Tariffs & the Path Forward
Tariffs continue to cause great stress in the financial markets and with certain industries. In fact, it divides manufacturers from distributors, logistics, and goods movement industries largely dependent on imports and trade. Of course, the devil is in the details. Depending on your industry and specific situation, you must create a near-term path forward while simultaneously developing a longer term strategy for success. After listening to business colleagues, panicked trade and logistics panelists, and alarmed newscasters, we decided to provide our insights and forecasts along with strategies for supply chain success.
Snapshot of the Current State of Manufacturing & Logistics
There has certainly been a lot of turbulence in the news on tariffs. Let’s start with the current state with a focus on the industries we are expert in.
- Manufacturing: Let’s take a step back. Manufacturing was in a recession throughout the last year. In fact, backlogs dropped dramatically in the second half of last year as the economy that was fueled with government spending ran out of gas. Positive signs of life started returning early this year as favorable and competitive tax and regulatory policies gained momentum. The tariffs are likely to spur domestic and regional manufacturing while causing concern and initial inflation for manufacturers dependent on materials and components from China. Overall, businesses do not like volatility and instability, and so the unknown creates market jitters. Thus, consumer confidence can impact volumes, at least in the short-term.
- Logistics: The big money in the logistics industries relates largely to trade as ocean freight, Amazon type products (package freight), and port related transportation (rail, trucks etc.) are largely dependent on imports from China. This industry and specifically the Southern California region with 80% of the port volume related to China is extremely concerned. Companies pre-bought inventory prior to the tariffs taking effect, and so it is not surprising that orders would come to a screeching halt (similar to manufacturing orders in late 2024). This impact in future orders will start showing up in a month, and so the distribution, transportation, and deliveries continue at a normal pace although executives are concerned. Although it will be a BIG topic in these circles and on the news, this volume will pick back up as companies work through their inventory. The question is the timing, supply chain reconfigurations and the specific impacts on your portion of the supply chain.
Likely Reasoning Behind the Tariffs
Although there has been a lot of volatility in the rollout of tariffs, an alternate, more positive view is that it might be organized chaos. To explain further, let’s talk about the likely reasoning behind the tariffs and how seemingly contradictory items might come together.
Manufacturing has been on a downward slope since the early 2000’s as trade favored the U.S.’s trading partners and China entered the WTO. Originally, there were short-term strategies to give favorable trade conditions to other countries for foreign policy reasons; however, continuing them for the long-term has created trade imbalances and negative consequences. Manufacturing capabilities have flipped from the U.S. to China, national security issues have escalated, and high paying manufacturing jobs have disappeared.
Since 1997, 5 million manufacturing jobs have been lost, and 90,000 factories have been closed. Why does this matter if U.S. companies are still growing, they can make higher profits (as they don’t have to follow compensation, employee, regulatory, environmental, and financial rules for imported product from countries like China) and customers are satisfied? The environment isn’t sustainable. No matter how innovative, U.S. companies cannot follow U.S. rules and compete with those companies that don’t and/or those that have huge tariff and non-tariff trade barrier discrepancies (you might pay 10, 100 times or even larger tariffs in comparison).
Over time, more and more companies move manufacturing to less expensive options as they have to meet quarterly objectives whereas China can throw money at whatever issue arises for years at a time while implementing their 100 year plan. For every $1 invested in manufacturing, $2.67 is added to the economy. Instead, the U.S. economy has become based on consumption ($1 to $1 ratio). In essence, it is a bit like empty calories. If you have a stronger base with a value added foundation (investing your dollars in something that returns added value), it is like eating healthy food. On the other hand, if you run on pure sugar, you will run on a high for a long time until you eventually hit the wall.
You might wonder why it matters if the economy remains robust and the stock market continues to go up. Continuing with the empty calories theme, racking up debt for empty calories isn’t sustainable. Additionally, COVID was a wake up call. Should we be dependent on countries and companies we cannot trust with a proven track record of turning off supplies when desired? It is quite clear that we should not rely on them for items related to national defense, infrastructure (supplying electricity, water, food, transportation, etc.), food, and medical/ health. However, in today’s end-to-end supply chain, you are only as strong as your weakest link. Thus, you must ensure every aspect can be covered from equipment manufacturers to steel and aluminum to rare earths to water delivery systems and tires (after all, vehicles don’t go anywhere without tires!).
You cannot turn on a dime when an emergency occurs. Instead, you must build capabilities, capacity, culture, and cost effective strategies over time while continuously improving along the way. On the other hand, if you pursue this plan, you can turn on a dime with resiliency to changing conditions.
Do we need the old world view of industrial manufacturing as we hear accusations of going back to the 1950’s? No! Our clients are high-tech, innovative, pursue lean principles and forward-thinking strategies and create a family environment. There are fewer low skilled positions as jobs are automated for improved and consistent quality, safety and interesting work, yet there are more high-skilled, high-paid roles. Smart companies are pursuing training, education, mentoring, and upskilling strategies. Wages are 16-20% higher in manufacturing than average wages. Based on our client base, this is a low figure as manufacturing continues to go high-tech. These industries require the trades as well such as electricians, plumbers, maintenance, etc. Keeping these types of skills to fuel key industries such as aerospace and energy is of paramount importance.
The future is in AI. AI requires semiconductors, rare earths, and vast amounts of energy. For example, estimates are that AI will require at minimum, ten times the energy to fuel. A recent study showed that the computational power tor AI growth doubles every 100 days. Refer to our Supply Chain Bytes videos on energy, manufacturing etc.
Thus, tariffs seem to be the strategy to ensure capabilities around critical industries and related supply chains. Although not targeted specifically, we estimate it is the expected outcome, thinking multiple steps down-the-line.
Our View of the Current State with Tariffs
Listening to the news, it might sound like tariffs are being used as a negotiating tool, to pay down our debt, to fund tax decreases (to stimulate growth), to level the playing field for all manufacturing, to focus exclusively on critical industries, to prevent dumping, to get back at countries taking advantage of unfair trade policies, or simply just for crazy reasons. Our view is that it could be a bit of all of the above with a heavy dose of focus on critical industries, talent and technologies (AI) to fuel the future.
Businesses
Of course, large businesses are negatively impacted if access to cheap goods is turned off, and so the stock market does not like the near-term prospects (as the next few quarters and year ahead is considered long term in those terms). These companies are also worried that if the consumers get scared, they will stop consuming which will negatively impact growth. They aren’t wrong. This is a problem that relates back to the empty calorie theory! Businesses also like stability, and so the unknown and changing nature of the discussion is also a drag on the stock market. However, if you look at it from the other side of the equation, if businesses know the end result, the competition does as well, thereby showing your hand and losing the deal. What is the point of looking long-term and suffering pain if you lose every deal even when starting at a steep tariff inequity? Smaller companies are especially worried about inflationary pressures as they struggle to survive as it is, and they know they are at a competitive disadvantage globally and struggle to invest in technology, talent, and expansion. 98% of manufacturers are considered small businesses (refer to our Made in the America Supply Chain Byte).
Large manufacturers
Large manufacturers are generally better prepared to reallocate production, invest in new equipment and facilities, and produce to scale. On the other hand, small companies tend to be more innovative and develop new technologies and strategies to take a sharp right turn when everyone else is going left. During the Depression, more forward-thinking companies willing to invest and take prudent risk shot to the top of their industry or market than in any other time in history. The next several years will provide the same level of opportunity due to volatility and stabilizing from the high risk and vulnerability in the current state environment (we are not forecasting a depression).
Logistics
Manufacturers have been in a recession for a year; however, many other industries have been booming. For example, logistics has been booming since COVID as people purchased products like they were going out of style. This was followed by panic buying safety stock so they wouldn’t have to worry about being caught off guard again. Next up, geopolitical and supply chain risks rose up mightily (ship stuck in the Suez Canal, water shortage in the Panama Canal causing 50% capacity cut, Houthi rebels attacking ships in the Suez Canal, China Taiwan tensions, Russia-Ukraine war, the Middle East war, exploding pagers and so on). Logistics soared as companies continued to purchase safety stocks and started thinking and talking about domestic supply chains, but inflationary pressures were extreme and the cost differential was still too high for much movement to occur. In fact, our researcher scoured the internet to find examples with a few drops here or there. Mexico did become popular as some companies added Mexico capacity with the benefits of USMCA, and China started building mega factories to ship products to Mexico to take advantage of free access to the U.S. market. This came to a halt when it looked like Trump might win. Last but not least, when tariffs came into focus, logistics boomed again as companies wanted to pre-position inventory to mitigate the impacts of tariffs.
Economy
From an economy standpoint, if you are dependent on large stock market returns which have only become commonplace the last few years, you do not want to hear that you might need to work longer or even run out of money vs your expectation (however unrealistic it might be vs historical returns). In fact, you are likely to spend less, which could create a recession thereby spiraling out of control. Making the transition to domestic and regional supply chains from the global status quo will take time for companies to reconfigure supply chains, vertically integrate, and gain the capital required to invest in expansion as governments and private funders enhance the required support systems (rare earths, energy, etc.) Companies will have to be better (people, processes, systems, capabilities, strategies) to achieve these goals in a sustainable way in a commonsense regulatory environment. No empty calorie strategies will succeed long-term.
On the other hand, if you never address the issue because there are downsides, you are likely to run straight into a wall (instead of a light at the end of the tunnel, you are likely to hit a train). However, because of the downsides (even to some manufacturers if they source materials from China or other countries at high tariff risk), it is normal to prefer to address the issue in the future.
What propels change
This situation reminds me of one of my HR mentor’s best pieces of advice. As she used to say, most people do not change unless there is a significant emotional event. There are simply too many compelling factors (bottlenecks) stalling meaningful progress on the critical industries. As much as it seems logical to create training and mentoring programs and make the appropriate changes in the organization and related supply chains to ensure long-term success, you are still responsible for quarterly results and gaining access to capital. In addition, Newton’s First Law of Motion remains intact – an object will maintain its state of motion (either at rest or in motion at a constant velocity) unless acted upon by an external force. Thus, the decline of U.S. manufacturing and the rise of China manufacturing will carry on unless accompanied by a significant emotional event. COVID is no longer top of mind enough to address the harsh realities.
Whether planned or chaotic, tariffs created a significant emotional event.
Our Tariff Forecast & Impacts on Manufacturing, Logistics & the Market
We believe negotiations will take place around the world, creating a new trade playing field. The field will not be leveled as that would tip the scales to a global recession; however, more favorable (“fairer”) terms will be set up with friendly nations and specifically targeted on building regional supply chains. End-to-end supply chains will come into sharper focus from rare earths, natural resources, energy, end-to-end manufacturing and processing capabilities and supporting logistics / goods movement systems required to support critical industries.
Domestic manufacturing
Domestic manufacturing will ramp up (reshoring, expansion, new investments, foreign direct investment, vertical integration) but remain focused on critical industries and supporting supply chains as well as commonsense, innovative solutions. For example, if you are going to re-configure your supply chain, why not take a step back and redesign products to require less labor, provide enhanced value to the customer etc.? That might change your sourcing and network design decisions. New entrepreneurs will jump into the mix to take advantage of the opportunities whereas some owners/ companies might decide to retire or sell instead of taking on the significant challenges.
Regional supply chains
Regional players will gain. Mexico wants access to the U.S. market (as they have gained significantly with the USMCA) and has the advantage of scale since they have been building capabilities for quite some time. It is important in manufacturing. China is #1 in the world in manufacturing, and the U.S. is #1 in consumption, therefore requiring the ability to produce/ supply at scale. With that said, you must remember your end-to-end supply chain and supporting factors such as water, electricity and goods movement infrastructure. Canada has the advantage of natural resources and wants protection and also has an intermixed supply chain with the U.S. Thus, the USMCA countries will remain committed to working together with tweaks although there will be lots of tense discussions and ranting and raving to go around.
Latin America
Latin America will flourish. Brazil is a strong trading partner. Argentina is a rising star (refer to our recent article on this topic). Costa Rica has been a haven for semiconductor and high-tech manufacturing such as medical devices although isn’t producing at scale. Puerto Rico has focused on pharmaceuticals. Panama has the critical waterway connecting the Atlantic and Pacific. There will be opportunities across the board.
Asia
With that said, companies will not fully move out of China. You don’t go from being #1 to #10 in a flash, and they do 85% of rare earth processing in today’s marketplace and control 60% of the globe’s semiconductors (with Taiwan controlling 90% of the advanced semiconductors). Our estimate is that 25% of China’s supply chains will move to the U.S. and supporting regional supply chains over the next ten years. With that said, additional supply chains will move out of China to Vietnam, South Korea, India, and Latin America. Companies will move towards producing for regional consumption (ie. Asia for Asia, Europe for Europe etc.), and so large companies will continue to have global supply chains even though they will be reallocated and re-configured.
China
It is likely the U.S. will work out a deal with China, and companies will continue to purchase from China especially if it is non-essential and a small percentage of their requirements. For example, a food and beverage manufacturer purchases 3% of their ingredients from China, and so although it will cost more to pay the tariffs, it isn’t the priority to change suppliers. Of course, backup sources of supply remain a priority. There are also items that China has developed an expertise in producing that will remain there for the foreseeable future. New technologies will be developed which will further evolve supply chains. In fact, new technologies have the capacity to completely revamp current thinking and make domestic and/or regional sourcing a reality. For example, additive manufacturing changes the game.
Global Logistics
There will be significant changes in global logistics. The Southern California ports and related logistics partners will be most impacted because China drives 70-80% of their volume. Near-term, customers have stopped ordering as they prepared for a temporary pause with tariffs by driving up safety stock levels. Others simply cannot afford the tariffs and are sourcing alternatives. Thus, container shipping, port volumes and related logistics systems will slow down dramatically for 30-90 days depending on inventory levels and tariff discussions. Other trading partners such as Vietnam remain steady and increase over time; however, they are the smaller player vs. China. Warehousing and distribution is likely to slow down briefly after the rush of accelerated shipments to avoid tariffs; however, we expect it to remain robust as customers look for overflow space and short-term flexibility while evaluating free trade zones and reevaluate supply chains. Transportation and goods movement follows evolving supply chains. Although certain segments will be impacted more than others, if volumes stay even overall, this segment will “follow the goods”. The exception is the really small package di minimis exception loophole that is scheduled to be closed in the next month. It won’t impact the overall logistics industry but it will decimate that particular loophole and companies related to it.
Southern CA Logistics
Longer term, the Southern California ports might slow down as China’s volume is replaced with India (and others in Asia), Latin America and domestic manufacturing. Companies can ship to the East Coast through the Suez Canal, and are less likely to send through the West Coast ports; however, companies will stay resilient to evolving conditions. The competitive, innovative and those with advanced technologies will thrive. As supply chains reconfigure, distribution and warehousing will evolve with the changing conditions. For Southern CA, we expect a reallocation and reconfiguration of warehouse space. It will remain a key hub as there is a high concentration of consumers, and the ports have competitive advantages (deep water for larger ships). We expect warehouses to continue to support outgoing shipments for the western states (at a minimum) assuming they focus on being cost competitive, and rail will remain robust as the capabilities are significant. Warehouses will also be redeployed to receive goods from the interior to support the local consumer base.
Markets
In terms of the markets, there will be volatility. Since businesses have relied on cheap goods, there will be some inflationary pressure since costs from China will be higher even though a deal is expected. On the other hand, other major trading partners will work out deals, and since the U.S. tariffs and other barriers are so high, prices could come down. Additionally, other countries will take advantage of the opportunity to sell into the U.S. with lower tariffs. Thus, there will be volatility and dramatic changes per item, industry, and/or country; however, overall, we expect overall costs to be mildly inflationary for imported goods. These costs are likely to be offset and possibly deflationary when you take energy costs into account. Since energy and electricity fuels manufacturing, logistics, agriculture and food processing, and everyday needs, as supply increases and costs decrease (our favorite supply / demand conversation!), it will impact prices across the board. Also, as taxes decrease, it will have a deflationary impact on prices. Thus, overall, our longer-term expectation is for prices to remain in line.
From a personal point-of-view, I will stick with my Aunt Joan’s theory of investing. Focus on companies that make things people need (and obviously with solid companies). Clearly, we will need whatever it takes to fuel manufacturing growth, energy production, active pharmaceutical ingredients (API) to ensure drug security, and advanced technologies / AI. Pick the best and invest in the long-term. Everyone (me included) thought she was insane in her investing choices and seemingly taking big risks for a senior person, but she has turned out to be better than almost everyone else.
Path Forward to Navigate Tariffs
You must leap into action if you haven’t already. In the next few years, there will be more opportunities to shoot to the top of your market than ever before. Or, there will be more opportunities to accelerate your decline. Choose wisely. Leadership is not going to be easy or a “cake job” yet it will have massive payouts.
Immediately, you should take action to secure your business in the short-term while preparing for long-term success.
- Secure supply: for near-term needs at a minimum and evaluate additional steps including safety stock, jumping on sourcing (expansion, new sources, new locations, etc.) etc.
- Assess: Rapidly figure out your end-to-end supply chain – start by asking the 5 whys. Who, what, when, where, why? Review the priority and criticality of each material. Assess your risks, alternatives, likeliness, and urgency.
- Visibility: Increase your end-to-end supply chain visibility so that you can trace changes and/or issues in your end-to-end supply chain. It will enable you to stay ahead of changing conditions.
- Build resiliency: No matter your position in the supply chain, the more flexible, agile, capable, and ability to pivot and/or scale up or down, the better.
- Culture of innovation: Only the innovative will thrive during these VUCA-laden (volatility, uncertainty, complexity, ambiguity) times when you must think on your feet.
- Create predictability: It will no longer be enough to react quickly; you must predict, take prudent risks, and invest wisely so that you are ready to leverage the opportunities when they arise, mitigate the risks or avoid the bottlenecks.
- SIOP (Sales Inventory Operations Planning): Roll out a SIOP process to better predict demand and adjust your operations and supply chain to prepare for success.
- Upgrade talent & technologies: Navigating tariffs successfully and preparing for the future will necessitate upgraded talent (upskill, expand, supplement, add) and technologies (additive manufacturing, ERP, AI, digital twins, IoT)
- Redesign products: It is an opportune time to redesign products to be less dependent on labor, to address material supply considerations, to reduce cost while maintaining quality etc.
- Regional supply chains: The future will be mainly focused on regional supply chains with quick responsiveness to changing product designs, customer and market conditions, supplier needs, lead times, etc.
- Energy & natural resources: Ensure availability for what you need currently and down-the-line (ie. AI, changing requirements)
- Financial: There is no doubt that the successful will have access to capital when needed and will be forward-thinking on how to support the business.
- Common sense assumptions: Use common sense and proceed accordingly. You cannot wait for clarity (wait too long) although it is important to not jump before you know if you are going in the directionally correct “right” direction (not wait long enough). Most people should push forward sooner rather than waiting for every i to be dotted and t to be crossed.
- Deep dive into tariffs: Learn about tariffs in detail, find online training and education, hire trusted advisors (coach/ consultant, attorney and CPA) familiar with navigating the process, evaluate potential bottlenecks etc.
Depending on your company type and situation, modify your response.
- If domestic manufacturer: If you are a manufacturer with minimal items dependent on China in your end-to-end supply chain, build your capabilities and capacities (including your key suppliers) as you will have significant opportunities to expand. Upgrade your talent, processes, systems/ technologies, strategies, etc.
- If global manufacturer: Get ready to pivot, expand and/or move equipment and reallocate capacity, keep key suppliers and transportation partners in the loop, etc.
- If dependent on China: Secure supply for your core customers, diversify key sources of supply immediately in your end-to-end supply chain, source backup sources of supply, and bring in additional critical items while preparing for the future.
- If distributor: Get ready to pivot, take advantage of short-term space needs and keep your ear to the ground for changing conditions so that you can stay ahead of new trends and needs..
- If transportation partner: Get ready to pivot and take advantage of opportunities arising out of changing conditions.
Refer to our recent article, “How Businesses Can Address Supply Chain Management with Looming Tariffs” for additional details on navigating tariffs successfully. Please provide your insights and learnings and we will share with our contacts and colleagues. The key question is whether you will be thinking ahead and thriving or staying still and focusing on the volatility (putting items on hold or panicking) which will lead to decline.
If you are interested in reading more on this topic:
Resilience in Supply Chain of Paramount Importance