When your business deals with imports, whether paid directly by you or indirectly by your vendors, tariffs affect expenses. So, if your products or any part of those products come from another country, you must factor these taxes into your budget and pricing strategies. But, exactly how do tariffs impact your bottom-line costs?
There are obvious, direct costs of importing your products or parts from another country and paying taxes immediately at customs. Further down the supply chain, there are at least four key ways tariffs increase the price of a product or part. Now, let’s take a closer look at them.
An Overview of Tariffs on Imports to the US
According to the USTR, the average trade-weighted industrial tariff on US imports is 2%. Any import that is non-agricultural falls into the category of an industrial good. But, not all tariffs are the same. In fact, some are much higher.
For example, since the implementation of Section 301 in 2018, there has been a China-only tariff of 25%. This means that all goods from China that enter the US are subject to a tax of ¼ the price of said good and applies to any item in which at least 75% of the components originate in China.
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Whether your products or parts originate in China or anywhere other than the US, they are subject to taxation at US customs. Even if you don’t pay the tax directly, your vendor will. Next, let’s explore precisely how tariffs affect imported product costs.
1. Insurance for Inbound Goods
First of all, it’s amazing how many shipping containers get lost at sea. According to the WSC, a yearly average of 1,382 containers were lost over a recent 12 year period due to catastrophic events. A single vendor might lose a container every couple of years. So, insurance is crucial.
From the time a product is made until it is in the hands of your company, it must be insured. Your vendor generally will carry insurance on products or parts from the manufacturing plant to the port to the VMI warehouse in the country of origin.
After a container arrives at a port in the US, the goods typically travel by train then truck to a warehouse. Until you pick your product up, which usually takes between 6-12 weeks from production, the vendor pays insurance costs.
Now, here’s where tariffs come in. The amount paid for insurance is based on the cost of the product. In this case, tariffs are included in product costs. So, higher tariffs indirectly lead to higher insurance costs. In the case where tariffs are as high as 25%, the insured party might pay 25% higher insurance. So, insurance is an expense that impacts your costs.
2. Reduced Cash Flow
In most cases, vendors work with customers on 60, 90, or 120-day net payment terms. So, you don’t pay for products until a few months after you pick them up from the warehouse. Net terms on imported goods are especially common with larger orders.
As a buyer of imported products and parts, net terms give you the opportunity to pay after you receive a profit from the sale of goods. But, as a vendor responsible to pay tariffs, there are no net terms. Taxes on goods are due immediately when products arrive in the US.
So, a company that pays higher tariffs is subject to reduced cash flow. A $1 million shipment that enters the US with a 2% tariff costs $20K. On the other hand, a $1 million shipment with a 25% tariff costs $250K. And, that’s not all.
In addition to the upfront costs, any tariff costs that are financed through a lender will incur additional interest charges until the funds are repaid. In the case of vendors that offer net terms, these lines of credit can’t be paid back until you pay for the goods some months later. Hence, increased tariffs incur greater direct and indirect costs, inciting further cash flow reductions.
3. Continuous Renegotiations
Increased tariff costs can lead to continuous renegotiations between you and your vendors. For example, an extreme cost spike like that experienced with Section 301 might leave you asking your vendors to absorb the costs. In some cases, everyone is in agreement and you can save money in the short term. In other cases, this doesn’t make financial sense for the vendor, so they will decline.
Even when a vendor agrees to absorb tariff costs temporarily, this is usually a “band-aid solution,” since their profits will decrease. In this case, the vendor will likely come back to you after some time has passed and try to renegotiate. At this point, you might be left with no immediate option except to pay the costs. But, when you do, you have to increase your prices, which can create another problem that needs a new solution.
Partnerships that are able to find permanent solutions often do so by moving production to a country with lower tariffs on imports to the US. In the meantime, you will likely incur new costs and use up valuable resources on the costs of the negotiations themselves. Low and consistent tariffs don’t cause this problem.
4. New Vendor Onboarding Resources
Once you’ve been in negotiations with vendors to the point that you are unable to find a solution, you may need to move on. As mentioned above, it might seem like a quick solution to move production to another country. But, anyone who has ever invested in the act of onboarding a new vendor knows that it can be a time-consuming and expensive task.
In most cases, it’s best to fly out to production facilities to check them out first-hand. COVID has complicated the situation by making it more difficult to audit manufacturing plants in-person. Furthermore, your operations could be entrenched in one country with tier-1, 2, 3, and 4 vendors in close proximity. In this case, if you decide to move operations, you could be forced to onboard an entirely new supply chain at one time.
Note: Some vendors around the world have implemented systems for live, virtual facility audits. In the case that you do make a move out of China or another high-tariff country, ask your potential vendors if they offer such services and how they work.
Final Thoughts
Increased tariffs can have a tremendous, negative impact on your bottom line costs. In addition to direct costs, tariffs can lead to increased insurance expenses, reduced cash flows, continuous renegotiations, and sometimes even the need to allocate resources to new vendor onboarding.
If you’ve experienced the impacts of increased tariffs and you’re seeking a new solution for electroplating, PVD, multi-material molding (MMM), or high precision tooling, we can schedule a virtual facility tour, walk you through our plant and perform a virtual quality audit. To learn more, contact us today.
