its VAT rates for Chinese export manufacturers, thereby reducing their overall costs by 4%.
3. China pushes down the value of the RMB, thereby increasing by 2% the RMB Chinese export manufacturers get from their Dollar and Euro sales.
So right there we have a 12% reduction in costs for China Factory. Note that the numbers above are rough calculations and individual valuations will vary.
What should and what will the European Widget Company do in light of the above numbers? It will go to China Factory and say something like the following:
Monsieur, as you well know, times are tough selling widgets to the United States because of the new and onerous tariffs. We essentially have to pay 25% more than if we were to purchase them from any country other than China. Speaking of other countries, did I tell you we’ve been looking at having some of our other products made in Vietnam or Thailand? I went to both countries last week and they were so nice and they have such great food and I was surprised at how many people in both countries speak French. Do you realize that if we were to have our widgets made in Vietnam or Thailand we’d be free from the 25% tariffs and free from all this acrimony and risk tied in with the US-China relationship. I have a friend who says the United States and China will at some point cease all trade between them. I don’t think that is possible, do you?
But I keep hearing that China’s recent income tax reductions and VAT rebate increases and RMB devaluations — and who knows what else the Chinese government is doing and will do to subsidize you Chinese manufacturers — has reduced your manufacturing costs by 15% to 20%. With all this it seems you should cut your pricing to us by 20%. I know this will cut into your profits a tiny bit but our profits are going to get cut as well no matter what you do and no matter what happens. Because we have had such a great relationship with you for the last 8 years (including our willingness to overlook your early indiscretions, like when you (1) sold our product in the grey market out the side door; (2) registered OUR trademark in China and we had to convince you to assign it to us or (3) you reduced the steel content in our widgets from 20% to 5% to save money and we only learned of this by enduring massive customer returns of our widgets due to failures and then as compensation you offered us a 5% discount on our next set of purchases), don’t you think it only fair that our two companies share in the profit losses here? Gosh I would hate to spoil our relationship that took us so long to build by moving our widget production to Thailand or Vietnam, which is what my General Manager says we should do.
And in the end, China Factory reduces its prices to European Widget Company by 12% and their new contract makes clear all pricing is in RMB, though payments will be made in Euros.
European Widget Company, is now paying $88 for widgets for which it previously paid $100. If you add the 25% tariff to the new $88 price, European Widget Company is now looking at a new $110 US landed price.
Does European Widget Company then go to its Big Box Retailer buyers and say, “Hey, you have always been great so I am going to keep selling you our widgets for $140 so your profits are not impacted?” No. Does European Widget Company go to its Big Box Retailer buyers and say, “Hey, because of the 25% tariffs I will need to increase my sales price to you by $25 and so I am now going to charge you $165 per widget?” Let’s imagine European Widget Company does this. How will Big Box Retailers respond? There is a 99+ percent chance they will tell European Widget Company “no way” and then talk about how ,”Maybe we should start having our own widgets made in Vietnam or Thailand” and they very well might. For this reason, this scenario is very unlikely.
A more realistic scenario would be for European Widget Company to go to Big Box Retailers and say that its costs have gone up and it is working hard to diversify its widget production outside China, that it has done some exploratory trips to Vietnam and Thailand and will soon be testing some widget manufacturers there, but in the meantime, it needs to raise its prices by $7 and can that price increase work. The Big Box Retailers will say no and trot out their own Vietnam/Thailand/Malaysia/Pakistan/Mexico/Indonesia/India/Philippines/Taiwan scenarios and in the end agree to pay $2 more per widget. And then Big Box Retailers will flip around and raise its retail widget prices anywhere from zero to five dollars.
So in the end, the China government, the China Factory, the European Widget Company, the Big Box Retailers and the Consumers all end up paying some portion of the 25% tariffs. Of course the portions will vary depending on profit margins and on the market and on the industry and on the product and on supply and demand and on the price elasticity of demand and on Chinese government subsidies and tax cuts and RMB devaluations and on the companies involved and on a whole host of other things. But the above scenario is not an unrealistic one and it mimics some of the scenarios our international lawyers saw play out during the last round of tariffs.
So what about the flip side? What about the soybean farmers in the United States who are now likely to get socked by Chinese tariffs against their soybeans? Here is how I see that playing out. These farmers will likely be hurt badly in the short term, but they may end up barely being impacted in the long term. How can that be, when the U.S. was at one time selling approximately $15 billion in soy beans to China annually, which constitutes around 60% of U.S. soybean production? The soybean farmers will all be wiped out, right? Wrong. I am not for a minute going to tell you that America’s soybean farmers will be just fine because that is not likely to be the case. But I am going to tell you that soybeans are essentially a commodity. This means that if the U.S. stops selling soybeans to China, China will get its soybeans from other countries, and the subsequent vacuums created in non-China markets will be filled by U.S. soybean farmers. I mention this not to minimize any impacts but to make clear that U.S. soybean farmers are not going to lose $15 billion a year in sales.
Bottom Line: U.S. tariffs on Chinese goods will in most cases lead to increased pricing/decreased profits for pretty much everybody in the product supply and selling chain. But the impact on your business will depend at least in part on the steps you take now.
5-18-2019 UPDATE. In China’s currency is sending a warning signal about the trade war, CNBC.com writes that the RMB has lost 2.7% of its value as against the dollar, just since President Trump’s May 5 tariff tweet! Are you making your China product supply contracts dollar or Euro denominated?