Best Practices for Distributors and Manufacturers in a Tumultuous Time
In the U.S., another round of tariffs was announced recently on imports from Argentina and Brazil, building upon the substantial tariffs imposed on Chinese imports in August 2019 and a looming $300 billion tariff action proposed for early 2020. The ripple effects are being felt by manufacturers, whose costs are rising for certain inputs, and distributors, who are paying higher prices to their suppliers and having to pass that cost on to their customers.
Nearly every customer we work with is impacted by tariffs in some form or fashion. The administrative burden alone is an unforeseen curve ball, as some companies have had to dedicate one or more full time employees to the cause. This is because the products included in each tariff exclusion changes each month, bringing substantial additional paperwork and a steep penalty for underpayment or nonpayment.
Beyond administration, tariff actions are highly impactful to financial results. The challenges revolve around changing cost basis, updating prices and making inventory decisions that incorporate tariff considerations. If a company’s costs are increasing due to tariffs, they do have a number of options on the table for an effective response.
The right tariff strategy is unique to each business, so we have put a lot of thought into various pricing game plans based on real-world customer experience.
What are Tariffs, How Do They Work, and What Does It All Mean for Pricing
Before we can understand the impacts that tariffs have on business, we first must understand what tariffs are and how they work. With that in mind, here’s a quick primer on the basics of tariffs:
WHAT IS IT?
A tariff is a tax on imports or exports between sovereign states.
WHY IS IT DONE?
It is a form of regulation of foreign trade and a policy that taxes foreign products to encourage or safeguard domestic industry.
WHO PAYS IT?
Tariffs are typically first paid by the importer but are then passed on to whoever buys from that importer.
WHAT ARE THE COMPONENTS OF A TARIFF?
A tariff policy will contain a range of products (defined by HTS codes), a designated country of origin, a tariff fee applied (typically a % of the imported goods) and exclusions. A tariff may be in effect for months or years; however, the list of products excluded from paying the tariff fee are usually updated monthly. Products can be added or removed each month.
WAIT, WHAT’S AN HTS CODE?
Harmonized Tariff Schedule codes are numerical identifiers representing a group of products that the exporter assigns. Each individual HTS code covers a narrow scope of products. Data challenges abound with HTS codes as different manufacturers of the same good may assign different HTS codes. For instance:
HTS codes are vitally important for distributors and manufacturers to track, as monthly changes can instantly alter which products are impacted by tariff policy. The trouble is, it becomes a full-time job to administer these changes. Any mistakes made can lead to either large fines or severe hits to margin if costs aren’t updated correctly. Many companies have to redirect one or two members of their pricing team to handle HTS code administration, which is tedious work that distracts from other proactive pricing functions.
Beyond administration, the major tariff pain comes down to costing and pricing, of course. If a company’s costs are going up because of tariffs, they can either:
- Pass the cost increase on in full – relying on sales reps to clearly explain the reasons for the increase so as to not lose volume.
- Pass the cost increase on in part – suffering margin loss.
- Change their source of supply – a slow-moving process with more administrative overhead.
For straightforward cost increases, this problem is easy enough to solve with a centralized price management tool. However, many deals are complex, with tariff-related cost hikes only affecting a portion of the Bill of Materials (BOM). Here is an illustration of that complexity matriculating through the supply chain:
Clearly, it’s a lot to manage. Added on top of the normal pricing activities that companies often struggle to attack strategically, it can become a nightmare.
Simplifying the BOM Scenario
When you look at a BOM like a recipe, this picture becomes clearer. For instance:
Who’s hungry? Now let’s say there is a 25 percent tariff slapped onto flour. Since a pancake isn’t just made up of flour, the cost of the pancake itself doesn’t go up by 25 percent. Pancake buyers who are sensitive to pancake prices will know flour has a tariff, so they’ll expect an increase. But they also know flour is just a fractional ingredient.
Do they know the exact fraction? Do you, the (pan)cake boss?
Now, in our tasty scenario here, the input cost goes up just over 8 percent. The pancake maker needs to consider its cost pass through strategy. Can it pass on 100 percent of the cost impact? More (or less)? This is where a comprehensive understanding of price elasticity is crucial. The strategy the pancake maker picks will be dependent on its goals – is it seeking to preserve its profit dollars, margin percentage, maintain market share, or some combination of these?
Going a level deeper, price elasticity likely varies by product category, signaling a need for category-aware cost pass through guidance. In our example above, just one category is implicated. But many deals will be vastly more complicated.
What is there to do about these seemingly endless complexities, changing by the month and muddying the waters of any coherent pricing strategy you’re trying to implement?
Pricing Strategies to Hold the Line on Margin
What can pricing professionals do right now to preserve margin, maintain volume and remain compliant with audit requirements? The following recommendations have been developed through first-hand experience with customers dealing with tariffs in the manufacturing and distribution industries.
More Intentional Cost Pass-Through = More Profit
Higher tariffs equate to higher costs and, in a perfect world, you could pass 100 percent of every cost increase on to your customers. However, your competitive situation and the price elasticity of different segments may mean you can’t do that in every case. You may also be able to pass on more than 100 percent in some segments where sensitivity is low.
This means you must first be able to identify price sensitivity and then have the tools and processes in place to execute price changes quickly and on a mass scale.
Pricing professionals should consider flexible price management solutions that empower them to set up category-specific and customer segment-specific cost pass through strategies. In this tool, prices at any level in the product hierarchy can be updated quickly in a central location and pushed out to quoting tools with transparency so that price changes can easily be calculated, tracked and communicated. For the pricing team, rather than toiling in spreadsheets to track the latest product additions and exclusions to the Harmonized Tariff Schedule (an arduous task fraught with potential costly mistakes), a central price management tool simplifies your to-do list.
The right tools eliminate guesswork and give the pricing department the ability to capture more margin and manage costs in any environment. When unpredictable tariff actions disrupt the ordinary flow of business and threaten margins, such capabilities are invaluable.
Combat tariffs with a price management tool that provides:
- A central data repository of product data and tariff information, which all appropriate team members can access.
- Clear visibility into how tariffs are applied. This is crucial to be able to explain price changes to others and either change or back out the tariff charge if the tariff action changes.
- The ability to calculate the impact product by product, as well as the overall change automatically.
- Integration with other tools or existing price administration applications.
Communicate an Informed Strategy
It’s more important than ever during times of market disruption to enforce price behavior in the field. This can be achieved through a mix of technology and process improvement. Price optimization can produce market-aligned prices for each selling circumstance that’s presented as a range of prices, giving sales representatives room to negotiate. By doing so, pricing teams can offer price guidance that maintains necessary margin levels while preventing a panic-like race to the bottom on price that ultimately erodes margins. Yet even in the most rigorous of pricing departments, there will be times when exceptions need to be made. When these situations arise, it’s imperative to have a deal management solution in place to provide smooth and actionable visibility into override requests.
Your deal management application must be equipped to help teams:
- Understand the impacts of pricing decisions during negotiation on margin and target attainment.
- View price guidance in a quickly evolving price environment.
- Route for approval so sales management can help negotiate the potential customer discussions.
Another weapon against tariffs for the data-driven pricing analyst is a comprehensive visual analytics tool. Most businesses are going to have a range of impacted segments where tariffs are concerned. It’s important to clearly understand the most and least affected segments, then adjust prices intelligently to preserve available volume.
Pick a Trusted Partner
The rest of your daily tasks aren’t going away. Your organization has likely redirected quite a bit of manpower and brainpower to managing tariff administration and strategy. Price departments are stretched thin. It’s unrealistic to accomplish it all on your own.
Similarly, it’s not enough to drop a pricing solution in your team’s lap and expect all the tariff pain to go away. Software is only as effective as its adoption and when it comes to price optimization and management, there is no one-size-fits-all answer. Each industry is unique, as is each company within each industry. Your price optimization supplier needs to be heavily involved beyond implementation.
In addition to bringing the necessary tools to address challenges brought on by tariffs, if you’re considering a pricing and sales technology provider, ensure that the candidates have a deep knowledge of the challenges common to your vertical industry. An ideal partner would arm you with an experienced implementation team and a dedicated customer success team to develop a shared understanding of the impact of tariffs and quantify your potential margin exposure. By proactively engaging in this way, you can be better equipped to tackle the challenge from all angles – including administrative cost, business performance, real-time reporting on margin impact and new price governance.
Now, a Curve Ball – Planning for a Post-Tariff World
This article has gone deep and wide on tariffs’ impact on pricing and costing. It’s important to remember that these tariff actions will end. Fantastic, right? Well, not so fast. If you’re a manufacturer or distributor with tariff-induced headaches, your pain doesn’t stop when they go away. For instance, you may have paid a 25 percent tariff lift to your supplier for products that are still sitting in your inventory when the tariffs end. How ruthlessly will your customers act with regard to taking that inventory off your hands? Will they want to pay more for a tariff that doesn’t exist? How do you avoid getting stuck with tariff cost-inflated inventory?
Why the Eventual End of Tariffs isn’t the End of the Threat (And What You Can Do)
With the January 15 signing of a “Phase 1” trade deal with China, the U.S. tariff actions may be inching closer to a resolution.
For many U.S. manufacturers and distributors, the prospect of tariffs in the rear-view mirror should be a call for celebration, right? Not so fast.
The transition period, whenever it arrives, is fraught with obstacles. An end to the tariff program (whether quick and precipitous or more drawn out) presents a massive pricing problem. During the tariff period, most distributors have added a tariff line item to their quotes to pass costs on to customers. This brings transparency and is palatable, as customers expect some level of raised prices during this time. Most manufacturers have been forced to fold the extra cost into their product price, again finding their customer base both reluctant and sympathetic.
But consider the unique cost and price circumstances when the tariff program finally ends. Will any customer want to pay for tariffs that no longer exist? How will customers respond to prices heavily influenced by tariff-laden, high cost inventory? What do your competitors’ tariff-influenced inventory positions look like? The risk for substantial margin erosion and/or volume loss caused by this zombified inventory is real.
Imagine you’re a distributor that operates with thin net margins (<5 percent) and you currently hold inventory dominated by items that carry 25 percent higher costs due to tariffs. If tariffs go away tomorrow, the nightmare scenario is easy to envision. Your customers are unwilling to pay for tariffs on a program that no longer exists. You must do everything you can to avoid being caught holding the bag when tariffs are repealed. This will involve walking and chewing gum at the same time. Meaning, you must prepare for the end of tariffs without kneecapping your ability to hit margin and revenue goals in the interim.
The companies quickest to act in the most innovative ways will be the ones who come out ahead of all this. With that in mind, let’s discuss some of the major decisions looming, how to prepare for the end of tariffs and how to manage your pricing in a post-tariff world.
In order to act quickly and meaningfully, you will have to collaborate on a game plan with other parts of the business. Connect with Procurement/Supply Chain to get a sense of the tariff-affected inventory you already hold and buying plans going forward. Align with the executive team and sales management on a post-tariff pricing strategy. These conversations will be crucial to understanding the scope of your problem, the right timing of price changes and the prices your customers are likely to accept before and after the tariff actions go away.
With the team on the same page, sharpen your pencil and attempt to decide on unified answers to questions like:
- How do we change our prices when tariff programs end in order to offset or recoup already-made tariff payments?
- How have we passed along the cost of tariffs to date (as a line item or within our product price)? What has the competition been doing?
- Should we spread out price increases in smaller increments over a year or a large pricing action? How should the pricing action be communicated to the market, if at all?
- Should we take a hit to the bottom line by discounting prices on tariff-affected inventory?
- Where are we in the supply chain (i.e. how much of the “upstream” supply chain might be loaded with tariff costs)?
- Do we know which customers are price-sensitive? Do we know which products are sensitive? Can we even begin to manage the price increases with so many unique segments? How do we manage pricing campaigns when they aren’t directly tied to product costs?
This last point is a particularly sticky one for most companies, who have either defaulted to cost-plus pricing over the years or rely on manual processes to arrive at a price. Neither option constitutes a successful pricing strategy in steady times, let alone when navigating modern tariff flux.
Preparing for Post-Tariff Business (Playing Defense)
If you’re like most companies, you might come out of these strategy meetings with less-than-satisfying answers and likely more questions. But in aligning your departments on a plan, you’re doing more than most. Looking to the future, we understand that tariffs won’t go on forever and you need to be putting together your strategy now.
The right strategy will include implementing surgical price changes while reducing your cost basis. More intentional cost pass-through driven by data science is something every tariff-impacted company should be doing today. The ability to identify segments with low price sensitivity where prices can be raised is invaluable. Raising prices preemptively, in accordance with price elasticity, can help make up for anticipated post-tariff margin loss.
On the cost side, work with your procurement team early. An analysis on your own buying patterns will help determine the need for preparatory tactics like:
- Making smaller and more frequent purchases to maximize flexibility.
- Avoiding locked-in quantities / deliveries.
- Arranging for larger purchases to occur after the tariff program ends, rather than before.
- Sourcing from non-tariff-impacted suppliers while tariff programs are winding down, even at a higher base product price.
It will clearly take more than the pricing team to determine feasibility and to execute on your strategy. Coordinate with internal partners on immediate changes and ensure everyone across the organization is ready to put post-tariff plans into effect abruptly when the time comes.
Managing a Tariff-Free Market (Playing Offense)
Fast-forward to the day of the formal announcement stating that the long tariff saga is over. If you’ve done your prep work, you can respond to new market conditions before the ink is dry. This is where you have the opportunity to stop playing prevent defense and start putting points on the board.
Thanks to your preparation, you may find that you are well-positioned compared to your competitors to take advantage of the situation. You’ve proactively minimized your cost-inflated inventory and captured additional margin where achievable, while others in your industry are now in panic mode. As the saying goes, “Never let a good crisis go to waste.”
If your competitors emerge post-tariffs with inflated costs, you can likely keep your prices higher even though your cost basis has decreased. There’s less of a chance of getting beaten on price, so it’s time to rake in the margin.
After years of inflated costs, the market may take some time to psychologically “reset” when tariffs go away. This presents another opportunity to scoop up big margins by keeping prices higher for a time and gradually gliding them back down. Don’t do this blindly, however. Price elasticity is still your North Star.
Tariffs will come to an end. The only questions are when, and how ready will you be? When the inevitable happens, there’s no excuse to be caught by surprise. Instead, organize your internal teams, collectively determine your risk exposure and put the right pricing tools in place to formulate a winning strategy now.