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Tariff battles stall manufacturers’ expansion plans

Trade uncertainty creating "wait and see" approach to investment

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Container portA steady drumbeat of tariffs, changing trade policy and the uncertainty of where it will all end are resulting in a “wait and see” approach to investment and expansion for today’s manufacturers. Companies are reassessing spending plans and finding it challenging to adjust how they do business on the fly in response to shifting trade policies which are far from settled.

Consider that the current Administration has dangled the threat of additional tariffs on China while also suggesting a compromise can be reached. New tariffs have been assessed via executive, rather than congressional action, and could just as easily be reversed.

However, during the G-20 Summit held recently in Argentina, President Donald Trump and Chinese President Xi Jinping agreed to put their bilateral trade war on pause temporarily, holding off on assessing additional tariffs on each other’s goods after January 1. As part of the agreement, the U.S. will hold off raising China tariffs to 25 percent and instead leave the tariffs on $200 billion worth of goods at 10 percent. This will give both countries time over the next 90 days to negotiate disagreements on technology transfer, intellectual property and agriculture. If a mutual agreement cannot be satisfactorily reached after the 90 days, the 10 percent tariffs will be raised to 25 percent.

The agreement sets a March 1 deadline for a trade deal which may give both countries some much needed political breathing room. China has pledged to purchase a not yet agreed upon amount of agricultural, energy, industrial and other products from the United States. While there was some discussion about whether Beijing will reduce and move its 40 percent tariffs on U.S. cars imported into China, time will tell whether the auto industry will see that change.

In the meantime, U.S. manufacturers and consumers alike will adopt a wait and see approach to determine whether China will be willing to make the types of broad concessions the U.S. seeks within a relatively short window of time as defined by the agreement.

Simultaneously, Trump, Canada Prime Minister Justin Trudeau and outgoing Mexican President Enrique Pena Nieto signed an authorization agreement to replace the quarter-century-old NAFTA pact, ending a year of intense negotiations. While the pact still needs to be ratified by lawmakers in the three countries, the signing allows for a number of immediate protections, including those related to auto tariffs. Uncertainties, remain, however, as the U.S. Congress, where Democrats will have a majority in the House starting in January, will need to ratify the deal.

If your company is concerned about how uncertain trade policies will impact your future business strategies, you’re not alone. In a recent Insights Exchange sponsored by Grant Thornton, leaders from around the manufacturing sector discussed their efforts in responding to new tariffs and changing trade developments.

One manufacturer noted that because 25 to 40 percent of its raw materials are impacted by tariffs, costs have increased leading customers with long-term pricing agreements to push back against the tariff impacts. Some manufacturers are finding they need to negotiate changes to contract terms while others are faced with locating new supply sources.

As a result, manufacturers are hesitant to commit to large investments or expansion plans unless they can be certain they’d pay off in the long run. Whether a manufacturer needs to change their supply chain strategy, find alternative sourcing or re-source materials, these are long-term initiatives they can’t implement until there is more evidence of stability in trade policy.

Jeffrey French“Capital investment has been lower than expected....Many companies are taking a ‘wait and see’ approach until the current tariff tensions settle.”
Jeff French
Grant Thornton National Managing Partner
Consumer & Industrial Products
“Capital investment has been lower than expected and GDP declined from a 4.2 % high in Q2 to 3.2% in Q3,” noted Jeff French, National Managing Partner of Grant Thornton’s manufacturing practice. “This is likely tariff-related with many companies taking a ‘wait and see’ approach until the current tariff tensions settle.”

Linda Dempsey, Vice President of International Economic Affairs at the National Association of Manufacturers, agreed that “Overall, manufacturers facing China tariffs have been tightening their belt and trying to take action to prevent major changes. Given economic reports that there may be a slowdown in GDP going into the fourth quarter and possibly the first or second quarter of next year, these companies are worried about their future ability to deal with the impact of China tariffs without more drastic activity.”

She added, “Companies are facing a period of uncertainty and are disappointed they can’t focus on capital investment and leveraging the benefits from tax reform because they’ve got a bigger bill on the cost side of the ledger.”

The result is that recent tariff hikes with fears of more to come are impacting how companies are reassessing their capital-investment plans. A number of manufacturers are responding to the uncertainty by delaying investments and expansion plans.

In fact, the results of a July 2018 Survey of Business Uncertainty found that 30 percent of manufacturing companies report reassessing capital-expenditure plans because of tariff concerns. Of those companies reassessing, 67 percent have placed at least some of their previously planned capital expenditures for 2018-19 under review, while 31 percent have “postponed” or “dropped” previously planned expenditures.

The impact of the U.S.-China trade war, specifically, is driving changes in investment strategy. According to an American Chamber of Commerce poll of 219 firms, 67 percent of foreign and Chinese firms indicated they would move, delay or cancel investment in the U.S. and 66 percent would do the same in China. Additionally, 77 percent said they would move supply chains out of the U.S.

The uncertainty created by current trade policy isn’t just impacting manufacturers’ investment and expansion strategies; it’s also affecting hiring plans. A survey of 800 companies by IHS Markit found that nearly 1 in 10 acknowledge the tariffs would result in moving more jobs offshore while 4 in 10 companies revealed they plan to raise prices to offset the higher cost of production.

Weathering the storm: Tips to prepare your business While the next round of tariffs may be out of the control of today’s manufacturers, they can be proactive in preparing for changing trade policies by considering these action steps:

  1. Renegotiate rates with suppliers.

    Even if your company’s products aren’t directly targeted by tariffs, they may incorporate some materials, like steel and aluminum, which are affected. The result can be higher cost of goods and materials. Now is the time to renegotiate terms with suppliers and try to lock them into long-term deals with favorable pricing. It may be easier said than done in many cases, particularly since some suppliers may be using the assessment of new tariffs as an opportunity to raise prices. However, effectively locking in rates can help you avoid the worse of price increases if tariffs directly impact costs. When entering into an amended, extended or new supply contract, remember to incorporate key protection clauses to avoid major spikes in prices that would be damaging to your business model.

  2. Evaluate profit margins.

    With increasing costs of goods and materials due to tariffs, it is critical to examine what costs you can absorb and what costs you’ll need to pass on to customers. Understanding where you might offset material cost increases with other efficiencies or cost rationalization and the level of cost increase your customers may be willing to tolerate is necessary in order to make appropriate adjustments. If your customer contracts have price escalation clauses or limitations, you may need to attempt renegotiating clauses that prevent recovery of tariffs paid.

  3. Consider free-trade zone opportunities.

    Too often, manufacturers overlook available opportunities provided by free-trade zones. The free-trade zone option allows companies to develop a product, then export it to a U.S. customs territory or foreign destination, potentially bypassing any tariffs on the product if it has been transformed.

  4. Establish a dedicated trade and customs compliance group.

    Consider forming a trade compliance group with clear governance. Build strong “what-if” capabilities to understand the impact of tariff and trade scenarios including inventory and supply chain strategies, sourcing alternatives and modeling multiple data sources.

  5. Take advantage of exclusion processes.

    When granted, exclusions apply retroactively to the date the tariff went into effect. The Commerce Department reviews exclusion requests for Section 232 Steel and Aluminum tariffs while the United States Trade Representative (USTR) provides a mechanism to request exclusions for Section 301 (China) tariffs. The Commerce Department has received over 30,000 requests to date and has shown a willingness to provide exemptions in certain cases so manufacturers should take action to evaluate opportunities for exclusions.

    Since March, when the tariffs of 25 percent on steel and 10 percent on aluminum went into effect, the Commerce Department has approved a higher share of exclusion requests that include imports from China than it has from U.S. allies like Japan and Canada. The exclusions stem from the Commerce Department’s process for determining whether companies can win tariff relief for imported metals. The requests are generally granted as long as no American producer formally objects and says it can provide the metals.

  6. Assess the classifications of imported products.

    The classification of each product determines whether or not it is included in the tariff order. Whether there is an accidental misclassification, an intentional misclassification by the overseas seller or a product that is within a gray area, an audit of the classifications of your imported goods will avoid surprises, potential liabilities and could result in an avoidance of higher tariffs.

  7. Import sooner rather than later if you can.

    If your source material is subject to the 10 percent tariff, you may want to procure more before the tariff jumps to 25 percent.

  8. Seek out alternative sources of supply.

    In order to shield your business from the disruption caused by tariffs, explore alternate sources of supply. Be prepared to onboard new supply partners quickly, a process that might include partner profiles, legacy systems, custom coding and new systems to securely exchange order, invoicing, shipping and payment data.

Time will tell what the extent the impact of new tariffs and trade policy will have on the manufacturing industry. There is one clear certainty among today’s uncertainty: whether short- or long-term in duration, the time to prepare and protect your business interests in today’s shifting trade environment is now.

Insight Exchange GT logoThis article is part of an exclusive content series for Grant Thornton’s Insights Exchange, where you will be connected with peer executives and leading experts to share best practices and solutions to help build tomorrow’s organizations today.

Contact:

Jeffrey FrenchJeff French
National Managing Partner, Consumer & Industrial Products
T +1 920 968 6710