Revenge of the Tariffs

Hello Sellouts

At the beginning of January, we talked about the impact tariffs can have on our businesses.

In that episode, we talked about how tariffs contributed to the bankruptcy filing of Kristen Bell's DTC baby brand Hello Bello.

We also talked about how True Classic Tees was able to thrive through tariffs due to a combination of good planning and good luck.

Tariffs are officially upon us, and I've gotten a lot of requests to revisit this topic with a little more explanation on what exactly tariffs are, how they impact us and what you should look out for as a small business.

In today's episode, we're going to do quick answers for six big questions every business owner needs to get about this topic:

1. What are tariffs?

2. Why do tariffs exist?

3. How do tariffs raise prices?

4. How much can tariffs impact your business?

5. When will prices increase?

6. Where are some opportunities?

What are Tariffs?

Don't be embarrassed if you don't really get tariffs.

Unless you work in specific industries like imports, agriculture or steel, they don't usually come up very often.

If you buy a foreign good, your government might charge you a fee for not buying domestic. That fee is a “duty”. A tariff is just a kind of duty.

In other words, it’s a tax you pay for importing. That’s it!

The new US tariffs were a flat 25% tariff on all Canadian and Mexican imports and up to 100% on Chinese goods (from 15% on Chinese clothes to 100% on Chinese electric vehicles).

Some of those tariffs from Canada and Mexico were almost immediately paused, though the majority of goods from both countries will still be impacted.

US exports will also face tariffs as Canada put a 25% tariff on many American goods.

Yikes, that's a lot to follow.

Why Do Tariffs Exist?

There's two reasons countries usually impose tariffs:

1. Protecting domestic business from cheap competition. For example, the US has had a sugar tariff in place almost continuously since 1789! This makes foreign sugar more expensive and ensures at least some sugar is produced in the US.
   

2. Punishing other countries. By taxing the goods from another country, the government can make those goods less appealing to consumers. For example, the US has had a 35% tariff on many Russian goods since its attempt to occupy Ukraine in 2022.

The Trump tariffs on Canada and Mexico are supposedly punishments for allowing drugs to enter the US illegally (specifically fentanyl). The administration simply states it’s for ‘National Security’. I'll leave it with you to make your own decisions about that justification.

How Do Tariffs Raise Prices?

Imagine your business sells Canadian maple syrup to Americans:

• You pay your supplier $1.00 per ounce

• You sell it for $1.20 per ounce

Now the US government puts a 25% tariff on all Canadian goods. Now:

• You pay your supplier $1.00 per ounce

• You pay the US government $0.25 per ounce

• You either increase your prices or sell it at a loss

Maybe you decide to switch to a Vermont supplier to avoid importing at all.

But now everybody who sells maple syrup has the same idea, and Vermont companies can also charge more because there’s more demand. The prices go up even from suppliers not impacted by tariffs!

How Much Do Tariffs Impact Your Business?

A tariff can cause overall costs to increase many times more than the cost of the tariff itself. More complex goods tend to have higher cost increases from tariffs.

For a real-world example, the US put a 20-50% tariff on washing machines from China in 2018. The National Bureau of Economic Research found that this tax increased the overall cost of washing machines by up to 125%, even for machines made in the US.

If your business sells anything with a complex supply chain, tariffs can even hit you multiple times per product.

Let’s look at 3 hypotheticals:

1. Running a business without tariffs

2. Running a business with tariffs, but you own the entire process

3. Running a business with tariffs, but you are buying your goods from a supplier.

HYPOTHETICAL 1: NO TARIFFS

Imagine you sell shirts. You buy the shirts from China, store them in the US, but your printer is in Mexico. Without tariffs, that looks like this:

1. You buy blank shirts from China for $10 each.

2. You store them in the US until you're ready to print.

3. You ship them to your printer in Mexico. The printing and shipping process costs $5 per shirt.

4. Your printer ships them back to your warehouse in the US.

5. Your final cost is $15 per shirt.

HYPOTHETICAL 2: TARIFFS WITHOUT INTERMEDIARIES

If there's 25% tariffs both ways between Mexico/US and 20% tariffs between US/China:

1. You buy blank shirts, pay $10 and $2 to the US government

2. You store them.

3. You pay the Mexican government $2.50 to send it into Mexico

4. You spend $5 for printing and shipping without selling the shirts.

5. You pay the US government again to get your shirts back from your printer, this time $1.25 to get them back from your printer.*

6. Your final cost is $20.75.

If you ship a good out of the US, do some refinement, then re-import it, you only pay a tariff on the value added in the foreign country. That’s why step 5 is only $1.25, which is 25% of the $5 in value added in Mexico.

HYPOTHETICAL 3: TARIFFS WITH INTERMEDIARIES

It can get even worse if that good is changing hands. A new tariff is charged in full on the good every time it crosses the border with a new owner.

1. Company A buys the Chinese shirts for $10 and pays $2 to the US government.

2. Company B in Mexico buys the shirts for $12 (Company A passed on their tariff costs).

3. Company B pays the Mexican tariff of $3 and spends $5 printing.

4. You buy the final shirts for $20.00 (the $12 + $3 + $5 spent by your supplier so far).

5. To bring them into the US, you pay the tariff again, meaning you pay another $5.00 per shirt.

6. Your final cost is $25.00, 40% of which were tariffs… even though the highest tariff actually levied was only 25%.

That doesn't even factor in that more tariffs can increase freight prices and slow down processing at ports.

You can reduce some of these costs by:

• Diversifying your supply chains to include non-tariff sources

• Using bonded warehouses to store incomplete goods

• Simplifying your process to cross fewer borders

 A Quick Note On Inflation

Countries usually respond to tariffs by applying their own tariffs, as Canada already has and China has promised to do soon. Prices in both countries start to go up.

As prices go up, people start to need higher wages, which also increases business costs and impacts industries not directly impacted by tariffs.

That's inflation, baby!

Inflation causes consumers to buy less stuff, which then means you have a triple threat:

• Your material costs are increasing

• Your labor costs are increasing

• Your consumer base is decreasing

It's particularly difficult for small businesses because of smaller profit margins, less control over the supply chain, and other factors.

 When Will Prices Increase?

Your business prices could already be increasing if you directly import goods.

However, tariffs will probably only have a small impact on your prices at first, especially if you use American suppliers or have simple supply chains.

It could be a very good idea to buy a surplus of inventory if:

1. You know you will need it

2. You know storage costs are reasonable

3. You know it is storage stable over a long period

Ideally, you want to be the last business to raise prices due to tariffs or inflation. As long as you have domestic inventory locked in at pre-tariff prices, that means you can raise prices more gradually.

The risk is, of course, the tariffs might end up short-lived. After all, they've already been declared, then delayed, then declared, then delayed again, then reduced in just about a month.

Use your best judgment, but the uncertainty around trade policy means that prices are unlikely to go down anytime soon.

Where Are Some Opportunities?

There's three general tariff-related opportunities that you can look for:

1. If tariffs continue for a long time, the demand for freight and manufacturing from affected countries can plummet. As tariffs increase the overall costs, the base rates can go down as providers struggle to maintain customers.
   
   With good timing and some luck, you can use tariff-depressed based prices to lock in low long-term contracts, eat the increased tax burden, and make the difference back up when your low-rate contract continues well after tariffs are lifted.
   
   Think of this like buying a house while mortgage rates are high. Yes, you will pay more in interest, but there's also fewer buyers competing with you. If you can secure a good long-term investment now, then refinance later, you may end up saving money.
   

2. When prices change, consumers are more likely to consider alternative brands. If you can pitch the right message and price, there may be more brand defectors available than usual.
   

3. Retaliatory tariffs from China, Mexico and Canada can create massive short-term surpluses in the US and temporarily lower prices.
   
   Canada already has 25% tariffs on $30B in American goods. That means fewer Canadians will buy those goods, and American companies need to sell them somewhere else, flooding the market and temporarily reducing prices.
   
   This is especially true for goods that spoil or decompose.
   
   If you happen to have a business that takes spoil-prone products and converts them into shelf-stable ones, you may be able to offset some of the increase in tariff prices by buying heavily discounted surpluses early in a trade war.

Until next time, keep selling out (in the best way possible). If you found this interesting, please share it with a friend and hit reply.

Until next week,
Luke

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