Adjusting to Tariff Variations: Strategies for Maintaining Profitability
Rewritten Article:
Here's a guest post from Lou Longo, a partner and head of the international consulting practice at Plante Moran. Opinions expressed are his own.
In the last 40-plus years, U.S. businesses have seldom encountered a tariff-driven economy. As a result, numerous organizations don't possess the extensive expertise and data required to navigate the new difficulties presented by today's tariff landscape.
With many companies concerned that tariffs could affect their margins, now is the perfect time for them to enhance three skill sets that will help them handle the current industrial climate: cash flow analysis, supply chain expertise, and currency risk management.
Although our organizations might understand the fundamentals of these skill sets, navigating today's tariff effects calls for a more advanced level of mastery. Fortunately, solidifying these skills might enable organizations to safeguard their margins temporarily while also enhancing their financial resilience over the long term.
Reinforce Your Cash Flow Analysis
Cash flow is always vital, but the continually changing tariffs emphasize its significance for various reasons. First, many recently implemented tariffs represent true added production costs for businesses that import supplies into the United States. Duty drawbacks, for instance, have not been included in executive orders. This implies that organizations cannot recover the tariffs imposed on imported parts used in U.S.-made products destined for export.
Additionally, tariffs might heighten the likelihood of companies needing liquid assets exceeding their immediate cash flow.
To shore up cash flow, organizations should utilize two strategies:
- Identify non-obvious cash flow sources. Determine all available levers for securing cash, along with their liquidity options and costs. Make a running list of the most liquid and least expensive sources for getting cash, as well as the most challenging and costliest cash flow choices. These might include unfavorable alternatives like:
- Selling leased assets
- Selling non-core businesses or assets
- Issuing high-yield bonds
Organizations should know not only the various sources available but also the degree to which their business may want to tap into them. This critical information should be documented in a dashboard that the entire C-suite can use to inform organizational decisions.
- Renegotiate vendor agreements. Surprisingly, vendors don't appear eager to voluntarily absorb tariff-related cost increases. Nevertheless, organizations might be able to secure a little extra cash flow by adjusting vendor payment terms (such as changing net 60-day purchase orders to 75-day or 90-day terms).
Maintain an understanding of the potential impact of this "slow pay" approach. How much additional cash flow does the extra 15 or 30 days grant the organization? Do the benefits of that cash flow justify the potential drawbacks? Businesses should fully grasp their vendor relationships and their priorities with their customers before using this option.
deepen into the supply chain
The vast majority of tangible goods produced in the U.S. are part of a global supply chain, regardless of whether they involve raw materials, components, or finished goods. Some piece of nearly every product has likely crossed borders at some point.
However, many organizations are aware only of their immediate subcomponents crossing borders. Many non-public entities, particularly, seldom delve deeper into the supply chain to understand their second and third tiers (that is, their suppliers' suppliers and beyond).
To understand the true impacts of tariffs on their organizations, companies must recognize multiple tiers of their supply chain and bring "hidden" tariff exposure to the surface. The more intricate the product, the deeper they should probe into the supply chain.
At a minimum, businesses in any industry should be conscious of their suppliers and their suppliers' suppliers, or the second tier. In complex industries - such as automotive - they should go at least three layers deep.
While most suppliers aren't eager to reveal their own suppliers, tariff and free-trade environments should motivate our organizations to ask about the geographic locations of the vendors providing components for their subassemblies. At the very least, suppliers should be able to disclose where the components originate, allowing a company to see if sub-tier components are crossing borders.
To continually discover the supply chain, organizations should engage in periodic supply chain optimization reviews, starting with the highest-volume components, then moving to lower-volume but high-value items, etc.
Though continual review processes might necessitate investments in technology, support resources, and targeted internal expertise, the resulting data and insights are crucial for making informed decisions and safeguarding profit margins at risk.
Manage Currency Risk
Currency risk is a unique factor in tariff discussions, particularly given that the U.S. dollar has historically been a stable currency. However, in the current tariff landscape, the dollar will likely be subject to more frequent adjustments. Hence, our organizations must better understand their exposure to foreign currency exchange rates.
First, they must recognize that buying and selling in dollars does not inherently protect them against exchange rate risks. By scrutinizing their supply chains, most companies will find they have some exposure to foreign currencies. For example, a company that manufactures products in Europe will have direct or indirect exposure to the euro. Consequently, our organizations should review their currency exposure while examining their supply chain origination.
To support executive management decisions, our organizations should create a dashboard that tracks the major currencies to which their business is exposed - such as dollar-to-euro or dollar-to-peso. Once they understand their organizations' currency exposure risk, they can:
- Set contractual metrics within vendor agreements to adjust costs within currency bands, typically tied to an index. Contracts could stipulate that "Prices won't change if the currency exchange rate is between X and Y; otherwise, they are subject to negotiation."
- Seek expert bids to evaluate and possibly manage their currency risk. Boutique currency groups, community banks, and others can offer competitive currency reviews.
- Establish forward contracts in which banks agree to lock in the exchange rate (and risk) for a set period. While not overly flexible, this approach encourages companies to at least evaluate how much money they need to buy in foreign currency.
- Request open credit from foreign vendors if required to post letters of credit or other guarantees on purchases. Although this practice is not as widespread as in the past, posting guarantees adds to transaction costs, and organizations should move toward open contracts if possible.
Transform margin protection into ongoing improvement
For our organizations worried about keeping up with the constant flux of tariffs, the answer could be deceptively simple: don't. Instead of attempting to react to every piece of tariff-related news, use the current environment as an opportunity to strengthen the long-term game. Rather than viewing tariffs as temporary phenomena, consider them endemic to the business landscape.
Our organizations should turn to their trade associations and other organizations for insight into their industries' stance on tariffs. After all, these organizations are responsible for monitoring tariff impacts and educating the public.
In the interim, our organizations should adhere to best practices to fortify their understanding of cash flow, supply chain, and currency risks. Doing so will enable their organizations to adapt to tariffs, safeguard margins, and foster a continuous improvement mindset that instills ongoing operational efficiency. Thus, our organizations can enable their companies to make decisions, endure change, and remain prosperous for years to come.
Selected Enrichment Data Suggestions
- Cost Allocation: Businesses can distribute tariff costs throughout their value chains, sharing them with foreign-related parties via price adjustments or through transfer pricing mechanisms[2].
- Cost Unbundling: Breaking down the cost components of imported goods to identify non-dutiable costs can minimize dutiable value and reduce overall duty payments. This encompasses unbundling costs like freight, insurance, and services[3].
- Diversification: Diversify suppliers by locating alternatives in regions with favorable trade agreements, reducing dependence on high-tariff countries. This might include nearshoring to nations like Mexico or Canada, though recent tariffs may complicate these strategies[2][5].
- Supply Chain Redesign: Businesses can reconfigure products using more domestically available materials or fewer imported components, minimizing the impact of tariffs[2].
- Dual or Multi-Sourcing: Engaging multiple suppliers enhances supply chain resilience and mitigates the risks associated with relying on a single supplier[5].
- Foreign Trade Zones (FTZs): Using U.S. FTZs can delay duty payments until goods leave the zone for U.S. consumption, benefiting businesses importing goods[3].
- Inventory Management: Maintaining more inventory can serve as a buffer against tariffs or border slowdowns, but it necessitates additional working capital[2].
- Hedging Strategies: Businesses should consider using currency hedging instruments like forwards or options to manage exchange rate fluctuations that might exacerbate tariff impacts.
- Finance and Insurance: Explore financial instruments and insurance options that can offer protection against currency volatility.
- Reshoring and Onshoring: Consider relocating manufacturing operations to the U.S. to reduce tariff impacts and potentially capitalize on government incentives[5].
- Automation: Invest in automation technologies to reduce higher domestic production costs and improve competitiveness[5].
- Staying Informed and Advocacy: Keep a close eye on tariff policy changes and collaborate with industry groups to advocate for favorable trade policies[5].
By adopting these strategies, U.S. businesses can lessen the financial burden of tariffs and enhance their resilience during an evolving global trade environment.
- Organizations must enhance their expertise in cash flow analysis, supply chain management, and currency risk management to navigate the current tariff landscape.
- Duty drawbacks have not been included in executive orders, implying businesses cannot recover tariffs imposed on imported parts used in U.S.-made products destined for export.
- Tariffs may heighten the need for companies to secure liquid assets exceeding immediate cash flow.
- To shore up cash flow, organizations should identify non-obvious cash flow sources and renegotiate vendor agreements.
- Companies must recognize multiple tiers of their supply chain and bring "hidden" tariff exposure to the surface, especially for complex industries.
- Organizations should engage in periodic supply chain optimization reviews, starting with the highest-volume components, then moving to lower-volume but high-value items.
- Our organizations must better understand their exposure to foreign currency exchange rates in the current tariff landscape.
- Companies should set contractual metrics within vendor agreements to adjust costs within currency bands, typically tied to an index, and seek expert bids to evaluate and manage their currency risk.
- To foster a continuous improvement mindset, our organizations should turn to their trade associations and other organizations for insight into their industries' stance on tariffs.
- Diversification, cost unbundling, supply chain redesign, dual or multi-sourcing, using foreign trade zones (FTZs), inventory management, hedging strategies, finance and insurance, reshoring and onshoring, and automation are strategies businesses can adopt to lessen the financial burden of tariffs and enhance resilience.
- Staying informed and advocacy are crucial for keeping a close eye on tariff policy changes and collaborating with industry groups to advocate for favorable trade policies.
