What would you do?
Assume you own a company that manufactures products overseas. You may even own the factory, have invested millions of dollars in the building and equipment. You make products that customers import to the US for sales to US consumers. You may be the importer also, or the importer is your customer.
Your products now face a 15% tariff upon importation.
What do you do?
THE EFFECT OF TARIFFS ON THE MARKET
How do tariffs affect the market?
Either the producer sees their profit margins shrink, the Importer sees its profits shrink, or the Consumer sees their prices rise.
In all of these cases, the US Government collects the tariffs from the Import Company.
There is no involvement, NONE! of the foreign governments in this revenue transaction.
To be absolutely clear, just think of this example:
Canada has placed a 100% tariff on Jack Daniels whiskey.
Who pays that tariff? Jack Daniels? The state of Tennessee? The US Government?
NO! The Canadian importer pays it to the Canadian Government.
How much of that tariff can Jack Daniels “pay”? If they sell a bottle for $50, a 100% tariff would be $50. Can they pay that tariff and net the whiskey for $0?
The Producer and the Importer need to make profits to satisfy their owners and investors. They cannot simply cut their profit margins in half to keep consumer prices level.
Let’s look at the potential use cases.
We will assume that a Foreign Producer makes a product for $64 and sells it to an Import Company for $80, landed.
The Foreign Producer makes a gross profit of 25%.
The Import Company sells that item for $100.
The Import Company makes a gross profit of 25%.
We will assume a tariff of 15%.
1. There is a 15% tariff on the import.
The Import Company pays $92 ($80 + $15 tariff) for the item and then sells it for $115.The Import Company makes a profit of $23, or 25%.
The Consumer sees a price increase of 15%.
THE IMPORT COMPANY PAYS THE US GOVERNMENT $12
2. The Foreign Producer “absorbs” the tariffs.
It charges the Importer $69.57 so that after the tariff, the cost to the Importer remains at $80.
The Foreign Producer’s profits decrease to 8.7%
The Import Company pays $80 ($69.57 + $10.43 tariff) for the item and then sells it for $100.
The Consumer sees no price increase.
The Company makes a profit of $20, or 25%
THE IMPORT COMPANY PAYS THE US GOVERNMENT $10.43
3.The Import Company “absorbs” the tariffs.Its costs rise from $80 to $92 ($80 + $12 tariff).
The Import Company sells the product for $100.
The Consumer sees no price increase.
The Import Company makes a profit of $8, or 6%
THE IMPORT COMPANY PAYS THE US GOVERNMENT $12.
4. The Foreign Producer “absorbs” a portion of the tariffs.
The Foreign Producer charges the Import Company $74.50 for the item, absorbing $5.50 of adjusted tariff charges of $11.
Its profits decrease to 16%
The Import Company sees a new cost of $85.50 ($74.50 + $11 tariff) increase its price to $106.90 , maintaining its profit of 25%.
The Consumer sees a price increase of9%.
THE IMPORT COMPANY PAYS THE US GOVERNMENT $11
- The Foreign Producer and the Import Company BOTH share in “absorbing” the tariffs.
The Foreign Producer charges the Import Company $74.50 for the item, absorbing $5.50 of tariff charges.
The Foreign Producer’s profits decrease to 16%.
The Import Company absorbs the additional $5.50.
The Import Company’s product cost is now $74.50 + $5.67 = $85.68.
The Consumer sees no price increase.
the Import Company profits decrease to 3%
THE IMPORT COMPANY PAYS THE US GOVERNMENT $11.17
HOW DOES A FOREIGN PRODUCER WEIGH THE CHOICES?
Here is an example:
Suppose, as above, that the Foreign Producer sells a product for $80, with a profit margin of 25%. They make $16 per unit sold.
Assume that they sell 1,000 units per year.
That would result in a profit of $16,000 per year.
Now, assume that they “share” in absorbing the tariff.
They sell their product of $74.50 (absorbing half of the tariff), reducing their profit per item to $10.50.
How many units do they need to sell in order to maintain a profit of $16,000 per year?
They now need to sell 1,524 units, or a unit sales increase of 52%.
Selling only 1,000 units would reduce their profit from $16,000 per year to $7,450 per year.
But what if the Foreign Producer chooses not to lower its price to help offset the tariff.
Now, they still make $16 per unit sold.
They now compare how many sales may be lost due to the price increase. How would those losses equate to the loss of profits due to reduced profit margins?
If they keep the price the same, how many units must they sell to make $7,450 in profits, the amount that they would have made by absorbing the tariffs?
The answer is that they would need to sell only 465 units, a loss of 54% in sales.
So, the problem for the Foreign Producer is that they need to try to predict whether reducing their profits can be offset by an increase in sales by 50%, or if the price increase will result in a decrease of more than 50% in sales. If they conclude that the likelihood of a decrease of 50% in sales due to a 15% increase in price is less likely than an increase of 50% in sales with maintaining the same price, they may opt to NOT absorb any of the tariff costs.
What would you do?