How Tariffs are Impacting Your Profits

I'm Stephen Brown. I am the COO of LedgerGurus. I'm also co-owner of LedgerGurus. I'm the co-owner and CFO of a DTC brand, Solé Toscana. This is our sandbox. I do advisory and fractional CFO work. I have 20 years in tech leadership, eight years in CFO accounting services, and an MBA and an engineering degree.

0:34 Stephen Brown

And with me, I have Lauren Maillard. Lauren, would you like to introduce yourself?

0:39 Lauren Maillard

Yeah, I'm Lauren. I'm the Director of Service Delivery here at LedgerGurus. I've got a lot of experience in sales tax. I helped build and lead the sales tax team. I do some advising, consulting, fractional CFO.

Once upon a lifetime, I was a small business owner. We sold that just before COVID. I'm also a CPA and I have my master's from BYU.

1:09 Stephen Brown

Okay, let's dive into the nuts.

We're going to talk about today, revisiting the tariff impact, tariff response strategy for China specifically, because that has some unique challenges, response strategy for the rest of the world, and other considerations for everywhere. And I'll give you a little preview of our sequel to this webinar, A Smart Approach to Cutting Costs.

1:40 Revisiting tariff impact

Stephen Brown

So let's revisit tariff impact. We're now a little over a month since the big announcement of global tariffs. And we're in the middle of, in some cases, a pause for the rest of the world.

So there were some big numbers that were thrown around, but were put on pause with a 10% increase place held. But if you're dealing with China, you are dealing with significant tariffs today.

2:10 Stephen Brown

Lauren, what's been really interesting is there hasn't been a lot of communication since the pause went into effect. What are you hearing?

2:24 Lauren Maillard

Well, from our clients, it almost feels like they are putting everything on the back burner and kind of forgotten about tariffs, except for a few who are really keeping it front of mind. But what I have heard is that Trump does want to get down to 50%. That's kind of the gossip and the leaks that are coming out of the White House.

2:46 Stephen Brown

50%. Yeah. And then what's been really interesting is we haven't been hearing much about other countries. All you hear is, we're talking.

2:59 Stephen Brown

So we're dealing with a lot of uncertainty. And when you're dealing with a lot of uncertainty, I want to introduce a concept of game theory. Game theory is a concept of trying to more or less estimate what is going to happen as you make your plans for your business.

3:23 Stephen Brown

So to start with, the best thing to do is to measure what your impact is. We have built a Tariff Impact Calculator, and Kelley can put the link to that in the chat where you can download it.

But what that will allow you to do is to input different values. We have a basic impact calculator where you could put the increased tariff rate, or the effective tariff rate if you're importing from multiple countries, put in some key values from your financials, and see what that impact is.

3:58 Stephen Brown

Now, most people know that that impact is going to be negative, but you can see, like in this example, a 25% tariff does result in a significant decrease in profitability.

4:12 Stephen Brown

We also in this calculator have some advanced scenarios, where we not only look at tariff impact, but like in scenario, apologies, my mouse is being sensitive. Like in scenario two, where we're looking at what would happen if you were to increase prices, while considering some elasticity of demand.

4:36 Stephen Brown

We have scenario three, where you have some custom elasticity, and scenario four, where you can integrate some cost cutting.

And what you'll see in a lot of these scenarios is a lot of challenges. Price increases alone may not be enough, because of a decreased demand that might come with them. And so I want to talk through how to think through strategy with different issues.

And again, if you haven't taken a look, go ahead and run your numbers through that calculator.

5:10 Lauren Maillard

Stephen, I'll just say, if there's anyone on this webinar who wants to meet with me to go over the tariff calculator, send me an email and we can set something up. And I'm definitely willing to do that, no charge, just wanting to help people out and help them understand what the impact is going to be.

5:31 China: hold, bond, or import

Stephen Brown

All right, so let's talk specifically about China, because it's a unique category.

The 145% tariff increase in most cases is an embargo.

5:45 Stephen Brown

I had a customer who has very efficient COGS, cost of goods sold at about 20% of their sales. They have a 20% net income across all areas of the business. Very efficient. And if they were to have to take the full impact of those 145% tariffs, they'd go from a 20% profit to a 10% loss.

6:13 Stephen Brown

And so with China, we have to think very uniquely. The first thing we have to think about, and this is what I'm seeing a lot of customers doing and recommending, is how long can you hold off?

Because we saw an escalation in tariffs, and then finally I think both China and the US realised they created more or less an embargo. So if you can pause bringing in current orders, that could be the best scenario for now.

6:45 Stephen Brown

The second scenario you could consider if you have an order in process is moving them to a bonded warehouse, as a holding strategy. I'm going to talk about that. So if you had product that you need to get close to being sold and you want to wait, a bonded warehouse could be a good strategy. It could also be a good strategy for other reasons that I'll talk about a little bit later.

7:10 Stephen Brown

The challenge is, if you do bring that product in, like the scenario I just told you, you are going to have a significant financial impact. So you have to decide, is selling at a loss better than not selling at all?

And that's a really hard decision, because it's a reality, and there are a lot of projections that we're going to see major shortages, because I think everybody is going through this situation.

7:32 Stephen Brown

One other thing to think about is air freight from China is plummeting due to the de minimis changes that happened over the weekend. The de minimis rule allowed products under $800 to come in with no tariffs. This was what was being heavily used by Temu and Shein.

And with the implementation of that de minimis rule change, air freight is [unclear], and one can expect that the prices should follow. That may be a tool that you can use to be agile if you need to.

8:17 Stephen Brown

Let's talk about what a bonded warehouse is. This is something that you should really be considering in your supply chain strategy right now, especially if you're importing from China.

Bonded warehouses allow goods to stay in the warehouse for a set period, up to five years. So basically, you can hold it there and choose to bring it through customs at a time of your choosing.

8:41 Stephen Brown

Now the value here is, if we think that tariffs are going to go down, as we should with China, using a bonded warehouse could be really good. But what I am hearing is that bonded warehouses are under high demand because of this strategy.

So again, duties are only paid when the goods leave the warehouse. And then if you have to re-export, they're not paid at all.

9:02 Stephen Brown

I'm hearing a couple of things. I'm hearing that there are a lot of people looking at this strategy, so it may be difficult to find a bonded warehouse. My guess is that costs are going up there. The other thing I'm hearing about is using bonded warehouses in Mexico as a place to stage things. So I expect a lot of savvy companies are looking at this strategy.

9:25 Stephen Brown

And this is valuable for a couple of reasons. The next reason you have to think about is future orders.

Tariffs should be better with China, but we should expect that they're going to be higher. How much higher? We just don't know. Unless some killer deal is made between China and the United States, I think it would be foolhardy to assume we're not going to see an increase.

9:55 Stephen Brown

Now, one of the things you have to think about though is current inbound freight from China is dropping. I'm reading every day about the decreases in orders in factories and the decreases in freight. Sailings are being cancelled altogether.

And what that's going to create is bottlenecks in the future.

10:19 Stephen Brown

So if we go back to the Long Beach port issue, I think it was 21 or 22, I can't remember exactly when it was, we could be seeing that again later this year. Once everybody knows what they're dealing with, and hopefully what we're dealing with isn't catastrophic, now the orders are going to go through the roof. And so there's a lot of concern around imports becoming bottlenecked later this year.

10:47 Stephen Brown

So you've got some options. You could think about the bonded warehouse strategy to keep the product moving, getting it closer. You could look at air freight. Air freight's expensive, but there is a lot of belief that you're going to see more capacity, but that capacity will be gobbled up once people start importing again.

11:09 The rest of the world

Stephen Brown

So, unique challenges with China. With the rest of the world, it's a little bit different. We're currently on that 10% pause.

We've got July 7th, and until July 7th we have an additional 10%. So let me clarify this. This is not the current rate. This is the additional rate of 10%.

11:35 Stephen Brown

So the question you have to ask yourself is, do you think rates are going to go up or down for the country that you're importing from?

If we were to game plan this out, game theory this out, one of the things I would be looking at very closely is what is the trade balance with that country and the United States.

11:54 Stephen Brown

There are countries where there is a trade surplus. I think we can assume there's a better probability that the tariff rates are going to be hopefully generous. I don't know if I'd assume they're going to go down to zero, but maybe they'll go down from an additional 10%.

If there's a larger trade imbalance, we may want to assume that it's going to be closer to somewhere between the 10% and the proposed rates that we saw on April 2nd.

12:31 Lauren Maillard

Stephen, for those of us who haven't taken an economics class in a while, can you explain a little bit why that trade surplus will have an effect on what you think is going to happen in the future?

12:42 Stephen Brown

My reasoning for why you should consider your trade balance as you're game planning is, that's something that the current administration has communicated a lot. It's something that they care about. So it's something that they're looking at.

And if I'm game planning, I'm looking at the trade balance to say, do I think it's going to be lower than 10%, or do I think it's going to be somewhere between 10% and the proposed rate?

13:09 Stephen Brown

Unfortunately, you just don't know. But that's the gamble you have to take. And so import accordingly.

If you think that 10% is the best rate you're going to get, then I'd bring as much product in as you can. If you think the rate's going to go lower, then you may want to pace your imports.

13:34 Stephen Brown

Now, future orders is a similar logic. And I think you balance these two together. Hey, if I think the rate's going to go above 10%, then bring my orders in and maybe accelerate orders forward. If I think the rates are going to go down, then maybe I want to wait.

14:02 Stephen Brown

What I've seen in a healthy business with healthy financials, 10% is manageable. It's not great, it sucks, but it's manageable.

20, 30, and 40%, that starts to get more painful. I think once you get to about 30 to 40%, depending on your cost of goods sold as a percentage of sales, and depending on your overall profitability, I've usually seen around 30 to 40% tariff rates really start to cripple businesses.

14:34 Stephen Brown

So that's something you have to think about. And the information we had to work with is 10% and whatever was proposed.

I would argue that we shouldn't expect the rates to go higher than what was proposed. I would also argue that the rates probably won't go to zero, that there will probably be increases across the board. So don't assume that you're going to get zero.

15:11 Lauren Maillard

Stephen, you have a direct to consumer brand that you're importing product from Europe. What are you doing? What's your plan?

15:18 Stephen Brown

We bring in orders three times a year. We've got two orders coming up. One will be in the summer, that we'll probably get our holiday orders, and the second order will hit probably for our end of holiday inventory and beginning of next year inventory.

15:43 Stephen Brown

We are taking a little bit of a wait and see approach. With the challenges, we are importing from Italy. Italy, I think, is being treated as part of the broader EU. And there's a lot of variance in terms of trade balance in the EU. So we're taking a little bit of a wait and see approach.

16:07 Stephen Brown

Our next order won't make it in before July 7th. So we're kind of gambling that I think it's going to be better than 10% after July 7th.

And I think a lot of the brands that I've worked with in the capacity here at LedgerGurus, I think there's a lot of wait and see. Because in reality, the order that really counts is that next order that's coming in in the summer. That's really going to fuel your holiday sales. And so we're all trying to get the best outcome possible, because that one is going to be a high volume order.

16:46 Stephen Brown

We're also not too worried about bottlenecks. I'm not hearing about bottlenecks from the rest of the world as much, because we're dealing with 10%, which is manageable.

I can tell you that 10% for Solé Toscana, the brand that I own, is something that will have an impact, and we're going to have to think through it, but it's not catastrophic like a China.

17:09 Lauren Maillard

So when you're thinking about it, you're going to make orders in the summer for the holidays. Even if Trump was to get rid of all of the tariffs tomorrow, are you worried about any supply chain disruptions then? Because if everyone is waiting and waiting and waiting, and then these tariffs go away, how do you approach it?

17:40 Stephen Brown

I'm not worried about product coming from outside of Europe. Everything that I'm reading, I think you're still seeing movement. It's probably a little bit paced.

If anything, if brands are concerned that 10% is a low watermark, you may see a surge. I haven't read anything about surges on East Coast ports. I definitely am reading about declines in the West Coast ports.

18:09 Stephen Brown

So depending on the ports you're importing through, if you're importing from Latin America, going into Long Beach or one of the other West Coast ports, it may be a good time to push product in, because there's a lot of capacity there that might not be there in a couple of months.

18:27 Stephen Brown

But yeah, it's a tough situation. And that's the strategy we've chosen. We're kind of staying the course, hoping for the best. We are modelling those costs and talking about how to adjust for them.

18:42 Distributing the financial impact

Stephen Brown

And that gets into the next part of the conversation, which is, what are the general strategies?

So right now we all are experiencing higher costs, whether it's 10% or 145%.

19:00 Stephen Brown

One of the best strategies I've come across is a distribution of financial impact. When we get to those high double digit tariffs, and even the lower double digit tariffs at 10%, it still can have a meaningful impact. It's probably too big to try and distribute to one party.

19:22 Stephen Brown

So this strategy I learned about was, hey, what can you do with your manufacturers? Especially China, their orders are plummeting. Now is a good time to work with your Chinese manufacturers, because what I'm reading is orders are being cancelled, they're having capacity challenges. And machinery doesn't like to be shut down. Most manufacturing machinery needs to be running.

19:49 Stephen Brown

It's a good time to work with your manufacturers and say, what can you do for me? I'm hearing different things from our customers.

One thing you can consider is just working with them to see, do they have flexibility on the buy price? China is known to manipulate currencies, to have a very government-led process to support their businesses. So you should be asking, what can you do? And in some cases, I know they're getting squeezed, but they're also losing business. So there may be opportunities there.

20:25 Stephen Brown

With your customers, what can you do? You can pass a price along. The biggest strategy I'm telling people is, now is the time to be authentic.

Now is the time to explain, if you are passing a price increase along, why you're passing it along, or why you may not be passing it along. Because regardless, if your prices are going up and you choose to not pass a price increase, your customers should know that, because they're getting a benefit and that should generate loyalty.

21:06 Stephen Brown

I think most consumers are realising prices will go up. So they're not going to be mad. They know this is coming. This is why we saw such a surge of consumer purchasing in Q1, because savvy consumers got it. They're stocking up.

21:17 Stephen Brown

So as you do have to pass a price increase, the one thing I'd advise is just explain how much you're passing along, how much you're experiencing as a brand. Hey, my product costs went up 40%. I am passing a price increase of 5%.

I think if you can articulate that authentically and transparently, it can only build customer loyalty. Unless you pass the entire price increase off to them, in which case that could be dangerous.

21:48 Lauren Maillard

Stephen, what does that look like practically? So for your brand, are you putting that on Shopify?

21:58 Stephen Brown

Shopify does have the ability to, they added a feature at the beginning of the year that allows you to communicate a tariff surcharge. So that's one way you could do it.

I think I would communicate in my emails. I would probably communicate on the website, and just be very in your face about why the price increases are happening.

22:24 Stephen Brown

What you're seeing right now is a lot of buy now, because prices are going to go up. And that's not a bad strategy, as long as you don't run out of inventory. Because I think people will buy until they can't, knowing that prices will go up.

We haven't had to raise prices yet, so we're mostly in the conversation around that strategy. But this is something I'm reading a lot about, and talking with my operating partner about.

22:50 Lauren Maillard

So as a consumer, I haven't seen or haven't felt prices increase. And that's probably due to about an eight week cycle of getting goods and getting them sold. So do you think that we're going to start really feeling it in about a month?

23:08 Stephen Brown

Well, it'll depend on the company. What I was reading about, your big companies who have huge balance sheets, have lots of cash, they brought over product like crazy. I wouldn't be surprised if Walmart has maybe many quarters to a year of inventory. So really big retailers were moving products in in Q1. That's what I read.

23:34 Stephen Brown

Smaller brands don't have the ability to, we don't have the cash usually to bring in a lot of product, but I think we brought product over as much as we could. I think when you're dealing with smaller brands, they'll be the first ones to have to deal with the impact.

So when are we going to see it? Probably in the next month or two, we'll start to see prices start to creep up if things don't change.

24:01 Stephen Brown

Now, the third one is the brand. That's us being, I have an ecommerce business, I'm selling online. What can you do? Well, really the only thing you can do is cut costs. And that's something we're going to talk about in the sequel to this webinar. Where can you cut costs? How do I tackle that? That's not easy. Some things there's low hanging fruit, some things take more time. But that's the piece that you can do.

24:28 Stephen Brown

And the final one is, if you are selling through wholesale or through other retailers, is raising your wholesale price.

So if you distribute the impact, no one party is going to feel abused, and it's probably going to be easier to do. And I think this is a really smart strategy.

24:46 Short term considerations

Stephen Brown

Some other short term considerations. Consider delivery duty paid from your manufacturer. This is where the manufacturer is responsible for all the duties. They are the importer of record.

Some people I talked to use DDP, some people don't. But if the manufacturer wants to do some crazy things, they are now the importer of record, and they have to worry about it.

25:16 Lauren Maillard

Stephen, real quick about that. How does that decrease cost? I mean, eventually that's going to be pushed down to you anyway, right?

25:28 Stephen Brown

Let me explain this in context. I have a customer whose manufacturer in China continues to lower, and this strategy can get you into legal hot water, so I want to be really careful about this.

They're basically charging the same amount, but they're carving out part of the invoice. They're invoicing separately as a service fee, and the other invoice is the product. So basically the buy price goes down, so that the import cost is lower.

25:59 Stephen Brown

Everything I've researched, this is illegal, this can get you into trouble. If you had a manufacturer that's wanting to do that, I'd say get them to do delivery duty paid, so the burden, they are on the hook for that trick.

26:16 Stephen Brown

I'm not sure how many of these tricks are going on. There are a lot of things you can do. I don't know how they're going to get caught. But if your manufacturer is wanting to do those kinds of tricks, I would definitely look at delivery duty paid, so that you are not the importer of record who is going to get in trouble with Customs and Border Protection.

26:35 Stephen Brown

Second thing to consider, margin focus. Now is not the time to be doing discounting.

Now, if you have a really strategic sale, for example, my other business Solé Toscana, our primary consumer is women. We always do a Mother's Day sale. We decided to do a Mother's Day sale despite the fact that there's a potential impact.

27:03 Stephen Brown

But I wouldn't be doing crazy sales right now. I wouldn't be doing crazy discounting. Now is not the time. If anything, you should tell people, hey, get it now before prices go up. Your current inventory is too valuable to be discounting. Unless, like I said, in my case we have a traditional sale and our consumers expect it.

27:27 Stephen Brown

Now is the time to be scrutinising non-sales expenses. I can't tell you how many crazy things I've seen over the years in our customers. Crazy trips, crazy. Now's the time to cut out the waste. Don't wait.

We'll talk about cutting the hard stuff. There's easy stuff in almost every business. And cut it now.

27:51 Stephen Brown

Cash is king, right? At the end of the day, the thing that keeps you alive is cash. The reason you saw a lot of these big companies bringing product over is because they usually had cash. They had cash to stock up, knowing that they would have inventory that would be cheap.

28:12 Stephen Brown

We know big retailers, one of the things they'll do as soon as they can is raise the price. Even if that inventory was cheap, they'll raise it and they'll make huge margins off of it. We saw it during the inflation years.

If you're not in a strong cash position, do all you can to preserve cash. Because at the end of the day, that's the only resource that keeps you alive. Your inventory won't. Cash will.

28:35 Lauren Maillard

Stephen, quick question before you move on. When you're talking about cutting non-sales expenses, and you're doing consulting, what's the biggest thing that sticks out to you as easy?

28:49 Stephen Brown

Well, discretionary spending. All the corporate cards, all the lunches, all the meals, all the trips. Meals, for example, you don't need them, right?

I have customers and I say, do you want jobs or do you want food? What do you want for your people? And employees, I hope, would be smart enough to know that cutting meals is saving jobs.

29:15 Stephen Brown

Next, and again, this bleeds over into the next webinar, I would be scrutinising software. Software is a big category. I'd be scrutinising my labour. That's a little bit harder. But I would start with the discretionary spend, the meals, the travel. That's easy to cut. I'd start scrutinising software, and then your labour costs.

29:42 Stephen Brown

Now is not a time to be hiring, unless you absolutely need hiring.

What I read, there was something I read that cuts in retail went up 80% in March, or maybe it was April, I can't remember. There was a big jump. So people know. We've got to get lean and start, don't wait till the tariffs settle. If you've got waste in your business, cut that right away. And then we'll walk through a cost optimisation strategy in the sequel webinar.

30:20 Mid to long term, and what's next

Stephen Brown

Other mid to long term considerations. Obviously, exploring alternative countries of manufacturing. This is not easy. This takes time.

With China, China has a target on its back. At minimum, if you're in China, you should be seeing what their alternatives are. The challenge is China is really good at what they do. Sometimes they are the only place to get certain products manufactured.

30:52 Stephen Brown

But we've seen a lot of stuff shift from China to Vietnam, to Cambodia, to India. And if you didn't do this in 2017 to 2020, now is the time to really explore what your options are.

31:14 Stephen Brown

The dust will settle. I think China is going to be a targeted place. We've seen China rhetoric raise under Trump. We've seen China concerns maintained before Trump and during the Biden administration. The issues with China will be high.

What we're going to want to see is what is the rhetoric around other countries, and be really smart about your supply chain diversification.

31:39 Stephen Brown

I already talked about DDP. What are the new opportunities? With every change in a system, new opportunities are going to emerge. What you've got to figure out is what they are. And I don't know what those are right now.

I'll give you my business. We are an Italian brand. We can't move out of Italy. And so our hands are kind of cuffed in that regard.

32:13 Stephen Brown

But are there new products? Are there new strategies that we can deploy in light of this market?

To a certain extent, there's also a survival mentality. Some brands are going to die, which means the competition will go down. Survival will create strength.

32:32 Stephen Brown

It's really hard to not be pessimistic right now because of all the challenges. But there are always opportunities. And you're entrepreneurs, we just have to find them.

32:53 Stephen Brown

All right, a little preview. One of the big things you can do right now is look at your costs. And what we're going to talk about in two weeks is a smarter approach to cost cutting.

33:08 Stephen Brown

What I want to do as a preview for that is, this is something I've been researching and developing and we're starting to communicate, is ideal benchmark rings of costs and profitability.

You'll see the cost of goods sold ideally is between 20 and 30%, but it may go up to 20 to 60%. Your marketing spend should be between 20 and 33%. Your fulfilment cost should be between 10 and 15%. And these are percentages of sales. Payroll 10 to 15%. And an ideal net operating income of 10 to 20%.

33:44 Stephen Brown

I see a lot of brands that aren't at 10%. I can tell you the ones that are between 10 and 20% are having a much easier time with this situation.

So we're going to talk about why those are good ranges, how I got to those, and then how to get to those ranges, how to tackle those.

34:05 Stephen Brown

There are obviously other costs in here, non-payroll operating expense costs that would show up. And we'll walk through some key cost categories, and how I approach, how I talk to my customers about these, and how we tackle these. Some of these you can change relatively quickly. Some of these take some time.

34:27 Stephen Brown

And so we're going to talk through what these ideals are, how I got to them, how you can get to them, what to do if you can't get to them, and how to approach cost optimisation when you need to do it in a hurry.

34:39 Stephen Brown

We want to thank you for attending, and we hope you'll join us in two weeks where we will talk about a smarter approach to cutting costs.

Thank you for attending today. Hope this has been helpful, and good luck as we work through this turbulent economic time. And with that, we'll wrap things up. Thank you.

34:58 Lauren Maillard

Thanks, Stephen.