Tariffs and Procurement (Part 1): What tariffs are and what they mean for procurement

The results of the US elections forces us to focus on Donald Trump’s stance on tariffs. During his campaign, Trump was explicit about his intention to increase tariffs, including significant hikes on certain categories of goods (a global baseline tariff of 10%-20% on all imported goods, up to 100% for goods from countries that seek to reduce their dependence on the US dollar, 100% tariffs or more on cars imported from Mexico, etc.).

Uncertainty remains about how these proposals will translate into action, as Trump has yet to be sworn in and has not provided further specifics on his post-election trade strategy. This leaves room for speculation on whether his administration might adjust these plans in response to both domestic and international pressures or prioritize different aspects of economic policy.

What we can say for sure is that tariffs are nothing new — governments have long used them to protect domestic industries, address trade imbalances or respond to unfair practices. However, with the increasing frequency of tariff-related disputes and trade wars, the role of tariffs in shaping international commerce has never been more pronounced.

The consequences of tariffs stretch far beyond geopolitical tension; they directly affect consumers and companies. For consumers, tariffs translate into higher prices for imported goods, with manufacturers and retailers passing on increased costs. The implications are even more significant for businesses, especially those with complex, global supply chains.

Procurement professionals are at the forefront of managing tariff exposure, navigating disruptions and implementing strategies to mitigate cost increases while ensuring supply chains remain efficient and resilient.

Technology can be indispensable for procurement teams that must deal with these threats. As tariffs and trade dynamics shift, procurement technology can provide critical capabilities, from real-time tariff tracking to predictive analytics that help procurement professionals assess risk and optimize sourcing strategies.

This series on tariffs covers how tariffs work and how they impact procurement and supply chain professionals. It also provides guidance on what an action plan for enhanced tariff management capabilities could look like and how procurement technology can support it.

What are tariffs?

Tariffs are taxes governments impose on imported or exported goods and services. These taxes play an important role in shaping a country’s trade policies, impacting both the economy and international relations. Governments implement tariffs for various reasons, including revenue generation, protection of domestic industries and regulation of trade dynamics with other nations.

There are two main types of tariff:

• Import tariffs apply to goods entering a country. They are typically used to discourage foreign competition while promoting local production. By artificially inflating the costs of imported goods, tariffs aim to change purchasing behaviors.
• Export tariffs are levied on goods leaving a country, primarily to control the outflow of certain resources or products. This type of tariff is less common, but it can be strategically used to retain valuable domestic resources.

Tariffs serve several key economic functions. One of the primary purposes of tariffs is to generate revenue for governments, providing a source of income that can be used to fund public projects and services. Tariffs are also a tool of protectionism. Governments shield domestic industries by making foreign goods more expensive, thus encouraging consumers to buy locally-produced alternatives. Additionally, tariffs can act as regulatory tools to address trade issues like dumping, which is when foreign companies sell goods at artificially low prices in another market to undermine local businesses.

The economic impact of tariffs is multifaceted. Generally, tariffs increase the price of imported goods, which can reduce consumption of these products and, in turn, boost demand for domestic alternatives. However, the cost of tariffs often falls on importers and consumers, leading to higher prices for imported goods. This impact can disrupt trade dynamics, sometimes prompting retaliatory tariffs from other countries. Such escalation can lead to trade wars that can harm economies on both sides.

Historically, tariffs have played a significant role in economic policy worldwide. In ancient times, civilizations such as those in Mesopotamia and Greece used tariffs to generate government revenue and regulate trade. Tariffs were also collected along the Silk Road, where merchants paid duties when crossing borders, enriching the regions along these trade routes.

In the 18th and 19th centuries, tariffs became essential in industrializing countries. In the United States, the Tariff Act of 1789 imposed a 5% tax on imports to protect emerging industries. Many European nations adopted similar policies to support their own industrial growth.

Since then, most countries have used and are using tariffs and free trade agreements as a critical component of their economic policies. They influence trade practices, economic development and international relationships across centuries and regions and balance their goals of revenue generation, market protection and regulatory control.

In summary, the following are the high-level pros and cons of implementing tariffs:

Pros:

• Protects domestic industries: Tariffs make imported goods more expensive, which can encourage consumers to buy domestic products. It can help protect local businesses and industries from foreign competition.
• Generates government revenue: Tariffs provide additional revenue for the government, which can be used to fund public services or infrastructure projects.
• Promotes job retention: By shielding domestic industries, tariffs can help sustain local employment in sectors that might otherwise struggle to compete with cheaper imports.
• Encourages local production: Tariffs can incentivize companies to produce goods domestically instead of outsourcing manufacturing and in doing so, bolster national economic independence.

Cons:

• Increases consumer prices: Since tariffs raise the cost of imported goods, consumers often face higher prices for these goods, which can reduce their purchasing power.
• Risk of retaliation/trade wars: Countries affected by tariffs may impose their own tariffs in response, leading to a trade war that can harm exports and escalate economic tensions.
• Hurts competitiveness: Domestic industries protected by tariffs may have less incentive to innovate or improve efficiency, making them less competitive globally over time.
• Reduces market efficiency: Tariffs interfere with the free market by artificially altering prices, leading to inefficiencies and preventing the optimal allocation of resources.

What tariffs mean for procurement

Seasoned procurement and supply chain professionals have always had to navigate the landscape of tariffs and learn their Incoterms (International Commercial Terms), which are predefined commercial terms published by the International Chamber of Commerce (ICC) to define the responsibilities of exporters and importers in the management of shipments and the transfer of liability involved at various stages of a transaction.

Among the 11 terms, 10 specify that these taxes have to be paid by the buyer/importing party. Only one, Delivered Duty Paid (DDP), specifies that import taxes are paid by the seller, i.e., the foreign company.

In all cases, companies will pass these costs on to their customers and consumers because they aim to maintain profit margins. As such, they will incorporate the additional costs of those import taxes into the prices of the goods they sell.

Also, the same seasoned practitioners know how to perform market, TCO and trade-off analyses to identify best-cost/value sourcing areas. So, a price increase for certain goods coming from a specific country will be checked against:

• Local sourcing options, if they still exist at sufficient capacity and are economically viable.
• Sourcing options from other foreign countries with enough capacity to produce and that are not or less taxed.

This is why even if tariffs are implemented, a reshoring or return to local sourcing is not guaranteed.

However, things start to get slightly more complex when you consider complex global supply chains, in which goods move from one country to another and get ‘transformed’ and included into components, sub-assemblies, etc. Here are some examples.

Example 1:

Let’s imagine that Country A raises tariffs on electronics coming from Country B. Country A also has a trade agreement with Country C that grants electronics from Country C a lower tariff than B.

Now, imagine a company in Country A that is currently buying electronics manufactured in Country B. Would the company avoid these new higher tariffs by having its supplier or a distributor ship electronics coming from Country C?

Example 2:

Let’s imagine that Country A raises tariffs on batteries coming from Country B.

Now, imagine a company manufactures electrical vehicles in Country C. These cars include batteries coming from Country B.

Would cars imported into Country A see their prices increase because Country A would tax the batteries at a higher rate?

Example 3:

Let’s imagine that Country A raises tariffs on cars coming from Country B.

Now, imagine a company manufacturing cars in Country A. However, the manufacturing operation in Country A only adds wheels to the car. The almost-finished car is, in fact, produced in Country B. Would the company see the new tariffs applied to its semi-finished car? Or would the finished car qualify as ‘made’ in Country A?

As these examples show, an important concept when considering tariffs is the rule of origin (ROO). ROOs are a set of guidelines and criteria used to determine the national source of a product, primarily to implement tariffs and trade policies. ROOs are, therefore, crucial because they establish whether a product is eligible for preferential tariff treatment under specific free trade agreements and/or which tariff applies.

The next part of our series discusses what tariffs mean for procurement departments specifically, and the third will address how procurement technology solutions can help.