Global trade is riddled with uncertainties. Trade agreements have long existed to try to reduce some of that uncertainty, create a more even playing field, or to create mutually advantageous trade conditions between specific countries. The significant increase in tariffs proposed by the upcoming Trump administration adds to the challenge of businesses working to safeguard profitability. Tariffs hit hard on the bottom line by hiking up costs across supply chains, thereby affecting sourcing, manufacturing, and distribution decisions. However, if organizations adopt proactive tariff optimization strategies and build adaptive supply chains, these challenges can be turned into opportunities. Here’s how.
Understanding Tariff Dynamics
Optimization for tariffs requires that organizations understand how tariffs play into their supply chains and that they model their impact. Having a supply chain digital twin set up makes the process of understanding the impact of tariffs much easier. However, understanding tariffs in detail is only the first step, especially when they are constantly evolving. Below are some of key areas businesses need to familiarize themselves with to understand tariff dynamics:

A) Tariff Points in the Supply Chain

Tariffs can be imposed at any of the following levels: raw material, manufactured or semi-finished goods, or finished products. Knowing the product tariff points is crucial to enable enterprises to identify specific areas where costs are likely to be affected and create effective strategies for dealing with such impacts. The following are the stages of a product in its journey from raw material to the final consumer and where impact can occur:

1. Raw Material Stage:

Impact: Tariffs on raw materials, like metals, minerals, or agricultural products, directly increase input costs to the manufacturers.

Strategy: Diversification of raw materials sources, exploration of alternative materials, or investment in domestic production are some of the ways to limit exposure to the tariff.

2. Intermediate Goods Stage:

Impact: Tariffs on intermediate goods, like components or semi-finished products, will increase the manufacturing cost.

Strategy: Reshoring production, regionalizing supply chains, or finding alternative suppliers are among the strategies available to mitigate the impact of tariffs on intermediate goods.

3. Finished Goods Stage:

Impact: Finished goods tariffs can be so high that it increases the cost of goods sold, therefore impacting pricing and competitiveness in the marketplace.

Strategy: Product redesign, value-added manufacturing, and duty drawback are a few of the numerous potential strategies to implement to lower the tariff burden.

B) Rules of Origin

“Rules of origin” refers to regulations that identify the country of origin of a product and the tariff rates on that product. These are often complicated rules that differ for each commodity, state, or country.

Key considerations for rules of origin regulations:

Substantial transformation:

The product is substantially transformed in a country so it can be said to have originated from that country thereby avoiding a tariff.

Example: Aluminum ingots are imported from China into the U.S. and then fabricated into aluminum car parts. The fabrication process in the U.S. is considered a substantial transformation because the aluminum ingots are converted into an entirely new product with a different name, character, and use.

Regional value content:

A minimum percentage value of the product added within the specific region or economic block.

Example: A pickup truck assembled in Mexico using parts from the U.S. and Canada must meet the USMCA rule requiring 75% regional value content. If the truck’s total value is $30,000, at least $22,500 of the value must come from the USMCA region (U.S., Mexico, and Canada) to receive tariff-free treatment under USMCA.

Change in tariff classification:

There should be sufficient change in the tariff classification of the merchandise for the item to get preferential treatment.

Example: Imported raw cocoa beans (HS code: 1801) from Ghana are processed in the U.S. into chocolate bars (HS code: 1806). The significant processing alters the HS classification from raw cocoa beans to finished chocolate bars, qualifying the chocolate bars as a U.S.-origin product for preferential trade treatment under trade agreements that require a change in tariff classification.Understanding such rules helps companies to streamline their supply chains in order to reduce the tariff costs effectively.

C) Effect of Value Addition

Value addition is enhancing the value of a product by transforming raw materials or semi-finished goods into a more finished or marketable form, thereby increasing its worth. The more value addition, the higher the tariff rate. The implication of this on strategy:

Domestic Value Addition:

Companies can bring about value addition within their home countries in order to reduce the impact of tariffs on the imported components.

Example: A company imports semiconductors but designs and assembles final electronic products in the U.S. By adding domestic innovation and assembly, it minimizes tariff impact and qualifies as a U.S.-origin product under certain rules.

Strategic Sourcing:

This would involve sourcing components from countries that have lower value-added requirements, hence reducing tariff costs.

Example: A U.S. clothing brand sources fabric from Vietnam, which has a trade agreement with the U.S. requiring lower value addition thresholds for tariff reductions.By strategically sourcing from Vietnam instead of China, the company reduces overall tariff liability.

D) Dependent and Independent Variables:

Tariffs as a Double-Edged Sword

Whether tariffs are dependent or independent variables has a significant impact on how they impact companies.

Dependent Variable:

Tariffs are often dependent on trade agreements, geopolitical factors, and economic conditions. For instance, a country can negotiate preferential trade agreements with its trading partners, thus enjoying lower tariffs.

Independent Variable:

Tariffs can also be independently imposed regardless of the state and conditions of the trade agreements. This builds uncertainty for companies and makes consumers nervous about cost increases.

Tariffs could have positive or negative impacts depending on the scenario

Now that we have seen the factors that impact tariffs, the following examples illustrate three real-life scenarios of tariffs (both positive and negative):

Solar Industry:

● Section 201 Tariffs: In 2018, the Trump administration imposed tariffs on imported solar cells and modules under Section 201 of the Trade Act of 1974. This significantly increased the cost of solar energy projects, slowing the growth of the U.S. solar industry and leading to job losses.

Automotive Industry:

● Section 232 Tariffs: The Trump administration also imposed Section 232 tariffs on steel and aluminum imports, which are crucial components in automobile manufacturing. These tariffs increased the cost of producing vehicles in the U.S., making them less competitive in the global market.

Residential Appliances Industry:

● Section 201 Tariffs: The Trump administration imposed 20% Section 201 tariffs on imported large residential washing machines.Companies like Whirlpool expanded U.S. operations, creating more jobs and boosting local economies. After initial price increases, competition among domestic manufacturers drove prices down, leading to affordable options for consumers.
Key Strategies to Optimize Tariffs and Build Adaptive Supply Chains
In our opinion, tariffs are a constraint that must be modeled within the end-end supply chain model in addition to all other constraints such as production, logistics, consumer demand, interest rates, taxes, etc. Objectives such as costs, margins, resiliency, and sustainability must simultaneously be optimized to meet these goals.

In real-life it is not possible to optimize all objectives equally and hence the corporate and societal goals drives the priorities. For instance, is the goal to maximize corporate profits while not taking into consideration the goals of the society of improving employment or sustainability vs trying to balance profits with societal goals such as increased employment. In other words, it is important to have a clear idea of the objective and constraints. There are three strategies that companies can adopt in order to optimize around the constraints imposed by tariffs and build adaptive supply chains.

A) Integrated Scenario Planning

Integrated scenario planning lets companies model the effect of potential tariffs on their supply chain. Building adaptive supply chains equips organizations with the ability to react faster and more positively toward these changes. This includes:

Modeling Different Scenarios:

Quantify how tariffs change with regard to variables such as supply chain geography and the level of value addition.

Manufacturing Footprint Optimization:

Evaluate the cost-benefit tradeoffs of moving production to locations closer to key markets as a means of minimizing tariff exposure.

Sustainability improvements are often a byproduct of manufacturing footprint optimization.

Ensure that sustainability is one of the objectives modeled.

Export-Import Offsets:

Identify cases where exports can be used to offset import tariffs while maintaining balanced and strategic trade flows.

Antifragility:

Developing a highly adaptive supply chain – one that can move fast in response to disruptions, such as unexpected tariff increases. An antifragile supply chain improves supplier diversification, reduces capability redundancy, and can deploy advanced technologies quickly.

B) Optimizing Sourcing and Diversification

Being dependent on one country or one supplier greatly increases the risk to business due to tariffs. Diversification can be achieved in several ways:

Regional Sourcing:

Lessen the impact of tariffs by sourcing supplies from countries that have favorable trade pacts with the consuming countries.

Nearshoring and Onshoring:

Improve supply chain resilience and potentially avoid tariffs by moving production closer to home markets.

Optimize Supplier Mix:

Adopt a diverse mix of suppliers, irrespective of whether companies are nearshoring or offshoring, can help ensure that ESG goals are met.

Optimize Product – Production Type Mix:

Minimize the impact of tariffs by identifying opportunities for semi-finished goods import and final assembly versus importing finished goods. CKD (completely knocked down) kits for automotive is an example of countries performing final assembly to avoid tariffs.

C) Cost-to-Serve Models

Adopting the cost-to-serve model enables companies to adopt real-time measures to offset tariff effects. This will include:

Transport Node, Flow, and Mode Optimization:

Cost-to-serve models allow the consideration of different nodes of warehouses, cross-docks, and production facilities. Flows indicate the transportation of materials from one node to another using a transportation method such as air, rail, or truck. Tariffs will be an input factor to decide on the nodes, flow, and modes of the supply chain network.

Cost-Revenue Analysis:

Know how the tariff will impact the profitability of every product at various touchpoints in the supply chain.

Incremental Costing:

Understand how the imposition of the tariff impacts production and distribution costs and make decisions on cost absorption, offsetting, or passing on.

AI-Driven Insights:

Leverage AI and machine learning to get ongoing analyses of the tariff scenarios for next-best responses.

Companies can stay ahead of all the complexities of the global trade landscape and come out more robust by embracing scenario-based decision-making and building adaptive supply chains. Download the white paper, 6 Strategies for Building an Adaptive Supply Chain, to understand how institutionalized scenario-based decision-making helps you handle all types of disruptions with peace of mind.

Nari Viswanathan
Sr. Director, Product Segment Marketing, Coupa

Nari is currently Sr. Director of Product Segment Marketing at Coupa, where he brings products to markets in the areas of Direct Material Procurement and Supply Chain Design and Planning. Over the past 20 years, Nari has held VP and Director of Product Management, Research and Marketing roles at Aberdeen Group, River Logic, Steelwedge and E2open. He has significant experience building products from the ground up and managing the P&L for a product suite. He is a proven B2B marketer with expertise in content marketing, competitive intelligence, and positioning. He has published numerous thought leadership articles, whitepapers, blogs and delivered dozens of webinars during his career. Nari Viswanathan is a six times SDCExec Supply Chain Pro to Know award winner. Nari holds a master’s degree in Manufacturing Systems Engineering at the University of Wisconsin-Madison and a bachelor’s degree in Mechanical Engineering at the Indian Institute of Technology, Chennai.

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