Companies Scramble to Ease Impact of China Tariffs

Those surveyed by KPMG have employed various strategies to reduce the added cost.
David McCannJune 19, 2019
Companies Scramble to Ease Impact of China Tariffs

Even while some economists are predicting that the ultimate effect of President Trump’s tariffs on Chinese goods could actually be lower prices, many companies aren’t waiting to take action.

Employing a smorgasbord of tactics, 100-plus companies surveyed by KPMG this spring reported that they’d been able to mitigate the cost impact of the 25% tariffs by an average of 59%.

Companies that experience relatively greater success with such initiatives than competitors do gain a meaningful advantage, according to Doug Zuvich, global leader of KPMG’s trade and customs services practice.

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“Businesses come to realize that with geopolitical uncertainty comes either paralysis or opportunity,” he says. “Most are now choosing opportunity. And those that can read the interconnected, proverbial tea leaves and are willing to take unflinching action are coming out ahead.”

Reducing tariff costs potentially allows a company to underprice competitors that are less successful at doing so. “From a CFO’s perspective, it’s an opportunity to be better than your peers and take market share,” says Zuvich.

It’s an important point, because what’s often lost in debates over the impact of tariffs is the fact that companies can’t necessarily pass on costs through pricing. As always, supply and demand has much to say about what prices markets will bear. “If you do it and your competitor doesn’t, some of your business will go to them,” Zuvich points out.

Walmart, by far the largest U.S. importer of Chinese goods, plans to “pull all the levers [it’s] got” to spare consumers the pain of price hikes, said CEO Doug McMillon in a recent presentation to analysts.

In May, however, Walmart CFO Brett Biggs told Bloomberg that “increased tariffs lead to increased prices. It’s very item- and category-specific.”

Please Release Us

Hundreds of companies have successfully applied to the federal government to exclude from the tariffs certain products they purchase from China.

They’ve presented varying rationales to support their requests. Some argued that tariffs on the products being imported would not enhance the United States’ efforts to slow down the “Made in China 2025” initiative, which seeks to position China as dominant in global high-tech manufacturing.

Others presented evidence that the China tariffs would cause undue financial harm to a company or its industry. KPMG, for its part, helped a client file an exclusion request for automotive parts that contribute to driving safety.

There were nearly 11,000 applications for exclusions from the first wave of tariffs, on $34 billion worth of Chinese goods, which took effect in July 2018. By May of this year the government had granted nearly 2,000 of them, while 2,500 more were in the final stage of the approval process, according to KPMG.

Still, the exclusions granted so far cover only 112 specifically defined products, so most companies aren’t able to use them.

Any company that buys those products, not just those that filed for an exclusion, is exempt from paying the tariffs on them. There have been nearly 2,000 successful applications for the 112 products because companies didn’t know what other companies were requesting.

Besides, filing for an exclusion may be a smart thing to do, regardless.

“We had a client that did not submit an exclusion request — but its competitor did, and thus the competitor controlled the product description in the request,” Zuvich says. “The competitor’s product was excluded from the tariff, but our client’s product was not because it did not meet the exact description of the excluded product.”

A second wave of tariffs was imposed in August 2018, affecting $16 billion worth of imports from China. Exclusions from those have not yet been released. The exclusion process for a vastly larger wave of tariffs on $200 billion of imports, which took effect in September 2018, is expected to begin soon. (A fourth wave of China tariffs, on $300 billion of imports, has been proposed.)

A Grab Bag of Tactics

Another effective tariff-cost mitigation strategy is to use a duty reduction program called First Sale for Export. It’s available to importers of record that bring a manufacturer’s goods into the U.S. via a “middleman” vendor.

Normally, the basis for importers’ duties in such transactions includes the middle vendor’s markup. Under First Sale for Export, the markup is excluded from the customs value of the goods. The companies KPMG surveyed said they cut the impact of the China tariffs by an average of $74.1 million through the program.

Zuvich says “the big opportunity companies are looking at now” is moving manufacturing outside of China. Because of U.S. customs rules, though, it can be tricky to get that right.

The tariff applies to products of Chinese origin. So, if a product is manufactured in, say, Malaysia using parts sourced from China, customs officials could consider it of Chinese origin, depending on applicable rules.

“Companies might not know that, and they’ll have a hidden liability,” says Zuvich. “Or a CFO might try to get a certificate of origin from the Malaysian government, but it would mean absolutely nothing. It’s about what the U.S. regulations say.”

Conversely, a product could be manufactured in Sweden, sent to China for assembly, packaging, and shipping, and still not be subject to the tariff.

Companies can also step up their use of free trade zones — generally located near major ports, international airports, and national frontiers — for products they plan to sell internationally. Having goods shipped to the zones, where they may be stored, handled, manufactured, or reconfigured, enables companies to defer the payment of duties. If the goods don’t stay in the United States, no payment will be due.

Another avenue is what’s known as “tariff engineering,” or making a product in such a way that reduces the duty owed.

For example, a recent podcast presented by detailed how Columbia Sportswear designs its women’s shirts with small pockets at or below waist level.

Such positioning of a pocket, colloquially referred to as a “nurse’s pocket” but which Columbia calls a “chapstick pocket” or a “keys pocket,” lowers the duty on that product to 16% from 27%, noted Jeff Tooze, Columbia’s vice president of global customs and trade. “We ensure during the design process that we’re considering the impact of tariffs,” he said.

Then there’s the tactic of companies throwing themselves on the mercy of Chinese vendors to “help them absorb some of the pain” by lowering their prices, Zuvich notes. China’s currency has been significantly devalued since the tariffs were introduced, giving U.S. companies a modicum of leverage with the suppliers, he adds.

Final Thoughts

The methods U.S. companies are using to mitigate the costs related to the China tariffs are, for the most part, not revolutionary. Still, for many companies, performing them is a new experience.

“These strategies have been practiced in the trade world for decades, but now they’re applicable to many more industries,” says Zuvich. “In the past, most industries didn’t have significant duties.”

KPMG presented some other ideas that it said corporate leaders would be wise to consider:

Plan for many possible futures. However the future may unfold, CFOs and other business leaders need to keep a close eye on geopolitical developments so they can be ready for the new strategic and operational challenges they will face in the short, medium, and long terms.

Make use of smart technology. Today’s geopolitical forces may require quick action by CFOs to maintain access to high-quality goods and components. But even after investing significant sums in technology over the past several years, many enterprises may find their existing tools fail to provide complete supply chain visibility or otherwise fall short because they provide limited access to actionable information. So, making use of smart technology is critical.

Tackle tariffs and trade with multifunctional teams. With new and increased tariffs being imposed on short notice, it’s important to have the right mix of resources in place to deal with trade compliance. U.S. and other customs authorities are expected to become more aggressive in enforcing tariffs and customs regulations, so managing these obligations is gaining new importance.

Establish strong governance for all of the above. This is especially important in turbulent times. Clear accountabilities and strong oversight help steer companies toward operating compliance and business sustainability and give CFOs visibility into how trade is being managed.

Important elements for global trade may include developing or revising formal policies, minimum standards, global businesses processes, standard documentation, performance tracking, and reporting processes.