by Vivek Sood

May 31, 2019

As the saga with the US tariffs on Chinese goods is playing out in the public arena, there is a lot of speculation about who the ultimate losers and winners in this game will be.

There is Plenty of Shallow Analysis

Most journalists do not have time to think it through deeply, and most serious commentators are economists, who take a game theoretical approach.

I want to add one more, a real-world analytical perspective to the debate – the supply chain perspective – something that most economists and game theory exponents lack.

The Results of Deep Analysis are Startling

If President Trump knew this, probably he would not impose the tariffs, and perhaps even remove the existing ones.

So, what is the conventional wisdom about tariffs in general? Economists believe that all tariffs come out of the pockets of the end consumers – but that is because economists lack a deep supply chain perspective.

Let’s Go Deeper – Smile Curve

If you deeply explore the supply chain margins for a typical Chinese import into the USA – you will eventually come to the smile curve as shown below:

Margins in supply chains

A typical smile curve lays out the entire supply chain on the horizontal axis and the margins of each activity on the vertical axis. It allows companies to decide where, in the entire supply chain, is the highest margin.

Intuitively, or explicitly, almost every company is doing this analysis to determine where to play, and what to outsource. There is a lot more to be said about this body of work, that is relevant to strategic supply chain decision making, which I am not going into at the present moment. I will keep that discussion to another blog post.

Manufacturing Margins

For most items imported into the USA, only one activity – manufacturing (that is shown in a box) – is carried out in China. This activity also happens to have the lowest margins in the entire supply chain.

Every company configures its own business network of internal and external teams to carry out all the activities on the smile curve. Almost all other teams have a much higher margin than the manufacturing team. That is the reason why manufacturing was outsourced in the first place. That is also the reason why global supply chains are currently configured the way they are.

So, when it comes to bearing the cost of tariffs, manufacturing is not in the position to bear it. This is because manufacturing is a very small part of the overall value chain. For example, for a sneaker that is sold for $100 in the shopping mall, the manufacturer will be lucky to get around $15.

International Supply Contracts Are Very Clear

Imagine a sub-contractor in China – manufacturing shoes, or shirts, or bathroom scales, or anything out of the countless numbers of items being imported from China on a daily basis.

Almost all of their contracts with the US buyers are signed on FOB (with the occasional exception of CIF) basis. In both cases, the duty (tariffs) are paid by the US importer. In fact, in all but one case (DDP – Delivery Duty Paid), the tariff is paid by the US importer.

To get the details of these terms, and what they entail, look at the figure below. Each row below shows a different type of international sale contract and who is responsible for what activities in that type of contract:

The last row of the table shows DDP – an import contract that is almost never used in practice. That is the only type of contract where the Chinese exporters would be compelled to pay the tariffs.

This practice is so deeply entrenched that out of all the possibilities shown above only in a handful of cases have I seen DDU in while examining tens of thousands of import contracts in over 30 years of experience.

I do not expect President Trump to know this because he has barely any experience in the international sale of goods. However, his negotiation team and strategy planning team would have clearly known this because the table above is derived from the International Chamber of Commerce (ICC – 2018), and is common knowledge.

Why Importers Pay the Tariffs

In our work we never recommend DDP type of contracts, precisely for this reason – the seller cannot control unexpected imposition of tariffs any time after signing the contract, and before delivery of goods.

Additionally, there is no margin in this activity, so why take responsibility for extra work with no reward in return, and the additional risk of monetary loss?

The Key Question – Who Will Bear the Burden of the New Tariffs?

So if the US importers are going to pay the tariffs, would they be able to pass these on to the end consumers, or will they bear it themselves? That depends entirely on the price elasticity of demand and pricing power enjoyed by the importer, or end retailers.

To answer that question let us look at the latest news (April 2019) here. The most relevant quote is below:

America has too many stores.This year, US retailers have announced that 5,994 stores will close. That number already exceeds last year’s total of 5,864 closure announcements.

I do not want to belabour the point because it is amply clear that store chains have almost no pricing power left. Unfortunately, neither do their suppliers – the US importers. That eco-system is already drying up – otherwise, why would those stores be closing left, right and centre?

Who Has The Pricing Power?

Only one company has the margin, and pricing power in this entire supply network as is clear from the info-graphic below (click to see larger scale version):

It will take an entire blog post to go into the reasons for the pricing power differential between Amazon and its competitors. So I will not get into that discussion here. Let’s move to the impact of this differential.

Tariffs Would Lead to Closure of More Stores and Shopping Malls

In the short run, tariffs will accelerate the migration of market share to Amazon and its marketplace. This will be a surprising development given the other history between President Trump, and Mr Bezos – the owner of Amazon.

Amazon Would be The Biggest Beneficiary of These Tariffs

In the medium run – given Amazon’s growing pricing power, as the store chains close down – it is likely that some of the tariffs might even be passed down to the end consumers.

I would not like to speculate, how the tariffs will pan out in the long term because of much wider implications for the two economies that so closely intertwined.

Effect of The Trade Wars

“The benefits and costs of these tariffs are not falling where expected. In fact, their impact will be the opposite of what was intended.

If China retaliates, the effect may be even worse because the export commodities supply chain smile curve looks very different.”

— Vivek Sood

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Vivek Sood

  • But, I believe, when the government creates a benefit for one American, it is a virtual guarantee that it will come at the expense of another American, an unseen victim. The victims of steel and aluminum tariffs are the companies that use steel and aluminum. Faced with higher input costs, they become less competitive on the world market. For instance, companies such as John Deere may respond to higher steel prices by purchasing their parts in the international market rather than in the U.S. To become more competitive in the world market, some firms may move their production facilities to foreign countries that do not have tariffs on foreign steel and aluminum.

  • I think this choice comes when CEOs and officials must take a gander at options in contrast to the Chinese supply chain network. Many people articulate that Mexico would be an option, however at this point it looks in risk. The hazard is that these duties, alongside those forced on China; push an effectively delicate business cycle into an out and out retreat. That is as of now what bonds, oil, and copper are for the most part flagging.

  • I think this decision comes at a time when CEOs and executives have to be looking at alternatives to the Chinese supply chain. Many thought Mexico would be an alternative, but now that looks in jeopardy. The risk is that these tariffs, along with those imposed on China, pushes an already soft business cycle into a full-blown recession. That is currently what bonds, oil and copper are all signaling.

  • The move took aim at a country that has been one of the primary beneficiaries of the U.S. trade escalation with China. It also comes as tensions between the countries had eased, with the U.S. preparing to formally submit the United States-Mexico-Canada Agreement, the so-called new Nafta, to Congress, and after a recent move to lift steel and aluminum tariffs on Canada and Mexico and delay a decision regarding auto exports. But the thaw was short-lived, and the administration’s tariff announcement adds further uncertainty to an already fraught situation.

  • Such a worthy article. There are a few significant monetary exercises that American individuals ought to learn. I’m going to state it the seen and inconspicuous. President Donald Trump instituted high duties on imports of steel and aluminum. Why on the planet would the U.S. steel and aluminum enterprises press the president to impose overwhelming duties? The appropriate response is basic. Lessening the measures of steel and aluminum that hit our shores empowers American makers to charge more expensive rates. In this way, U.S. steel and aluminum makers will win higher benefits, employ more laborers and pay them higher wages. They are the unmistakable recipients of Trump’s duties.

  • In any case, I accept, when the administrative bodies make an advantage for one American, it is a virtual assurance that it will come to the detriment of another American, a concealed injured individual. The casualties of steel and aluminum levies are the organizations that utilize steel and aluminum. By looking with higher information costs, they become less aggressive on the world market. To turn out to be progressively aggressive on the planet advertise, a few firms may move their offices to remote nations that don’t have taxes on outside steel and aluminum.

  • There are a couple of important economic lessons that the American people should learn. I’m going to say it the seen and unseen. President Donald Trump enacted high tariffs on imports of steel and aluminum. Why in the world would the U.S. steel and aluminum industries press the president to levy heavy tariffs? The answer is simple. Reducing the amounts of steel and aluminum that hit our shores enables American producers to charge higher prices. Thus, U.S. steel and aluminum producers will earn higher profits, hire more workers and pay them higher wages. They are the visible beneficiaries of Trump’s tariffs.

  • The move trained in on a nation that has been one of the essential recipients of the U.S. exchange heightening with China. It additionally comes as a pressure between the nations that had facilitated with the U.S. planning to officially present the United States-Mexico-Canada Agreement, the supposed new Nafta, to Congress and after an ongoing move to lift steel and aluminum levies on Canada and Mexico and postpone a choice with respect to auto sends out. In any case, the halt was brief, and the organization’s tax declaration adds further vulnerability to an officially full circumstance.

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