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What’s Your U.S. Manufacturing and Tariff Strategy?

With the uncertain future of new tariffs and penalties, is it time to consider building a manufacturing site in the United States?

Q4 2018
U.S. tax reform legislation of 2017 allowed companies to repatriate overseas cash at a one-time 15.5 percent tax rate, down from the 35 percent paid in the past. But what will companies do with all that cash now that it’s back home? Some are buying back stock, but others are investing in U.S. manufacturing sites. And now, with nearly 6,000 Harmonized Tariff Schedule (HTS) item classifications identified for the imposition of a 10 percent to 25 percent penalty tariff on imports from China, it is time to consider all options. Even though some products, parts, and raw materials have escaped the penalties so far, the future of new tariffs and penalties is uncertain. Will your products be next? What is your U.S. manufacturing and tariff strategy?

Should you be considering reshoring? Sourcing from other countries? Building inventories? Use of a foreign-trade zone? Increasing prices to your customers? And what about exports? Every time we impose a penalty tariff, foreign countries respond with an import tariff of their own. Have you considered how these foreign tariffs will affect your export sales?

The goal of the Trump administration is to tax upward of $200 billion worth of goods coming to the U.S. from China, and there is no way to determine which categories, products, or countries might be targeted next. The processes the U.S. Trade Representative is using for selecting items is unclear, which makes many importers rightfully nervous. Import tariffs are adding cost, but no value to global supply chains. In the end, it’s consumers who will have to pay increased prices as the cost is passed along the supply chain and more protectionist measures are implemented by the Trump administration.

It appears that the trade wars aren’t going to end anytime soon, either. In fact, there is some discussion about targeting additional countries and additional classification categories. Section 232 tariffs apply to aluminum and steel as of June 1, 2018. Section 301 penalty tariffs on Chinese imports are in three tranches: Section 301 penalty tariffs on Chinese imports (List 1) July 6, 2018 – 25 percent; Section 301 penalty tariffs on Chinese imports (List 2) Aug. 23, 2018 – 25 percent; and Section 301 penalty tariffs on Chinese imports (List 3) Sept. 24, 2018 – 10 percent to 25 percent. Escalating trade tensions between the world’s two largest economies are creating havoc in global supply chains.

Trade wars mean that countries will retaliate with their own import tariffs on American goods. Which countries or which items might be next is uncertain. Whether or not these tariffs will be effective in addressing the long-term policies of foreign governments is anybody’s guess. In the meantime, they are likely to affect your current operations. Now is the time to consider how to respond.

Return Manufacturing to the U.S.?
Returning, establishing, or expanding manufacturing in the U.S. is our favorite strategy at the Reshoring Institute. Over the long term, this is a solid strategy, especially when your customers are in the U.S. But it takes time to re-establish domestic manufacturing. A new factory location must be secured, new workers hired, and new distribution channels must be secured. Setting up operations in the U.S. could take as long as 12–18 months. In the meantime, if you need to source products, parts, and raw materials from China to support U.S. production, you will still be stuck paying the penalty tariffs.

Use of American contract manufacturers is also a possibility, but keep in mind that if parts and products come from China, the 301 tariffs still apply to these imports. If the contract manufacturer is buying parts on your behalf, they will surely pass the increase in cost due to penalty tariffs on to your company.

Source Parts and Raw Materials in the U.S.?
Sourcing parts in America is another good strategy if you intend to manufacture here. But even with the 25 percent penalty tariffs on Chinese parts, American-made parts are often still not cost-competitive. In addition, some U.S. suppliers are completely overwhelmed with current requests for quotes, are operating at capacity, and not accepting any new orders. Rebuilding your supply chain with U.S. suppliers could take years.

This is a genuine opportunity to work with your design and engineering staff to consider different approaches to building your product and extracting costs. For example, you might consider plastic housing instead of aluminum, or unpainted internal parts, to reduce costs. Working cross-functionally within your organization (design-engineering-procurement) is likely to yield new, innovative ideas for production.

Establish or Use an Existing Foreign-Trade Zone?
Perhaps you are considering the use of a foreign-trade zone to substantially transform component parts into a finished product and a new HTS number, or to avoid paying duty until you are ready to import. Unfortunately, certain provisions in Section 301 require payment on the value of the Chinese components regardless if you are now importing transformed finished goods from the FTZ. Even if you ship products from the zone directly to Mexico or Canada, the China penalty tariffs still apply.

Some companies have been stockpiling inventory in advance of the tariffs going into effect. The result has been worldwide shortages of parts and overstock of finished goods for wholesalers and retailers. Should You Buy More Inventory?
Some companies have been stockpiling inventory in advance of the tariffs going into effect. The result has been worldwide shortages of parts and overstock of finished goods for wholesalers and retailers. In addition, some companies are now paying for additional warehousing space to store production parts. This bullwhip effect adds unsustainable costs in global supply chains. Hoarding inventory also ties up working capital and may put a stranglehold on your company’s ability to operate. In industries with rapid product development, seasonality, and trends such as fashion or electronics, inventory quickly becomes obsolete, so buying too far in advance is a losing proposition resulting in mark-downs and sell-offs.

Pass Increased Costs to Your Customers?
In the end, consumers always pay the price for increasing tariffs as these costs are passed through by importers. Economists tell us that sooner or later, consumers will balk at increased prices and stop buying or limit buying of expensive goods.

We know that a large portion of the consuming population is price-sensitive. We also know that most companies simply cannot or will not absorb the additional cost of goods sold that are burdened with 25 percent tariffs; instead, they will tack on the increased costs to the selling price of finished goods. As long as all of your competitors are doing the same, this is no problem. But if some competitors can sell for less, you may see an unfortunate drop in demand for your products due to noncompetitive pricing. If increasing your product sales price is your only option, you should brace for decreasing demand.

Rebuilding your supply chain with U.S. suppliers could take years. Effect on Exports
Exports to other countries are also affected. Trade wars mean that countries will retaliate with their own import tariffs on American goods. China announced tariffs on American goods immediately after each of the Trump administration’s 301 list announcements.

Unfortunately, retaliatory tariffs are often meant to hurt economic sectors unrelated to U.S. tariff categories. For example, U.S. 301 tariffs may apply to electronic goods imported from China, but Chinese retaliatory import tariffs apply to soybeans or almonds. Again, which items and industries may be next? Keep an eye on what is happening in export markets. It is difficult to predict how other countries will react to U.S. protectionist policies.

Develop Your Strategy
No matter what your opinion about trade wars, it’s in your best interest to develop a strategy that will work for your company as U.S. trade policy changes and different imports are targeted. Examine all of your options and be ready to make changes if necessary.
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