Sun Tzu’s Art of "Trade War"

While we are certainly taking liberties with the title of this classic treatise on war, it is appropriate that we quote China’s most famous military strategist as the United States has levied tariffs on Sun Tzu’s native land.  Not surprisingly, China has countered with its own tariffs in return.

Prelude to Trade War?

Vocal opposition and renegotiation of existing trade pacts was part of Donald Trump’s 2016 presidential campaign platform.  At the beginning of his term in 2017, President Trump pulled the U.S. from the Trans-Pacific Partnership via an executive order and has since renegotiated the North American Free Trade Agreement with Canada and Mexico.  Over the course of 2018, the Trump Administration has targeted international business in an attempt to stimulate the American economy and business landscape.  As part of these efforts, the administration introduced and imposed tariffs in a three-part series of lists, which heavily targeted China and the European Union, among others. 

• List 1 (eff. July 6, 2018) -- targets $34 billion worth of imports from China at a 25% tariff.  The list focuses primarily on industrial products not intended for the end user.  
• List 2 (eff. August 23, 2018) -- targets an additional $16 billion of Chinese imports for the same 25% tariff.  Among the second list of products are a high volume of those used by chemical and plastic manufacturers. 
• List 3 (eff. September 24, 2018) -- The third and most recent list of tariffs added a 10% levy on $200 billion of goods imported from China.  Based on a recent White House statement, the tariff on the third list of goods will match the 25% rate of its counterparts in early 2019.

China, among other nations, has filed a complaint with the World Trade Organization and retaliated by imposing equal counter-tariffs on the second round and threatening additional tariffs in a back-and-forth battle of protectionism.

How to avoid “collateral damage” in today’s environment

Take Sun Tzu’s advice to heart: Educate yourself and prepare. Re-evaluate supply chains, distribution approaches, and overall management processes.

Streamline manufacturing and production operations:

• Map your supply chain from end-to-end.
• Leverage digital technology to manage supply chain mapping and management.  
• Capture internal and external data leverage to generate insights for future business.
• Assess the product specifications and determine if they may be altered to allow for business with different suppliers.

Investigate alternative sourcing and cost structure of operations

• Focus on long-term supply chain risk as you assess sourcing alternatives.
• Attempt to maximize cost efficiency on non-tariffed goods as tariffed goods will always result in increased cost of components.
• Evaluate and anticipate supply shortage impact on operational costs. 
• Evaluate market capacity to absorb price increases as soon as possible.
• Evaluate what percentage of supplies can be sourced from tariffed nations before cost is affected.
• Develop deeper bench of back-up suppliers in non-affected countries.

Examine transfer pricing

• Evaluate transfer pricing strategy to understand cost/benefit of adjusting focus from tax optimization to tariff minimization. 
• Note: It is important to align the transfer pricing policy with the customs policy to support consistency across both policies.  Even though there is not a one-to-one correlation between transfer pricing and customs, meaning that customs matters are dealt with on a product-by-product basis and transfer pricing is based on a more aggregated transactional review, consistency is key to demonstrate compliance.  There have been instances where a transfer pricing report was used as a "road-map" in a customs dispute.

Be proactive in the approach to business operations

• Renew focus on liquidity management – sharpen receivable collections and bolster borrowing capacity.

• Maintain a stock of inventory higher than normal to mitigate the unexpected. 
• Anticipate rising interest rates.
• Highlight your company’s competitive differentiation if price is compromised.
• Raise prices as a precaution for future uncertainties. 
• Delay purchases and investments until trade conflict settles if possible.
• Changing suppliers or bringing business domestic can be a lengthy and expensive process, the early companies act the better if this is chosen as an alternative. 
• Monitor U.S. action and potential retaliatory action closely